Topic  Loan Capital

9
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Discuss the difference between debt capital and share capital;
2. Explain the concept of debenture and loan;
3. Differentiate between fixed and floating charges; and
4. Determine the priority claims of various creditors.

 INTRODUCTION
A company needs capital from time to time to fund its business activities. There
are various methods for the company to raise its capital internally or externally
such as through the issuance of shares or borrowing money from external parties.
This topic will discuss the power of the company to borrow with a particular
reference to charge and debenture. The topic explains the term of charge and
debenture, type of charges, the importance of registration of charge and priority of
claims.

9.1 DEBT CAPITAL

Debt or loan capital is defined as money lent to the company with the expectation
that the company will pay interest throughout the term of the loan and repay the
principal by the end of the term. It is another important source of capital for a
company to carry out its activities in the market. Debt capital includes overdraft,
debenture and private lender. The difference between debt capital and share
capital is described in Table 9.1.

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Table 9.1: Differences between Debt and Share Capital

Debt Capital Share Capital

Creditor relationship (not a member)
Repayment of principal plus interest
Repayment of loans can be taken out
of capital
Debt can be redeemed at any time
during the business going concern
In general, creditors have no voting
rights although in some situations
their consents are required before a
transaction can be implemented
Shareholder relationship (members)
Payment of dividends
Payment of dividends must be taken out
of available profits
Shares cannot be redeemed or bought
back during the business going concern
except in accordance with the Companies
Act.
Normally, shareholders (especially
ordinary shareholders) are entitled to
attend meeting and vote (while limited
for preference shareholders)

9.2 BORROWING POWER

According to Section 21 of the CA 2016, a company has the power to carry on or
undertake any business activity including the power to borrow in order to raise its
capital unless expressly prohibited by the CA 2016 or by its constitution. The
power to borrow includes the power to issue debentures and create fixed or
floating charge over the debentures issued.

The power to borrow is normally exercised by the board of directors (BOD) on

behalf of the company. The board will normally decide on the best way to raise
capital, taking into consideration the companyÊs position and needs. For example,
raising capital through issuing shares may end up diluting the voting powers of
the existing shareholders. Raising capital by obtaining loan may be more attractive
than through the issuance of shares as the repayment of the loan is tax deductible.
However, if the financial position of a company is not sound, raising capital
through issuing shares is better than incurring debts through loans.

9.3 DEBENTURE
Section 2 of CA 2016 defines debenture to include „debenture stocks, bonds,
sukuk, notes and any other securities of a corporation whether constituting a
charge on the assets of the corporation or not.‰

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In the case of Chitty J in Levy v Abercorris Slate & Slab Co (1887) 37 Ch D 260, the
court defines debenture as:

„a document which creates a debt or acknowledges it, and any document which
fulfils either of these conditions is a debenture.‰

Although debenture in general term is associated with document acknowledging

a debt, „it implies a certain degree of permanence and is usually associated with
long-term loan taken by a company‰ excluding documents such as bills of
exchange, promissory notes and bank deposit slips. Nevertheless, the purpose of
its use and the circumstances in which it is used should be considered before
determining whether a particular instrument falls under the definition of
debenture (Krishnan Arjunan, 2006).

The definition of debenture is further explained in Section 2 of the Capital Market

and Services Act (CMSA) 2007. It has the same definition as debenture under
Section 2 of CA 2016. However, it further excludes certain categories of
instruments from the definition, namely:
(a) Any instrument acknowledging or creating indebtedness for, or for money
borrowed to defray the consideration payable under, a contract for sale or
supply of goods, property or services or any contract for hire in the ordinary
course of business;
(b) A cheque, bankerÊs draft or any other bill of exchange or letter of credit;
(c) A banknote, guarantee or an insurance policy;
(d) A statement, passbook or other documents showing any balance in a current,
deposit or savings account;
(e) Any agreement for a loan where the lender and borrower are signatories to
the agreement and where the lending of money is in the ordinary course of
business of the lender, and any promissory note issued under the terms of
such an agreement; or
(f) Any instrument or product, or class of instruments or products as the
Minister may, on the recommendation of the Commission, prescribed by
order published in the Gazette.

Under Section 158 of CA 2016, when a company makes an invitation to the public
to deposit money with or lend money to the company, it must issue to that person
a document, which acknowledges or evidences, or constitutes an
acknowledgement of indebtedness of the company in respect of that deposit or
loan. The document may be described in the prospectus or in such other
documents or in the document itself as a debenture by virtue of Section 158(6)(b).
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Under Section 158(10), a document issued by a borrowing corporation, which

certifies that a named person therein is a registered holder of a specified number
or value of debentures, is evidence of the indebtedness of the corporation in
respect of that loan.

