Institutions For Money Management

Money needs brain and expertise to manage, it cannot manage itself. Individuals cannot raise huge funds nor can they store huge funds in their houses. Therefore people trust others for this need. There are various institutions for money management. A well developed financial market has mechanism for issuing a wide variety of assets like stocks, bonds, loans, notes etc, in the primary market. [2] However people trust banks more than other financial institutions for finance related requirements. What is a bank? Until the Banking Act 1979 the statute law has not been very helpful in defining a bank. Several Acts of Parliament described bank as a company or body corporate or partnership carrying on the business of banking. The 1979 Act, as amended in 1987, gave a wide range of banking services like, 1) current or deposit account facilities, 2) finance in form of overdraft or loan facilities or the lending of funds in wholesale money market, 3) Foreign exchange services, etc. [3] Bank has been defined in other ways too. Banks are a financial intermediary those who accepts deposits and channels those deposits into lending activities. Banks are a fundamental component of the financial system, and are also active players in financial markets. [4] The essential role of a bank is to connect those who have capital (such as investors or depositors), with those who seek capital (such as individuals wanting a loan, or businesses wanting to grow). [5] Banks borrow money by accepting funds deposited in current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending. [6] The banking industry is dynamic and client oriented. [7] Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account. [8] The banking industry has a wide array of business line like retail banking, investment banking, trading etc. [9]

In the present scenario, Sebb Co wanted to acquire and run an office in Paris. It approached Olympic Bank for a £5m loan. Sebb Co and Olympic Bank made a commitment letter, with a term sheet. When the agreement was about to be signed a huge explosion occurred in Paris. Therefore Sebb Co rethinks plans to locate to Paris and no longer wishes to proceed with the loan agreement. Olympic Bank demands fees and expenses of £75,000. Because Sebb Co has not yet paid the fees, Olympic Bank has sued them in the High Court in London. The case is moot regarding the provision of fees or other charges in term sheet. The case is also moot regarding the remedies for breach of the terms in term sheet. Banking business is primarily run for profit and revenue. A bank can generate revenue in a variety of different ways including interest, transaction fees and financial advice. [10] Bank charges can be defined as any cost incurred in banking. These should include the normal external costs charged by the bank either directly or indirectly through transmission charges, interest charges, float time and higher interest income on funds which could gain a higher rate elsewhere. [11] There was a commitment letter with a term sheet setting out the main terms of the proposed loan but no agreement between the parties, Commitment letters are formal and legally binding documents that are issued by a lender to a loan applicant. The text of the commitment lender contains an offer to extend a loan to the applicant. Within the content of the letter, the exact terms and conditions involved with the loan commitment are specified. [12] It is a result of negotiations between a lender and a prospective borrower. This document sets out the nature of the requested loan, and the requisite terms and conditions for the loan. The ingredients of a commitment letter can be summarised as the amount of the loan, the interest rate, repayment terms, collateral and other credit support, financial covenants, borrowing base requirements, closing conditions, fees and other costs payable by the borrower, governing law and dispute resolution. Commitment letter in a legal framework can be referred to as a type of agreement by which a formal process for a borrowing starts and includes the other clauses regarding to expenses rising from diligence, administrative processes and also the syndication costs. Commitment letters are also known as letter of intent. Commitment letter also requires to bear the charges incurred in due diligence It also requires the borrower to bear the expenses for attorneys fees and other fees and expenses associated with due diligence in connection with preparation and negotiation of the loan documents, the amount of the loan, the interest rate, repayment terms, collateral and other credit support, financial covenants, borrowing base requirements, closing conditions, fees and other costs payable by the borrower, governing law and dispute resolution, regardless of the fact that loan closes or not [13] . However, the due diligence was not carried out by Olympci Bank. It was also suggested by Cranston that just because of the fact that a commitment letter is not binding, does not mean that the expenses and fees mentioned in the letter are not payable. The fee and expenses can be characterized for things like, for considering whether to grant the proposed loan, for an ‘in principle’ commitment to lend or even for issuing the commitment letter [14] . However, the demand of fees and expenses by Olympic Bank of £75,000 is very high. The bank may have incurred cost towards processing of the loan demanded. However as the loan was not disbursed the expenses should not be as high as demanded. The contract is incomplete. As the process of loan is not complete, the bank should not ask for fees and expenses. The cost of borrowing is and should be, market driven. At the same time, an appreciation of what it costs the bank to lend would place the corporation in a better position to understand the bank’s position and the pricing of different financial instruments. [15] Sebb Co. can take a stand of unliquidated damages. Unliquidated damages are assessed by the court and are designed to compensate the innocent party for any losses incurred as a result of a breach of contract. However, where loss can not be proved, the innocent party will only be entitled to claim nominal damages. [16] Unliquidated damages include Loss of Bargain, this is designed to put the claimant back in the position they were in before the breach of contract occurred. However, there are numerous factors to consider: whether the damage was too remote to be able to be linked with the defendant; whether the breach of contract actually caused the loss; the type of loss suffered by the claimant; and whether the claimant sufficiently mitigated their loss once there had been a breach of contract. [17] Unliquidated damages are not a means by which to punish the defendant and punitive damages will not be awarded for a breach of contract. They are also not a way to recover any gain made by the defendant as a result of a breach. [18] In Hayes v Dodd [1990] 2 All ER 815, at 825, Purchas LJ said, “The measure of damages is that figure which, so far as is practical in the circumstances, achieves the maximum restitutio in integrum.”. [19] The Company made a request for loan and therefore is liable to some fees. The case is moot regarding the provision of fees in term sheet or commitment letter. This fee can be negotiated between the parties. The bank has filed a suit against the company; however it could have opted to resolve the dispute by ombudsman. United Kingdom is unique in having specialized Ombudsman in the field of financial services. The Banking Ombudsman is sponsored by the Banking sector through a voluntary scheme which was adopted in January 1986, in response to an initiative by the National Consumer Council. The function of Ombudsman is the resolution of disputes between their members and their private customers by an informal process of arbitration. This service is available to individuals and not to company [20] The Jack committee was of view that the Banking Ombudsman scheme should be extended to small business [21] so that they too benefit from it. Hence bank could have thought of service of a mediator or negotiator. This would have been cost effective as well as both the parties would have been able to hear each other, and arrive at a solution beneficial for them.

