Floating CHARGE AND PRIORITY-

Prof sarah Worthington explaining the advent of floating charge says-Victorian England burgeoned with industry and creativity and the judges inEngland’s Chancery courts struggled to keep pace. Joint stock companies needed toraise working capital and their financiers increasingly looked to their current assets as a form of security. These assets – raw materials, work in progress, stock-in-trade and, above all, book debts – were different in nature from land or other assets that had traditionally been offered by way of security, in that they were transitory in nature and circulated in the course of carrying on the business. The new security had to cover future assets as well as present assets and accordingly could only be identified

generically by reference to a class, and because they were dealt with in the course of the company’s business it was not practicable for the financier to be involved in these dealings; critically, it was not practicable for the financier to execute a release on each occasion that goods were sold or a book debt was collected. It is against this background that the judges invented the concept of a floating charge.

explaining floating charge In Illingworth v Houldsworth [2] Lord MacNaughten's asserted 'ambulatory and shifting in its nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp"

It is a general practice to include a negative pledge in the loan agreements, restricting the disposition of the charged asset without the prior permission of the creditor or the chargor. A negative pledge is not a proprietary right in the asset rather negative covenant, that borrower will not give security over the asset [3] . In an event of breach it could trigger the default clause within the agreement. An injunction could be brought immediately restricting the party to breach the pledge. However as against the third party the mandatory injunction could only be brought if the party had the actual notice of the pre existing pledge.

Lord Knight Bruce [4] 

“Where a man has acquired property, with a full knowledge of a previous existing contract, legally entered into, that that property should be used in a particular manner, the acquirer should not be allowed to apply or use the property otherwise than under the contract, or to the damage of the person with whom that earlier contract had been made"

However the rule in the case a third party could be restrained from the benefits under a contract when they already knew about the prior contract and an injunction could be brought about by the

A breach of negative clause could trigger the default clause which would contain the remedies in a breach of negative pledge English law practices the principle of strictly adhering to one’s obligation under the loan agreement [5] , General rule of priority is, a floating charge would rank behind the subsequent fixed disposition. However if the subsequent encumbrancer has the notice of the restriction under the debenture having floating charge in that case an injunction could be brought against the subsequent chargee. However there needs to be an actual notice rather a constructive one [6] . The constructive notice and registration of the floating charge has been dealt in the separate chapter. The chapter discusses about the priority determination in between a floating charge and other subsequent assets.

Ordinary course of business

the priority would be bases upon; the disposition was under the realm of ordinary course of business. The debtor was restricted to dispose by a negative pledge and most importantly, the disposition is before or after crystallisation.

the ordinary course of business has been widely interpreted by the courts, the ordinary course of business was summarised by the “business people would be expected to give them" [7] , “not embrace a transaction for the preservation and continuation of a company's business" [8] , The view was confirmed by ethorn j in ashborder bv v green [9] (1) First, it needed to be ascertained, as a matter of fact, whether an objective observer, with knowledge of the company, its memorandum of association and its business, would view the transaction as having taken place in the ordinary course of its business.(2) Secondly, it had to be considered whether, on the proper interpretation of the document creating the floating charge, the parties nonetheless intended that the transaction should not be regarded as being in the ordinary course of business for the purposes of the charge.(3) Subject to any such special considerations, there was no reason why an unprecedented or exceptional transaction could not, in appropriate circumstances, be regarded as in the ordinary course of business.(4) Subject to any such special considerations, the mere fact that a transaction would be a preference in a liquidation, or was made in breach of the directors' duties, did not necessarily preclude the transaction from being in the ordinary course of business.(5) Such matters in (4) could, however, where appropriate and in all the circumstances, be among the factors leading to the conclusion that the transaction was not in the ordinary course of business.(6) Transactions which were intended to bring to an end, or have the effect of bringing to an end, the company's business were not transactions in the ordinary course of its business.

Hence from the above authority it could be deduced that an ordinary course of business shall encompass reasonable dealings on the behalf of the company, for instance the ordinary course of business embraces a sale by the company, further charge or disposition by way of hire purchase [10] . It was decided in the case a lincense to transfer share to save the liquidation of the company is out of ordinary course of business [11] .

