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Published: Fri, 02 Feb 2018

Trading Company

Company Law 2006 Companies Act

A trading company has implied power to borrow, however,

whether express or implied, it carries implications by law a power to give a

security for the loan and to pay interest upon it (General Auction Estate and

Monetary Co V Smith [1891] 3 Ch 432). There is no limit on the amount the

directors can borrow, so long as they remain within the company’s power. The

most usual form of borrowing by companies is by means of debentures. A

debenture is a document executed by a company as a deed in favour of a creditor,

providing the creditor with security over the whole or substantially the whole

of the company’s assets and undertaking. Debentures may be secured by a fixed

or floating charge, or by a combination of both types of charge.

(SMITH AND KEENAN’S COMPANY LAW, P.440)

It has been argued that a floating charge is not as

effective as a fixed charge but is more flexible.

Smith and Keenan’s company law

p.447-8

A fixed charge usually takes the form of a legal mortgage

over specified assets of the company e.g. its land and building and fixed

plant. The mortgage is usually created by a charge by deed expressed to be by

way of legal mortgage under s.85 (1) of the Law of Property Act 1925. The major

disadvantage from the company’s point of view is that it cannot dispose of the

asset or assets subject to the charge without the consent of the debenture

holder. However, there is a major advantage for directors in a fixed charge

because they will almost always have personally guaranteed the company’s

overdraft, and in an insolvency it is important to them that the bank gets as

much as possible from the debenture securing the overdraft so that their

liability is extinguished or reduced. In this connection, it is worth noting

that a fixed charge is not postponed to preferential creditors and other

creditors as is a floating charge and the bank will get more from the security

on realisation. This will not apply if the fixed charge is by agreement between

lenders, to rank behind a floating charge, in which case the second ranking

fixed charge is subject to the floating charge and ranks after it and claims of

the preferential debts e.g. wages and salaries, upon it (see Re Portbase

(Clothing) Ltd, Mond V Taylor [1993] 3 All ER 829).Where the company has no

land, buildings or fixed plant, a bank can be asked to take a fixed charge over

book debts.

Fixed charges over book debts

The advantage to the directors and to the bank as debenture

holder, of such a charge has already been considered. However, since a charge

over book debts is over after-acquired property, the legal position was

absolutely settled, though it had been held in England that such a charge was

valid (see Siebe Gorman & Co Ltd V Barclays Bank Ltd [1979] 2 Lloyd’s Rep

142), and this decision was affirmed by the Irish Supreme Court in Re Keenan

Bros Ltd [1985] 1 RLM 641, and again by the English Court of Appeal in Re New

Bullas Trading Ltd [1994] 1 BCLC 485.

There are procedures to be set up by the bank in order to

safeguard its position as a fixed charge holder but these are not considered

here because they are a matter for the bank’s legal advisers. Those advising

the company can only suggest the fixed charge and point out to the directors

its advantage to them in terms of their guarantees to the bank.

It is, however, of interest to note that the High Court has

held that the terms of a debenture which contained provisions for a lending

bank to have control of the borrowing company’s book debts and other debts over

which it had taken a specific charge, were essential to protect the validity of

such a charge. Although the terms restricted the company’s commercial use of

its book and other debts, they were not anti-competitive, nor contrary to Arts

81 and 82 of the Treaty of Rome (Oakdale (Richmond) Ltd V National Westminster

Bank plc [1997] 1 BCLC 63).

A major difficulty arose in connection with fixed charges

over book debts following the ruling of the Privy Council in Agnew V Inland

Revenue [2001] All ER (D) 21 (the Brumark case).

This ruling came out of an appeal from New Zealand and represented the usual sort of challenge to the fixed charge. If it is a

fixed charge it will as we have noted rank before the preferential creditors.

The Inland Revenue is now no longer a preferential creditor but ranks with the

unsecured trade creditors but the Revenue often tried to attack the fixed

charge over book debts hoping that it would be regarded as a floating charge

which is postponed to preferential creditors.

The difficulty with Brumark was that the Privy

Council ruled that the lender must have systems in place to exercise control

over the book debts both collected and uncollected. In Brumark the

charge left the company free to collect and use the book debts in the ordinary

course of its business. This in the view of the Privy Council made the charge

floating not fixed by reason of the lender’s lack of sufficient control. The

Brumark decision was of course only persuasive as are decisions of the Privy

Council but it added a new strand worrying to business because businessmen and

women had always understood that if a debenture took a fixed charge over book

debts under what was known as the Siebe Gorman formula the court would

treat it as a fixed charge. The Siebe Gorman charge merely: prohibits the

borrower from disposing (as by sale) of its book debts before collection; and

requires the proceeds of the book debts to be paid into an account with the

lending bank. It does not prevent use of the proceeds by the company in its

business.