As mentioned above due to the huge terrorist explosion in Paris, Sebb Co decided to locate to Wigan instead as this is thought to be a safer location. They requested Commonwealth Bank for a loan of £5m to purchase the property and to cover the costs of relocation. The Commonwealth Bank agreed to provide the loan, for 5 years term, on the following terms. Sebb Co cannot divest itself of assets above £500,000. It cannot charge other assets held by company except with permission of Commonwealth Bank. In addition, there would be a charge over the book of debts of the company in following terms: “As a continuing security for payment of the Secured Liabilities, the Borrower charges in favour of the Bank the following assets (or the Borrower’s interest therein), both present and future, from time to time owned by way of first fixed charge: …all book, and other debts, revenues and monetary claims of the borrower…. “. Let us see why the Commonwealth Bank must have created a charge over the assets of Sebb Co. Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending of savings. A bank can generate revenue in a variety of different ways including interest, transaction fees and financial advice. The main method is via charging interest on the capital it lends out to customers. The bank profits from the differential between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities. This difference is referred to as the spread between the cost of funds and the loan interest rate. Historically, profitability from lending activities has been cyclical and dependent on the needs and strengths of loan customers and the stage of the economic cycle. Fees and financial advice constitute a more stable revenue stream and banks have therefore placed more emphasis on these revenue lines to smooth their financial performance. [22] What motivates the banking business is the customer base, particularly the more demanding, wealthy and sophisticated clients, who are also more profitable to the bank. [23] These customers provide bank with good business. Therefore banks are eager to lend money to such clients. Such clients of bank usually include companies and corporation rather than individuals. However this business is not without risks. Risks are uncertainties resulting in adverse variation of profitability or in loss. [24] In order to minimize risks banks take certain preventive measures. These measures are most probably incorporated in the contract made with the client. Bank managers, responsible for review of financial proposals give weights to profitability, financial stability and liquidity of the company. [25] The bank creates a security in different forms like charge, lien, pledge, guarantee, letter of comfort, rather than relying solely against a debtor. The reason to create a charge is in event of insolvency of a company a secured creditor will have priority at least over unsecured creditors, and according to seniority of his claim have priority over other less senior security holders. This is a direct consequence of the fact that a security interest confers some type of proprietary interest in its holder. The secured creditor may have right to pursue property subject to a charge unless it is acquired by bona fide purchaser for the value. The security interest gives its holder the right of enforcement. Finally a charge affords a degree of measure of control over the business of the debtor company. [26] Charge may be fixed or floating. A floating charge may be vulnerable, because it may be deferred to any subsequent fixed or equtable charge created by company over its assets. In Re Castell & Brown Ltd. (1898)1 Ch 315, the court held that a fixed charge may be created having priority over an earlier floating charge. This is so even where the creation of charges having priority is expressly prohibited by the terms of the instrument which established the floating charge provided person taking the later security has no notice of the prohibition. [27] In Brandao v. Barnett (1846) 12 Cl & Fin 787, the bank had claimed lien over the bills of exchange. The court held that, “the general lien of bankers is part of the law merchant, and is to be judicially noticed like the negotiability of bill of exchange, or the days of grace allowed for their payment. All securities may be subject of lien, this includes both negotiable and non-negotiable securities.” In pledge the security is vested in pledgee consists exclusively of the possession of goods in question and not any derivative proprietary interest in them. A pledge is not complete unless there has been actual or constructive delivery. [28] A guarantee is a promise to answer for debts, obligations or liability of other made to a person to whom that other is already, or about to become, liable. A guarantee undertaking makes the guarantor secondarily liable. A contract of guarantee is not a contract of uberrimae fidei. [29] Guarantee is the one of the most used instrument of security in banking business. The bank can hold the guarantor liable for the non-payment of loan. A surety for repayment of money borrowed may be liable under the guarantee if the contract was entered in good faith and in belief that it was legal. In Garrard v. James (1925) Ch 616, the plaintiff provided £ 1,500 for the purchase of shares under certain circumstances. Two of the company’s directors had guaranteed the due performance of the undertaking. The company later refused to buy back its shares on the ground that it was contrary to law. The bank claimed against the directors under the guarantee and the court held that the bank was entitled to sue on the guarantee. [30] Letter of comfort is provided where no security is provided for a loan, and a contract of guarantee or indemnity is inappropriate. Such letters may be given by parent company in relation to the debts incurred by a subsidiary company or by a government agency which is unable to provide guarantees. The purpose of such undertaking is that the parent company (or other entity) will give an undertaking to support the subsidiary’s business ventures and confirm that the latter will be in position to meet its liabilities to the lender. [31] However in Kleinwort Benson Ltd v. Malaysia Mining Corp. Berhad (1988) 1 All ER 714, the court held that “the words used in letter of comfort did not amount to a promise by the defendants which was contractual in nature. The letter of comfort was therefore evidence of a certain yet unenforceable and purely moral obligation.” Therefore letter of comfort is not legally binding. Hence that is avoided by the banks. That is why Commonwealth bank created a charge over the assets of Sebb Co. so that in case the company is not able to repay the loan, they have a security. Commonwealth bank not only created charge over the assets but also has a negative pledge and cross default provision in the agreement. A negative pledge is a provision in a contract which prohibits a party to the contract from creating any security interests over certain property specified in the provision. [32] Cross defaults are provisions in which a borrower with multiple debt obligations defaults on one of the debts, triggering an automatic default on all other debts held by the same lender. [33]