The importance of determining the “ordinary course of business", is that a third party who acquires an interest in the charged asset under the realm of ordinary course of business shall have priority over the floating charge holder. if floating charge, incorporates no restriction, even if it is a creation of a subsequent fixed charge over the same asset. Usually to avoid such disposition the chargee makes a restriction, in form of negative pledge. if on the crystallisation it is proved that the later incumbrancer acquire the charge with the notice such restriction, the priority will be of the floating charge. the retention of priority in case of a negative pledge is due to the fact that the negative pledge created an equity in favour of the charge holder, hence it would be out of ordinary course of business for a debtor to dispose the asset. [12] 

as lord macnaghten [13] said in government stock and other securities investment co . ltd v manila railway co . ltd- a floating security is an equitable charge on the assets for the time being of a going concern it attaches to the subject charged in the varying condition in which it happens to be from time to time, it is of the essence of such a charge that it remains dormant until the undertaking charged ceases ot be be a going concern or until the person in whose favour the charge is creted intervenes. Hos right to intervene may ofcourse be suspended by agreemen,t but if there is no agreement for suspension, he may excersize his rights whenever he pleases after default .........during the eriod of grace, or until their is winding up the compny are to be free to carry on their business; they are to carry to on as of right. When that perod comes to an end the charge will have its ordinary effect.

(1897) A.C 81 AT P.86

The debenture holder’s right to assert priority would only occur on the event of crystallisation, it should be noted that a crystallisation event does not accrue with mere default on the part of the company giving a floating charge. The crystallisation is an event where the floating charge becomes fixed, under section of insolvency act, a floating charge holder can appoint an administrator. Hence it could be said that till the event of crystallisation, the charge holder has no rights over the charged asset. The crystallisation is contingent upon certain circumstances; in brief these circumstances are insolvency of a company [14] , winding up of the company [15] , cessation of trade of the company [16] . These events trigger the clause known as a default clause of the charge agreement, importance of crystallisation for a floating charge is, and the floating charge is converted into fixed charge. however there have been incorporation of the automatic crystallisation clause in the agreement creating the charge, in which case the charge holder could enforce the charge in the event of default specified under the default clause.

The relevance of crystallisation in relation to priority is that before the crystallisation, a charge holder cannot enforce the charge and also the priority, the priority of a charge which is floating can only be ascertained after crystallisation. The reason for such a rule is if there are two charge holders over the same property the charge and the prior charge holder comes to know about the disposition which the charge holder has made in breach of the negative pledge, in such a case such a charge holder would like to enforce his security but there is another party with the interest in the security hence it would be difficult to determine such a scenario [17] . Crystallisation effects are different depending upon the notice of the charge a buyer or a later incumbrancer, if the buyer acquires the property before the crystallisation, in such a case the charge-holder only remedy for a charge holder is to get a injunction order from the court, restraining the charge to be disposed off subject to a restriction provided in the charge, the asset would be redeemed back to the company. however redemption of an asset back to company, is not determination of priority for the charge-holder. On the other hand in a case where the buyer takes the charge asset after the crystallisation, the buyer would be bound by the charge.

In a situation where the company gives a fixed asset, to the later incumbrancer, if the charge has already been crystallised, the fixed charge would rank the floating charge. But because the fixed charge is not bound by any rule of crystallisation, in event of default. The choice of the fixed charge-holder whether to take hold of the interest before or after the crystallisation, would be determinative of priority over an asset. It should be kept in mind with regard to above disposal to second person or the third party that such a disposal should be within the ordinary course of business of the company as explained above. If the company chooses to dispose of the asset outside it, the transfer of interest in such a case would be outside the actual authority of the company. Hence the common law rule exception of the nemo dat quad non habet shall not apply in this case. But it is also subject to one condition that the buyer or the debenture holder should have the notice that the charge is been given outside the ordinary course of business. But only a proof that the buyer has taken the interest outside ordinary course of business is not sufficient, such determination could only be relevant if the charge has already crystallised and without that the priority would not be able to be determined. According to Morritt J [18] ‘If the floating charge contained in the 1985 debenture crystallised then prima facie it would take priority over the floating charge contained in the 1977 debenture, which would not be lost on the subsequent crystallisation of the latter.’ According to the judgement the first one to serve the notice wins the race of priority. judiciary takes the view that a company is not allowed to give a flaoting charge over the part of asset which is already charge. however this does not bar them from giving a charge over a part of same asset, which will rank in priority over parri passu with the earlier charge-holder rights. in case where the charge has been crystallised, subsequent to which an inerest has been taken in the charge or the charge has been purchased. In such a case the rgard must be had to whether the interest taken or purchase is with notice of the already crystallised charge. but in can of no notice, the purchaser rights would not be undermined.

