1 Which Of The Following Regarding Preferred Stock Is True Safeguards of Creditors

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Safeguards of Creditors


This essay seeks to determine that during provide day mortgage transactions what measures can make sure the repayments; and the way efficient they’re. The essay seems on the commonplace approach of coverage: the safety _ by the use of loan and price; the nontraditional and sensible ways in which have developed with the passage of time: quasi-security _ retention of name, rent acquire and sale and hire again preparations; and different safeguards like contractual covenants and so on. Each of those measures of coverage, excluding the covenants, has been mentioned in percentage in their significance, in particular, for those that successfully fund corporations. Thus the primary focal point stays at the banks.


Banks, particular person or syndicates, are the entities that successfully fund corporations and their operations. They obtain deposits on one hand and advance those deposits as loans at the different; and thus make income. However this procedure may be very subtle, as though sufficient loans aren’t granted, little benefit could be earned; and if an excessive amount of loans are granted, in a position money would possibly not suffice to meet the calls for of the depositors. They must stay a steadiness and focal point similarly on liquidity in addition to profitability (1). In this sort of scenario, they can not manage to pay for to lose large quantities of cash complicated as loans. As lengthy as a industry, funded by way of the banks, continues running easily, each one related to that industry is benefited in come what may. But when it’s not able to paintings anymore or defaults in discharging its liabilities, it is going bankrupt. In the development of chapter those liabilities are paid out of the proceeds of sale of its belongings.Creditors’ claims most often are extra in worth than the belongings of the bankrupt. In this sort of scenario a creditor must be in an positive place to understand his claims forward of others. This, normally, can also be executed by way of being a secured creditor: who holds some safety and is paid off forward of the opposite collectors who do not hang any securities. Banks, most often, whilst granting loans, download safety and private ensure along with the opposite precautions to safeguard themselves within the match of such unlucky happenings. Following are the techniques to safeguard the placement of the lending banks:

SECURITY (Collateral):

Security is an asset which a lender holds for cash he has lent. “Under the Insolvency Act 1986 (the Act), security is defined by section 248 as ‘any mortgage, charge, lien or other security’. This definition is taken to mean that the rights the creditor have are proprietary in character. The proprietary interest in the debtor’s assets allows the creditor to realize the secured assets to discharge the debtor’s obligation to the creditor” (2). Generally, securities come with shares, stocks, debentures, bonds, tools developing or acknowledging indebtedness, warrants and choices (3). More standard time period for a safety towards a debt is ‘collateral’. The file granting collateral or every other price is known as ‘debenture’. “Under the terms of a debenture, the secured creditor will usually have the power, upon default by the company, either to enter into possession of the assets and sell them to pay off the secured debt or to appoint a receiver with the power to manage and sell the company’s business as a going concern to raise the money”(4).That is why the collateral is granted as a regimen for acquiring loans all through the sector; and it’s the most typical characteristic of trade in each nation (5). However, for financially sturdy corporations, in particular the general public companies, secured mortgage isn’t most often a ravishing possibility (6). That is why “large unsecured overdrafts are quite common for established companies” (7). But in many of the instances safety is a commonplace characteristic, because the secured credit score is the “principal means of financing’ for ongoing ventures as well as expansion purposes (8). Security or Collateral, documented as debenture, is secured, usually, by way of mortgage or charge. Both these terms are sometimes used interchangeably, as every mortgage implies a charge, though every charge is not necessarily a mortgage.


It is ‘an interest in property created as a form of security for a loan or payment of a debt and terminated on payment of the loan or debt’ (9). Mortgage is the most typical form of loan security. Through a mortgage, the title of the secured property is transferred in the name of the creditor (mortgagee), which is transferred back to the debtor (mortgager) when the loan is paid off. The most common fixed charge securities created by companies are legal mortgages over land (10). In the event of default in payment by the debtor, the creditor is entitled to realize his money by sale of the mortgaged property. Thus, a mortgage ensures the repayment of loan of the creditor at the end of the mortgaged period or in the event of bankruptcy.


A charge is also ‘an interest in company property created in favour of a creditor (e.g. as a debenture holder) to secure the amount owing’ (11). It is different from mortgage in the sense that it does not require transfer of title like a mortgage. ‘It merely gives the chargee the right to have the charged assets realized in order to pay off the debt’ (12). As a result, a charge is a security that gives rise to the priority of the holder over unsecured creditors. A charge can either be a fixed charge or a floating charge. Every charge is a result of contract between the parties. A fixed charged is associated with specific assets and limits the debtor’s free dealing with such assets. These can be intangible assets, like shares in other companies (13). It, being a fixed security, is enforced prior to all other classes of creditors (14).On the other hand, a floating charge floats over all the assets of the debtor. It usually is suitable in case of those assets the value of which fluctuates, like stocks, cash, shares, book debts etc. It allows the debtor to use the charged assets freely until the event of default or bankruptcy. The floating charge is desirable sometimes because the specific assets lose their value through market fluctuation or depreciation. In that case collateral may not continue to be of sufficient value equivalent to the amount of loan. That is why in certain cases floating charge is preferred by the creditors. However, in case of bankruptcy, not only the fixed charge holders, but the preferential creditors get priority over the floating charge holders in the order of payment (15). Thus, a floating charge, though necessary in certain situations, does not make its holder a secured creditor in the true sense. But certainly his position is better than that of the unsecured creditors.

