Technology &
Internet Law

Fixed and Floating Charges - Briefing Note

In the most recent judgment delivered by the Judicial Committee of the Privy Council (which is highly persuasive, if not binding in the UK) in Richard Dale Agnew v The Commissioner of Inland Revenue [2001] UKPC 28 (' Agnew'), it was held that the label slapped on by the parties to a charge over the assets (in this case uncollected book debts) of a company does not determine whether it is a fixed or floating charge. The ultimate question is whether the company is free to deal with the charged assets and withdraw them from the security without the consent of the charge or debenture holder (in other words, the bank). If the answer is in the affirmative, then the charge is a floating, as opposed to a fixed, charge. Accordingly, so long as the charged assets were intended to be under the control of the company and not the bank, the charge is floating. 

In reaching this conclusion, Lord Millet observed that the intention of the parties - i.e. a company which has taken out facilities with a bank and the bank itself - is unimportant in categorising whether a charge is floating or fixed. He said: 

'the only intention which is relevant is the intention of the company that the company should be free to deal with the charged assets and withdraw them from the security without the consent of the holder of the charge.'

This effectively overrules the decision of the English Court of Appeal in In re New Bullas Trading Ltd [1994] 1 BCLC 449, which amounted to a triumph (for banks that is) of clever drafting by banking lawyers in an area of banking and corporate law which has been long regarded as well-settled. In Agnew their Lordships concluded that New Bullas was wrongly decided. This decision is sure to send alarm bells ringing in the chambers and offices of banking lawyers as well as banks and other financial institutions involved in corporate finance, albeit that this decision is only persuasive authority at this stage.  The fact is that the New Bullas decision was legally far less logical that the Agnew decision. 

The Distinction Between Fixed & Floating Charges 

It has long been established that a charge granted by a company to a bank (in return for banking facilities) over the uncollected book debts of a company (i.e. money outstanding to the company from its customers) which leaves the company free to collect them and use the proceeds in the ordinary course of its business (i.e. as its cash flow) is a floating charge. The most crucial characteristic and hallmark of a floating charge (and this is the feature that distinguishes it from a fixed charge) is 'the company's freedom to receive the book debts for its own account and deal with the proceeds without reference to the charge holder'. In other words, if a company is free to collect its debts and pay the proceeds into its ordinary bank account - and once in the account, it would be at the free disposal of the company - the charge is a floating charge. 

If, however, the charge (usually by way of debenture) assigns the uncollected book debts and their proceeds absolutely to the chargee/assignee (i.e. the bank), in such a way as to only allow the bank to 'touch it' to the exclusion of the company, the charge becomes a fixed one. Again, it has been long established that the classification of a security as floating charge is a matter of substance and not form (i.e. not merely a matter of drafting). So, if a charge over uncollected book debts provides that the company can collect the debts but must place them in a special account to the benefit of the bank (and not in the company's ordinary account), thus excluding the proceeds from the company's cash flow, it would be effective to create a fixed charge on the book debts. 

The Implications 

In respect of book debts outstanding when a company goes into liquidation or receivership, the identification of whether the book debts were subject to a floating or fixed charge becomes of fundamental significance. This is because, if the charge is a fixed charge, the proceeds become payable to the bank. However, if it is a floating charge upon its creation, they become payable to the employees and revenue authorities as preferential creditors. 

Commercially speaking, the reality is that a fixed charge over book debts would cripple a company's business because it gives the bank an immediate interest in the book debts and unless the company obtains the consent of the bank, the company cannot touch them. Thus, a fixed charge would deprive the company of access to its cash flow, which is the life blood of a business. Accordingly, it is reasonable to presume that where the parties contemplate that the company would continue to carry on business despite the existence of the charge, they must be taken to have agreed on a form of charge which did not possess the ordinary incidents of a fixed charge. 

New Bullas 

The Court of Appeal in New Bullas in effect disturbed otherwise well-settled principles in this area of the law by holding that the parties to a charge (i.e the bank and the company taking facilities from it), were free to make whatever agreement they liked. According to Nourse LJ, the question was merely one of interpretation of the words of the charge agreement (the debenture) and ascertaining from it what the parties intended, and this intention should prevail. He concluded, therefore, that since (on the facts of New Bullas) it was clear from the descriptions which the parties attached to the charge that they had intended to create a fixed charge over the book debts while they were uncollected, they were entitled to do so as matter of freedom of contract. 

The way in which the charge was drafted in New Bullas, was intended to let the bank have the best of both worlds. The bank wanted to have a fixed charge on the book debts while allowing the company the freedom to use the proceeds that it would have if the charge were floating. The draftsman of the charge debenture drew a purposeful distinction between book debts and their proceeds. He then subjected the former, while they remain uncollected, to a fixed charge, but the latter to a floating charge. Accordingly, the company could continue to collect the debts and upon receipt, the debt would be discharged. Now, in respect of the proceeds (being different assets) they would from the outset be subject to a floating charge. 

So, the question in New Bullas case was whether the book debts which were uncollected when the receivers were appointed were subject to a fixed or floating charge. Nourse LJ concluded that there being usually no need to deal with a book debt before collection, an uncollected book debt can be subject to a fixed charge; but once collected, the proceeds being needed for the conduct of the business, it becomes a natural subject of a floating charge. 

Lord Millet in Agnew 

As to the freedom of contract and the supremacy of the intention of the parties points taken in New Bullas by Nourse LJ, Lord Millet comprehensively rejected them. He said that the question is not merely one of construction, but one of 'categorisation'. As mentioned earlier he said that the only intention which is relevant is the intention of the company that the company should be free to deal with the charged assets and withdraw them from the security without the consent of the holder of the charge. If it is so, there is no fixed charge. He then drew the analogy with the situation in which a distinction is sought to be drawn between a licence and a lease. He observed: 

'A similar process is involved in construing a document to see whether it creates a licence or a tenancy. The Court must construe the grant to ascertain the intention of the parties: but the only intention which is relevant is the intention to grant exclusive possession. 

As to the ingenious way in which book debts and their proceeds were separated in New Bullas (as indeed was also the case in Agnew) and accepted by Nourse LJ that a charge on the debts takes effect as a divisible fixed charge on the debts, Lord Millett took the view that so long as the bank cannot prevent the company from collecting the debts and having the free use of the proceeds, it was a floating charge. 'The question is not whether the company is free to collect the uncollected debts, but whether it is free to do so for its own benefit'. 

He concluded that any attempt in the present context to separate the ownership of the debts from the ownership of their proceeds (even if conceptually possible) makes no commercial sense. The simple point is that the debentures in both New Bullas and Agnew were so drafted that the company was at liberty to turn the uncollected book debts to its own account by its own act. In other words, the company could receive the payments on the debts and bank them into its own ordinary bank account and use them. It is this, it was held, which was inconsistent with the nature of a fixed charge. 

Conclusion 

Accordingly - immaterial of how assets are classified by the parties to a charge over them and immaterial of whether, in the case of book debts, uncollected book debts are separated from their proceeds or not - so long as a company, in respect of uncollected book debts, is left at liberty to collect then and use the proceeds in the ordinary course of business, any charge over it is a floating, and not a fixed, charge.  It is only a matter of time before this ruling is used in English courts but given the nature of the issue, there is no preventive action one can take, short of the commercially unacceptable prospect of preventing collection and damaging the customer's cash flow.

NEED TO KNOW MORE?

For further information on fixed and floating charges and company law, contact Maitland Kalton or Julian Danobeitia.  Should you prefer to telephone, call us on +44 (0)207 278 1817.

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