Saturday, April 14, 2012
finance law notes
Finance Law Seminar One
1. Sources of Law
a. English Law
i. Common law – law of precedence
1. Common law (Strict and Narrow)
2. Common law (Precedence)
ii. Regulations under the acts of parliaments, state or federal law.
b. Roman Law
2. Contracts – What determines a contract?
a. Elements of a valid contract
i. Actual agreement and certainty.
1. Contract: where two or more parties make an agreement with regards to performance of certain actions.
Certainty: How definite is the said agreement? Is the agreement something which can be understanderble and achievable within reasonable means.
2. Traditionally an agreement entails two parties with one setting out terms of the agreement in return for performance and the second party undergoing a process of review of the said terms and a form of reply to the initial party.
3. However, in the eyes of the court, this definition of a contract is too rigid therefore other forms of contracts are also available. Examples of such are verbal contracts for example. (Stock broker; contracts are carried out through “faith” being put in the customer)
4. Methods to remedy such contracts can include tape recordings or a letter entailing actions carried out under instructions. There must be action taken against these notification should the actions not correspond to the intended outcome.
5. Certainty, when you say to be decided at a later date, can I really be done?
ii. Intention to enter into a legally binding agreement.
1. Is there enough evidence that there was an intention to enter into a contract?
2. For example is a letter good enough?
look at the problems related to letters of comfort. Why do these carry weight despite the fact that it has the clause that it is not meant to be legally binding?
3. Discussion at a golf course. Was it intended to be legally binding??
iii. Consideration – price of performance.
1. Was there sufficient consideration given?
2. Consideration does not need to be something of equal value as the agreement.
3. Time at which the consideration was given is also important.
4. If there is a simultaneous exchange of for example guarantor to that of the debtor and creditor the terms and performance of actions, then it is a legally binding contract.
5. Past considerations are not legally binding.
6. Gippsreal case, insufficient consideration given in the contract. Gippsreal could get out of the contract at any time without any penalties. This resulted in the court ruling that it had not presented sufficient consideration and as such the contract could be nullified.
3. Contract law
a. For guarantees, it is important that there is sufficient consideration being given with respect to the contract.
b. Guarantees-
Elements of a deed
i. Documents under seal
ii. Somewhat similar to a seal
iii. If these elements are included, there is no need for consideration.
c. Bills of exchange
i. Examples of bills of exchange are cheques, commercial papers, bank bills; 30,60,90 day bills.
ii. Essentially it is a command from one person to a second person to pay a stated sum to a third person or bearer or to the order of the third person on a stated date.
iii. If it says non-negotiable, it means that the bill cannot be sold (like bank bills for example.)
iv. If accepted by the second person (by signing it), the second person is bound to pay on the due date
v. In this case, past consideration is sufficient and consideration is presumed unless the contrary is proved.
vi. Cheques are bulls of exchange where the second person is a bank and the bill is payable upon demand- cheques are not usually “accepted” by the bank.
4. Property law (once again this is governed mainly by judge-made law)
a. Types of property
i. Land
in most cases, (title usually based on registration)
ii. Goods
(basic ownership rules, includes animals, ships and aircraft.)
in some of these items, there are registers. However for some of the others they do not have a register to regulate ownership.
iii. Intellectual property
(these includes patents, trademarks and copyrights.)
iv. Company shares
these cover the different types of shares, ownership rights and implications.
v. Debts
(viewed as the property of the creditor and so transferable by the creditor.)
b. Transfer of property
i. Governed by common law
ii. Registered title system.
c. In Australia, the law regarding registered property states that if you are an innocent party and unknowingly purchase a property that is stolen and manage to register it under your name, the property is now yours. They have some avenue for recourse with regards to land but other types of registered properties offer little or no avenues for recourse.
d. Sale of goods legislation. (goods act?)
5. Security
a. Why do people want some form of security in contracts?
i. Known property to which recourse may be had
ii. Simpler recovery procedures
iii. Protection from unsecured creditors in bankruptcy or liquidation. This means that the creditors debt is not part of the general asset but because of the security, it is separate from general property. This enables creditor to get the full value of the the security instead of having to share the asset between all the other creditors.
b. Security as a type of property interest.
i. Mortgages
there is a legal transfer of ownership of the property. Able to sell property to reclaim debt. Any residual value after that will then be returned to old owner.
ii. Charges
an agreement using land as security interest but there is no transfer of ownership. More complicated and less commonly used.
iii. Pledges
only relevant to goods, the actual handing over of goods for creditor to hold until the debtor pays back the legal obligations to creditor. Examples of it would be the bill of loading. In which the creditor holds cargo until they are paid for their services. Two willing parties. Eg. Inability to fulfill a contract resulting in pledgee selling the item of the pledgor by default.
iv. Possessory liens
this is in the case of cars servicing, they hold the property unless you pay them back. Legal for them to do so. Determination of when and where liens can arise is important. Only one willing party.
