Floating charge

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A floating charge is a security interest over all of the assets of a company, which 'floats' until an event of default is triggered or until the company goes into insolvent liquidation, at which time the floating charge crystallises and attaches to all of the assets of the company.

Floating charges can only be granted by companies. If an individual person or a partnership[1] was to purport to grant a floating charge, it would be void as a general assignment in bankruptcy.[2]

Floating charges take effect in equity only, and consequently are defeated by a bona fide purchaser for value without notice of any asset caught by them. In practice, as the chargor has power to dispose of assets under a floating charge, this is only of any consequence in relation to disposals after the charge has crystallised.

Contents

[edit] Definition

Although the nature of a floating charge has been widely considered by the courts, historically no full definition has ever been given (a description was given in Re Yorkshire Woolcombers Association [1903] 2 Ch 284 - which has been widely used since – but Romer LJ stated in that case that he did not intend to give a definition of the term floating charge). In that case the description was:

  • it is a charge over a class of assets present and future;
  • that class will be changing from time to time; and
  • until the charge crystallises and attaches to the assets, the chargor may carry on its business in the ordinary way.

In keeping with that tradition, in National Westminster bank plc v Spectrum Plus Limited and others [2005] UKHL 41, the House of Lords elected instead to describe the essential characteristic of a floating charge, and they described it thus:

"the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event. In the meantime the chargor is left free to use the charged asset and to remove it from the security."

[edit] Recharacterisation

Because of the lower priority of a floating charge (as to which see below), most security documents that create floating charges also seek to create fixed charges over as many assets of the company as they reasonably can. In relation to certain assets, this has historically given rise to tension as to whether the charge created is actually a fixed charge, or whether (despite being expressed as a fixed charge) it should be recharacterised as a floating charge, with the lower priority that floating charges have. This issue arises most frequently in relation to trade receivables and cash in bank accounts.

In National Westminster bank plc v Spectrum Plus Limited and others [2005] UKHL 41 the House of Lords finally brought some welcome clarity to this area of the law. The essential test of whether a charge was a fixed charge related to the chargor's power to continue to deal with the asset. In order to preserve the status of a charge as a fixed one, the bank must be able to exercise actual control over the asset. If the chargor is able to deal with the asset, such as by drawing from the account in which charged funds are kept, or into which the proceeds of trade receivables are deposited, then the holder of the floating charge does not have effective control. Their Lordships held that as this is inconsistent with the status of the charge as fixed (if the chargor company is able to use the proceeds in the ordinary course of its business without the consent of the charge holder), the charge could only take effect as a floating charge.

See also: analysis of the House of Lords decision

[edit] History

Historically, floating charges are a fascinating concept in that they are legal devices created entirely by lawyers in private practice; there is no legislation and no judicial decision that was the genesis of a floating charge. In 1862 in an apparently unconnected decision of Holroyd v Marshall (1862) 10 HL Cas 191 it was held that equity would recognise a charge over after-acquired property as being effective to create a security interest over that property automatically upon its acquisition.

This decision lead to "a further manifestation of the English genius for harnessing the most abstract conceptions to the service of commerce."[3] Documents came to be drafted that purported to grant security over all of the debtor's present and future property, but by contract expressly permitted the debtor to dispose of those assets, free from the charge, until such times as the debtor's business ceased. This charge came to be known as the "floating charge".

The first case in which a floating security device was tested and upheld came a mere eight years after Holroyd v Marshall in Re Panama, New Zealand and Australian Royal Mint Company (1870) 5 Ch App 318; a remarkably quick gestation by any reckoning. The Court of Appeal held that the effect of the document was that the secured creditor could not interfere with the running of the business until and its dealings with its own assets until the winding up of the company, but the occurrence of that event entitled the secured creditor to realise its security over the assets and to assert its charge in priority to the general body of creditors

[edit] Flexibility

Floating charges are enormously popular as a security device for two principle reasons. From the secured creditor's perspective, the security will cover each and every asset of the chargor. From the chargor's perspective, although all of their assets are encumbered, because the security "floats", they remain free to deal with the assets and dispose of them in the ordinary course of business, thereby obtaining the maximum credit benefit from the lender, but without the inconvenience of requiring the secured creditor's consent to dispose of stock in trade.

However, in many jurisdictions, floating charges are required to be registered in order to perfect them; otherwise they may be unenforceable on the bankruptcy of the debtor. This registration requirement has often led to other property rights (such as rights under a defective retention of title clause), which have been recharacterised as a floating charge being held to be void for non-registration.

[edit] Remedies

Broadly speaking, holding a floating charge gives the secured creditor two key remedies in the event of non-payment of the secured debt by the company. Firstly, the secured creditor can crystallise the charge, and then sell of any assets that the charge then attaches to as if the charge was a fixed charge. Secondly (and more frequently the case, to preserve the company as a going concern), if the floating charge encompasses substantially all of the assets and undertaking of the company, the secured creditor can appoint an administrative receiver to take over the management and control of the business with a view to discharging the debt out of income or selling off the entire business as a going concern.

