Buying, selling, trading and borrowing are the foundations of commercial businesses today.
The ability to borrow money to gain access to new markets is vital, but what is often not understood is that the directors must be granted the ability to borrow on behalf of the company.
Most companies provide for this in their articles of association thus giving directors the ability to act as agents and place charges on company property.
Types of Securities
Loans to companies are most commonly done in two ways either a mortgage or debenture. With a mortgage, lenders secure their interest in borrowers assets by holding the legal title over the asset. Another type of mortgage is an equitable mortgage where share certificates are deposited or an agreement to create a security over the asset in question is agreed. With a debenture, the borrower retains the legal title over their assets. With both type of loan physical possession of the asset by the lender required.
A debenture is a charge placed on the asset of a company to act as security. It is defined by the Companies Act 2014 is a” mortgage or a charge, in an agreement (written or oral), that is created over an interest in any property of the company.”
Where this concept may cause confusion is in the fact that there are two forms of charges, fixed and floating, these are used in different ways to create security over different types of assets.
Fixed and Floating Charges
A fixed charge attaches to the particular asset, and the borrower has no ability to sell or trade on that asset until the charge is lifted i.e. the agreement is completed or terminated. This is typically used on physical assets such as land or plant equipment
A floating charge is an equitable charge linked to all or a class of assets current and or future. A floating charge allows the borrower to continue in the normal course of business, trading with the assets or even to sell them. This can often be used by companies with low levels of capital or assets as it enables them to secure loans and trade. This form of charge is typically used for intellectual property, stocks and shares.
The floating charge has a security mechanism that comes into affect if the agreement is broken via failure to make payment or the company entering liquidation.. Should the agreement be broken the floating charge will ‘crystalize’, becoming a fixed charge and fix upon the asset or assets. This removes the ability of the borrower to carry on the normal course of business and thus the newly crystallised charge can not be traded on or sold unless expressly allowed by the lender.
This position was confirmed in the case of Illingworth v Houldsworth where a distinction between fixed and floating charges was laid down by the court. It should also be noted if a receiver is appointed in the case of receivership the crystallization reverts and once again becomes a floating charge.
Drawbacks of Using Charges
Domestic charges must be registered with the CRO within 21 days of their creation and will be prioritised in the case of liquidation by using the date the CRO received notice of said charge. Failure to register a charge will result in the charge being void.
The main weakness of floating charges is the fact that they rank weakly against the claims of purchasers, employees, certain preferential creditors, however they do allow for continued business which is undoubtedly a benefit.
If a charge is created in the 12 months prior to the beginning of winding up, section 597 of the Irish Companies Act 2014 states that the charge may be deemed to be invalid unless it can be proved that the company was solvent immediately following the commencement of the charge.