These laws go back to the times when contracrs not under seal were still in early stages of development.
Floating charges
founded in contract and their legal effect derives from the agreement between parties. Originally the usual form of contract which was held to create a floating charge provided that, upon the happening of some stipulated event or events, the charge would become enforceable. The charge was then entitled but not bound, to intervene, ordinarily by appointing a receiver. The courts held that in such a case the charge crystallised (that is to say, become converted to a fixed charge on the subjects assets) upon such an intervention. This was usually a fairly public occurrence, and third parties would normally be aware of it.
in more recent times, there has been an increase in floating charges that automatically crystallise upon the occurrence of certain event.
Continuation from last week.
mortgages
charges,
pledge: physical possession handed over
possessory lien: property in the hands of the other party, point in case, car repairs. Repairer to keep the property until the financial obligations have been fulfilled. Right that will prevail over unsecured creditors. Liens only last as long as physical possession is kept.
Floating charge:
creation of an ordinary security, intended to cover property of the kind which is dealt with in the business of the company.
eg. Manufacturing company, given a charge over all of its property present and future to fulfill its’ debt obligations with the bank. Because of the high turnover of assets, it does not make sense to use fixed assets as security.
floating charge allows the company to deal over any kinds of charge. When ownership is passed on, the new owners take on assets without any debt obligations linked to the bank.
Book debts, customers pay just the company and don’t have to worry about the bank. the debts the customers owe are subject to the charge.
how does floating charge work if there is a default? bank takes possession of a company/ take receivership. Debt crystallises, making the floating charge a fixed charge. Change in the type of debt.
all of them provide a real property interest for the creditor to the extent of the debt being secured. Property must be returned after debt has been fulfilled. If there is a default, property can then be sold. Once there has been a sale, the money obtained by the sale is used to pay off underlying debt. Residual finance must be returned if assets valued in excess. If insufficient, the creditor then becomes an unsecured creditor.
Because there is the possibility that the asset might not be sufficient, we have occurences such as first , second, third mortgage/ security holder.
At any point in the process, the creditor gets paid in full. If not then creditor becomes unsecured creditor and will have to seek relief from general assets.
usually the subsequent mortgages/ security are contracted at a much higher interest rates. Company shares are property and can be subject to charges pledges etc. but company shares are by law just residual claimants, rank behind unsecured creditors. Can shares be pledged? No idea really.
Bearer shares (rare form of shareholding), can be pledged. But most governments do not like it and is trying to phase it out. Illegal in Aust.
Pledges MUST be something that can be physically held. Charges and mortgages however can be attached to shares.
the property interest of the first mortgages cannot be “over-taken” by the second mortgage until it expires in the eyes of the law. In the common law, time of creation is the most critical thing.
Land law, registration of title. Not just registered owner but also registered mortgages. In the register system, the first one registered will be the first. Therefore not time of creation of contract anymore but the time of registration of mortgage. MAKE SURE YOU GET REGISTERED QUICKLY.
transfer of ownership of mortgages do not alter the priority of the mortgage order. There are instances where you many also be the mortgagee of a mortgage. You can use securities that you have taken from someone else and used it for your security/ mortgage too. Sub-mortgage. Something similar to CDOs.
Fairly recently, personal property etc… listen to recording. Personal property security act. Covers everything other than land. A registration system of securities. It doesn’t affect whether the security is valid or not. It only affects priority eg, first second third. It depends on the order the security is being registered or charged. Does not apply to pledges because it covers physical possession. To enable people to search in the system to understand the debt obligations or security obligations of the company you are lending money to. Know if you are a priority claimant with respect to the security. Not a full type of register but it does cover securities. The act calls registration, perfecting of securities.
PHYSICAL POSSESSION OR REGISTRATION.
The act not just applicable to aust but also to USA, Canada and new Zealand. Started 31Jan 2012.
bears on three further forms of retention of title in asset financing.
1) transfer of ownership conditional on payment
in order to avoid default, eg. Ownership does not pass to buyer UNTIL payment is made. Protection against default, seller is still owner in such a situation. Takes the goods out of the control of the unsercured creditor of the buyer.