The Customary Safeguard:

‘Secured creditors are, as a matter of policy, immune from the loss.’ (16) While in liquidation the creditors could get only a small percentage of their claims, (17) 75 per cent creditors could get nothing, and only 2 per cent could recover their full amount; (18) banks’ rate of recovery remained as high as 77 per cent as compared to the 27 per cent of the preferential creditors.(19) In globalized financial system, many companies’ assets and creditors are spread over more than one jurisdiction.’European Union, too, is to have an internal financial market “with open get entry to to banks’ and monetary establishments’ operation in member nations” (20). On the other hand, “The fragility of the monetary machine, constructed as it’s on self belief, can imply that there’s a actual chance of systemic chance spreading all through the machine.” (21) In such a situation, banks, like every creditor, get the best security (22) _ though, the security is merely a contingency measure, otherwise primarily, banks loan against feasibility and cash flow (23). Still in case of any unfortunate event like default or insolvency of the debtor, it is only the security that can be the best safeguard for a creditor. Collaterals by way of mortgage or charge are the most reliable and customary safeguards available to the creditors. But there are certain other measures that can be taken by the creditors to ensure secure repayment of their loans.


Credit is granted on four major grounds: by getting a security, without any security (an unsecured loan), by having guarantee of a third party or by making use of a sale as a security arrangement. (24) These security-by-sales arrangements provide a reasonable level of security to the person who advances money, but in most cases he is not a typical creditor. These transactions, not being typical loans, cannot be described to be made on the basis of security; instead they are said to be made for quasi securities. Hereunder are the most common types of quasi-security:


In case, a bank finances a company to purchase some machinery, raw material or any other item, it may require retaining of the title of such items with itself unless the full amount loaned for the purchase is paid off. ‘Retention of title clause’ in an agreement, normally, defends such items from any claims by other secured or preferential creditors (25), in case of insolvency of the debtor, as long as this item is recognizable (26). However if such an item is processed and loses its identity before the insolvency proceedings start, then the title cannot be retained (27). In that case, the title holder will have to be among other unsecured creditors. This type of security is typical for trade creditors.However, a bank can benefit from this method in certain cases; although banks, in case of other creditors, have expressed disapproval of retention of title. (28) ‘Surveys suggest that majority of suppliers employ such clauses in their conditions of sales’ (29). But they can only bear a fruit if the user of these clauses are not affected by the complex, time-consuming and expensive legal proceedings involving a number of other secured and unsecured creditors. Critics usually do not find the retention of title clause as useful as it seems on the face of it: ‘the device fails, at the end of long and legally uncertain day, to deliver real protection to the quasi-secured creditor.’ (30) It, however, remains equally effective in liquidation, administrative receivership, administration and voluntary arrangement, in the event of insolvency of the debtor. (31)


This is another mode of securitization that is a sale arrangement of the face of it but in fact operates as a security device. It is a method of buying goods in which the buyer advances a small amount as deposit to the seller and takes the possession of the goods (and not the title), as a bailee. The balance price is paid in periodical installments over a longer period of time. When the price is fully paid off, the ownership is transferred to the buyer. During this period from taking possession till getting ownership, if the buyer defaults in payments, the seller can exercise his right to take the goods back being the real owner. This is something like ‘retention of title’. This method is generally used by the small and medium businesses and the trade creditors. But it can be used by the banks to advance loan in cash while converting it into kind _ by purchasing the required equipment or land etc for the debtor _ and retaining the title until the debt is paid off. However, a property purchased mainly for credit purposes, _ which originally meant for some different use by the original owner _ sometimes, may not be one easily disposable. In such a case, the creditor may have to sell it at a lower price to save expense of resources on looking after it. Still it is a better option to safeguard the interests of the creditor. That is why there has been a rise in number in this type of arrangements in recent years (32).


