Floating charge
Encyclopedia
A floating charge is a security interest
over a fund of changing assets of a company or a limited liability partnership
(LLP), which 'floats' or 'hovers' until conversion into a fixed charge, at which point the charge attaches to specific assets. The conversion (called crystallisation) can be triggered by a number of events; it has become an implied term in debentures (in English law) that a cessation of the company's right to deal with the assets in the ordinary course of business will lead to automatic crystallisation. Additionally, according to express terms of a typical loan agreement, default by the chargor is a trigger for crystallisation. Such defaults typically include non-payment, invalidity of any of the lending or security documents or the launch of insolvency proceedings
.
Floating charges can only be granted by companies. If an individual person or a partnership
was to purport to grant a floating charge, it 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 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 floating charge has been described as "one of equity's most brilliant creations."
in two cases.
In Government Stocks and Other Securities Investment Co Ltd v Manila Rly Co [1897] AC 81 at 86 he said:
Later in Illingworth v Houldsworth [1904] AC 355 at 358 he stated:
A description was subsequently given in Re Yorkshire Woolcombers Association [1903] 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:
When conducting a recent review of the authorities, in keeping with that tradition, in National Westminster bank plc v Spectrum Plus Ltd [2005] UKHL 41, the House of Lords
elected instead to describe the essential characteristic of a floating charge rather than define it, and they described it thus:
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.
In National Westminster bank plc v Spectrum Plus Limited and others
[2005] 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. The judges 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.
) 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 possibity 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.
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 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 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 [1897] AC 22.
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.
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 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 [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.
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.
. However, because of the nature of floating charge, the priority of floating charge holder's claims normally rank behind:
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 that was created as a floating charge is treated as a floating charge.
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 creditor
s. 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
(and a fixed charge that 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.
s. In Salomon v. Salomon & Co.
[1897] AC 22 Lord Macnaghten
observed that the injustice of the case (as he saw it) 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 [1905] 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 charge
s 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.
to the floating charge is the floating lien.
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
The floating mortgage can be specific or general with respect to immovables and movables, separately or together. The mortgage is not perfected until it crystallises. Crystallisation occurs upon default of the mortgagor and registration of a notice of default, and the mortgage ranks from the date notice is filed. This means that a floating mortgage ranks lower than a fixed mortgage.
to be taken over the pooled movable asset
s held or acquired for the use of a business
or income
-producing activity (going concern
) and not for sale. The pool is restricted to movable (personal
) property
of a long-term nature and of value to the operation of the business, or in other words:
The pledge never crystallises like a floating charge; instead the pool is a universitas rerum and treated as a single movable security subject. The asset pool is referred to as a fonds de commerce (French), fondo de comercio (Spanish), fondo di commercio (Italian), Geschäftsfonds (German), handelsfonds (Dutch), and so on.
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 (floating asset
s and investment
s).
Security interest
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 the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
over a fund of changing assets of a company or a limited liability partnership
Limited liability partnership
A limited liability partnership is a partnership in which some or all partners have limited liability. It therefore exhibits elements of partnerships and corporations. In an LLP one partner is not responsible or liable for another partner's misconduct or negligence. This is an important...
(LLP), which 'floats' or 'hovers' until conversion into a fixed charge, at which point the charge attaches to specific assets. The conversion (called crystallisation) can be triggered by a number of events; it has become an implied term in debentures (in English law) that a cessation of the company's right to deal with the assets in the ordinary course of business will lead to automatic crystallisation. Additionally, according to express terms of a typical loan agreement, default by the chargor is a trigger for crystallisation. Such defaults typically include non-payment, invalidity of any of the lending or security documents or the launch of insolvency proceedings
Liquidation
In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation...
.
Floating charges can only be granted by companies. If an individual person or a partnership
Partnership
A partnership is an arrangement where parties agree to cooperate to advance their mutual interests.Since humans are social beings, partnerships between individuals, businesses, interest-based organizations, schools, governments, and varied combinations thereof, have always been and remain commonplace...
was to purport to grant a floating charge, it would be void
Void (law)
In law, void means of no legal effect. An action, document or transaction which is void is of no legal effect whatsoever: an absolute nullity - the law treats it as if it had never existed or happened....
as a general assignment
General assignment
A general assignment or assignment is a concept in bankruptcy law that has a similar meaning, due to common law ancestry, in different jurisdictions, but wide dispersion in practical application...
in bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
.
Floating charges take effect in equity only, and consequently are defeated by a bona fide purchaser for value without notice
Bona fide purchaser
A bona fide purchaser referred to more completely as a bona fide purchaser for value without notice is a term used in the law of real property and personal property to refer to an innocent party who purchases property without notice of any other party's claim to the title of that property...