2) Finance leases
Instead of there being a sale of goods, the goods are leased to the lessee or hirer and rent is paid. Rent being sufficient to cover value plus interest. Therefore in real terms, practically this is seen as a sale in installments. BUT legally speaking, it is NOT the same! Ownership is not passed on. Most commonly done when person supplying goods is selling asset to bank, the bank then leases back the asset to the “buyer” this way, debt obligations is with the bank. Not a satisfactory agreement for goods like raw materials as there can be no way to “reclaim” assets. Does not have the option to buy the asset.
3) hire purchase
exactly the same as the lease EXCEPT that at the time of the expiry of the lease, the person has the option/right to buy the asset.
These kinds of agreements ARE treated as though they are SECURITIES and must be REGISTERED. If you didn’t register it, you as the financier, you are at risk for any subsequent dealings. At risk of any potential changes to ability to reclaim value. IMMEDIATE registration for protection. “PPSA”
This is the same for land register. The order at which you register is IMPORTANT.
corporations act 2001 s.262 superseded by PPSA.
From last week.
companies being separate legal entities.
bodies that have been set up for public purposes. (a separate corporation BUT it is not a company)
general rule about companies: able to do anything a natural person can do,ie: full legal ability to enter contracts etc.
this may not be the same for some corporations which are limited by their constitution. Eg; inability to enter derivatives contract etc.
do not have to worry when it comes to companies but yes do note the difference for corporations.
LTD: companies with limited liability; shareholders not liable for debt beyond a particular limit. What is the limit? The limit is anything which has not been paid up on the issue of the share. Where there is a limit as such, LTD abbreviation is required. Britain, they use PLC instead of LTD. There are a few companies that DO NOT have limits, these are for example accounting firm or law firm which for ethical reasons, shareholders are required to have unlimited liability.
PTY: company with limited number of shareholders which means that there are limitations on the way you can trade shares and ownership of the companies. Not listed in a public exchange. SINGAPORE uses PTE instead of PTY
NL; no liability companies
even the unpaid amount on the shares does not have to be paid by the shareholder. If they don’t pay it, forfeit shares. Usually used for mining companies when it is floated the first time.
Partnership: pg 81. Partnership act 1892 (NSW)
all the partners are 100% liable for the activities and actions of the company. The problem was that each individual partner throughout the world had to pay up damages. Eg. Arthur Andersen. Partnership does not need to just be humans but also companies for example.
Joint Venture: where there is not joint business. Number of companies doing an activity together but not within the definition of a partnership. Eg. BHP billiton and Exxon joint venture with regards to the oil reserve in Victoria. BHP owns mining rights (provide resources) , Exxon brings the expertise (exploit resources).
The importance of this distinction lies in that when one of the oil refinery blew up, people killed, gas pipes affected. In such a case, who is liable for the damages? Who is liable for the losses of the other damages incurred?
Trust: Basic idea of what a trust is.
a law of property; you have some kind of property and a legal owner of the property. The legal owner is supposed to use the property for the 3rd person’s benefit. Owner and beneficiary. Remb: for the BENEFIT of the 3rd party (beneficiary). Trustee is the owner.
Unit trust: the entire goodwill is owned by the trustee and is supposed to use it for the benefit of the beneficiaries. Unit trust is split up and the beneficiary is assigned units to the number of beneficiaries. Beneficiaries will benefit from the income which may come. Income is shared out based on the amount of units each beneficiary holds. Units are then naturally sale-able, do see that happening around the world. Eg. The trust called the commonwealth office property trust (almost all the land the bank uses is run by this trust which operates for the benefits of the shareholders of the trust, bank pays money to its’ trust etc). UNITS are quoted on the stock exchange.
can the trustee be a beneficiary?? Hard to determine. There may be times when it may be possible. Normally trustee is a company that has no money, but the beneficiaries act as the shareholders. Most common structure.
complications
suppose trustee wants to raise money for its operations.
supposed a loan agreement is made.
the loan agreement is with the trustee and the bank. The people who gets the benefits are not liable at all. TRUST property can only be used to pay for proper legal debts. Hence while the trustee is liable, must be careful that the trust document permits the deal. DANGEROUS THINGS TO DEAL WITH- read trust instruments to see if it is possible for certain trades and transactions be done.
Duties of directors and duties of trustees
company director: must use power of director for benefit of company and not for self
trustee: must use power of trustee to act in the benefit of the beneficiary and not for self.
not difficult to prove that trustee is not acting in best interest.
fiduciary duty: using your power for someone elses benefit and not for your own benefit.
where problems can arise:
1) company which has a business and you want to sell it.
there are a number of possible buyeers ( one of which might be a director).
decision to sell to another director, conflict of interest is evident. If you can prove that you bought it for its full price and that there had been no loss, then can prove that you were stll acting in best interest.
in the case of a company director, any conflict of interest can almost be confirmed as a breach of fiduciary duty.
where you have a company, if you are able to get the approval of the shareholders and board, such a sale can then go through.
preference shares:
shareholder has special rights over that of original shareholders:
1) for example, a fixed right to a 5% preference dividend. Preference shareholders get more
2) Ordinary shareholders have the upside of great success but preference shares gets the stability if the company is available. They get it before ordinary shareholders.
there may be for example, a fixed return and no more
3) voting rights of preference shareholders are different as well. May or may not have legal authority to vote for example.
