Types of security (fixed and floating charges)

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Leafy Supplies, a large fertiliser distribution company, recently entered into a financing arrangement with GrowFund Bank to secure operational capital. As part of the arrangement, Leafy Supplies granted GrowFund Bank a charge over its accounts receivable, specifying that the company retained the right to use the proceeds as it saw fit. GrowFund Bank claims the charge was intended to be fixed, pointing to language in the agreement that states it ‘attaches immediately’ to the debts and their proceeds. However, Leafy Supplies continued to collect and spend the receivables without requiring GrowFund Bank’s consent or segregating the proceeds. Now, in an insolvency scenario, GrowFund Bank argues that the charge should be treated like a fixed charge to ensure a higher priority for its claim.


Which of the following is the single best explanation regarding the classification of GrowFund Bank’s charge over Leafy Supplies’ accounts receivable in the event of insolvency?

Introduction

Fixed and floating charges are fundamental concepts in corporate finance, serving as key mechanisms for securing company debts. A fixed charge attaches to specific identifiable assets, granting the charge holder direct rights over those assets. In contrast, a floating charge hovers over a class of assets that may change in the ordinary course of business, becoming a fixed charge upon certain events. Understanding the legal frameworks governing these charges, including registration requirements under the Companies Act 2006 and priority rules in insolvency under the Insolvency Act 1986, is essential. This analysis examines the technical aspects, key principles, and legal requirements of fixed and floating charges within the context of UK corporate law.

Fixed Charges

A fixed charge is a form of security interest that attaches to specific assets of a company, such as land, buildings, or significant equipment. It confers upon the charge holder a proprietary interest in the charged assets, restricting the company's ability to deal with those assets without the charge holder's consent.

Key Features of Fixed Charges

  1. Specificity: The charge is attached to identifiable assets, providing the charge holder with direct control over those assets.

  2. Control and Restrictions: The company (chargor) retains possession but cannot dispose of or deal with the assets without the charge holder's (chargee's) permission.

  3. Priority in Insolvency: In the event of insolvency, fixed charge holders have priority over other creditors with respect to the charged assets.

Legal Framework

Under the Companies Act 2006, fixed charges must be registered with Companies House within 21 days of creation (Section 859A). Failure to register renders the charge void against a liquidator, administrator, and any creditor (Section 859H). This means the charge holder may lose their priority status if registration requirements are not complied with.

Case Law Reference

In National Westminster Bank plc v Spectrum Plus Limited [2005] UKHL 41, the House of Lords examined the distinction between fixed and floating charges over book debts. The court held that for a charge over book debts to be a fixed charge, the chargee must exercise sufficient control over the proceeds of those debts. Without such control, the charge would be deemed floating, affecting the charge holder's priority in insolvency.

Floating Charges

A floating charge is a security interest over a class of assets that are fluctuating in nature, such as stock-in-trade, receivables, or inventory. Unlike fixed charges, a floating charge allows the company to use and dispose of the assets in the ordinary course of business until an event of crystallization occurs.

Key Features of Floating Charges

  1. General Security: It covers a class of assets, both present and future, which can change over time.

  2. Operational Freedom: The company retains the ability to deal with the assets without seeking consent, enabling normal business operations.

  3. Priority in Insolvency: Floating charge holders rank below fixed charge holders and certain preferential creditors in the event of insolvency.

Legal Framework

Floating charges also require registration with Companies House within 21 days of creation (Section 859A of the Companies Act 2006). Additionally, under Section 176A of the Insolvency Act 1986, a prescribed part of the company's net property is set aside for unsecured creditors before floating charge holders are paid.

Crystallization

Crystallization is the process by which a floating charge converts into a fixed charge upon the occurrence of specified events, such as:

  • Appointment of an administrator or receiver
  • Commencement of winding up
  • Default under the terms of the charge

Upon crystallization, the charge fixes on the assets in their state at that time, and the company loses the right to deal with them without the charge holder's consent.

Priority and Enforcement in Insolvency

Understanding the order of priority in insolvency is critical, as it determines how the company's assets are distributed among creditors.

Order of Priority

The general order in which claims are settled is as follows:

  1. Fixed Charge Holders

  2. Insolvency Practitioner's Fees and Expenses

  3. Preferential Creditors (e.g., certain employee claims, contributions to occupational pension schemes)

  4. Prescribed Part for Unsecured Creditors

  5. Floating Charge Holders

  6. Unsecured Creditors

  7. Shareholders

The Prescribed Part

The prescribed part is a portion of the company's net property allocated to unsecured creditors before any payment to floating charge holders. Under Section 176A of the Insolvency Act 1986, it is calculated as:

  • 50% of the first £10,000 of net property
  • 20% of the remainder, up to a maximum of £600,000

This ensures that unsecured creditors receive some distribution from the insolvency proceedings.

Negative Pledge Clauses

Negative pledge clauses are contractual terms included in floating charge agreements to prevent the company from creating subsequent charges with priority over the existing floating charge. While they aim to protect the charge holder's interest, they do not prevent the creation of new charges but may render the company in breach of covenant.

Practical Examples

Example 1: Financing of TechSolutions Ltd

TechSolutions Ltd seeks to raise capital for expansion and secures:

  1. A Fixed Charge over its headquarters and key machinery.

  2. A Floating Charge over its inventory and receivables.

Analysis:

  • The fixed charge provides the lender with security over significant assets, ensuring priority in insolvency.
  • The floating charge allows TechSolutions Ltd to continue its operations without hindrance, as it can use and dispose of inventory and collect receivables in the ordinary course of business.
  • Registration of the charges is essential to maintain their validity and priority status.

Example 2: Insolvency of RetailGroup plc

RetailGroup plc enters insolvency with the following debts:

  1. Bank X: Holds a fixed charge over real estate for £10 million.

  2. Bank Y: Holds a floating charge over assets for £15 million.

  3. HM Revenue & Customs (HMRC): Preferential creditor for £2 million.

  4. Unsecured Trade Creditors: £5 million.

Analysis:

  • Real estate is sold, and proceeds are used to satisfy Bank X's fixed charge.
  • Insolvency practitioner's fees and expenses are paid next.
  • HMRC, as a preferential creditor, is paid before floating charge holders.
  • The prescribed part is calculated and allocated to unsecured creditors.
  • Remaining assets are distributed to Bank Y under its floating charge.
  • Unsecured creditors receive payment from the prescribed part, and any shortfall remains unpaid.

Conclusion

The distinction between fixed and floating charges is critical in corporate finance and insolvency law. Fixed charges attach to specific assets and grant the charge holder priority over those assets upon insolvency, provided registration requirements under the Companies Act 2006 are met. Floating charges offer companies operational flexibility but rank lower in priority and are subject to the prescribed part provisions under the Insolvency Act 1986. Crystallization converts a floating charge into a fixed charge, altering the rights of the charge holder and the company. Key cases like National Westminster Bank plc v Spectrum Plus Limited emphasize the importance of control in determining the nature of a charge. Understanding these mechanisms is essential for handling creditor priorities and securing corporate debts within the legal framework of UK corporate law.

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