CG53425 | Shares and securities: debts: debt on a security: essential characteristics of

Both speeches in the House of Lords emphasised that for a debt to be the debt on a security it should be capable of being

• held as an investment; and

• realised at a profit.

These conditions are, to some extent, interrelated, but it is important that both should be satisfied. For example, a debt may be regarded as a good investment. But if it cannot be realised at a profit it cannot be a debt on a security. These points are discussed in the following paragraphs.

Held as an investment

For a debt to be held as an investment it should either

• carry a commercial rate of interest; or

• carry a premium on repayment, equivalent to the interest which would have been paid; or

• be issued at a discount, so that repayment at face value again reflects the interest which would have been paid on the debt.

Where these criteria are not met and the return on the investment is clearly uncommercial, debt on a security status should not be accepted.

Sold at a profit

Whether a debt can be realised at a profit will depend, in part, on the premium, or rate of interest which the debt carries. But even if a debt carries an attractive rate of interest, it may not be regarded as a worthwhile investment by a potential purchaser. For example, the terms of the loan may enable the borrower to repay the debt early. A potential purchaser would need to consider whether the loan would last long enough to cover the costs of acquisition, and obtain a worthwhile return on the investment.

Structure of permanence

This point was made by Lord Wilberforce, in, where he commented (at page 190) that the relevant loan had “....” In fact, the loan in that case was repaid early. But it had been issued on terms which meant that a large penalty would be payable in the event of early repayment. It is not possible to set any precise limits for the ‘life’ of a debt, which would enable it to be regarded as a debt on a security. The attractiveness of any particular debt will depend upon the other terms of the loan, and on the type of market in which the debt would normally be traded.

You can accept that any loan which could not be terminated by the borrower within a year from the date of commencement will have the required ‘structure of permanence’. But a debt will ‘not have a structure of permanence’ merely because the borrower is not in a position to repay the debt in the foreseeable future.

Repayment at short notice

You cannot say that a debt is not a debt on a security simply because it can be repaid at short notice. But it is reasonable to suggest that in such cases there should be some compensation for the creditor to counterbalance the uncertainty as to the term of the loan. For example, a penalty can turn an otherwise uncertain, and therefore inherently unattractive, loan into a worthwhile investment. If a loan can be repaid at short notice, but there is no compensating benefit for the creditor, this would count against accepting the loan as a debts on a security.

Events of default

Some agreements include standard clauses requiring the debt to be repaid immediately if certain events happen. For example, if the borrower defaults on repayment, or goes into liquidation. These standard clauses should not be taken as displacing any stated terms for repayment for the debt set out in the agreement.