A floating charge is a security interest over all of the assets of a company which 'floats' until an event of default is triggered or until the company goes into insolvent liquidation at which time the floating charge crystallises and attaches to all of the assets of the company. A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation (usually but not always the payment of a debt) which gives the beneficiary of the security interest certain preferential rights in relation to the assets. ... The term company may refer to a separate legal entity, as in English law, or may simply refer to a business, as is the common use in the United States. ... Liquidation, or winding up, refers to a business whose assets are converted to money in order to pay off debt. ...

Floating charges can only be granted by companies. If an individual person or a partnership^[1] was to purport to grant a floating charge, it would be void as a general assignment in bankruptcy.^[2] A partnership is a type of business entity in which partners share with each other the profits or losses of the business undertaking in which all have invested. ... In law, void means of no legal effect. ... A general assignment is a concept in bankruptcy law that has different meanings in different jurisdictions. ... The examples and perspective in this article or section may not represent a worldwide view. ...

Floating charges take effect in equity only, and consequently are defeated by a bona fide purchaser for value without notice of any asset caught by them. In practice, as the chargor has power to dispose of assets under a floating charge, this is only of any consequence in relation to disposals after the charge has crystallised. The Court of Chancery, London, early 19th century This article is about the concept of equity in the jurisprudence of common law countries. ... A bona fide purchaser (BFP)—or bona fide purchaser for value without notice (BFPFVWN)—in the law of real property, is an innocent party who purchases property for value, without notice of any other partys claim to the title of that property. ...

Definition

Although the nature of a floating charge has been widely considered by the courts, historically no full definition has ever been given (a description was given in Re Yorkshire Woolcombers Association [1903] 2 Ch 284 - which has been widely used since – but Romer LJ stated in that case that he did not intend to give a definition of the term floating charge). In that case the description was:

• 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.

In keeping with that tradition, in National Westminster bank plc v Spectrum Plus Limited and others [2005] UKHL 41, the House of Lords elected instead to describe the essential characteristic of a floating charge, and they described it thus: The House of Lords, in addition to having a legislative function, has a judicial function as a court of last resort within the United Kingdom. ...

"the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event. In the meantime the chargor is left free to use the charged asset and to remove it from the security."

Recharacterisation

Because of the lower priority which a floating charge has (as to which see below), most security documents which create floating charges also seek to create fixed charges over as many assets of the company as they reasonably can. In relation to certain assets, this has historically given rise to tension as to whether the charge created is actually a fixed charge, or whether (despite being expressed as a fixed charge) it should be recharacterised as a floating charge, with the lower priority that floating charges have. This issue arises most frequently in relation to trade receivables and cash in bank accounts. Recharacterisation in law (and sometimes in accountancy) means the treatment of a certain course of conduct in a different manner to which the participants describe it. ...

In National Westminster bank plc v Spectrum Plus Limited and others [2005] UKHL 41 the House of Lords finally brought some welcome 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 be able to exercise actual control over 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 floating charge does not have effective control. Their Lordships held that as this is inconsistent with the status of the charge as fixed (if the chargor company is able to use the proceeds in the ordinary course of its business without the consent of the charge holder), the charge could only take effect as a floating charge.

See also: analysis of the House of Lords decision

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 which was the genesis of a floating charge. In 1862 in an apparently unconnected decision of Holroyd v Marshall (1862) 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. 1862 was a common year starting on Wednesday (see link for calendar). ...

This decision lead to "a further manifestation of the English genius for harnessing the most abstract conceptions to the service of commerce."^[3] Documents came to be drafted which 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 Re Panama, New Zealand and Australian Royal Mint Company (1870) 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 until 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 Her Majestys Court of Appeal is the second most senior court in the English legal system, with only the Judicial Committee of the House of Lords above it. ... Liquidation, or winding up, refers to a business whose assets are converted to money in order to pay off debt. ... An unsecured creditor is a creditor which is not a preferential creditor and which does not have the benefit of any security interests over the assets of the debtor. ...

Flexibility

Floating charges are enormously popular as a security device for two principle reasons. From the secured creditor's perspective, the security will cover each and every asset of the chargor. From the chargor'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. A secured creditor is a creditor which has the benefit of a security interest over some or all of the assets of the debtor. ... In law, the ordinary course of business covers the usual transactions, customs and practices of a certain business and of a certain firm. ... In business management, inventory consists of a list of goods and materials held available in stock. ...

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 (such as rights under a defective retention of title clause) which have been recharacterised as a floating charge being held to be void for non-registration. In law, perfection is generally the process for extending, as against third parties, a creditors rights against a debtor with respect to a security interest (such as a lien) in collateral property. ... A retention of title clause (also called a Romalpa clause in some jurisdictions[1]) is a provision in a contract for the sale of goods that the title to the goods remains vested in the seller until certain obligations (usually payment of the purchase price) are fulfilled by the buyer. ... Recharacterisation in law (and sometimes in accountancy) means the treatment of a certain course of conduct in a different manner to which the participants describe it. ... In law, void means of no legal effect. ...

