Regulatory lawyers have for many years struggled with the issue of whether a standard loan agreement may constitute a debenture under Article 77 of the Regulated Activities Order 2001 and therefore whether business undertaken in relation to such an agreement requires authorisation from the Financial Conduct Authority (“FCA”) under the Financial Services and Markets Act 2000 (the “Act”). The Court of Appeal in Fons HF (In Liquidation) v Corporal Limited, Pillar Securitisation Sarl has now answered the question.
Although the text of Article 77 is relatively clear (“any instrument creating or acknowledging indebtedness”), general market practice seems to have been to consider private loan agreements as not being debentures. The judge at first instance, Mark Cawson QC, sitting as a deputy judge of the High Court, concluded that they were not debentures. He said:
As to the “debentures”, whilst debentures might, in an appropriate context, be construed as a extending to a simple loan agreement, I accept that the ordinary businessman or, indeed, the ordinary company lawyer, would be surprised to hear a simple loan agreement described as a debenture absent more by way of indicia of a debenture as commonly understood.
The Court of Appeal has now reversed this decision, concluding that the literal words of the statute make loan agreements debentures. No issues of regulatory law were argued, however; the case was a purely commercial dispute between various parties.
The case will, however, have some important regulatory consequences for entities involved in primary and secondary lending:
- Companies that issue their own debentures (using the Court of Appeal’s wider definition) will not require authorisation under the Act since there is an exemption for bodies corporate when issuing their own securities.
- Primary market lenders also will not require authorisation when accepting debentures in respect of loans made to that issuer since there is an exemption for lenders (the “Bankers’ Exemption”).
- The issue becomes more difficult for entities (often, but not exclusively, funds) that acquire secondary market debt. These entities may be dealing as principal in debentures when they buy and sell debt, although it is likely that they would benefit from the “absence of holding out” exemption. This provides, very broadly, that only market makers need authorisation when dealing as principal.
- Both fund managers of debt funds and portfolio managers whose sole portfolio instruments are debt securities will need authorisation. This may be less of an issue for fund managers since they will probably also be authorised by the FCA as AIFMs under the alternative investment fund managers directive rules.
- Corporate finance advisers and arrangers may well also require authorisation to carry on corporate finance activities in relation to debt issues, both in the primary and secondary markets. It is this area where there are probably the greatest number of unauthorised entities that are currently at risk of carrying on unauthorised regulated activities. These entities should carefully and quickly consider whether they need to apply for authorisation.