In the latest case in the saga, in re Spectrum Plus Ltd (in

liquidation) [2004] NLJR 890, the Court of Appeal refused to follow Brumark and

restored the Siebe Gorman formula to validity. Why! Well as the Master of the

Rolls pointed out, for 25 years parties have used the Gorman form of debenture

on the understanding that its meaning and effect were those held by the judge

in the High Court in that case, i.e. that a fixed charge was created. That form

of debenture had therefore acquired by customary usage the meaning and

effect attributed to it as creating a fixed charge. The ruling put the bank as

lender before the preferential creditors. We have yet to hear from the House of

Lords on the matter.

p.454

A fixed charge, whether legal or equitable and whenever

created, takes priority over the equitable floating charge on the asset(s)

concerned. The only exception is where the floating charge expressly prohibits

the creation of charges in priority to the floating charge (called a negative

pledge clause) and the person taking the fixed charge knew this to be so. At

the present time this has to be actual knowledge, because registration of the

charge at Companies House gives only constructive notice of the charge but not

its particulars (see Wilson V Kelland [1910] 2 Ch 306). However, s.416 of the

CA 1985 (which has not yet been implemented) provides that registration of the

charge gives constructive notice also of its contents or particulars. The

effect would be that the negative pledge clause would be constructively

communicated and Wilson overruled.

There may be agreement between lenders that a particular

floating charge shall rank in front of a particular fixed charge. Where this is

the so, the first floating charge remains subject to preferential debts and the

second ranking fixed charge is subject to the prior ranking floating charge and

the calls of the preferential debts on it (Re Portbase (Clothing) Ltd, Mond V

Taylor [1993] 3 All ER 829).

p.448

Floating Charge

This is a charge which is not attached to any particular

asset(s) identified when the charge is made. Instead it attaches to the

company’s assets as they then are, if and when the charge crystallises. The

company is in the meantime free to dispose of its assets, and any new assets

which the company may acquire are available to the debenture holder should the

charge crystallise. Because such a charge does not fix at the time of its

creation upon any particular asset, it is equitable by nature, and this is

relevant when considering the question of priority of charges when more than

one has been created over the assets of the company.

p.449 Crystallisation of floating charges

A floating charge crystallises:

(a) In the circumstance specified in the debenture. This

means that crystallisation can take place by agreement between the parties and

the particular debenture must be looked at. However, most usually where the

loan is repayable on demand, as in the case of an overdraft, the charge will

crystallise automatically when the bank calls in the overdraft which the

company cannot pay. The bank may then appoint an administrative receiver.

However, the High Court has decided that where a bank has lent a company money

that is repayable on demand with a security over the company’s assets, the

timing of the bank’s appointment of an administrative receiver is governed,

where the company has the means to repay by the time it needs to set the

mechanics of repayment in motion. If the company has made it clear that it

cannot pay, the bank may make the appointment straight away as could any other

secured creditor (see Sheppard and Cooper Ltd V TSB Bank plc [1996] 2 All Err

654). Other circumstances specified include failure of the company to pay

interest or the principal sum when due as agreed. These may also result in

automatic crystallisation. In some cases the charge may be stipulated to

crystallise when the company exceeds a specified borrowing limit.

(b) Automatic crystallisation occurs on the appointment of a

receiver under a fixed charge or an administrative receiver under a

fixed/floating charge, or if the company commences to wind up on cessation of

its business (Re Woodroffes (Musical Instruments) [1985] 2 All ER 908).

Once a floating charge crystallises, the assets subject to

the charge pass into the eventual control of the receiver and pass out the

control of the company immediately. Any disposition of those assets by the

company after the charge crystallises means that the purchaser from the company

takes the assets subject to the charge, i.e. the right of the debenture holder

to proceed against them to satisfy the debt.

Postponement of floating charges

A person who lends money on the security of a fixed charge

over the company’s property is always entitled to repayment of his loan from

the proceeds of sale of the mortgaged property before any other creditor,

except a creditor with a prior fixed charge. A person who takes a floating

charge is not so secure. There are cases in which his receiver will have to

yield priority to other classes of creditors. The detailed law in this area is

not considered because it is relevant only in insolvency and is therefore more

within the specialist province of the insolvency practitioner. It is not likely

to be examined in detail in a general paper on company law. However, an outline

of the position is given below.

Preferential creditors

Once a floating charge has crystallised the owner of the

charge, e.g. the bank, is entitled to repayment of the loan out of the assets

to which the charge has attached before the company’s unsecured creditors.