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 floating charge has been described as "one of equity's most brilliant creations."
Definition
Although the nature of a floating charge has been widely considered by the courts, historically no full definition has ever been given, and the nature of the chargee's interest in the charged assets (or fund of assets) remains doctrinally uncertain. The earliest descriptions were given by Lord MacnaghtenEdward Macnaghten, Baron Macnaghten
Edward Macnaghten, Baron Macnaghten, Bart., GCB, GCMG was an Anglo-Irish rower, barrister, Conservative-Unionist politician and one of seven Lords of Appeal in Ordinary.-Early life and rowing:...
in two cases.
In Government Stocks and Other Securities Investment Co Ltd v Manila Rly Co [1897] AC 81 at 86 he said:
- "A floating security is an equitable charge on the assets for the time being of a going concern. It attaches to the subject charged in the varying condition in which it happens to be from time to time. It is the essence of such a charge that it remains dormant until the undertaking ceases to be a going concern, or until the person in whose favour the charge is created intervenes. His right to intervene may of course be suspended by agreement. But if there is no agreement for suspension, he may exercise his right whenever he pleases after default."
Later in Illingworth v Houldsworth [1904] AC 355 at 358 he stated:
- "...a floating is ambulatory and shifting in nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp."
A description was subsequently given in Re Yorkshire Woolcombers Association [1903] 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.
When conducting a recent review of the authorities, in keeping with that tradition, in National Westminster bank plc v Spectrum Plus Ltd [2005] UKHL 41, the House of Lords
Judicial functions of the House of Lords
The House of Lords, in addition to having a legislative function, historically also had a judicial function. It functioned as a court of first instance for the trials of peers, for impeachment cases, and as a court of last resort within the United Kingdom. In the latter case the House's...
elected instead to describe the essential characteristic of a floating charge rather than define it, and they described it thus:
- "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 of a floating charge (as to which see below), most security documents that 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 recharacterisedRecharacterisation
Recharacterization in law means the treatment of a certain course of conduct in a different manner to which the participants describe it....
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.
In National Westminster bank plc v Spectrum Plus Limited and others
National Westminster Bank plc v Spectrum Plus Limited
Re Spectrum Plus Ltd [2005] was a UK company law decision of House of Lords which settled a number of outstanding legal issues relating to floating charges and recharacterisation risk under the English common law...
[2005] 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. The judges 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
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 (such as SpectrumNational Westminster Bank plc v Spectrum Plus Limited
Re Spectrum Plus Ltd [2005] was a UK company law decision of House of Lords which settled a number of outstanding legal issues relating to floating charges and recharacterisation risk under the English common law...
) 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
National Westminster Bank plc v Spectrum Plus Limited
Re Spectrum Plus Ltd [2005] was a UK company law decision of House of Lords which settled a number of outstanding legal issues relating to floating charges and recharacterisation risk under the English common law...
, for example.
Another possibity 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 (1862) 10 HL Cas 191 it was held that equity would recognise a charge over after-acquired propertyAfter-acquired property
The After Acquired Title Doctrine is a legal doctrine under which, if a grantor conveys what is mistakenly believed to be good title to land that he or she did not own, and the grantor later acquires that title, it vests automatically in the grantee. A practical example is Husband and Wife own...
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 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
Court of Appeal of England and Wales
The Court of Appeal of England and Wales is the second most senior court in the English legal system, with only the Supreme Court of the United Kingdom above it...
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
Unsecured creditor
An unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....
Any residual concern about the efficacy of such charges were comprehensively ousted by the House of Lords in Salomon v A Salomon & Co Ltd [1897] AC 22.
Flexibility
Floating charges are enormously popular as a security device for two principal reasons. From the secured creditor'sSecured creditor
A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and avoid competing for a distribution on liquidation with...
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
Ordinary course of business
In law, the ordinary course of business covers the usual transactions, customs and practices of a certain business and of a certain firm. This term is used particularly to judge the validity of certain transactions...
, 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
Perfection (law)
In law, perfection relates to the additional steps required to be taken in relation to a security interest in order to make it effective against third parties and/or to retain its effectiveness in the event of default by the grantor of the security interest...
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
Recharacterisation
Recharacterization in law means the treatment of a certain course of conduct in a different manner to which the participants describe it....
as a floating charge being held to be void
Void (law)
In law, void means of no legal effect. An action, document or transaction which is void is of no legal effect whatsoever: an absolute nullity - the law treats it as if it had never existed or happened....