One year later, Sebb Co. needed fund of £3m, for period of 5 years, to acquire the Ovett Co, a rival company. It approached the Grandprix Bank, who was willing to provide the loan. However the bank demanded security in form of equitable charge over shares in Ovett Co to the value of £1.5m. After the loan agreement was signed, the share certificates were deposited with Commonwealth Bank, along with a blank transfer form, and a power of attorney authorizing Grandprix Bank to complete the transfer. Grandprix Bank doesn’t bother to see the previous loan agreement with Commonwealth Bank and hence is unaware of the negative pledge. However during the course of negotiations Sebb Co has mentioned that it has no existing assets which it was free to charge in favour of Grandprix Bank. Grandprix Bank undertook no further due diligence on why this was so but instead elected to use the acquired shares in Ovett Co as security. Therefore it is quite clear that Grandprix Bank knew that there are no assets it can put a charge on. Later Sebb Co developed a cash flow problem because the customers were slow in making payments. Sebb Co missed 5 payment dates, however, Grandprix Bank had taken no action. When Sebb Co again missed the payment, Grandprix Bank decided to declare an event of default. It said that it will use the power of attorney to transfer shares in its name. It also demanded repayment of both, capital and all the compounded interest, over the outstanding period of loan. It also said that, whatever amount in Sebb Co’s account, by payment made by customers, will also be set off against the outstanding loan. The Commonwealth Bank has a provision of cross default in its loan agreement. It has recently found out about these events, and was thinking about what action should be taken.

