Distinguishing between a fixed and floating charge is highly important for parties engaged in commercial relationships. This distinction is significant because, according to English law, a fixed charge takes precedence over a floating charge. This means that even if a company has granted a floating charge to a creditor before establishing a fixed security, the fixed charge will still take priority.
Another reason for the less favorable position of holders of a floating charge, compared to holders of a fixed charge, is the provisions of Insolvency Act 1986. Particularly, section 176 of the Act prevents the distribution of part of the company’s net property to the holder of a floating charge unless the claims of unsecured creditors are fully satisfied. Additionally, the assets granted to the holder of a floating security can cover general expenses incurred during administration.
Determining the category of a specific charge among the aforementioned options is not a simple task. Although both parties have the freedom to determine their own rights and obligations, it is ultimately a legal matter to determine whether a charge is fixed or floating. The English courts have developed certain rules that must be taken into account (Agnew). This essay will analyze the criteria used to differentiate between fixed and floating charges, and will also discuss situations in which a charge over book debts should be considered fixed or floating.
The Yorkshire Woolcombers case, in which Romer LJ provided a definition of a floating charge, serves as the foundation for establishing differences between the charges mentioned above. According to Romer LJ, a floating charge fulfills three criteria: 1) it covers a class of assets of a company, both present and future; 2) this class of assets is one that typically changes over time in the ordinary course of the company’s business; 3) until some action is taken in relation to the charge by the interested parties, the company is allowed to continue its business as usual.
Lord Millett, in the Agnew case, stressed the final characteristic identified by Romer LJ, referred to as a defining feature of a floating charge. Lord Scott, in Re Spectrum, went even further by asserting that the initial two criteria are not always significant for every floating charge. When differentiating between the aforementioned charges, English courts must employ the two-step process of legal characterization established in Agnew.
The first stage of the process involves determining the intended rights and obligations between the parties regarding the charged assets. After this step, the Court can proceed to the second stage, which categorizes and assigns the appropriate legal label to the package of rights and obligations.
The House of Lords approved Lord Millett’s reasoning in Re Spectrum. This case highlighted the importance of a company’s freedom to handle its assets according to normal business practices, rather than focusing on the nature of the secured assets. The Siebe Gorman case set a groundbreaking precedent for distinguishing charges over book debts. Slade J determined that the restrictions placed on a company’s ability to use the proceeds from these debts constituted a level of control inconsistent with a floating charge. As a result, the debenture given to Barclays was classified as a fixed charge.
The case had a major impact on commercial practice. It granted creditors control over book debts and allowed chargors access to secured assets. In a separate case, the Court of Appeal ruled that a fixed and floating charge could be merged (New Bullas Trading). This involved establishing a fixed charge on the company’s outstanding book debts and a floating charge once the debts were deposited into a specific account, enabling the company to use them for regular business operations.
This structure had benefits for both the company and the bank. The company had the freedom to handle the proceeds, while the bank had priority over the uncollected book debt due to a fixed charge. This decision was made based on the principle of freedom of contract. Lord Millet later criticized this decision in New Bullas, stating that separating the charge was contradictory to the nature of a fixed charge. Both Siebe Gorman and Re New Bullas were later overturned by the House of Lords in Spectrum.
According to the reasoning behind Re Spectrum, if the company can handle its assets without the creditor’s approval, the charge should be classified as floating security regardless of how it is described in the agreement between the parties. However, if the company needs to get the creditor’s explicit approval before disposing of any of the charged assets, then the charge is considered fixed. It was clarified that if the chargor can freely manage the charged assets or their proceeds without prior consent from the chargee, then the charge must be floating.