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 (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.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 [1990] BCC 781. In the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
the law has now been changed by statute, but the power to block appointments of administrators has been retained in many other common law
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
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 receiverReceivership
In law, receivership is the situation in which an institution or enterprise is being held by a receiver, a person "placed in the custodial responsibility for the property of others, including tangible and intangible assets and rights." The receivership remedy is an equitable remedy that emerged in...
or upon the commencement of liquidation
Liquidation
In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation...
. It has also been suggested, relying upon obiter dictum
Obiter dictum
Obiter dictum is Latin for a statement "said in passing". An obiter dictum is a remark or observation made by a judge that, although included in the body of the court's opinion, does not form a necessary part of the court's decision...
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
Going concern
A going concern is a business that functions without the threat of liquidation for the foreseeable future, usually regarded as at least within 12 months.-Definition of the 'going concern' concept:...
. 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 insolvencyInsolvency
Insolvency means the inability to pay one's debts as they fall due. Usually used to refer to a business, insolvency refers to the inability of a company to pay off its debts.Business insolvency is defined in two different ways:...
. However, because of the nature of floating charge, the priority of floating charge holder's claims normally rank behind:
- holders of fixed security (such as a mortgage or fixed charge); and
- preferential creditorPreferential creditorA preferential creditor is a creditor receiving a preferential right to payment upon the debtor's bankruptcy under applicable insolvency laws....
s, who are given priority by statute.
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 that was created as a floating charge is treated as a floating charge.
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 creditor
Preferential creditor
A preferential creditor is a creditor receiving a preferential right to payment upon the debtor's bankruptcy under applicable insolvency laws....
s. 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
Accounts receivable
Accounts receivable also known as Debtors, is money owed to a business by its clients and shown on its Balance Sheet as an asset...
(and a fixed charge that did not contain those characteristics would be "recharacterised
Recharacterisation
Recharacterization in law means the treatment of a certain course of conduct in a different manner to which the participants describe it....
" 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.
- See also: Liquidation - Priority of claims
Criticisms
Floating charges have been criticised as a "raw deal" for unsecured creditorUnsecured creditor
An unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....
s. In Salomon v. Salomon & Co.
Salomon v. Salomon & Co.
Salomon v A Salomon & Co Ltd [1897] AC 22 is a landmark UK company law case. The effect of the Lords' unanimous ruling was to uphold firmly the doctrine of corporate personality, as set out in the Companies Act 1862, so that creditors of an insolvent company could not sue the company's shareholders...
[1897] AC 22 Lord Macnaghten
Edward Macnaghten, Baron Macnaghten
Edward Macnaghten, Baron Macnaghten, Bart., GCB, GCMG was an Anglo-Irish rower, barrister, Conservative-Unionist politician and one of seven Lords of Appeal in Ordinary.-Early life and rowing:...
observed that the injustice of the case (as he saw it) was not caused by the introduction of the concept of limited liability
Limited liability
Limited liability is a concept where by a person's financial liability is limited to a fixed sum, most commonly the value of a person's investment in a company or partnership with limited liability. If a company with limited liability is sued, then the plaintiffs are suing the company, not its...
, but by the excessive security created by the floating charge. In Re London Pressed Hinge Co Ltd [1905] 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 charge
Voidable floating charge
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....
s 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
Wrongful trading
Wrongful trading is a type of civil wrong found in UK insolvency law, under s 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the insolvent company....
or fraudulent trading
Fraudulent trading
Fraudulent trading is an insolvency law concept, and in particular a UK insolvency law concept. It refers to a company that has carried on business with intent to defraud creditors.-Law:...
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.United States
The analogous concept in the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
to the floating charge is the floating lien.
Quebec
When the Quebec Civil CodeCivil Code of Quebec
The Civil Code of Quebec is the civil code in force in the province of Quebec, Canada. The Civil Code of Quebec came into effect on January 1, 1994, except for certain parts of the book on Family Law which were adopted by the National Assembly in the 1980s...
came into force in 1994 and superseded the Civil Code of Lower Canada
Civil Code of Lower Canada
Civil Code of Lower Canada was the civil code in force in Lower Canada from July 1, 1866 to June 30, 1867 and in Quebec from July 1, 1867 to December 31, 1993...
, it abolished the charge flottante "floating charge" and created and introduced an analogous security device into Quebec law
Quebec law
Quebec law is unique in Canada because Quebec is the only province in Canada to have a bijuridical legal system under which civil matters are regulated by French-heritage civil law. Public law, criminal law and other federal law operate according to Canadian common law.- Historical Development...
under the name hypothèque ouverte, or "floating mortgage
Mortgage
A mortgage is a security interest in real property held by a lender as a security for a debt, usually a loan of money. A mortgage in itself is not a debt, it is the lender's security for a debt...
