Floating charge
A floating charge is a security interest over a fund of changing assets of a company or other legal person. Unlike a fixed charge, which is created over ascertained and definite property, a floating charge is created over property of an ambulatory and shifting nature. Examples of such property are receivables and stocks. The floating charge This conversion of the floating charge into a fixed charge can trigger common law jurisdictions it is an implied term in security documents creating floating charges that a cessation of the company's right to deal with the assets in the ordinary course of business leads to automatic crystallisation. Additionally, security documents will usually include express terms that a default by the person granting the security will trigger crystallisation.
In most countries floating charges can only be granted by companies, LLPs or similar entities with separate legal personality. If an individual person or a partnership was to try to grant a floating charge, then in most jurisdictions which recognise floating charges this would be void as a general assignment in bankruptcy.
Floating charges take effect in equity only, and consequently are defeated by a bona fide purchaser for value without notice of any asset covered by them. In practice, as the chargor has power to dispose of assets subject to a floating charge, so this is only of consequence in relation to disposals that occur after the charge has crystallised.
History
The floating charge has been described as "one of equity's most brilliant creations."The first recorded English case where a floating charge was recognised was In re Panama, New Zealand, and Australian Royal Mail Co 5 Ch App 318. The use of such floating charges increased in popularity and expanded rapidly until, as Lord Walker described it: "The floating charge had become a cuckoo in the nest of corporate insolvency." Criticism of the effect of floating charges grew, until Lord Macnaghten finally proclaimed in :
This led to a push back against the effect of floating charges in the form of the Preferential Payments in Bankruptcy Amendment Act 1897.
Definition
Later in Illingworth v Houldsworth AC 355 at 358 he stated:A description was subsequently given in Re Yorkshire Woolcombers Association 2 Ch 284, and despite Romer LJ clearly stating in that case that he did not intend to give a definition of the term floating charge, his description is generally cited as the most authoritative definition of what a floating charge is:
- 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.
Recharacterisation
In National Westminster bank plc v Spectrum Plus Limited and others UKHL 41 the House of Lords finally brought some 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 exercise actual control over disposal of 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 charge does not have effective control.Nature of the chargee's interest
Several authors have suggested that the floating chargee, prior to crystallisation, may have no proprietary interest at all in the charged assets. However, this is inconsistent with cases at the highest level which suggest a proprietary interest does exist.Alternatively, the floating chargee may have an inchoate type of proprietary interest, with characteristics that are proprietary but of a lesser order than the proprietary interest of a chargee with a fixed charge. Some authors have suggested that there is an interest in a fund of assets, but the nature and incidents of the interest remain unclear. This has received some judicial support, from Lord Walker in Spectrum, for example.
Another possibility is that the holder of a floating charge may have the same quality of proprietary interest as a fixed chargee, but one that is subject to defeasance or overreaching by permitted dealings by the chargor with the charged assets.
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 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." 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 In re Panama, New Zealand, and Australian Royal Mail Co 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 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.
Any residual concern about the efficacy of such charges were comprehensively ousted by the House of Lords in Salomon v A Salomon & Co Ltd AC 22.
Flexibility
Floating charges are enormously popular as a security device for two principal reasons. From the secured creditor's perspective, the security will cover each and every asset of the chargor. From the charger'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, which have been re-characterized as a floating charge being held to be void for non-registration.
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 off any assets that the charge then attaches to as if the charge was a fixed charge. Secondly, 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 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.
Crystallisation
Strictly speaking, it is not possible to enforce a floating charge at all - the charge must first crystallise into a fixed charge. In the absence of any special provisions in the relevant document, a floating charge crystallises either upon the appointment of a receiver or upon the commencement of liquidation. It has also been suggested, relying upon obiter dictum comments by Lord Macnaghten in Government Stocks and Securities Investments Co Ltd v Manila Rly Co that a charge should also crystallise upon the company ceasing to trade as a going concern. However, this view is not yet supported by judicial authority.In certain countries, notably Australia and New Zealand, it was for a time very common to include "automatic crystallisation" provisions which would provide that the floating charge would crystallise upon an event of default automatically and without action from the chargee. Automatic crystallisation provisions have been upheld in New Zealand but there are judicial comments suggesting they may not be recognised as effective in Canada. In the United Kingdom there is some inferential support for the validity of automatic crystallisation provisions, but they have never been subject to full judicial consideration.
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:- holders of fixed security ; and
- preferential creditors, who are given priority by statute.
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 preferential creditors. A number of judicial decisions gave conflicting interpretations over the characteristics that were definitive of a fixed charge, particularly with reference to charges over book debts. 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.
Criticisms
Floating charges have been criticised as a "raw deal" for unsecured creditors. In Salomon v. Salomon & Co. AC 22 Lord Macnaghten observed that the injustice of the case 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 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 led 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.
Voidable floating charges
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.Registration
In many jurisdictions, because of their dramatic effect on the availability of assets to unsecured creditors on an insolvency, floating charges are required to be registered.Analogous security interests
United States
An analogous concept in the United States to the floating charge is the floating lien, which was implemented by Article 9 of the Uniform Commercial Code.The U.S. never adopted the floating charge directly because at the time it was developing in England in the 19th century, U.S. courts generally held that a debtor simply could not create a security interest in future property; general creditors ought to have a pool of unencumbered assets to look to; and even if such a thing could exist, it was a fraudulent conveyance. However, creditors' lawyers gradually developed an diverse variety of methods, some authorized by state legislatures and others tolerated by state courts, to evade the general ban on security interests in future property. As it had become clear that creditors and debtors were going to find ways to create enforceable de facto security interests in after-acquired property and general intangibles whether courts liked it or not, the UCC drafters in the 1940s successfully argued that such interests should be legitimized and simplified in the form of the floating lien.
A critical difference between the floating charge and the floating lien is that UCC security interests, including floating liens, can be granted by any kind of debtor, including individuals or partnerships, whereas the floating charge can be granted only by corporate entities.
Quebec
When the Quebec Civil Code came into force in 1994 and superseded the Civil Code of Lower Canada, it abolished the charge flottante "floating charge" and created and introduced an analogous security device into Quebec law under the name hypothèque ouverte, or "floating mortgage". As a mortgage, it- can be taken over immovables and movables ;
- must be in due form, i.e. passed before a notary and registered;
- confers rights in rem: priority ranking, right of pursuit, creditor's consent required to dispose of subject;
- grants powers of recourse: repossession, judicial foreclosure, sale by mortgagee in possession, or administrative receivership.
Civil law countries
countries generally allow for a commercial pledge to be taken over the pooled movable assets held or acquired for the use of a business or income-producing activity and not for sale. The pool is restricted to movable property of a long-term nature and of value to the operation of the business, or in other words:- inventory ;
- fixed assets
- * movable tangibles: trade fixtures, equipment, machinery, tools, furniture; and
- * legal intangibles: company style, logos, goodwill, intellectual property, leases.
Besides the class of assets secured, the civilian commercial pledge differs from a floating charge in that fixed assets are not always changing, and the creditor ranks prior to all secured and unsecured claims. Commercial pledges exist in common law countries but are usually taken over working capital.