Debentures can take the following forms:

(a) Redeemable debenture is one that can be redeemed by the company at the
companyÊs option;
(b) Perpetual debenture is one that cannot be redeemed except after a long
stipulated period, upon a contingency arising or the happening of an event;
and
(c) Bearer debenture is a debenture that requires the company to pay the loan to
the person holding or in possession of the debenture, that is, the bearer
(Aiman Nariman & Effendy Othman, 2018).

SELF CHECK 9.1

1. What is the definition of debenture?

2. How many forms of debenture are there?

3. What are the differences between share capital and debt capital?

9.4 CHARGES
Under Section 2 of CA 2016, charge includes mortgage and any agreement to give
or execute a charge or mortgage whether upon demand or otherwise. „In view of
this broad definition, a charge may be legal or equitable and includes any form of
security for repayment of a debt, thereby encompassing mortgages, charges and
other securities such as pledges and liens‰ (Aiman Nariman & Effendy Othman,
2018).

When a company obtains loan or financing, the lender may require the company
to provide security for the loan. For example, the company may create a charge
over its assets as a condition for granting the loan. In the event of default, the
lender or creditor may enforce the security and sell the assets to settle the
companyÊs debt.

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A company may create several charges over several different properties or several
charges over the same property. Normally the value of properties secured by the
charges exceeds the amount of money borrowed by the company. It is important
for the company and the creditors to ensure that the value of the total assets is
sufficient to satisfy all the debts that the company owes to several creditors.

It is important to note that the creditor whose charge is created and registered first
will have priority in the repayment of the loan using the proceeds from the sale of
the property. The companyÊs asset may be insufficient to pay off all the creditorsÊ
debts. Therefore, some creditors, especially unsecured ones, may not be able to
have their debts repaid. Any loan that has no security is known as unsecured
creditor. This is normally relevant to short-term capital providers such as supplier
of goods or services.

9.4.1 Fixed and Floating Charge

A charge can be categorised into fixed or floating charge. In order to determine
whether the charge is a fixed or a floating charge, the court will consider the nature
or characteristic of the charge and not the term used. The mere fact that an
instrument uses the word Âfixed chargedÊ does not prevent the charge to be treated
as a floating charge, if the charge is created over all properties of the company,
because it allows the company to use those secured assets in its ordinary course of
business without the consent of the chargee (see for example, Re Lin Securities Pte
Ltd (1988) 2 MLJ 137); (Chan, Koh & Ling, 2006). „The most important
characteristic is whether the asset subject to the charge is under the control of the
charge or creditor and whether the asset is of a type that is constantly changing
and needs to be disposed of in the companyÊs ordinary course of business‰ (Aiman
Nariman & Effendy Othman, 2018).

Fixed charge has the following characteristics:

(a) It attaches to a specified asset;
(b) A company cannot dispose (deal) the property without the consent of the
lender;
(c) It creates an immediate interest in the charge in favour of the charge; and
(d) Examples of fixed charge: Land, machinery, factories, fixed deposits, shares,
bonds and so forth.

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Floating charge has the following characteristics:

(a) It is a charge over a class of present and future assets;
(b) The class of assets is one that, in the ordinary course of business, constantly
changes;
(c) In the case of Re Yorkshire Woolcombers Association Ltd (1903) 2 Ch 284, the
company is at liberty to dispose the subject matter of the charge in the
ordinary course of business (until some future steps are taken by those
interested in the charge); and
(d) Examples of floating charge: Stocks in present and future trade, companyÊs
entire assets and undertakings, raw materials, inventory and book debts.

Book debt has the following characteristics:

(a) A charge over book debt, which gives the chargor the freedom to draw from
the account and to use them in the ordinary course of business, is a floating
charge;
(b) Who has control over the book debt is the determining factor whether it is a
fixed or a floating charge; and
(c) If the chargor is required to pay all monies received with respect to the book
debt into a designated account from which withdrawal could only be made
with the consent of the chargee, then it is a fixed charge.

9.4.2 Crystallisation
Crystallisation is the transformation of a floating charge created over the assets of
the company into a fixed charge. Once crystallisation takes effect, the companyÊs
power to deal with the property ceases, which means that the company is unable
to dispose the asset without the creditorÊs consent. However, this does not mean
that the floating charge, which has crystallised, is of the same status as a charge
that was originally created to be a fixed charge.

