3. Commercial credit and security

What these notes are

A loan chapter: Credit, in the lecture's scheme, is sale, lease or loan. Sale and hire are other modules. This chapter is the loan, the security that may support it, and the covenants in a facility that has little or no security. The sources the lecture names are Philip Wood's Law and Practice of International Finance and Goode on Commercial Law. The cases are English. They are illustrations of those books, not Sierra Leone banking statutes.

Figures are not law: One slide gives a 2017 syndicated-loan total from Bloomberg, a different 2019 total from Refinitiv, and another 2019 total from Dealogic. The numbers do not agree. None of them is a rule of law. If an essay needs a current volume, look it up and cite the source. Do not memorise the slide.

Why credit exists

Spend first: A business pays for people, premises, stock and equipment before customers pay it. If the owner's capital is not enough, it borrows. The loan is an asset of the lender and a debt of the borrower. Enterprises do live by credit. They also fail by it.

The lender's question: Will this be repaid on the day? Even a well run borrower meets exchange rates, recession, the collapse of its own customers, and events it did not cause. Security, and contractual covenants, are how the lender answers that risk.

The bank and the deposit

Foley v Hill: Money paid to a bank is not held on trust. The banker may use it. The relationship is debtor and creditor. The customer is the creditor. If the bank fails, the customer proves as an unsecured creditor for the debt. He cannot demand the identical notes.

When it is payable: The lecture's point about banking hours is the practical limit on the debt. The customer calls for repayment in the ordinary way, at the branch, during hours when the bank can pay. It is not a rule that the bank may pay whenever it likes and keep the customer waiting as a trustee would not.

Real security

The point of it: The lender takes a right in an asset so that, if the debt is not paid, he is not left to share the borrower's general assets with everyone else. The lecture's four are pledge, contractual lien, mortgage and equitable charge.

Pledge: The creditor takes possession of the debtor's asset until payment, and must return it when the debt is paid. Constructive possession can suffice, which is why a pledge of goods represented by documents became possible. A pledge is a poor security over stock that must be sold every day, and it cannot be taken by physical possession of a pure intangible. Possession is both the strength and the limit.

Contractual lien: The creditor already has the goods, for repair, storage or a similar dealing, and keeps them until the charge for that dealing is paid. The original purpose was not to create a security. Because of that, the lecture's rule is that there is no automatic power of sale. A lien is a right to retain, not a mortgage.

Mortgage: Ownership is transferred to the creditor as security, on terms that it will be transferred back when the debt is paid. The debtor keeps an equity of redemption. Modern practice often uses a charge or a deposit of title deeds rather than a full conveyance, but the idea is the same. There can be a legal mortgage and an equitable mortgage. An equitable mortgage is not a second name for a pledge.

Equitable charge: No transfer of possession and no transfer of ownership. By contract or trust, a particular asset is appropriated to the debt. A fixed charge identifies the asset and restricts dealing with it. A floating charge covers a class of assets that the company may deal with until an event of default crystallises the charge into a fixed security. Crystallisation is that fastening. It is not a new loan. Company charges have registration rules. The company-law notes on debentures and charges are the place for those rules. This chapter only needs the distinction.

Loans without security

Where they are used: Borrowers with a strong credit, and large syndicated facilities, are often unsecured or only lightly secured. The contract is still simple in outline. The lender advances money. The borrower repays it and pays interest in the meantime.

Shapes: A term loan runs for an agreed period. An overdraft or revolving line is cancellable and repayable on notice. A bilateral loan is between the borrower and one lender. A syndicated loan is between the borrower and several lenders, common for companies and for states. A guarantee is a separate contract by which a third person promises to pay if the borrower does not. It is not itself a real right in an asset.

Why covenants exist: On a five or ten year unsecured loan the lender cannot rely on a pledge. The contract restrains the borrower from conduct that would make repayment less likely. A breach is an event of default. It is not, by itself, a proprietary right over the borrower's assets.

The covenants the lecture lists

Negative pledge: A promise not to create security over assets in favour of another creditor. A stronger form promises that if security is given, the lender will receive equal and rateable security. A still stronger form claims that security given in breach is shared, or arises automatically in favour of the lender. The basic form is only a promise. Breaking it is a default. It does not, without more, give the lender a charge that beats a later secured creditor who knew nothing of it. Do not call a negative pledge a mortgage.

Restriction on disposal: A promise not to dispose of all or a substantial part of the assets while the loan is outstanding. The aim is to stop the borrower emptying the balance sheet.

Cross-default: A default on another financial debt is a default on this one. The lender does not wait to be the last unpaid creditor.

Change of control: If control of the borrower changes, the loan can be called. The lender chose this borrower, not a new owner.

Change of business: A promise not to make a substantial change in the nature of the business, and often not to make large acquisitions, until the loan is repaid. It is a brake on a gamble with the lender's money.

Financial covenants: Promises to provide accounts, and to keep stated levels of assets, earnings or solvency. They let the lender see trouble before a payment is missed.

Purpose, or ring-fence: The money is used only for the stated purpose. Drawing it for something else is a breach even if the borrower could have afforded the other project.

Material adverse change

The clause: If circumstances arise that are likely to have a material adverse effect on the borrower's financial condition, or on its ability to perform, the lender may treat that as a default and call the loan. The words of the clause decide. There is no single judicial definition that replaces the contract.

BNP Paribas SA v Yukos Oil Co: A syndicate of banks had lent to Yukos under an English-law agreement. Evans-Lombe J dealt with the banks' summary-judgment application in June 2005. The claim, after a set-off, was about 472.8 million dollars. The judgment records the background the banks relied on. In October 2003 the chief executive was arrested. In December 2003 the tax authority fixed a liability of 3.3 billion dollars for one year. In April 2004 a court froze Yukos's assets. The facility agent demanded about 525.8 million dollars, later reduced by set-off to the sum claimed. The judge gave summary judgment. On the material-adverse-effect wording, the freeze, the tax claim and the prospect of further tax claims and insolvency meant Yukos had no real prospect of showing that the banks' determination was unreasonable. The arrest is part of that history. It is not, standing alone, the holding.

A later citation, and no more: In Grupo Hotelero Urvasco SA v Carey Value Added SL, Blair J treated Yukos as a case in which, in extreme circumstances, the court had no difficulty finding a material adverse effect on the borrower's ability to repay. That is all this chapter takes from Grupo. Do not invent the facts of that dispute.

Acceleration

What it is: On a default the lender may cancel any promise to lend more and require immediate payment of what is already outstanding, with interest. The contract must give the power. A covenant broken is not acceleration unless the default clause says so.

Sheppard & Cooper Ltd v TSB Bank plc: The name is Sheppard, not Shepherd. The report is [1996] 2 All ER 654. Use it for the principle, not for the lecture's extra facts. A debtor who receives a proper demand must have a reasonable opportunity to pay. What is reasonable depends on the circumstances, including whether the demand arrives in banking hours. The opportunity is to make the mechanics of payment, not a long extra period in which to go and raise the money. Bank of Baroda v Panessar is the companion statement of that limit. The lecture's "one hour" and a stated sum of £600,000 are not the holding. Do not memorise them, and do not write that the bank need give no chance to pay at all.

How to read a facility in a problem

Three questions: Is there a real security, and over which asset? If not, which covenant is said to be broken, and does the clause actually cover these facts? If it does, does the default clause allow acceleration, and has the lender given the borrower the chance to pay that the demand cases require? A negative pledge is not a charge. A MAC clause is not an excuse for a vague loss of confidence. Yukos was an extreme case, and the judge tied the clause to ability to perform.