Let us see what is the remedy for charge? As we have seen there are two types of charges, fixed and floating. In Re Connolly Brothers, Limited, [1912] 2 Ch. 25, the company had issued debentures in the usual form and executed a trust deed for the purpose of securing them on the present and future property of the company, and by the terms of one of the conditions indorsed on the debentures the company were not to be at liberty to create any other mortgage or charge to rank equally with or in priority to these debentures. In the year 1904 the company wanted to purchase certain freehold property, but could not do so without obtaining the money wherewith to make the purchase. They accordingly applied to Mrs. O’Reilly to advance them the sum of 1000l., and they agreed to give her a charge upon the property so purchased to secure the sum to be advanced by her. She consented to make the advance on those terms. The company thereupon entered into a contract for the purchase of the property for the sum of 1100l and paid a deposit of 150l. leaving 950l. of the purchase-money unpaid. Mrs. O’Reilly found the 1000l she was present at the completion of the purchase, and her cheque for 1000l was not handed to the vendor because there was only 950l due on the purchase. It was paid into the company’s banking account, upon which the company drew a cheque for 950l, which was cashed, and on the completion of the purchase that cash was paid over to the vendor. It was held that Mrs. O’Reilly takes priority over the debentures because it takes priority over the interest of the company itself, and that nothing was ever subject to the trust deed except what one may describe as the equity of redemption, subject to the security created in favour of Mrs. O’Reilly. All the company in equity obtained was the equity of redemption in the property subject to Mrs. O’Reilly’s charge of 1000l. [34]

On June 30, 2005, the House of Lords delivered their decision in National Westminster Bank plc v Spectrum Plus Limited. [2005] UKHL 41. The judges, unanimously found that the bank’s debenture created a charge over book debts which was merely floating, not fixed. In doing so, they overturned a decision of the Court of Appeal (which had unanimously reached the opposite conclusion a year ago) and upheld the Vice Chancellor’s first instance decision. The decision is welcome to the extent that it finally resolves an area where uncertainty had existed in the law, particularly during the last few years. It will enable the several hundred receiverships, administrations and liquidations that had remained open pending this judgment now finally to be closed. The Spectrum judgment has implications for charges not just with respect to book debts but with respect to the whole range of income-producing assets. in Siebe Gorman & Co Limited v Barclays Bank, [1979] 2 Lloyd’s Rep. 142 (Ch D), had to consider a Barclays Bank debenture by which the company granted the bank what was expressed to be a fixed charge over all book debts and other debts then and from time to time due or owing to the company. Slade J. commenced by making it clear that it was conceptually perfectly possible to grant a charge over future book debts. The material factor in determining whether the charge was fixed or floating was whether the debtor company was left with the unrestricted right to deal with the debts charged in the ordinary course of its business. If the charger of the book debts, having collected them, had the unrestricted right to deal with the proceeds of any of the relevant book debts paid into its account, so long as that account remained in credit, the charge could have been no more than a floating charge. [35]