In countries that permit the making of an administration order, the floating charge had another key benefit. The holder of a floating charge could appoint an administrative receiver and block the appointment of a court appointed administrator, and thus retain control of the distribution of the assets of the company. Practice became such that companies were asked to give "lightweight" floating charges to secured lenders which had no collateral value purely to allow the holders to block administration orders, an approach that was approved by the courts in Re Croftbell Ltd [1990] BCC 781. In the United Kingdom the law has now been changed by statute, but the power to block appointments of administrators has been retained in many other common law jurisdictions.

[edit] Priority

The main purpose of any security is to enable the secured creditor to have priority of claim to the bankrupt party's assets in the event of an insolvency. However, because of the nature of floating charge, the priority of floating charge holder's claims normally rank behind:

  1. holders of fixed security (such as a mortgage or fixed charge);[4] and
  2. preferred creditors, who are given priority by statute.[5]

The floating charge cannot normally be enforced until it has crystallised (and thus, effectively, become a fixed charge) and so most statutes provide that the priority of a fixed charge that was created as a floating charge is treated as a floating charge.[6]

Because of the differences in priority of fixed charges and floating charges, security documents came to be drafted to contain as many charges expressed to be fixed charges as possible, and leave as little as possible covered by the floating charge, where it would have secondary priority to the claims of the preferred creditors. A number of judicial decisions[7] gave conflicting interpretations over the characteristics that were definitive of a fixed charge, particularly with reference to charges over book debts (and a fixed charge that did not contain those characteristics would be "recharacterised" as a floating charge). The position was definitively resolved in NatWest v Spectrum Plus Limited when the House of Lords confirmed that a charge over book debts could be a fixed charge, provided that the secured creditor exhibited the necessary degree of control over the proceeds of the book debts. This would normally require that they either be paid into a blocked account, or that they be paid directly to the secured creditor. Any lesser degree of control was not consistent with a fixed charge, and such charges would be construed as floating charges, regardless of what label the parties had given them.

See also: Liquidation - Priority of claims

[edit] Criticisms

Floating charges have been criticised as a "raw deal" for unsecured creditors.[1] In Salomon v. Salomon & Co. [1897] AC 22 Lord Macnaghten observed that the injustice of the case (as he saw it) was not caused by the introduction of the concept of limited liability, but by the excessive security created by the floating charge. In Re London Pressed Hinge Co Ltd [1905] 1 Ch 576 Buckley J observed that great mischief arose from the very nature of the floating charge as few of general unsecured trade creditors of the company would even be aware of its existence.

As most secured lenders will not usually have recourse to their security until the debtor company is in a parlous financial state, the usual position is that even all the remaining assets of the company are not enough to repay the debt secured by the floating charge, leaving the unsecured creditors with nothing. This perception has lead to a widening of the classes of preferred creditors who take ahead of the floating charge holders in a number of countries. The introduction of a regime of voidable floating charges for floating charges taken just prior to the onset of insolvency is a partial response to these criticisms.

Some countries have also sought to "ring fence" recoveries made for wrongful trading or fraudulent trading from the floating charge to create an artificial pool of assets available to the unsecured creditors.

[edit] Voidable floating charges

Main article: Voidable floating charge

Because of the potential for abuse of a security interest that catches all of a company's assets, many jurisdictions have enacted provisions in their insolvency legislation providing that a floating charge granted shortly prior to the company going into liquidation will be invalid, or invalid to the extent that it does not secure new loans made to the company.

[edit] Registration

In many jurisdictions, because of their dramatic affect on the availability of assets to unsecured creditors on an insolvency, floating charges are required to be registered.[8]

[edit] Analogous security interests

[edit] Analogous concept in the United States

The analogous concept in the United States to the floating charge is the floating lien.

[edit] Analogous concept in Quebec civil law

When the new Civil Code of Quebec replaced the Civil Code of Lower Canada in 1994, a concept analogous to the floating charge was introduced into Quebec's civil law under the name floating hypothec.

[edit] See also

[edit] External links

[edit] Further Reading

[edit] Footnotes

  1. ^ Although possibly not a limited liability partnership with separate legal personality
  2. ^ For example, under English law, a general assignment of book debts by a natural person is void as regards book debts that were not paid before the presentation of the bankruptcy petition, unless the assignment has been registered under the Bills of Sale Act 1878 if the person goes into bankruptcy. See section 344(2) of the Insolvency Act 1986.
  3. ^ Commercial Law, Roy Goode, 2nd ed., at page 731
  4. ^ This was confirmed in Wheatley v Silkstone & Haigh Moor Coal Co (1885) 29 Ch D 715; because the disposition by the chargor (in creating the mortgage or fixed charge) is permitted by the concept of the floating charge, the grant of a mortgage or charge takes the relevant asset out of the pool of assets caught by the floating charge.
  5. ^ See for example in the United Kingdom section 175(2)(b) of the Insolvency Act 1986
  6. ^ See for example section 29(a)(a) of the Insolvency Act 1986
  7. ^ Commencing with the decision of Slade J in Siebe Gorman v Barclays Bank [1979] 2 Lloyd's Rep 142
  8. ^ For example, in the United Kingdom, see section 395 of the Companies Act 1985
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