Legal Updates

Staying Afloat – Court of Appeal case on floating charges

Written by Henry Evans
01/11/2017

Corporate solicitor Henry Evans explores conditions necessary for the creation of valid qualifying floating charges by reviewing the recent court of appeal case judgment of SAW (SW) 2010 Ltd & Anor v Wilson & Ors.

Legal Background

The floating charge is a key tool for lenders when taking security. It is also of great importance to borrowers, as without the ability to take floating charges, lenders might be less inclined to lend. A floating charge is a form of security which hovers above a shifting pool of assets, rather than attaching to assets immediately as is the case with a fixed charge, or transferring title to an asset to the holder of the security as is the case with a mortgage. A floating charge can only be granted by a corporate entity such as a company or an LLP; an individual cannot grant a floating charge (except farmers in certain specified circumstances).

A floating charge allows a borrower to sell assets (in the ordinary course of its business) within the class or classes of assets which has been charged without the need for the consent of the lender (such consent will be required where a fixed charge or a mortgage has been granted), so it allows a chargee (usually a lender) to take security over the inventory and current accounts of the chargor (usually a borrower) and in other instances where the borrower needs to be able to dispose of assets as part of its business.

Automatic crystallisation

In certain circumstances, such as an event of default under a secured facility agreement, the floating charge will “crystallise”, meaning that it will become a fixed charge and attach to the assets in the classes of assets subject to the floating charge. For the purposes of priority on insolvency, a charge that is created as a floating charge will rank behind charges that were created as fixed charges, even though a floating charge converts into a fixed charge on crystallisation.

Depending on the drafting of the instrument creating the floating charge, some events will allow the lender to declare that the floating charge has crystallised, while other events may mean that the floating charge crystallises automatically. A floating charge will crystallise automatically at common law on the occurrence of certain events, such as the borrower ceasing to carry on its business or entering into liquidation. An instrument creating a floating charge will often be drafted so that, in addition to the common law events triggering automatic crystallisation, the floating charge will automatically crystallise if the chargor grants a security interest in favour of another chargee over assets over which security already exists, without the consent of the original chargee. Where a floating charge has crystallised, a chargor will no longer be able to freely sell the assets subject to the charge.

“Qualifying Floating Charge”

If the instrument creating a floating charge complies with certain criteria set out in the Insolvency Act 1986, the floating charge will be a “qualifying floating charge”. The holder of a qualifying floating charge has the ability to appoint an administrator of the chargor without having to apply to court. The criteria for the creation of a valid qualifying floating charge are set out in paragraph 14(2) of Schedule B1 of the Insolvency Act 1986 (Paragraph 14.2) and are as follows:

  • the instrument creating the floating charge must state that Paragraph 14(2) applies to the floating charge;
  • the instrument must purport to empower the holder of the floating charge to appoint an administrator of the company; and
  • the instrument must purport to empower the holding of the floating charge to make an appointment which would be the appointment of an administrative receiver within the meaning of section 29(2) of the Insolvency Act 1986.

Pursuant to paragraph 14.3 of Schedule B1 of the Insolvency Act 1986, a person is the holder of a qualifying floating charge if they have security over the whole or substantially the whole of the borrower’s property and at least one of the forms of security held is a floating charge. In practice, it is usual for a floating charge to be expressed to be granted over all assets of a borrower in respect of which a fixed charge or mortgage has not been taken.

Court of Appeal case

In the recent case of SAW (SW) 2010 Ltd & Anor v Wilson & Ors, the Court of Appeal has confirmed that, where a floating charge has been created which triggers the automatic crystallisation of an earlier floating charge, this does not mean that the later floating charge is invalid, as its validity does not depend upon the existence of uncharged assets or the ability of the chargor to acquire such assets in the future. The fact of the crystallisation of a pre-existing floating charge will only affect the priority, not the validity, of a later floating charge, meaning that it is possible to appoint an administrator using the out-of-court process under a second floating charge where there are no assets to which the floating charge can attach.

Background
A property letting company, Property Edge Lettings Ltd (PEL), granted a floating charge (First Floating Charge) over all of its assets to Capital Homes Limited (CHL) in December 2007 as part of a security package for a loan facility. The document creating the floating charge contained a clause whereby PEL promised not to create any further security over its assets without the consent of CHL (this is a standard clause in security documentation and is called a “negative pledge”); the document stated that if PEL were to breach this clause then the First Floating Charge would crystallise automatically.

In May 2008, PEL borrowed money from another lender, Salt Commercial (Salt, part of Derbyshire Building Society) and granted security including a floating charge (Second Floating Charge) over all of PEL’s assets, without obtaining CHL’s consent. Nationwide Building Society (NBS) later took over the facility and the security. In 2012, NBS appointed administrators in respect of PEL using the out-of-court process on the basis that the Second Floating Charge was a qualifying floating charge.

PEL’s parent company, SAW (SW) 2010 Ltd (SAW) challenged the validity of the appointment of the administrators, on the basis that:

  • the Second Floating Charge was granted without the consent of CHL, in breach of the negative pledge, and this had meant that the First Floating Charge had crystallised automatically;
  • as a result of the automatic crystallisation of the First Floating Charge, PEL held no property to which the Second Floating Charge could attach (and PEL’s directors had no authority to acquire property to which it could attach in future); and
  • the Second Floating Charge was invalid at the time of the appointment of the administrators as there was still no property to which it could attach.

Judgment
The Court of Appeal rejected this, finding that the validity of an instrument creating a floating charge is not affected by whether the floating charge can attach to any assets or not, but only by whether the statutory conditions for the creation of qualifying floating charge are met. The Court also found that a floating charge is enforceable if a condition of enforcement has been satisfied and there is an outstanding debt secured by the floating charge.

Comment
The court’s decision in this case provides welcome certainty that the sole conditions for the creation of a valid qualifying floating charge are the conditions set out in the Insolvency Act 1986 and that there is no need for the floating charge to relate to any existing assets for it to be valid. In practice, lenders often take floating charges over companies with few if any assets on the basis that they may acquire such assets in the future. Lenders will also often take a floating charge where one exists already, since a second floating charge could be valuable if the first floating charge is redeemed, and will also grant a lender the ability to appoint an administrator using the out of court process. It is useful to know that, where a floating charge is granted in breach of a negative pledge contained in a prior security document, the subsequent floating charge is not invalidated.

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Disclaimer: This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.

Contact the Author

Henry Evans

Gordon Dadds