Grounds for crystallisation are as follows:

(a) When winding up commences: Section 467 stipulates that the date of the
winding up order or by the time of passing of the resolution by the company
for voluntary winding up, is the time when winding up commences.
(b) Company stops trading, that is, disposing its whole undertaking or trading
assets with a view to cease trading;

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(c) Appointment of a receiver by the court or by a creditor (as stated in the

debenture) to realise the charged assets; and
(d) Automatic crystallisation, which occurs upon the happening of an event
expressly defined in the debenture as a crystallising event, are as follows:
(i) The company defaults to pay interests on the principal sum for a
specified period;
(ii) Assets of the company falling below a certain amount; and
(iii) Incurring debts exceeding a certain amount.

9.4.3 Priority Rights

A company may create several charges on the same asset. For example, a fixed
charge may be created on a specific asset that is under a floating charge, which
covers the whole or part of the companyÊs undertakings.

Priority of debts or charges arises upon winding up whereby a company needs to

pay off all of its creditorsÊ debts. The determination of which creditors are entitled
to have priority over its claim is very important as the companyÊs existing
properties may not be sufficient to settle all the debts.

In determining the priority of debts or charges, the following should be considered

(Aiman Nariman & Effendy Othman, 2018):
(a) The type of creditors, whether they are secured or unsecured;
(b) If the loan is secured, whether the security has been registered;
(c) If the loan is secured by a charge, whether the charge is fixed or floating
charge; and
(d) Where the charge is a floating charge:
(i) Is the floating charge valid?
(ii) Are there any unsecured creditors who can affect the entitlement of the
floating charge?
(iii) Did the floating charge crystallise before any of the unsecured creditors
obtained a judgement against the company?

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Fixed Charge
If a company creates the same class of charge over the same identified property,
the priority will be determined based on the order of creation except when the
latter charge is created ranking parri passu or in priority of the earlier charge.
However, the charge must be registered. Unregistered charge will lose priority to
subsequently created charge that has been registered.

Floating Charge
If a company creates charges over the companyÊs entire assets in favour of several
creditors, the priority will be determined based on the order of creation except
when the latter charge ranking parri passu or in priority of the earlier charge. As
in the case of fixed charge, in order for the first created floating charge to get
priority, it must be registered. When a floating charge crystallises, the charge will
be treated as a fixed charge with charges created after crystallisation.

The crystallisation does not affect its nature (as floating charge) for the purpose of
registration nor does it improve its priority over other charges existing at the time
of crystallisation. A floating charge created within six months of the presentation
of the winding up petition or the passing of resolution in the case of voluntary
winding up shall be invalid unless the company is solvent after the creation of the
charge.

Fixed Charge versus Floating Charge

Fixed charges have priority over floating charges, irrespective of time created,
provided the fixed charges are registered; except where a negative pledge clause
existed in the instrument of the floating charge and latter fixed chargee have
knowledge of the negative pledge clause. When the company created a floating
charge, it may still sell or charge the assets (subjected to a floating charge) in the
ordinary course of business. In the event that there is a negative pledge, the
floating charge would have priority over a latter fixed charge.

Negative Pledge or Restrictive Clause

Negative pledge is a clause, which stipulates that the company is prohibited from
creating subsequent charges without the consent of the chargee. It is a contractual
promise given by a borrowing company that it will not grant further charges
without the prior consent of the creditor.

However, subsequent charges are valid; the negative pledge only affects its
priority. This restrictive clause only takes effect (affect priority) if the subsequent
chargee has notice and knowledge about it. There must be an actual notice of the
clause, not only of the existence of the floating charge.

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9.4.4 Registration
Registration of charge is very important as it conveys a message to others that there
is a creditor (chargee) who has a right over the companyÊs property. Registration
is also important in determining which creditors have the priority to enforce the
security and have the debt repaid. The determination of priority is based on the
time of registration and not on the time of creation of the charge. Unregistered
charges are considered as unsecured debts and the chargee who has become an
unsecured creditor will rank equally with other unsecured creditors.

(a) Section 352(1) of CA 2016

Charges created over a property or undertakings shall be lodged with the
Registrar of Companies within 30 days after its creation, together with a
statement of particulars of the charge in the manner prescribed by the
Registrar. Any company who fails to comply with the statutory provision
would commit an offence and would be liable to a fine not exceeding
RM50,000 and in the case of a continuing offence, the company would be
liable for a further fine not exceeding RM500,000 by virtue of Section 352(10).