The case of a execution creditor- an execution creditor is a creditor who has already received a jugdemnet from the court and the debtor had not complied with the courts order, hence the creditor went into an appeal writ of "fieri facias". It is a writ to seize goods. under the insolvency act 1986 s 346(5), specifies that for the perfection of the execution, sale, seizure of the asset .however the claim of execution creditor is subject insolvency of the debtor, if within the 14 days of the notice of the sheriff the judgement creditor becomes bankrupt or calls in a meeting for insolvency, in such a case the execution creditor is divested of its interest. Crystallisation and judgement creditor- the judgment creditor can get its decree enforced by a sheriff, but seizure by sheriff of goods doe not comprise execution.The crystallisation is not only important for the charge-holder but simultaneously for rest of the creditors who get an interest in the charge by other means, such is the case of an execution creditor, adnexecution creditor cannot enforce its claim if the charge has been crystallised, the charge holder will get priority to the the asset taken in the execution. where the sheriff executes and sells the good, just before the crystallisation, its not been firmly settled whether the creditor is entitled to the proceeds of the sale

The flaoting charge gives a permission to deal with the asset in the ordinary course of business, which is referred to as license theory. Within the terms of license theory execution cannot be described as a transaction in ordinary course of business, however according to ruseell cj, ‘we cannot accent to the view... that the seizure under an execution against a compnay is a deal against the compnay, in the ordinary course of business..it is not in the ordinary course of business that the debt of the the going business firm or compnay shall be liquidated by seizure of their asset under legal [process’ seizure and execution on an instrument wich already marked by a flaoting charge, doenot conmstitutes ordinary course of business, according ro prof penninton, this view is too far stetched, the above statement implies that a judgemnt debtor who has already taken the proceeds of the sale, will return the amount to the floating charge holder, the rule under statues is that a claim of judgment debtor cannot be prevented if execution s completed before the charge is being crystallised and the company is allowed to perform the normal civil consequence.

Hence it could be said the stage of execution has the judgement creditor reached if he wants to benefit by it. the analyses by examples would reveal the real picture- the judgement creditor is entitled to proceeds of the execution, however if on the seizure of goods by the sheriff, the compbay pays the part or the entire amount of debt, before the crystallisation of the charge, the judgement creditor is entitled to keep the money that sheriff holds. Its amibigous whether the proceeds of sale before the cyrtsallsation belongs to the judegemnet creditor

If the judgement creditor obtains and order of garnishee against the debtor of the company, in such a case the judgement creditor the priority of judgement creditor shall depend on two things, whether the creditor order is absolute against the debtor and the charge encapsulating such a debt had not been crystallised.

Cross claims and priority- when the floating charge crystallises as a general policy rule, a company cannot grant a better title than it got. Hence implied the charge holder rights would be subservient in relation to the other debts owned to the company against te charge, which would cover a claim of setoff or cross claim. the company whose goods are charged by way of flaoting charge, deals in producing oil, contracts to sell oit to the customer, and the customer advances the money. The company fails to satisfy the agreement, the customer also held some rent to the compnay for the warfage, the compnay brings a claim against the customer and the customer puts a counter claim against the company, even after knoweing that there is flaoting charge. the cross claims were awarded.

Profesoor goode, citing Kellnar j, if sheriff has not been paid, due to the statuory provisions. sale and seizure before crystallisation by the execution creditor should be able to give rights against the floating charge. under the provisions of insolvency law such prov the title of the trustee or the liquidator is expressed to be good only as against the execution creditor the provisions of insol however the sale should have taken place before cyrtsallisation of the charge. hence the execution creditor could gain his interest against the charge –holder ,it could be only to the maount specified in the judgement.