Convertible Notes
Starts off as a loan but ends up as equity finance.
loan arrangement maybe that according to the face value of the convertible note, the lender will be given an option at some defined time into a shareholding at some point in the future if they choose.
lending money at the start and get interest rates etc. if the company does well, the bank may get a higher value from the difference in the price in the stock value. Option to convert is at a particular time, if not converted, will just get loan repaid. Though the actual term varies depending on the agreement/ contract made.
Debt Finance:
equity not a loan, not required to be repaid. But with Debt finance, we are looking into a area of contract law and a liability for the company. If unable to pay then the company will be declared as insolvent.
loan: borrowing from bank, straight loan, note issue (repay the note holder at maturity).
provisions for loan repayment, provisions for interest payments (written by the lawyers). Fundamentals
1) when is it going to be repaid
2) who is able to repay
3) how is it going to be repaid.
what are the terms of agreement?
early payment
penalties? Fixed or variable rates?
variable rates: needs clear determination of how who can change rates (discretionary rates). Can borrower repay at any time?
Reference to external events. Eg. Tagged to the interest rate+ x%.
but what if that rate/ external event stops existing? What is the index used changes or smth? (Law issues). Is there a second level of formula to the matrix of payment? Penalty of default of payment (one common clause is that if interest payments is not made, the entire debt must be paid etc.)?
Bill facility
-the person who signs at the bottem is the person who “draws” the bills
-the person to whom the bill it is addressed, accepts it. (financier)
-bill is saleable because of the financier credit-worthiness, financier is liable for the customers’ ability to fulfill the bill.
-customer gets money in by selling the bills.
-the customer is required by the agreement to cover the value of the bill for the face value of the bill on maturity.
-funds is repaid by customer by either paying it up or “rollover” the bill. At no point did the financier lend any of it’s own money. All it has done is to “loan” it’s credit-worthiness. The only time they have to pay is if the customer is unable to pay up and defaults. Financier then pays up to the person bill is sold to.
Book debts
sales on credit (for eg. 60 day credit)
in order to get money faster, the company sells the debt to financiers
recourse: customer promises financier that if the debtor doesn’t pay, the customer will either buy back the book debt or alternatively pay the difference. The financier will obviously pay less than face value at time of buying debt.
Non-recourse: the financier would not have any recourse, hence the debt must obviously be sold at a lower price than that of the debts with recourse. (relying on the credit rating of debtor and not customer which the bank has a clear idea of).
Non- proprietary collateral
guarantees: guarantee and guarantor. No element of property. Just an agreement of the guarantor to pay up if the guarantee defaults. In support of the guarantee.
Negative pledges: the borrowers had the upper hand and financiers wanted to lend money to them. A contractual arrangement (promise) between lender and borrower which the borrower signs a contract saying that they will not mortgage off their security to anyone else at all. Lender would know that although the lender doesn’t have a security, it will at least rank equally with the other lenders.
from a legal perspective, it is really undesirable because the borrower can breach negative pledge. Even in seeking relief, it still doesn’t provide the borrower assurance in ability to recoup the losses.
Letters of comfort: almost completely worthless other than for the fact that it is a moral obligation. Etc.
Public Fundraising
public issues
in most countries, a prospectus is ususally required in any public fundraising activity.
1) share issues
2) debenture issues
It is an acknowledgement of debt. (IOU) Company returns the terms of loan agreement to the public which participated in it.
3) convertible note issues
can be a subject of a public issue or from a company/corporation.
4) stapled securities
combination of a debt issue and a share issue. Both debt and share issued at the same time. SP- Ausnet
excluded offers: do not need prospectus
sophisticated investor: investing in amounts of more than 500,000 dollars
personal offers: no more than 12 people and no more than 2,000,000 is raised.
when only the “insiders” of the company can participate.
offering to outstanding debenture holders.
Law lecture 4
Some countries require the contract to be a proper and positive approval from the government in advance.
In Australia
• by virtue of the lodging process, there needs to be an approval process and that the lodging process is not just a formality.
What happens if there is something wrong with the prospectus?
