70 the context of corporate insolvency law

in designing credit arrangements (with their attendant insolvency implications), the objective should be to maximise the sum of benefits to those involved with both healthy and troubled companies. (Here ‘benefits’ refers to procedural and democratic as well as financial advantages.) It may be the case that companies need a wide range of flexible credit arrangements and insolvency law has to cope accordingly.

This chapter will consider the main methods by which companies can borrow money and will explore the insolvency law implications of different credit arrangements. The emphasis of the chapter will rest on the benchmark of economic efficiency since it is necessary to respond to a considerable body of debate on credit arrangements which has focused heavily on that yardstick. As was noted in chapter 2, however, it is essential to place economic efficiency debates in their proper, limited, context by considering questions of expertise, accountability and fairness. These matters, accordingly, will be returned to in parts III and IV of the book. The discussion here asks how the legal structure of each mode of obtaining credit contributes to the supply of funds for a healthy company and whether that structure fosters economic efficiency by allowing insolvencies to be dealt with at lowest cost. (The needs of healthy, trading companies will be dealt with briefly since this is not a book dealing centrally with corporate financing.) At this stage, it should be noted, it is the formal legal structure of financing arrangements that is the primary object of attention. Later chapters will broaden the discussion to consider in more detail how such arrangements are put into effect.

Arrangements for obtaining credit will be examined individually in this chapter but it will then be necessary to consider whether, as a package, the available legal arrangements perform well in relation to both healthy and troubled companies. It is conceivable, after all, that each device may perform adequately in its own right but that collectively they may prove economically inefficient because they give rise to legal confusions and uncertainties. We begin by looking at the parties involved in, and the incidence of, borrowing before considering in more detail the particular routes available for the financing of corporate activity.

Creditors, borrowing and debtors

Companies in England can raise capital through issuing equity – by selling shares3 – but they are also able to borrow from a wide variety of

3Space here does not allow a discussion of strategies for raising equity capital, on which see G. Arnold, The Handbook of Corporate Finance (Pearson Education, London, 2005)

individuals and institutions.4 A first kind of creditor is the institutional lender. This is exemplified by the high street clearing bank that plays an important role in offering companies not merely loans but flexible finance in the form of overdrafts.5 Other types of institution are the accepting houses: a number of merchant banks which usually offer term loans for periods of five years or more. The merchant banks have traditionally been associated with the supply of venture capital: money used in relation to high-risk activities, for example to start up ventures or to effect rescues and, in reflection of higher than average risks, tending to be accompanied by demands for higher than average returns or shares in the enterprise, or both.

A second kind of commonly encountered lender is the trade creditor,6 the individual or firm who supplies goods or services to the company but who does not require immediate payment. Such creditors will often transfer goods to a company and await payment at a later date but they may also offer goods in return for a bill of exchange (in the form, for example, of a post-dated cheque) or in accordance with leasing or hire purchase terms. These latter arrangements allow companies to spread the costs of purchasing an item (for example, a new piece of machinery) over a proportion, or all, of the asset’s lifetime.7

A third type of creditor is the wealthy individual who may be persuaded to put money into a venture. The term ‘business angel’ has developed to refer to individuals who perform venture capital roles, usually offering loans and, in return for these, combining repayment

ch. 17. It should be noted, however, that much activity goes on outside the world of the stock exchange. As Arnold notes: ‘There are over one million limited liability companies in the UK and only 0.2 percent of them have shares traded on the recognized exchanges. For decades there has been a perceived financing gap for small and medium-sized firms which has to a large extent been filled by the rapidly growing venture capital/private equity capital industry’ (p. 453). See further pp. 82–3, 85–7 below.

4See generally G. Fuller, Corporate Borrowing: Law and Practice (Jordans, Bristol, 2006); Bank of England, Finance for Small Firms, Eleventh Report (Bank of England, April 2004) (‘Bank of England 2004’); A. Cosh and A. Hughes, British Enterprise in Transition (ESRC Centre for Business Research, Cambridge, 2000) (‘Cosh and Hughes 2000’), especially ch. 5; Cosh and Hughes, British Enterprise: Thriving or Surviving? (ESRC Centre for Business Research, Cambridge, 2007) (‘Cosh and Hughes 2007’).

5On bank loans see Fuller, Corporate Borrowing, ch. 2.

6Though note that sale credit does not in law constitute a loan (in the sense of providing free funds to conduct business). In legal terms it is seen as the contractual deferment of a price obligation: see R. M. Goode, Commercial Law (3rd edn, Penguin Books, London, 2004) pp. 578–81.