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 of any assets which the charge then attaches to as if the charge was a fixed charge. Secondly (and more frequently the case, to preserve the company as a going concern), 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. Administrative Receivership is when an Official Receiver is put into a company to secure the assets. ...

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 which was approved by the courts in Re Croftbell Ltd [1990] 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. In English and Welsh insolvency law, an Administration Order is a method used to protect a company experiencing short or medium term financial problems from its creditors. ... This article concerns the common-law legal system, as contrasted with the civil law legal system; for other meanings of the term, within the field of law, see common law (disambiguation). ...

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: Insolvency is a financial condition experienced by a person or business entity when their assets no longer exceed their liabilities (commonly referred to as balance-sheet insolvency) or when the person or entity can no longer meet its debt obligations when they come due (commonly referred to as cash-flow...

1. holders of fixed security (such as a mortgage or fixed charge);^[4] and
2. preferred creditors, who are given priority by statute.^[5]

The floating charge cannot normally be enforced until it has crystallised (and thus, effectively, become a fixed charge) and so most statutes provide that the priority of a fixed charge which was created as a floating charge is treated as a floating charge.^[6] A mortgage is a method of using property (real or personal) as security for the payment of a debt. ... It has been suggested that this article or section be merged with Secured transaction. ... A preferential creditor (in some jurisdictions called a preferred creditor) is a creditor who receives a preferential right to payment upon the debtors bankruptcy under applicable insolvency laws. ...

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 preferred creditors. A number of judicial decisions^[7] gave conflicting interpretations over the characteristics that were definitive of a fixed charge, particularly with reference to charges over book debts (and a fixed charge which did not contain those characteristics would be "recharacterised" as a floating charge). 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. A preferential creditor (in some jurisdictions called a preferred creditor) is a creditor who receives a preferential right to payment upon the debtors bankruptcy under applicable insolvency laws. ... Accounts receivable is one of a series of accounting transactions dealing with the billing of customers who owe money to a person, company or organization for goods and services that have been provided to the customer. ... Recharacterisation in law (and sometimes in accountancy) means the treatment of a certain course of conduct in a different manner to which the participants describe it. ...

See also: Liquidation - Priority of claims

Liquidation, or winding up, refers to a business whose assets are converted to money in order to pay off debt. ...

Criticisms

Floating charges have been criticised as a "raw deal" for unsecured creditors.[1] 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 lead 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 insovlency is a partial response to these criticisms. An unsecured creditor is a creditor which is not a preferential creditor and which does not have the benefit of any security interests over the assets of the debtor. ... In law, a voidable floating charge refers to a floating charge entered into shortly prior to the company going into liquidation which is void or unenforceable in whole or in part under applicable insolvency legislation. ...

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. This article or section does not cite its references or sources. ... Wrongful trading is a principle of UK insolvency law. ... In insolvency law, fraudulent trading refers to a company which has carried on business with intent to defraud creditors. ...

Voidable floating charges

Main article: Voidable floating charge

Because of the potential for abuse of a security interest which catches all of a company's assets, many jurisdictions have enaced provisions in their insolvency legislation which provides 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. In law, a voidable floating charge refers to a floating charge entered into shortly prior to the company going into liquidation which is void or unenforceable in whole or in part under applicable insolvency legislation. ...

Registration

In many jurisdictions, because of their dramatic affect on the availability of assets to unsecured creditors on an insolvency, floating charges are required to be registered.^[8]

Analogous security interests

Analogous concept in the United States

The analogous concept in the United States to the floating charge is the floating lien. For other uses, see Lien (disambiguation). ...

Analogous concept in Quebec civil law

When the new Civil Code of Quebec replaced the Civil Code of Lower Canada in 1994, a concept analogous to the floating charge was introduced into Quebec's civil law under the name floating hypothec. The Civil Code of Québec (CcQ) is the legal text defining civil laws in the province of Quebec, Canada. ... Civil Code of Lower Canada was the civil code in force in Lower Canada from 1865 to 1867 and in Quebec from 1867 to 1994. ... This article or section does not cite its references or sources. ... Wikipedia does not yet have an article with this exact name. ... Hypothec (Lat. ...

See also

• Debenture
• Security interest
• Lien
• Qualifying floating charge
• Voidable floating charge

A debenture in finance, is a long term debt instrument used by governments and large companies to obtain funds. ... A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation (usually but not always the payment of a debt) which gives the beneficiary of the security interest certain preferential rights in relation to the assets. ... In law, lien is the broadest term for any sort of charge or encumbrance against an item of property that secures the payment of a debt or performance of some other obligation. ... In English law, a qualifying floating charge is a floating charge which enables the holder to appoint an administrator or administrative receiver under the Insolvency Act 1986 without the need for an order of the court. ... In law, a voidable floating charge refers to a floating charge entered into shortly prior to the company going into liquidation which is void or unenforceable in whole or in part under applicable insolvency legislation. ...

Other

See also in European law, E. Gabrielli, Il pegno, in Trattato di diritto civile diretto da Sacco, Torino, 2005, 41 ss. The European Union is unique among international organizations in having a complex and highly developed system of internal law which has direct effect within the legal systems of its member states. ...

External links

• Floating charges - www.accaglobal.com

Footnotes