(b) Section 352(2) of CA 2016

According to Section 352(2), failure to comply with Section 352(1) of the
charge will be void against the liquidator and the creditor. Section 352(3)
stipulates that when a charge becomes void, the money secured shall
immediately become payable. The companyÊs obligation to repay the money
borrowed remains. Section 353 states that registrable charges are charges to
secure any issues of debenture, on uncalled share capital, charge on land,
book debt, a floating charge on the undertaking and a charge on goodwill or
patent, among others.

(c) Section 352(8), 361 and 362 of CA 2016

Any person interested in the charge may register the charge within the
period allowed for the registration in accordance with Section 352(8). A
company or an interested person may apply for an extension time to register
a charge under certain circumstances, for example, if there is an unavoidable
or accidental circumstance. There could also be rectification on any
misstatement with respect to the charge. The application may be made by the
company or interested person. Section 357(1) stipulates that the register of
charges will be kept by the Registrar while the instrument of charges and
register of charges shall be kept at the companyÊs registered office in
accordance with Section 362. However, the lack of registration of a charge
does not make a debt void as against the company. Instead, the chargee will
lose the security interest in the companyÊs property and becomes an
unsecured creditor.

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9.4.5 Preferential Creditors

The existence of preferential creditors may affect the priority of floating charge.
Types of preferential creditors can be found under Section 527(1):
(a) All wages or salary of any employee not exceeding RM15,000 or any other
amount as may be prescribed in respect of services rendered within four
months before the commencement of the winding up;
(b) All remuneration payable to any employee in respect of vacation leave; and
(c) All amounts due in respect of contributions payable during the next 12
months before the commencement of the winding up relating to employeesÊ
social security contributions and superannuation or provident funds.

Section 527(3) states that if a company borrowed money from a person to pay the
company employeeÊs salary or vacation leave, that person is also considered as a
„preferential creditor.‰ Any preferential debts in Subparagraph 1(b), (d) and (e)
shall have priority over the claims of the holders of debentures under any floating
charge in so far as the assets of the company is insufficient to pay off the debts by
virtue of Section 527(4). The significance of preferential creditors is that under
Section 392(1), preferential creditors are entitled to be paid in priority to the holder
of a floating charge.

9.4.6 Unsecured Creditors and Judgement Debtor

Lastly, unsecured creditors would be last in priority. However, unsecured
creditors who obtain judgment against the company before the floating charge
crystallises, would have priority over the floating charge. This is also known as
judgement debt.

ACTIVITY 9.1

1. What is the difference between fixed charge and floating charge?

2. How does a floating charge become a fixed charge?

3. Who are preferential creditors?

4. What are the rights of an unsecured creditor?

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ACTIVITY 9.2
You are the legal adviser of Company B that is in the process of winding
up. The company has created a floating charge with a negative pledge in
favour of Bank Kita. Later, the company created a fixed charge in favour of
Bank Kami. The company has also failed to pay the employeesÊ salaries for
several months. The Board of Directors of Company B has approached you
to know which of the creditorsÊ debts they should settle first.

Explain the order of priority of claim and present it to your coursemates in

the myINSPIRE online forum.

 A company can take up debt or loan capital as a source of capital to carry out
its activities in the market. Debt capital includes debentures.

 Debenture is defined as a document that creates a debt or acknowledges it and

any document which fulfils either of these conditions is a debenture.

 A debenture can take three forms, namely redeemable debenture, perpetual

debenture and bearer debenture.

 Aside from debentures, the lender may require the company to provide
security for the loan when the company obtains loan or financing. This is
known as a charge.

 A charge is either fixed or floating, and the status changes according to

circumstances.

 A creditorÊs position of priority depends of the type of charge.

 Generally, a registered fixed charge will be given priority over other charges
followed by a floating charge except when the floating charge is created earlier
and contains a negative pledge clause.

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 Judgement creditor and preferential creditor will normally be given priority

over a floating charge.

 Unsecured creditors will be at the last of the priority order and will only be
repaid of its debt after the company has settled all the other creditorsÊ debts.

Debt capital Preferential creditors

Share capital Fixed charge
Debenture Floating charge
Charge Secured creditors
Crystallisation Unsecured creditors

Aiman Nariman, & Effendy Othman. (2018). Malaysia company law: Principles
and practices. Netherlands: Wolters Kluwer.

Chan, C. C. B, Koh, T. N. P, & Ling, P. S. W. (2006). Chan & Koh on Malaysian

company law: Principles & practice. Petaling Jaya, Selangor, Malaysia: Sweet
& Maxwell Asia.

Krishnan Arjunan. (2006). Company law in Malaysia: LexisNexis.

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