7Other (unsecured) creditors include landlords (rent arrears), utility suppliers and those with provable debts against a company in liquidation.

72 the context of corporate insolvency law

conditions with the taking of an equity stake in the debtor company.8 There is now a trade association for business angels: the British Business Angels Association (BBAA), which aims to promote business angel finance subject to its own code of conduct for members.

Governmental agencies comprise a fourth group of creditors.9 Thus the Government has deployed three main types of fund in order to stimulate the growth of private capital. These are Regional Venture Capital Funds (which by 2006 had committed over £250 million);10 the UK High Technology Fund (supporting 216 small high technology businesses by the end of 2005) and Early Growth Funds (distributing early growth funding on a regional basis).

In 2000 the Government set up the Small Business Service (SBS) which, in 2007, was renamed the ‘Enterprise Directorate’. This is a unit within the Department for Business Enterprise and Regulatory Reform (BERR) and is given policy responsibility for the Government’s investments in a range of business support tools – including Business Link, Enterprise Insight and access to finance funds. Such funds can be used to stimulate private sector funding as is the case with the Small Firms Loan Guarantee Scheme (SFLGS). This is a joint venture between BERR and a number of participating lenders and, under this scheme, government guarantees against default can be used to encourage lenders to fund small firms that lack the assets to cover a security.

At the European level, the European Investment Bank (EIB) operates as a non-profit-making body and is a source of venture capital as well as mediumand long-term loans to companies of all sizes.11 The Inland Revenue also constitutes a creditor (often an involuntary one)12 in so far

8See further p. 82 below.

9See NAO, Supporting Small Business (HC 962 Session 2005–6, London, May 2006) (‘NAO 2006’); HM Treasury and Small Business Service, Bridging the Finance Gap (London, 2003); J. Tucker and J. Lean, ‘Small Firm Finance and Public Policy’ (2003) 10 Journal of Small Business and Enterprise Development 50–61.

10See NAO 2006, p. 24.

11The European Commission decided to adopt a Fourth Multinational Programme for SMEs for the five years from January 2001 with a budget of €450 million: see EU Commission, Enterprise and Industry, Multinational Programme for SMEs 2001–6

(europa website). For an overview of funding opportunities available to European SMEs see European Commission, Enterprise Directorate-General, EU Support Programmes for SMEs, 2005.

12See Cork Report, paras. 1409–50. The Crown’s preferential status for moneys owed on PAYE or NI has now been abolished: see Enterprise Act 2002 s. 251.

as companies may owe tax payments, though in some cases they may have negotiated schedules for such payments.13

A further type of creditor is the holder of a document issued by the company which acknowledges indebtedness and which usually (but not necessarily) involves a charge on the assets of the company. Under the Companies Act 2006 a ‘debenture’ includes debenture stock and bonds14 and company debentures can also be referred to as ‘loan stock’. A debenture is a document given in exchange for money lent to the company and debentures and debenture stock can be offered for sale to the public.15 The debenture holder is a creditor of the company and the latter agrees to repay the holder the principal sum by a future date and to pay, each year, a stated rate of interest in return for use of the funds. The use of loan stock, particularly by larger companies, will be returned to below.16

Another major category of corporate creditor is the employee. In so far as employees have carried out work and are entitled contractually to wages and other benefits as yet unpaid, they constitute creditors of the firm. Shareholders, moreover, may also be creditors in that they may be owed money in their capacity as shareholders (such as dividends). Similarly, consumers of the company’s products and other corporate customers may provide credit to the company where they pay in advance for goods or services – practices common in the mail order, travel, furniture retail and building sectors.17 Those who prepay are almost invariably unsecured creditors where the supplying company becomes insolvent before delivery. They are, however, important creditors for many firms.18 Cork noted that ‘In many cases, advance payments are an essential part of the trader’s working capital.’19

13Local authorities can also be (unsecured) creditors for rate arrears and council taxes: see further D. Milman and C. Durrant, Corporate Insolvency: Law and Practice (3rd edn, Sweet & Maxwell, London, 1999) ch. 10.

16See pp. 91–3 below.

17See Office of Fair Trading (OFT), The Protection of Consumer Prepayments: A Discussion Paper (1984); Cork Report, para. 1052: ‘the customer who pays in advance for goods or services to be supplied later extends credit just as surely as the trader who supplies in advance goods or services to be paid for later. There is no essential difference.’ See chs. 14 and 15 below.

18The OFT has estimated there to be at least 15 million prepayment transactions each year (OFT, Protection of Consumer Prepayments, para. 2.12).

19Cork Report, para. 1050.