Exam paper 2008 Question 6

6 (a) Darling Ltd borrows £5 million from Southern Rock Bank. The loan is secured and the charging document states that Southern has:

- a fixed charge on certain machinery owned by Darling;

- a fixed charge on Darling’s present and future book debts, and

- a floating charge on all of Darling’s other present and future assets and undertaking.

The charging document also states that Darling may do the following:

- collect book debts itself provided that the proceeds so collected are paid into a special “A” account with Southern from which each month it may withdraw up to 10 per cent of the amount paid in during the previous month unless notified otherwise by Southern; and,

- without reference to Southern, dispose of any individual item of the charged machinery provided that the market value of that item at the time of the disposal does not exceed £1,000 and the total amount realised on disposals of other such items in the previous six months does not exceed £10,000.

- Finally, the charging document also provides that Darling must not create any other security over its assets, (negative pledge) and that doing so will be an event of default that triggers the automatic crystallisation of the floating charge.

In a separate charging document, Thompson Ltd, a subsidiary of Darling, gives security for Darling’s debt to Southern by giving it a fixed charge on the company’s deposit account with Southern.

The charges on the machinery and book debts and the floating charge are duly registered with the registrar of companies.

Some time later Southern finds out by chance that Darling has recently created a fixed charge over a portfolio of shares in favour of Brown Ltd. This charge has not been registered.

Advise Southern on its legal position. How would your advice differ (if at all) if you are informed by Southern that it withdrew the permission for Darling to make 10 per cent withdrawals from the special “A” account one month into the arrangement but that it has from time to time authorised withdrawals from the account when asked specifically by Darling to do so.

and

(b) Does your analysis of the issues raised by part (a) of this question suggest to you that the law is this area is in need of reform? If so, what would you recommend?

(a)

To advise Southern we need to consider the following questions:

1. Whether the created charges are fixed or floating

2. Whether it is possible to charge back debts to the debtor

3. What are the consequences of the breach of a negative pledge covenant?

1. Whether the created charges are fixed or floating

Parties agreed to create certain type of charge. However, as Lord Scott indicated in Spectrum Plus, the label that the parties have attributed to the charge is not conclusive. Using a two-stage test introduced by Lord Millett in Agnew, we should analyse each charge separately. In the first stage we will look at the nature of the rights and obligations the parties intended to grant each other. Second stage is a matter of characterization of these rights and obligations which is a question of law and does not depend on parties’ intention.

Why it is important. It is important to categorize the charges, because of the different treatment of fixed and floating charges, namely:

1. Priority: Debts secured by fixed charge generally rank for repayments before debts secured by floating charge

2. Insolvency: (i) floating charge ranks behind preferential debt (this category was limited significantly by the Enterprise Act 2002); (ii) certain provisions of Insolvency Act 1986 that have redistributable effect, affect floating, not fixed, charges (s 176A); (iii) general expenses of administration (Sch B1, para 99(3)) and winding-up (S 176 ZA) can be recouped out of assets that are subject to the floating charge and not the fixed; (iv) floating, but not fixed charge, can be invalid if it is created within the certain period before the onset of insolvency proceedings (s 245).

3. Registration: all floating charges should be registered; fixed charges on certain assets are out of scope of registration (s860 Companies Act 2006).

1. A charge on certain machinery owned by Darling (labeled by the parties as a fixed charge)

The charge provides a right of the chargor to dispose machinery without reference to Southern. This right is limited to certain market value of the machinery and depends on the value of previous disposals. This arrangement seems to be commercially workable. Darling enjoys limited independence to dispose machinery (for example, in order to update it). At the same time Southern can be sure that due to limited disposal rights he will not be deprived of security as a result of such disposal.

However, from a legal standpoint such arrangements may not qualify for a fixed charge. As Lord Walker suggested in Re Spectrum, assets could only be released from a fixed charge with the active concurrence of the chargee. In Agnew Lord Millet cited with approval Re Keenan Bros which said that the distinguishing feature of a fixed charge is that the assets were made undisposable save at the absolute discretion of the debenture holder. Also, Re Spectrum emphasized on the permanent appropriation of the secured assets, which might not be the case when certain assets are allowed to be disposed. In our case, this right is pre-agreed (contractual), and the chargee does not have any discretion and is not required to give its consent for every disposal. Even though Re Spectrum was a case concerning a charge over book debt, the key passages in the case are worded in general terms and do not appear to be confined to charges over book debts.

Agnew and Re Spectrum seem to overrule Queen’s Moat Houses where the right of a chargor to require a chargee to release the charged property from the charge was considered consistent with the fixed charge. It was later stated in Gray v G-T-P Group that Queens Moot Houses had very specific circumstances (it was a charge over a portforlio of hotels) and that Re Spectrum must take precedence over it because it came later. All these lead us to the conclusion, that the charge created by the parties would most likely be categorized as a floating charge. √

Taking into account specific nature of the machinery which requires updating from time to time, it might be commercially reasonable to include specific provisions for charge substitution in the charge documentation. However, it is not apparent that such provisions will be consistent with the fixed charge. If a chargor or will have a right to dispose machinery without chargee’s consent, it appears to be inconsistent with the fixed charge. The right to substitute would normally require that the value remains constant. However, Agnew and Spectrum do not contain a suggestion that the necessary control is limited to the value of borrowing (a charge appears to have extend to all charged assets). For these reasons, Gullifer and Payne think that the right to substitute assets is not consistent with a fixed charge. However, they agree with Beate that a power to substitute machinery for the purposes of updating with very specific criteria for substitution might be sufficient.√ Excellent analysis of the issues.

2. A charge on present and future book debts (labeled as fixed)

The parties agreed that the debt will be collected by Darling and paid into a special “A” account with Southern. Provided this account is blocked (Darling cannot make any withdrawals from the account), this is not inconsistent with the nature of a fixed charge. However, in our case Darling may withdraw up to 10% of the amount paid in each month. Such arrangements do not satisfy the test of control in Re Spectrum because two crucial characteristics are absent:

• Permanent appropriation of the secured assets, and

• Active concurrence of a chargee to release part of the charge.

The later authority in the question of a charge over account – Gray v G-T-P Group (2010) – also emphasizes on these two characteristics to conclude that the charge over an account was not fixed.

• Will the position change if Southern withdraws the permission to make 10% withdrawals each month but from time to time it authorizes such withdrawals when asked specifically by Darling to do so?

In this case, a test of active concurrence to release a part of the charge (Re Spectrum) is satisfied. This seems to be consistent with the fixed charge.√

3. A charge on all other present and future assets and undertaking (labeled as floating)

It is widely accepted now that a charge can be created over the future assets. The essence of the floating charge is the freedom allowed to the company to carry on its business in the ordinary way in relation to the assets that are subject matter of the security (a third characteristic of the floating charge in Re Yorkshire, which was held to be the most essential our of all three in Agnew and Re Spectrum). The test to identify transactions which are in the ordinary course of business is rather broad (Ashborder BV) and can even include unprecedented or exceptional transactions. √