However, there is one statutory exception to this, which is that when a

floating charge crystallises the claims which would be preferential in a

winding-up rank in front of the debenture holder in respect of realisation of

assets under the floating charge. The debenture debt is postponed only to

preferential payments accrued at the date of the appointment of an

administrator and not to those which accrue subsequently. Schedule 6 of the

Insolvency Act 1986, as amended by the Enterprise Act 2002 applies, and there

are no provisions for payment of interest on these debts until payment.

Schedule 6 should be referred to if necessary for further detail, but the main

preferential debts are as follows:

See page 451

Other floating charges

If a company is to have power to create a second floating

charge over its undertaking ranking before the first, the debenture securing

the first charge must so provide. Otherwise floating charges rank for priority

in the order in which they were created.

In this connection, it is worth noting that in H & K Medway

Ltd, Mackay V IRC [1997] 2 All ER 321, the High Court decided that if a company

grants two floating charges over its assets in favour of two different

debenture holders and the second ranking debenture holder appoints a receiver

first, the preferential creditors of the first ranking debenture holder are

entitled to be paid before the first ranking debenture holder even though that

debenture holder is not the person appointing the receiver.

Mayson, French and Ryan on Company Law

Intro p.302-303

Borrowing money is an important method of financing the

activities of companies in the United Kingdom. A lender of money to a company

usually insists on being granted a right of recourse against property of the

company if the loan is not repaid on time. The right of recourse is security

for the repayment of the loan.

Among business people the word ‘debenture’ usually denotes a

document by which a company gives security for the repayment of a loan.

However, the courts have always held that ‘debenture’ means any document issued

by a company acknowledging indebtedness, whether secured or not (Lemon V Austin

Friars Investment Trust Ltd [1926] Ch 1), and this is the sense in which the

word is used in CA 2006.

The term ‘charge’ is used to describe all the forms of

security contract which give a creditor a security interest. The security

interest created by a charge may, like any other property interest, be legal or

equitable. If it is a legal interest, it must be recognised by any person who

subsequently acquires title to the property or any interest in it. If it is an

equitable interest, it may be ignored by any person who subsequently acquires,

bona fide and for value, a legal interest in or legal title to the property

without notice, at the time of acquisition, of the existence of the equitable

interest.

p.310

It is an important characteristic of a floating charge that

until it crystallises, the company may buy, sell, replace and otherwise deal

with assets of the charged class in the normal course of its business without

reference to the chargee. In a series of cases it was held that this included

being able to create fixed charges on assets within the class covered by the

floating charge, having priority over the floating charge, in order to secure

borrowing in the ordinary course of the company’s business (see Wheatley V

Silkstone and High Moor Coal Co (1885) 29 Ch D 715).

The courts have recognised that the nature of a floating

charge precludes a company which has created one over its assets from creating

another floating charge over all of the same assets ranking equally with, or in

priority to, the first floating charge, except with the first chargee’s

permission (Re Benjamin Cope and Sons Ltd [1914] 1 Ch 800). However, it is

possible to create a second floating charge over a part of the assets with

priority over the first charge (Re Automatic Bottle Makers Ltd [1926] Ch 412).

In response to this it has become standard practice to

include in a contract of floating charge a ‘negative-pledge’ clause, providing that

the company will not create any charge over the assets covered by the floating

charge with priority over the floating charge.

If a company grants two floating charges over its property

and business then, as equitable charges, they take priority in order of

creation (Benjamin Cope), though priority may be lost by failure to register

under CA 2006, part 25, Chapter 1 (ss860 to 877) and see also the discussion of

Griffiths V Yorkshire Bank plc [1994] 1 WLR 1427.

Appointment of an administrator

Floating charges are equitable charges and, when they were

first invented in the mid 19th century, were enforced by asking the

court to appoint a receiver, because the charge had no right to take

possession. Victorian lawyers then began to insert into floating-charge

contracts a provision giving the charge the right to appoint a receiver of the

charged property, who would realise it for the benefit of the charge, but as

the agent of the company. The use of this devise has caused resentment because

it seems that such a receiver sells the company’s assets as quickly as possible

so as to pay the preferential debts and some of the debt secured by the

floating charge, leaving other creditors with nothing, without stopping to

consider whether the company’s business could be rescued.

Two or more floating charges

In Griffiths V Yorkshire Bank plc [1994] 1 WLR 1427, Morritt

J held that if a company creates two floating charges at different times and

the second crystallises before the first, then the fixed charge created on the

crystallisation of the second takes priority over the first charge even after

that has crystallised. The opposite conclusion was reached in the Ontario case

of Re Household Products Co Ltd and Federal Business Development Bank (1981)

124 DLR (3d) 325 which was not citied to Morritt J, whose decision seems to

ignore the rule that equitable interests take priority in order of creation.

