COMMERCIAL CREDIT

&
SECURITY
LLB 1
COMMERCIAL LAW
2ND SEMESTER
What are financial assets?
• Financial assets are a sub-class of intangible assets.
• Examples: actual currency and coin (legal tender is a tiny proportion of the overall amount of money in circulation);
Bank deposit; Commercial bank loans;
Securities (bonds, shares, collective investments etc.).
• Mankind as a marvelous inventor. Galileo, Sir Issac Newton, Einstein.
• There was another invention without which it would be impossible to run modern society. ??.
• It is as a result of the presence and use of money that all these financial assets originates.
BANKS AND THE ROLE OF CREDIT
• Once money was invented, there was the need to store it for safe custody and for paying others.
• Hence, Banks.
• Banks hold monies and use it by lending it to businesses, individuals and other entities on credit for an interest.
• For the purposes of taking deposits and paying monies to customers, the Bank is a debtor and the customer is a creditor. Thus
the Bank is entitled to pay at all reasonable banking hours.
• “Enterprises live (and sometimes die) by credit,” and thus, in a developed economy commerce is driven by the ability of
businesses to obtain credit.
• Why would they need credit? businesses must first spend money on various factors of production (staff, premises, equipment,
goods, services) in order to maximize profit and have a good turnover and returns. Unless the capital of the owner is
sufficient, it must look to lenders to put it in funds until the business begins to yield, hence LOANS.
• In as much as it is desirable for banks to grant loans as the loan is an asset to it, caution is always exercised to ensure that the
loan is repaid on or before the due date.
• Loans serve as a lifeblood of enterprises. Enterprises may need funds at the start of the business or to facilitate growth.
• This brings in the reality of risk and liability.
 RISK AND LIABILITY
• Risk is at the heart of commercial credit.
• Lenders want to know that a loan would be repaid.
• Well run companies bring comfort and special safeguards to lenders.
• BUT even these companies are overtaken by events beyond their control, i.e.
international incidents affecting supplies, exchange rates, trade recession, industrial
or labour action, collapse of borrower’s customers, reduction in demand for
product etc.
• Hence, the need for the lender to secure itself against such occurrences by way of
obtaining a SECURITY for the loan advanced.
CREDIT
• The provision of a benefit for which payment is
to be made by the recipient in money at a later
date.
• Commercially, a credit is usually in either of the
three forms: sale, lease or loan.
• We shall concentrate on the loan aspect for the
purposes of this class.
• Remember that lenders can be individuals, banks
or companies. But credit is mostly provided by
banks.
LOAN ON SECURITY
• The purpose of the lender is to have his loan repaid.
• It is usual for a lender to take ‘real security’ over the assets of another
person as collateral for the payment of a debt.
• The types of security that are generally recognizable in commercial law are
as follows: The Pledge, the contractual lien, the mortgage and the
equitable charge.
• The Pledge: Creditor takes possession of the debtor’s asset as security until
payment of a debt when the asset would be returned. The concept of
constructive possession became possible after 16th century. Limitations
are that it is inconvenient for stock in trade and impossibility to physically
take possession of intangibles. (Goode)
Loan on Security cont.
• The Contractual Lien: This is when the creditor is in possession of goods belonging
to the debtor for the purposes of repair or storage or after a sale for e.g., and if the
debtor fails to pay the charges or fees for the services performed by the creditor,
the creditor retains possession of goods belonging to the debtor until payment is
made or some other obligation is performed. Note that the original intention of the
parties was not to create a security of the goods. Thus, the creditor does not have
an automatic power of sale in such instances. (Goode)
• The Mortgage: A transfer of ownership of property to the creditor by way of
security, upon the express or implied condition that the asset shall be re-conveyed
to the debtor when the sum has been paid. Mostly effected now by delivery of title
deeds. (Goode)
Loan on Security cont.
• The Equitable Charge: It does not involve the transfer of possession or of
ownership but constitutes the right of the creditor, created by either trust or
contract, to have a designated asset of the debtor appropriated to the discharge
