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  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  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  2 Lloyd’s Rep
142), and this decision was affirmed by the Irish Supreme Court in Re Keenan
Bros Ltd  1 RLM 641, and again by the English Court of Appeal in Re New
Bullas Trading Ltd  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  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  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
In the latest case in the saga, in re Spectrum Plus Ltd (in
liquidation)  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.
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  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  3 All ER 829).
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  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)  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.
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  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
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  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
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  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  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  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  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.
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  1 Ch 498).
Effect of Failure to Register
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.
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
Compnay Law, Brenda Hannigan
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
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.
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.
charger can legitimately deal with the floating charge assets in the ordinary
course of business
floating charges need to be registered, but not all fixed charges
floating charge is subordinated to the costs and expenses of administration and
administrator can dispose of assets subject a floating charge without first
obtaining court approval
creditors rank ahead of the floating charge holder in their call on assets
subject to the floating charge.
insolvency, a statutory proportion of floating charge realisations must be set
aside for the unsecured creditors
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
Part 25 of CA 2006 imposes on companies a statutory
obligation to register particulars of charges which they have created over
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.
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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