Fixed and floating charges – a crucial new judgement
June 27, 2023
Those outside the lending and insolvency communities could be forgiven for struggling to understand the difference between Fixed and Floating Charges over business assets and why it can matter so much. Now there is a High Court ruling in the case of Avanti Communications, which simultaneously introduces both more flexibility and more uncertainty about the key characteristics of a Fixed Charge.
What are the basic characteristics of Fixed and Floating Charges?
When a Fixed Charge is created by a borrower in favour of a lender it immediately attaches to property that is capable of being definite. This can be identified and gives the lender proprietary rights in those assets. Despite this, ownership and possession of the relevant asset remains with the borrower. Nevertheless, the key characteristic of a Fixed Charge is that the lender can exercise some level of control over what is done with the relevant asset. Preventing the borrower from freely disposing of assets subject to a Fixed Charge in the ordinary course of their business is therefore crucial to the nature of a fixed charge.
By contrast, a floating charge will hover above a shifting pool of assets, until such time as an event occurs which causes the floating charge to “crystallise”. Crystallisation can occur if:
- an event happens which is incompatible with the borrower continuing to trade (e.g. if it is put into liquidation);
- the lender exercises its rights to intervene to take control of the charged assets; or,
- the security document provides for it, when the lender receives notice that certain specified events have occurred.
Until a Floating Charge crystallises, the borrower is free to deal with the charged assets and the consent of the lender is not required before they can be disposed of or used up, which means that the business can be operated as normal. As a result, Floating Charge security lends itself well to assets that fluctuate and circulate within a business (such as inventory, trade receivables and cash in current accounts). It would clearly be difficult for a lender to take a Fixed Charge over these assets because the level of control they would have to be able to exercise would stifle the actual ability of the borrower to run its business.
Why does it matter whether a charge is Fixed or Floating?
Whether a charge takes effect as a Fixed or Floating charge will often be very important to a secured creditor, particularly where there are a variety of secured creditors holding security over a company’s assets.
Unless there is some sort of intercreditor agreement that varies the default position under English law, when the borrower enters a formal insolvency procedure, such as Administration or Liquidation, fixed charge holders will rank ahead of any holders of a Floating Charge. English insolvency law dictates that the proceeds of asset realisations must be distributed in a set order of priority and debts secured by Fixed Charges rank at the top of the waterfall.
Crucially, holders of Floating Charges can get nothing from the proceeds of realising Floating Charge assets until amounts owed to Fixed Charge holders have been satisfied, the general costs of the insolvency process (which can be substantial) have been met, after the claims of preferential creditors have been paid and finally, the “Prescribed Part” (a ring-fenced sum of up to £800,000 set aside to help satisfy the claims of ordinary unsecured creditors from floating charge recoveries) has been set aside.
Also, English insolvency law sets a 12-month “hardening period” for Floating Charges, except where they are taken in return for a lender providing “new” funding, which is extended to two years if the Floating Charge. As such, a Floating Charge granted within the relevant hardening period prior to an insolvency can be set aside. This issue does not affect Fixed Charges.
What were the key points in the Avanti judgment?
- Avanti Communications suggests that for a charge to take effect as a Fixed Charge, there does not need to be a complete prohibition on the borrower dealing with the charged assets.
- Carefully worded exceptions to a complete prohibition on the disposal of certain assets – which are very commonly negotiated by borrowers in finance documents – are not necessarily inconsistent with the creation of a Fixed Charge.
How does Avanti affect future lending strategies?
As always with court decisions, the outcome depends on the facts. At Avanti, the charged assets comprised a HLAS-3 satellite, certain equipment used in the operation of network and ground station facilities, certain satellite network filings and certain ground station licences issued by Ofcom. The judge decided that while Avanti had more freedom to deal with these assets than normal with Fixed Charge assets, they nevertheless formed the infrastructure of the business rather than being free circulating assets and as such, the charges over them were Fixed Charges.
The judgment also set out a highly detailed set of criteria for first analysing security documentation and then for categorising Fixed Charge assets based on it. It seems likely to have significant ramifications for structured and asset-backed finance arrangements utilising finance industry standard forms.
It will bring more flexibility into how business assets can be funded, but equally it introduces more scope for disputes in future, especially where security documentation is badly or loosely drafted.
If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.