• pg143
• there must not be a misleading or deceptive statement etc. [22.420] the elements of s 728
• also if the prospectus omits something that is required and should be there must also be there
• consequences of breaching.
o Criminal offence.
o more commonly it will be a fine rather than a criminal charge.
o However it is only a criminal offence if and only if it is proved to be materially adverse for the investor.
o In the criminal court, before such a ruling is passed, it needs to be beyond reasonable doubt.
o in civil court, it only needs to be proven to probability of guilt. Civil court- civil penalty which is in essence a “fine”. This money that is paid is being paid to the government.
o the third form of remedy would be to sue for compensation for the amount of the loss. Only going to involve the loss caused by the breach if someone would have reacted differently as a result of the breach of the requirements. Eg. The accounts for the company was completely wrong. By publishing these falsely stated information, it would affect the way people made their decisions regarding investing in such a company as it was based on the information provided. Example of “harris scarfe”.
• Who is liable if there is such a breach?
o Criminal, civil and compensation.
o pg145 [22.430]
• the person making the offer
• the company itself
• each director of the company
• an underwriter of the issue who is named in disclosure document with their given consent.
• Any person who has given consent to be named in the document, accountant, geologist, director etc. They are liable their particular part of the document which they were related to. Eg. Geologist can be sued if there is misleading information relating to the geology report.
• these other people are important as they may have money/ have the ability to meet these liabilities. Negligence insurance/ personal wealth etc.
• the question of who is behind the director is important.
• underwriter must be careful because of the potential liability if such a situation occurs.
• Special defenses
o In the case of public fund-raising, there are more defenses available to the person liable.
o must be proved by defendant.
• If the defendant can prove that they have to the best of the abilities made sure that the information is true to the best of their knowledge at that point of time and acted reasonably in relation to such actions (due diligence).[pg.146]
• onus on plantif to first prove that information provided was misleading or deceptive.
• however in defense, the defendant must prove that they have made all effort in presenting the information in a reasonable interpretation. If they can prove it, the are acquitted. Otherwise they are still liable. Different for each person liable.
• Each plantiff needs to prove that the statements were based on the best knowledge available to any reasonable person and in the circumstances.
• if such evidence can be provided, then they will not be liable.
• Important to keep information related to such activities as onus or provision for evidence lies on the person itself.
o Reasonable reliance
• The defendant must prove that he or she placed reasonable reliance on information supplied by another party
• Relying on anyone that is not your own employee and if it is reasonable to rely on such an information.
• did not have any reason to believe otherwise.
• http://www.theage.com.au/articles/2002/07/30/1027926885796.html
• company hiring external experts etc.
o What is determined as misleading and deceptive statement?
• Something that is misleading to one person could be normal to another person. But the general rule is that such statements are address to a general public and that a reasonable person would be able to see it the same way. ”reasonable persons test”
• must be made in a way that is plain and would not give the wrong impression.
• no little “exclusion clauses”.
Managed investment schemes
People have tried to circumvent these laws through other investment schemes. In Singapore it is know as prescribed interest. Marketed for mainly tax avoidance purposes etc.
• not allowed to raise funds from public unless…
• one example is a public property trust. (however this must comply with prospectus requirement)
• broken down into two
o normal
• investors must contribute money to acquire rights for some interests from the scheme. (part ownership/equitable terms)
• contributions of investors must be pooled in order to be used for the benefit of the trust.common enterprise of money
• the members do not have day to day control over the operation of the scheme. Someone else runs it for them.
• laws have been set in place to make sure it is not an investment scheme set up just to avoid prospectus requirements.
o time-sharing
• eg. A holiday resort that gives you the right to occupy the unit for like one week out of the entire 52 weeks etc.
shareholders felt they were cheated. Judgement made shareholder a creditor to the company. Remedy to the case was disputed as the shareholders were now ranked parity passive to the other unsecured creditors.
seemed to be a natural progression as it is clear that the remedy to such a case would create a civil debt/liability to the shareholder.
Derivatives
• What is a derivative?
o difference between American and other countries with regards to liability
o all derivatives are from these concepts.
• Types of derivatives
o Option contract
• Put option
the right but not the obligation to sell someone something.
• Call option
the right but not the obligation to buy from someone something.
• under what circumstances would these options be exercised? well definitely if it is favourable for them to exercise such a right.
o Forward
• Contract for the delivery of a particular thing at an agreed price and a future date.
• some form of hedging by locking in price or delivery of goods.
o Swap
• Interest rate swap.
Float for fixed and vice versa. Based on the expectations of the future, find a counterparty that is willing to adopt your position in exchange for you to adopting another position based on your view of the future. Obligations to pay dealer the fixed rate and dealers’ obligation to pay the bank your floating rate.
