The Law of Corporate Finance: General Principles and EU Law: Volume III: Funding, Exit, Takeovers

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84 4 Debt


are usually dictated by the bank. (b) Sometimes the firm can borrow from other
non-financial firms. For example, the firm’s suppliers can extend credit in order to
further sales (see section 3.4.2). In this case, the firm may be able to negotiate the
terms of the borrowing. (c) If the firm is large enough, it can also turn to the mar-
ket and issue debt securities. In this case, the firm may be able to dictate its own
terms. On the other hand, the firm will not be able to raise any money, unless po-
tential subscribers of debt instruments find those instruments commercially attrac-
tive. (d) A debt instrument can be complemented by credit enhancements (Volume
II). (e) The firm can choose the seniority of the debt instruments that it issues by a
combination of maturity (long or short), repayment schedule (regular repayments
or bullet), and subordination (debt, collateral, corporate structure), and by using
the equity technique in general (for the equity technique, see section 5.1).
Trade debts. Trade debts are an important source of funding.^2 Trade debts were
already discussed in the context of accounts receivable and accounts payable
(section 3.4.2).
The firm usually does not pay interest on trade debts that it pays on time. In
addition, the seller can sometimes grant a discount for prompt payment.
Trade debts can be a particularly important source of funding for powerful
buyers that can force their suppliers to extend interest-free credit. Ruthless buyers
sometimes try to force suppliers to grant further discounts by claiming that the
goods do not conform to the contract (and are thus not what the supplier
promised).
The role of trade debts depends on, among other things: the nature of the
transaction; the country; and the parties. Sellers are more likely to extend credit if
the transaction is a simple sale of goods transaction (say, oranges) and less likely
to extend credit if the product is expensive and tailor-made for the buyer (e.g. a
ship). The buyer’s country of origin plays a role. Because of a lower country risk
and a different payment culture in Finland, a Finnish buyer is more likely to obtain
credit than, say, a Nigerian buyer would be. The identity of the parties is
important. For example, it is easier for the seller to extend credit in the context of
an established business relationship, because the seller has already had an
opportunity to verify such information about the quality of the customer’s
payment behaviour that cannot be verified in advance.
Loan facilities. Commercial lending by banks can take various forms.^3 The ge-
neric term “facility” is often used to describe them all and the terms loan facility
and loan agreement tend to be interchangeable.
In principle, however, a distinction could be made between a loan facility
agreement and a loan agreement. The term facility reflects the fact that the lender


(^2) Rajan and Zingales report that accounts payable for large firms equal to 15% of assets in
the US, 11.5% in Germany, and 17% in France. Rajan RG, Zingales L, What Do We
Know about Capital Structure? Some Evidence From International Data, J Fin 50 (1995)
pp 1421–1460. See also Tirole J, The Theory of Corporate Finance. Princeton U P,
Princeton and Oxford (2006) p 82.
(^3) See Fuller G, Corporate Borrowing. Third Edition. Jordans, Bristol (2006) paragraphs
2.4–2.6; Cranston R, Principles of Banking Law. Second Edition. OUP, Oxford (2002)
pp 299–300.

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