In Re Keenan Bros Limited [1989] B.C.L.C. 13, the company had executed two charges over its present and future book debts, both expressed to be “fixed”. As in Siebe Gorman, the charges required the company to pay all monies it received with respect to the book debts secured by the charges into designated bank accounts, and precluded the company disposing of its book debts or creating any other charges over them without the consent of the relevant bank. However, this charge went a stage further than in Siebe Gorman, in that it also precluded withdrawals from the designated account without the bank’s prior written consent. Initially, all monies received by the company, whether from book debts or other sources, were lodged to the company’s No.1 current account with the bank, which was operated in the ordinary way without any special restriction in practice. However, shortly before the company’s liquidation, a new bank account was opened with the Bank, and styled as a “receivables account”. From that date until the commencement of the liquidation, all receipts were lodged in this “receivables account”. The company’s day-to-day expenses and payments due by the company to its business creditors continued to be paid out of the No.1 account. The latter was now an overdrawn account operating in parallel with the receivables account. Time to time this account received transfers of funds from the receivables account, with the consent of the bank. The Supreme Court held that this was sufficient to create a fixed charge over book debts. [36]

In Richard Dale Agnew, Kevin James Bearsley v The Commissioner of Inland Revenue, 2001 WL 542215, it was held that, to constitute a charge on book debts a fixed charge, it is sufficient to prohibit the company from realising the debts itself, whether by assignment or collection. If the company seeks permission to do so in respect of a particular debt, the charge holder can refuse permission or grant permission on terms, and can thus direct the application of the proceeds. It has already been noted, it is not inconsistent with the fixed nature of a charge on book debts for the holder of the charge to appoint the company its agent to collect the debts for its account and on its behalf. Siebe Gorman and Re Keenanmerely introduced an alternative mechanism for appropriating the proceeds to the security. The proceeds of the debts collected by the company were no longer to be trust moneys but they were required to be paid into a blocked account with the charge holder. The commercial effect was the same: the proceeds were not at the company’s disposal. Such an arrangement is inconsistent with the charge being a floating charge, since the debts are not available to the company as a source of its cash flow. [37]

In H&K Medway Ltd (Mackay v Inland Revenue Commissioners), Re [1997] 2 All E.R. 321 (Ch D), the primary issue between the parties was the proper construction of s 40 of the Insolvency Act 1986. If the preferential creditors had priority over Ford, then the receivers would have had sufficient funds to pay the preferential creditors in full but Ford would only be left with a small amount. Conversely, if Ford had priority over the preferential creditors, the preferential creditors would receive nothing because the receivers would not have sufficient funds even to pay Ford in full. Thus the main issue of concern was between the preferential creditors and Ford as to who had priority. It was held that the preferential creditors had priority over Ford in relation to the money held by the administrative receivers. Accordingly, since a receiver appointed by a debenture holder was not the agent of the debenture holder, where he takes possession of goods he does not normally do so on behalf of the debenture holder who has appointed him. Hence they did not take possession on behalf of 3i within the meaning of s 196(2) of the Companies Act 1985. Hence 3i had not taken possession of the stocks under that section. The court also held that the wording in s 196 of the Companies Act 1985 and s 40 of the Insolvency Act 1986 was similar and thus the latter section should have the same result. The effect of the decision in the line of Re H&K Medway, is that in general preferential creditors will take priority over a floating charge in the event of both winding up and floating charge enforcement through receivership or possession prior to winding up. [38]

We can see from the above mentioned cases that the court recognizes the claim of charge. It also gives priority to secured creditors as compared to the floating charge. Commonwealth bank has created a negative charge. Lenders who make unsecured loans are aware that if the borrower takes out another loan and pledges assets as security, the new lender can seize those assets in the event of a default, leaving the unsecured lender with less chance of recovering the funds it is owed. When a negative pledge clause is included in the terms of a loan, the borrower may not create situations in which later lenders get priority in the event of a default. If the borrower does want to take out another loan, it can be negotiated with the lender and the lender can decide whether or not the borrower represents a security risk. [39]

In The Russell-Cooke Trust Company Limited v Elliott and others [2007] EWHC 1443 (Ch), the High Court decided that the recharacterisation principle in relation to charges works both ways, so that a floating charge can take effect as a fixed charge despite the label used by the parties to describe the charge in the security documents. The charges being considered by the High Court in this case were described as “floating” in the documentation creating them but contained severe restrictions on the charger’s ability to deal with the assets which were inconsistent with the nature of a floating charge. The case shows that care needs to be taken in relation to the nature of the restrictions app