• Caps and Floors
A combination of put and calls to fix a price within a range. Collaring of your derivatives. Minimizing your exposure to the derivatives.
• two purposes in derivatives
o hedging arrangement
protecting a certain position in the market, knowing what you will be getting and paying a premium for that security.
o speculative arrangement
when a player in the market is taking a guess or gamble on the outcome of the future of these contracts.
in such an arrangement, there is usually just a netting of the difference and not the actual transfer of the good. There are cases where both are speculators as well.
o trading places (movie)
• Contract issues
o Exchange traded derivatives
• provisions relating to the contract for eg.
Quality
quantity etc.
price
date
o Over the counter derivatives.
• A formation of the master agreement between derivative trader and client, a note is used to record the particular transaction. Eg. A master agreement relating to an interest swap agreement. Can be done by telephone and email
• the timing of such a trade being carried out is important. Preservation of particular advantage to be exploited. Time sensitive.
• ISDA master agreement
• covers and provides terms and conditions for a number of derivatives agreement
• The contractual side of the derivative contract.
• The capacity issue,
o illustrated in pg382
o it is all good and well other than for cases where corporations which are not considered as companies.
o it is a limited organisation. therefore even though there was every intention to enter such a deal, it was not legal.
o financiers dealing with trusts would essentially put them in similar position as hastings.therefore they need to be especially careful of such a transaction.
o for example Melb uni does not have the power to speculate in interest rates swaps.
• The authority of agents.
o Suppose a bank has a foreign currency trading room because of your dealings with foreign currency etc.
o BUT in the traders decision to increase profits, traders ignore bank limitations and rules in hope of earning more bonus/ commission etc.
o Would these traders still be liable?
o barings, NAB, AWA v Daniels
o all of these cases raise questions regarding the banks limitations to such cases. What would happen if the trading were outside instructions and limits?
o if an agent is found to not be acting properly, there would be a liability issue. Authority issue. Question of defense.
• Other issues
o Netting:
when there is just a payment of the net figure in whichever direction.
o counterparty default risk
o the law in AUS by special act of parliament called the netting act, states that in such a situation, the netting needs to occur before the liability is calculated. “netting act”
• Advisory issues
o because derivatives are complex, there is a question about the appropriateness and provision of these products to certain customers. The question here is that has the seller been in a position of an advisor? If yes, need to give best possible advise otherwise, it only needs to be concerned about not misleading.
o Advisory positions needs to make sure such an contract in the best interest of the customer. Need to make sure that it does not become an advisor.
o this problem becomes more acute when the investor is an unsophisticated investor.
• Regulation of derivatives.
in reference to trade and practices act
o gambling legislation
• these contracts are seem by law to be different from the derivatives.
• how do you tell the difference between a bet and a derivative? It is hard to determine.
• cannot distinguish based on underlying purpose. There are people who invest speculatively. Is this going too far?
o Insurance
• Idealistically there isn’t much different from derivatives.
• there is a question of whether the owner has a property that it is protecting.
• Also the amount being paid on the insurance needs to be close to the worth of the property.
• less obvious if it is talking about life insurance.
The risk lies in the classification of these activities. REMB it needs to be carefully catergorised and classified or it may bring about implications in other legal areas.
Continuing from last week
exam outline
• do all the part a questions
• do 3 out of 5 for part b
Insolvency
• what is insolvency?: not being able to pay your debts when they are due.
• different between won’t pay and can’t pay.
• insolvency law is regarded to how we deal with it
• broken into two parts
o bankruptcy- used to related to individuals or natural persons
• assets are transferred to trustee bankrupt individual appoints to spilt it out.
o liquidation/wound up : mostly dealing with companies and most other corporation.
• liquidator takes over board of directors with the purpose of closing it down.
• no transfer of assets
o a bankrupts’ house is available for recourse.
o the property of the person which is to be transferred to the trustee is only up to the point of the amount owed.
• company
o liquidator takes over company. No change of ownership in this sense. Liquidators’ job is to close company down and to get the assets for the purpose of paying back creditors.
o they are also required to ensure there is equal division of the assets. Pari passu. enforcement of different classes of debt.
o Starting point of liquidators’ job is to turn assets to cash through
• the ordinary powers afforded by directors through way of physical sale of assets.
• sometimes company which is insolvent might have a profitable business. Eg buying a good business for too much money.
• part of being a liquidator is knowing how to get the most out of the assets. be it selling assets/shares/suing people.
• Special methods of recovery from insolvency laws
o Recovery of preferences.
• Suppose you have a company which is insolvent and has not transferred to liquidator. At the same time there is an annoying creditor and they do pay a week before they collapse. The liquidator is able to et back that amount to pay all the other creditors
• corporations law section a payment of a company debt is only a preferences only if the money comes from the company itself.