of the indebtedness. It can take the form of either a fixed charge over specific
identifiable assets or a floating charge over the entire body of assets of the
company that will transform (crystallize) into a fixed charge if there is an event
of default (i.e if the loan is not paid). (Goode)
• All of these security measures are there to protect the Lender from creditors
who have defaulted on payment of their debts.
 LOAN WITHOUT SECURITY
• These are mostly seen in syndicated bank loans and with big businesses that have very
good credit rating.
• A loan contract is one of the simplest commercial contracts.
• A lender advances a loan to a borrower who has to pay it back and pays interest on it
in the meantime.
• Term loans are loans for a fixed term.
• Overdrafts or lines of credits are cancellable and repayable on notice from the Bank.
• Bilateral loans are loans between a borrower (sometimes a guarantor(s)) and a single
bank.
• Syndicated loans are between the Borrower and several Banks. Uniquely issued to
corporate bodies and governments.
 LOAN WITHOUT SECURITY Cont.
• According to Bloomberg, the total syndicated loan issued
out in 2017 was $4.3 Trillion issued to 40,000 borrowers
and according to Rifinitiv the total in 2019 was $4.5 Trillion.
• When a Bank grants a loan for five to ten years, it wants to
ensure that there should be some restraint on prejudicial
management of the Borrower’s business, especially in
unsecured lending. Hence the need for corporate
covenants to protect a commercial lender from non-
payment by creditors.
 Corporate Covenants
• Negative Pledge Clause: This is a fundamental term in an unsecured loan
agreement that basically provides that the borrower will not create or use
any of its assets as security for another loan.
• Restriction on Disposal Clause: A term that states that a borrower will not
dispose of all or a substantial part of its assets until the loan is repaid.
• Cross Default Clause: If a borrower fails to pay other financial debts when
due or defaulted in another loan, it will be treated as an event of default
for which the loan will become due and payable. In short, if the Borrower
cannot pay other loans, it is only a matter of time before he breaches its
loan with the lender.
• Material Adverse Change (MAC) Clause: This terms states that if any circumstances occur
which is likely to have adverse material effect on the financial condition of the borrower or
the ability of the borrower to comply with its obligations under the loan, the loan will
automatically become due and payable. In BNP Paribas S A v Yukos Oil Co (2005) EWHC
1321 the loan of almost $500 million was made to a Russian oil company Yukos. The
Russian tax ministry arrested the company’s CEO and fixed the tax liability of the company
at $3.3 billion for one year and anticipated similar tax claims for subsequent year. BNP
Paribas treated these as material adverse change of events and demanded immediate
payment of its loan of almost $500 million. Held: BNP Paribas were correct to treat the
events in Russia as a MAC that may affect the ability of Yukos to repay.
• Change of Control: This term states that if another person(s) acquire control
of the borrower or the existing controller of the borrower lose control, the
loan will automatically become due and payable.
• Change of Business Clause: This is a term that generally prohibits the
borrower from permitting any substantial change in its line and nature of its
business in a bid to control any excessively rapid growth. It can go further to
prevent mergers and limiting the making of investments and substantial
acquisitions of companies, until the the loan is repaid.
• Financial Covenants: These are terms that generally mandates the borrower
to provide its financial books and audit reports to the lender on an annual
basis, in order to enable the lender to monitor the conditions of the
borrower’s business and ensure that the asset quantity and solvency is
preserved.
• Ring Fence Clause: A clause that ensures that the loan is only utilized for the
intended purpose.
IF THERE IS FAILURE TO PAY, WHAT’S NEXT?

ACCELERATION AND CANCELLATION

In the event of default or if any of the corporate covenants are broken, the Bank may
immediately accelerate outstanding loans plus accrued interest and cancel its commitment
to make further loans. In Shepherd & Cooper Ltd v TSB Bank plc [1996] 2 All ER 654 the court
held that the Bank was right to accelerate demand immediate repayment just one hour after
the borrower failed to repay the sum of £600,000 and was not obligated to give any
reasonable time after it becomes clear that the borrower cannot pay.