This is another way for a person or company to secure money by sale of an asset to a bank or lender. But the sale agreement includes the condition that the same asset would be leased back to the seller for certain period of time on agreed terms and condition. Thus the seller secures required amount without losing the right to use that asset, whereas the buyer gets the ownership in lieu of the amount paid; and thus gets secured. This type of agreement despite not being a security offers more than sufficient security; and falls under the category of quasi security. This is said to be a lower-cost method by the creditors to achieve priority in insolvent regimes (33).This can reasonably safeguard the position of the creditors. Quasi Securities are quite an interest phenomenon. They are not securities in the true sense of the word; however they provide security to a creditor at the level of an original security. All of these arrangements _ of apparent sale for the purpose of security _ are well-liked by the lenders (buyers) and the debtors (sellers). But certain critics look at them from a different angle. To them, these seem to be tools of the so-called secured creditors and the debtors to grab the assets of companies leaving nothing for other classes of creditors in case of bankruptcy. Thus, this phenomenon looks like another aspect of ‘bankruptcy Darwinism’ (34). And if these types of arrangements continue, some critics predict more losses for the other classes of creditors: ‘If, however, the debtor looks to quasi security and shifts its asset patterns so as rely more heavily on the use of assets that are leased or subject to hire purchase agreements, retention of title or other sale-based security devices, the protection offered to the secured creditor will be diminished. Fewer assets will enter the insolvent estate in the scenario involving heavy reliance on quasi-security and the holder of, say, a floating charge, will have a call on a slimmer body of assets.’ (35) Anyway, quasi securities are good safeguards for the creditors.Continued as SAFEGUARDS OF CREDITORS – II


1. Dewett, K K (1984) Modern Economic Theory 21st ed, New Delhi: Shyam Lal Charitable Trust, p 449

2. Keay, A. R. & Walton P. (2003) Insolvency Law: Corporate and Personal, Harlow: Pearson Longman p 425
3. Paul C & Montagu G (2003) Banking and Capital Markets Companion, London: Cavendish Publishing,p2

4. Keay, A. R. & Walton P. op cit p 53

5. Mistelis, L ‘The EBRD Modern Law on Secured Transactions and its Impact of Collateral Law Reform in Central and Eastern Europe and the Former Soviet Union” (1998) 5 Parker School Journal of East European Law 455 at 456-7, as in McCormack, Gerard (2004) Secured Credit below English and American Law, Cambridge: Cambridge University Press, p 16

6. Mann, Ronald J (1997) “Explaining the Pattern of Secured Credit” Harvard Law Review 110 Harv L Rev 674
7. Ministry of Development , New Zealand (2004) ;Current New Zealand Law in Context of Rescue; to be had at visited on 05-08-2005

8. Scott, R (1994) ‘The Politics of Article 9’, 80 Va L Rev 1783 at 1784-5, as in McCormack, G op cit p 5
9. Oxford Dictionary of Law, fifth ed. (2003) Elizabeth A Martin, Ed., Oxford: Oxford University Press

10. Finch V (1999) ;Security, Insolvency and Risk: Who Pays the Price?” in Modern Law Review, Vol 62, No. 5 pp 633-670, at p 639
11. ibid
12. Keay, A. R. & Walton P. op cit p 55
13. Finch V op cit p 639
14. Dine, J (2001) Company law 4th ed. Basingstoke: Palgrave, p 347
15. s. 175 Insolvency Act, 1986
16. Keay, A (2001) “Balancing Interests in Bankruptcy Law” in Common Law World Review 206-235 p 211

17. Keay, A (1998) “Preferences in Liquidation Law: A Time for a Change” in Company Financial and Insolvency Law Review, Vol 2 1998 198-216, p 216
18. “Eighth Survey of Company Insolvency” (1997-8), by Society of Practitioners of Insolvency, p 20; see generally Milman, D & Mond, D (1999) Security and Corporate Rescue, London: Hodgsons; as in McCormack, G op cit p 7
19. Franks, J and Sussman, O (2000) “The Cycle of Corporate Distress, Rescue and Dissolution: A Study of Small and Medium Size UK Companies” available at http://facultyresearch.london.edu/docs/306.pdf > visited on 10-08-2005
20. Clarke, W M (2004) How the City of London Works London: Sweet & Maxwell 6th Ed p 122
21. Campbell, Andrew and Cartwright, Peter (2002) Banks in Crisis: The Legal Response, Aldershot: Ashgate Publishing Company, p 7
22. Salomon v. A. Salomon & Co ; [1897] AC 22 at 52
23. British Bankers’ Association (BBA) as referred to in, McCormack, G op cit p 10
24. Finch V op cit p 634
25. Keay, A. R. & Walton P. op cit p 431
26. Hendy Lennox (Industrial Engines) Ltd v Grahame Puttick Ltd ([1984] 1 WLR 485) as quoted by Keay, A. R. & Walton P. ibid p 432
27. Borden (UK) Ltd v Scottish Timber Products Ltd ([1981] Ch 25), as quoted by Keay, A. R. & Walton P. ibid p 433

28. Milman, D and Durrant, C. (1999) Corporate insolvency: law and practice, London: Sweet & Maxwell, Ch 9
29.Finch V op cit p 636
30. Ibid p 649
31. Keay, A. R. & Walton P. op cit pp 433-4
32. Finch V op cit 636

33. Jackson T & Kronman (1979) “Secured Financing And Pirorites Among Creditors” 88 Yale LJ 1143, as referred to in Finch op cit p 652
34. Gross, Karen (1994) “Taking Community Interests into Account in Bankruptcy: An Essay; Washington University Law Quarterly Vol. 72 pp 1031-1048 at p 1040

35. Finch V op cit p 648

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