• results in the creditor receiving from the company more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company. ( only for unsecured debt) secured creditor will not be considered as preference.
• exception:
a secured debt for purpose of this definition is one that is fully secured.
to the extent that the security is not enough, the remaining becomes an unsecured debt.
payment can be considered a preferences even if it is a judgment passed by the court.
onus on liquidator to prove that they are receiving more than what they would be entitled to.
the time line for preferences is 6 months.
relation back day: if the company is wound up by shareholders it is the actual day itself
if wound by court, it is the day application is made.
• under what circumstances would an unfair preferences be set aside for creditor?
is it what we call an insolvent transaction?
definition of “unfair preference”, a transaction, not necessarily payment of the debt. Can be in form of giving security which results in creditor getting more than it would normally get had it remained an unsecured debt.
• case handled by david. Tax office sent asked for amount 5 month after. Bank wanted to pay some of the tax. Asked the tax office to delay winding up application. There is no duty for any of the creditors other than to look after themselves.
• uncommercial transaction
o has a longer period of liability
o a transaction where a reasonable person would not have entered into the transaction.
o if it is an uncommercial transaction and an insolvent transaction, there is a 2 year period in which liquidator can undo it.
o if it is a preference/ uncommercial/insolvent and with a related entity, this period in which liquidator can seek recourse is 4 years. Related company, subsidiary/holding company/ parent/child/ director etc.
o company became a party in the transaction to deliberately avoid allowing creditor to be paid fairly in a liquidation. Time period is up to 10 years. For example, a loan made to director and nothing is done to improve situation.
o unfair loan. Unlimited time period
unfair if the interest of the loan is extortionate or has become extortionate. Have to consider risk of lender/amount loaned etc.
defence for creditors
• grounds for defense
o acting in good faith
o have no grounds of suspecting insolvency
o a reasonable person would not expect insolvency
o valuable consideration has been give.
• burden of proof would be on the creditor if it can prove the defense of the three stated elements
• example
o how much did the supplier know about the company. For example the debtor has been a regular paying customer. No grounds for suspicion.
o could be supplier/ landlord etc.
o compare this with the company’s bank and them having a better knowledge of the financial status of the bank.
o much more difficult for financial with this knowledge to take this defense.
• all three have to be proven. (valuable consideration)
o a past consideration can also be proven as consideration.
o Paying debt in the past can be considered as consideration.
• This is a far more common defense of preference or uncommercial transaction. The third situation will be more difficult to prove (related companies or in deliberate action..)
Payment for creditors
• Order of payment.
o Priority creditors
• liquidator/ although they come after receivers.
• liquidator can take legal actions against receivers.
• they need to get paid back in full BEFORE anyone else gets paid anything
• in other countries, government debts may also be considered to be priority creditors. (this is not the case in aus)
• higher than any priority creditors, it is the payment to employee.
o Secured creditors: they are paid to the extent of the securities outside the liquidation process. If it is a valid security, they are given it. If it is not enough, they become unsecured creditors. Receiver/receivership is not part of the liquidation process. It is a security situation/ secured creditor taking control of something and deriving value from it.
o ordinary creditors: people like trade creditors, insufficient secured creditor etc
o shareholders to the extent they are owed in the capacity as shareholders. They only received residual amount. Example: unpaid dividends,
• claiming from directors which have been trading when insolvent.
o Principles of corporations law, was person a director at time of insolvency
o was the company insolvent at time of trade
o were there reasonable grounds to suspect company was insolvent?
o if the above 3 conditions are all satisfied, then the director is liable.
o consequences
• criminal court. Director could end up in jail
• civil penalties.
• if liquidator can prove this, then there can be a recovery from the director of the amount of the loss.
o How does director avoid?
• If it prevents company from incurring debt. Being voted against in a director meeting is not enough
• can only happen if it forces company into liquidation or administration.
• they are only liable up to the point where such an action is taken. Still liable to previous insolvent trading.
o Defences
subsection (2)
• defence is if at the time debt was incurred, there was reasonable grounds to expect the company was solvent and that such a debt would not have made the company insolvent. ie been aware of the company financial at that point of time through weekly/monthly cashflow statements etc.
• the moment there are gounds to believe insolvency, there must be actions to stop such a debt from occurring
subsection (3)
• defence to prove that a competent and reliable person was providing information about the company’s solvency
• and that person was doing the said job and that it would be reasonable to believe that person.
• eg. CFO telling the company that it is solvent etc.
subsection (4)
• because of illness or some other reason that the person was not involved in the running of the company or decision that made the company insolvent.