Where a company’s property is subject to two or more

floating charges, crystallisation of one of them may cause cessation of the

company’s business and so crystallise the others, but whether this happens is a

question of fact in each case.

p.317

From the chargee’s point of view, a floating charge has the

disadvantages that the chargee’s debt may be subordinated to the company’s

preferential debts and liquidation expenses and a percentage of the floating

charge assets must be devoted to paying unsecured creditors. A charge whose

charge was created as a fixed charge may realise the security ignoring

preferential and unsecured creditors. Under a composite floating and fixed

charge it is legitimate for the charge to take the property subject to fixed

charges and treat only the remainder as subject to the floating charge and

therefore available to pay the preferential and unsecured creditors (Re Lewis

Merthyr Consolidated Collieries Ltd [1929] 1 Ch 498).

Effect of Failure to Register

p.323

If a registrable charge, which a company has created over

its own property, is unregistered at Companies House when the time limit has

expired then, as from the end of the time limit, the chargee’s right on

recourse against the charged property becomes ‘void against’ a liquidator,

administrator and creditor of the company (CA 2006, s 874(1)). If the company

commences winding up, the liquidator can take the property and sell it without

regard to the unregistered charge: the proceeds of the sale will then be

available for the benefit of the company’s creditors generally, and the

unregistered charge loses the priority which would otherwise have been

conferred by the charge.

p.647

A disadvantage of a floating charge, as far as the charge is

concerned, is that if an administrative receiver is appointed, of if the

company is wound up before an administrative receiver is appointed, certain of

the company’s debts, called its ‘preferential debts’, must be paid out of the

assets subject to the floating charge in priority to the chargee’s debt (IA

1986, ss40 and 175 (2)(b)). The preferential debts are defined in s.386 and sch

6.

Compnay Law, Brenda Hannigan

p.679

Given that a fixed charge offers a greater security than a

floating charge, much of the litigation to date has involved disputes between

creditors as to their respective places in the queue to claim the company’s

assets on insolvency.

Cases and Materials in Company Law, Sealy and Worthington

p.461

The floating charge thus allows a company to give security

over assets which are continually turned over or used up and replaced as a

matter of routing trading. This is an enormously valuable invention, devised by

equity draftsmen in the latter part of the nineteenth century, founded upon the

agreement of the parties and owing nothing to legislation – rather like the

device of hire-purchase which evolved at about the same time. What successive

Companies and Insolvency Acts have done since its creation is adopt a variety

of rules designed to restrict the full power of its impact, which is potentially

to sweep up all the company’s resources and dedicate them to securing the debt

of one of the company’s creditors, leaving all the others unprotected, unable

even to share pari passu in the company’s resources on a winding up.

The significance of the floating charge lies in the fact

that, for many businesses, fluctuating assets such as stock-in-trade, raw materials

and book debts may form a significant part of the property of the concern, and

may be the only worthwhile security available for an advance.

Different protections…

p.463

The distinction between fixed and floating charges has

important consequences. These charges are treated differently during the term

of the security, during receivership and on the insolvency of the debtor. E.g.

1) the

charger can legitimately deal with the floating charge assets in the ordinary

course of business

2) all

floating charges need to be registered, but not all fixed charges

3) a

floating charge is subordinated to the costs and expenses of administration and

liquidation

4) an

administrator can dispose of assets subject a floating charge without first

obtaining court approval

5) preferential

creditors rank ahead of the floating charge holder in their call on assets

subject to the floating charge.

6) on

insolvency, a statutory proportion of floating charge realisations must be set

aside for the unsecured creditors

7) a

floating charge may be set aside if it is created before a within a certain

time period prior to insolvency. No equivalent exists for fixed charges, which

can only be set aside if they involve a preference

Requirement to register charges

p.464

Part 25 of CA 2006 imposes on companies a statutory

obligation to register particulars of charges which they have created over

their property.

Registration does not itself confer priority or give any

protection to a charge-holder, although of course non-registration brings all

but fatal consequences for his security. Priority as between different charges

over the same property is determined by the ordinary rules of law. Thus for

example, a legal charge will normally have priority over an equitable charge, a

fixed charge over a floating charge and, as between two equitable charges; the

earlier in time will prevail.

The point has already been made that

floating charges can be a vulnerable form of security.

Suggested solution

As a consequence the holder of a floating charge is in a rather

precarious position as far as the security for his loan is concerned. This type

of charge ‘floats’ over the assets under the charge. The floating ceases to

‘float’ and becomes a fixed charge over the class of assets under the charge

upon crystallisation. Crystallisation may occur automatically upon specified

events Re Brightlife Ltd or when a receiver is appointed, the

company commences to wind up or on cessation of the company’s business.


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