Key takeaways
A total prohibition on the chargor dealing with the charged assets is not always necessary for the charge to take effect as a fixed charge. The High Court advocated a more nuanced approach to determining whether a charge is fixed or floating, depending on a combination of factors such as the nature of the chargor’s business and the charged assets, and the chargor’s ability to deal with the charged assets. There is therefore a “spectrum” of possibilities between total freedom to deal with the charged assets (plainly incompatible with a fixed charge) and a total prohibition on any kind of dealings in respect of those assets (typically a fixed charge).
This decision clarifies for creditors that taking fixed charge security with limited permissions for the chargor to deal with the charged assets may not necessarily be fatal to the characterisation of the charge.
Lenders will, however, need to exercise a degree of caution. For example, on trade finance transactions, the nature of a trading business and the assets subject to a charge (such as commodities or receivables) often fall on the wrong side of the “spectrum”, such that any significant freedom to deal with the assets without the lender’s consent will likely be inconsistent with the existence of a fixed charge.
Background
Under English law, a key consideration between the characterisation of a floating charge and a fixed charge is the degree of control exercised over the charged asset by the relevant lender.
Demonstrating sufficient control is, therefore, a key concern for lenders in order to mitigate the risk that a charge expressed as a fixed charge is re-characterised by the court as a floating charge.
The court undertakes a two-stage process when determining whether a charge is a fixed or floating charge. It:
- Construes the security documents and seeks to ascertain, from the language used, the intention of the parties as to the nature of the rights and obligations they intended to grant in respect of the charged assets.
- Determines the characterisation of the charge and whether – as a matter of law – the rights and obligations in respect of the charged assets are consistent with a fixed or floating charge.
The second stage is where the court considers the critical question of control over the charged assets. Certain academic commentary following the leading decision of the House of Lords in Re Spectrum Plus suggested that a fixed charge requires a total prohibition on the chargor dealing with the charged assets without the lender’s consent.
This lender desire for control is often at odds with the understandable desire of borrowers to maintain sufficient flexibility over the charged assets for commercial operation. It is a common point of negotiation since lenders are concerned that any exception to the total prohibition on the chargor dealing with the charged assets – although often negotiated by borrowers – may put them at risk of fixed security being re-characterised as a floating charge. This re-characterisation risk is ever more important now that HMRC ranks as a preferential creditor ahead of floating charge holders.
Avanti judgment
In Avanti, the High Court held that the House of Lords’ judgment in Re Spectrum Plus did not support the view expressed by a number of academics that a total prohibition on the chargor dealing with the charged assets is always necessary for the charge to take effect as a fixed charge.
Instead, the High Court advocated a more nuanced approach to determining whether a charge is fixed or floating, depending on a combination of factors such as the nature of the chargor’s business and the charged assets, and the chargor’s ability to deal with the charged assets. There is therefore a “spectrum” of possibilities between total freedom to deal with the charged assets (plainly incompatible with a fixed charge) and a total prohibition on any kind of dealings (typically indicative of a fixed charge).
In coming to this decision, the judge in Avanti undertook a useful exploration of the distinctions between fixed and floating charges:
- The nature of the assets: it is necessary to consider the nature of the charged assets. A distinction can be drawn between: (i) “infrastructure assets” (which are not required to be sold to generate income and are inherently difficult to transfer) where some flexibility to deal with the charged assets is not necessarily inconsistent with the existence of a fixed charge; and (ii) “circulating capital” (such as stock, where the assets are being accessed and used by the chargor) which needs to be sold to generate income. For the latter, the court will more readily conclude that freedom to deal with the charged assets by the chargor is inconsistent with a fixed charge.
- Nature of the business: the High Court also confirmed that it was right to have regard to the nature of the chargor’s business, as this can impact the analysis of the nature of the assets. For example, the same asset class, such as shares, could be categorised as circulating capital for a company engaged in the trading of shares but not categorised as circulating capital for another company that is not. The court will therefore tend to treat freedom to deal with charged assets that are naturally fluctuating in the ordinary course of a chargor’s business as more likely to be inconsistent with a fixed charge.
- Level of flexibility afforded: as such, having some freedom to deal with the charged assets will not necessarily be determinative in characterising a charge as a floating charge. Nevertheless, in Avanti the High Court relied on the “very significant control” by the chargee over the charged assets and the fact that freedom to deal with the charged assets by the chargor was “materially and significantly limited” to find that the relevant charge took effect as a fixed charge.
The key factors in Avanti that pointed to the charge taking effect as a fixed charge, notwithstanding the chargor having some ability to deal with the charged assets, were: (i) the charged assets (e.g., certain satellite and network/ground station equipment, rights to use orbital slots for satellites and ground station licences) were infrastructure assets which the chargor did not need to sell to generate income and were inherently difficult to transfer; and (ii) the charged assets were all subject to considerable restrictions upon their disposal and, crucially, the chargor was not permitted to dispose of the charged assets in the ordinary course of its business.
- [2023] EWHC 940 (Ch).
- [2005] UKHL 41.
Client Alert 2023-120