• not good enough if the director was just a silent director etc.
• recovery of loss in the case of insolvent trading
focus of 588G is that the director is supposed to prevent incurring of debt.
the particular creditor is going to suffer loss.
the loss is the amount the creditor is expected to lose.
creditor to decide to sue. Any recovery to the action would then be made individually to the said creditor.
Exam
• section A
o answer all
• section B
o 3 out of 5
• collect assignments from office?
• can answer the question in dot points.
Lecture 6
• Forged documents
o Esp international banks etc.
o general rule is that if there is a fake signature, the document does not operate/ is invalid. Bank is not entitled to honour the cheque.
• Exceptions to that.
o Forgery is later ratified by the person the signature pretends to be.
o if the person after the event has assented to the “illegal” transaction, the person is from that point bound by the agreement.
o forged documents when there is a registration ie in houses/ ships etc. because register is the key to operation of ownership, it would then become a real “sale”.
• Max green fraud.
o What rights of recovery does the investor have?
• Sued the estate of max green.
• residual amount in the trust.
• other partners in the firm? They said they it wasn’t legal business. HOWEVER, it was something that he was doing as a part of the firm. He was charging professional fees which was going to firms account. They benefitted from this “service”. It was marketed as a part of firm’s services. Seemed liable that the partners were part of this “scheme”
• Car dealer fraud.
Quite a common case.
linked to a finance firm
because some customers do not have deposits, the company persuades the customer to put in a higher price, with the difference being the deposit and the remaining as the loan itself.
financier could discover it if they had a term of agreement to look at the deposits.
actual customer has committed a fraud. Fraudulent misrepresentation
BUT how do you prove fraud? Have to prove that the person knew it was to be false.
from the finance company point of view, too difficult to prove fraud. Can use common law to prove that in a statement of trade and commerce, the statements made by con was misleading/ deceptive.
BUT when looking at this, we need to determine what is the loss in this particular case? If customers continue paying, there is no loss.
two classes of customers
• customers who continue paying. The most sensible thing is to allow the people to continue to pay.
• case two, the customer doesn’t pay. Why would you sue the customer when the amount left is recoverable from the sale of the property.
WHY then SUE the involved parties??
should only sue con when the customer doesn’t pay and there is genuine loss flowing from such an action. Only a loss to the extent where the debt is not collectable.
• Transactions not operating as expected or hoped. (misleading conduct) when someone misunderstand the terms of contracts.
Contract contains no provision for early payment etc.
what does the contract actually say?
how does these assumptions change the contract?
• Only if there was misleading conduct by either one party. I.E something that was said in trade and commerce and if the contract was signed based on a particular statement that was assumed to have been included in terms of agreement.
• Also an indication of the need for the formula of the interest payment to be set out in the contract. In this case, there must be a clear distinction of consequential action should the formula be called into disrepute.
• what is actually meant when they refer to Australian bureau of statistics?
• importance in being precise in cases of uncertainties.
• in this case, the lasting term would be that the loan would never be less than 8%.
• Title to securities.
o Case where a financier wants to lend money, taking a particular security and/or having a particular right under the lease: when the right may/may not actually exist.
o personal property security provisions.
o A finance lease needs to be registered.
o if it is registered, they can search the register against name of security.
o cases where they are not protected by registers. Eg when the goods itself do not actually exist.
• National safety council; manager trying to hide incompetence from board. Tried fraudulently to raise money when he was in fact losing a lot of money. Persuaded financiers to provide funds for assets that do not exist.
o When borrower spouse has equity over the asset promised.
• Ie. divorce, when the spouse has the right to the asset and will not allow the creditor to gain interest from asset.
• if the asset is registered, the registration rights would automatically belong to the registered party. BUT if it is not registered, it would be exposed to potential problems in recouping asset.
• if you don’t bother to register your claims, you WILL BE EXPOSED to these risks.
• situation where borrower has given a prior security.
o INTELLECTUAL PROPERTY.
• copyrights. Plays, books, softwares etc. employees employed at the company (Microsoft for example) ; therefore have the right for people not to copy your work.
• mortgaging copyrights? What is the value of the copyright? How do you know the person offering it to you is the owner or that they haven’t already mortgaged it to someone else? YOU DON’T. There isn’t such a register. Ownership is just passed down.
• once you do become the owner, if it is a genuine transaction, there is no way someone can take it away from you. If you happen to be the first, you have the right. This is a case of caveat emptor (buyer beware) situation.
• repairers lien.
depending on the nature of good, it is important to find out if there is in fact a repairers’ lien.
who does have the physical possession of the goods? If it is being offered as security, then no technical rights to the lien.
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