". As a mortgage, it
- can be taken over immovables and movables (that is, real and personal property);
- must be in due form, i.e. passed before a notaryCivil law notaryCivil-law notaries, or Latin notaries, are lawyers of noncontentious private civil law who draft, take, and record legal instruments for private parties, provide legal advice and give attendance in person, and are vested as public officers with the authentication power of the State...
and registered; - confers rightsIus in reius in re, under Civil law, more commonly referred to as a real right or right in rem, is a right in property, known as an interest under common law. A real right vests in a person with respect to property, inherent in his relation to it, and prevails against all the world. The primary real rights...
in remIn remIn rem is Latin for "against a thing." In a lawsuit, an action in rem is directed towards a piece of property rather than against a person . The action disputes or seeks to transfer title to property. When title to real estate In rem is Latin for "against a thing." In a lawsuit, an action in rem...
: priority ranking, right of pursuit (that is, it runs with the land and cannot be defeated by a bona fide purchaser), creditor's consent required to dispose of subject; - grants powers of recourse: repossession, judicial foreclosure, sale by mortgagee in possession, or administrative receivership.
The floating mortgage can be specific or general with respect to immovables and movables, separately or together. The mortgage is not perfected until it crystallises. Crystallisation occurs upon default of the mortgagor and registration of a notice of default, and the mortgage ranks from the date notice is filed. This means that a floating mortgage ranks lower than a fixed mortgage.
Civil law countries
Civilian countries generally allow for a commercial pledgePledge
-Promises:* A promise similar to an oath* A promise to donate funds, as in a pledge drive* Taxpayer Protection Pledge, a promise by politicians to oppose tax increases** The Pledge , a similar promise first used in New Hampshire...
to be taken over the pooled movable asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s held or acquired for the use of a business
Business
A business is an organization engaged in the trade of goods, services, or both to consumers. Businesses are predominant in capitalist economies, where most of them are privately owned and administered to earn profit to increase the wealth of their owners. Businesses may also be not-for-profit...
or income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
-producing activity (going concern
Going concern
A going concern is a business that functions without the threat of liquidation for the foreseeable future, usually regarded as at least within 12 months.-Definition of the 'going concern' concept:...
) and not for sale. The pool is restricted to movable (personal
Personal property
Personal property, roughly speaking, is private property that is moveable, as opposed to real property or real estate. In the common law systems personal property may also be called chattels or personalty. In the civil law systems personal property is often called movable property or movables - any...
) property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
of a long-term nature and of value to the operation of the business, or in other words:
- inventoryInventoryInventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
(UK: stock); - fixed assetFixed assetFixed assets, also known as a non-current asset or as property, plant, and equipment , is a term used in accounting for assets and property which cannot easily be converted into cash. This can be compared with current assets such as cash or bank accounts, which are described as liquid assets...
s- movable tangibles: trade fixtures, equipment, machinery, tools, furniture; and
- legal intangibleIntangible assetIntangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset...
s: company style (name), logoLogoA logo is a graphic mark or emblem commonly used by commercial enterprises, organizations and even individuals to aid and promote instant public recognition...
s, goodwillGoodwillGoodwill or Good Will may refer to:* Goodwill , the value of a business entity not directly attributable to its assets and liabilities* Goodwill, Maryland, United States...
, intellectual propertyIntellectual propertyIntellectual property is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law...
, leaseLeaseA lease is a contractual arrangement calling for the lessee to pay the lessor for use of an asset. A rental agreement is a lease in which the asset is tangible property...
s.
The pledge never crystallises like a floating charge; instead the pool is a universitas rerum and treated as a single movable security subject. The asset pool is referred to as a fonds de commerce (French), fondo de comercio (Spanish), fondo di commercio (Italian), Geschäftsfonds (German), handelsfonds (Dutch), and so on.
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
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
countries but are usually taken over working capital (floating asset
Current asset
In accounting, a current asset is an asset on the balance sheet which can either be converted to cash or used to pay current liabilities within 12 months...
s and investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
s).
See also
- DebentureDebentureA debenture is a document that either creates a debt or acknowledges it. In corporate finance, the term is used for a medium- to long-term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note...
- Security interestSecurity interestA security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
- LienLienIn law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
- Qualifying floating chargeQualifying floating chargeIn 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...
- Voidable floating chargeVoidable floating chargeIn 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....