Floating charge
In finance, a floating charge is a security interest over a fund of changing assets of a company or other legal person. Unlike a fixed charge, which is created over ascertained and definite property, a floating charge is created over property of an ambulatory and shifting nature, such as receivables and stock.
The floating charge 'floats' or 'hovers' until the point at which it is converted into a fixed charge, attached to specific assets of the business. This crystallisation can be triggered by a number of events. In most common law jurisdictions it is an implied term in the security documents creating floating charges that a cessation of the company's right to deal with the assets in the ordinary course of business leads to automatic crystallisation. Additionally, security documents will usually include express terms that a default by the person granting the security will trigger crystallisation.
In most countries floating charges can only be granted by companies. If an individual person or a partnership was to try to grant a floating charge, then in most jurisdictions which recognise floating charges this 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 covered by them. In practice, as the charger has power to dispose of assets subject to a floating charge, so this is only of consequence in relation to disposals that occur after the charge has crystallised.
History
The floating charge has been described as "one of equity's most brilliant creations". They are legal devices created entirely by lawyers in private practice; there is no legislation or judicial decision that was the genesis of a floating charge.In Holroyd v Marshall 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. 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 recorded English case where a floating charge was recognised was Re Panama, New Zealand, and Australian Royal Mail Co 5 Ch App 318. 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.
The use of such floating charges increased in popularity and expanded rapidly until, as Lord Walker described it: "The floating charge had become a cuckoo in the nest of corporate insolvency." Criticism of the effect of floating charges grew, until Lord Macnaghten finally proclaimed in :
This led to a push back against the effect of floating charges in the form of the Preferential Payments in Bankruptcy Amendment Act 1897.
Definition
Later in Illingworth v Houldsworth AC 355 at 358 he stated:A description was subsequently given in Re Yorkshire Woolcombers Association 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.
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 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 possibility 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.
Flexibility
Floating charges are popular as a security device for two principal reasons. From the secured creditor's perspective, the security will cover each and every asset of the chargor. From the charger'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, which have been re-characterized as a floating charge being held to be void 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, 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 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.
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 receiver 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.
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:- holders of fixed security ; and
- preferential creditors, who are given priority by statute.
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 creditors. 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. 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.