#10444 - Security And Quasi Security - BPC Corporate Insolvency

Security and Quasi-Security Revision

Security

Context: When liquidator is appointed he can have recourse to the company’s corporate assets to distribute to creditors (the statutory trust property). But an asset is not available for this purpose if it is subject to a security interest.

Bristol Airport v Powdrill – ‘Security’ means ‘the creditor, in addition to the personal promise of the debtor to discharge the obligation, obtains rights exercisable against some property in which the debtor has an interest, to enforce the obligation’

(Note that the American definition is slightly different)

There are several types of ‘security’:

• Real vs. Personal (e.g. 3^rd party guarantee)

• Possessory (lien) vs. Non-possessory (mortgage/charge)

• Security (debtor grants interest over property in which it has an interest) vs. Quasi-security (fulfils the function of security but does not involve the grant of such rights e.g. retention of title)

Company charges

These do not involve the conveyance of ownership, but create an equitable property right held by creditor over the asset in question.

Re BCCI (No. 8) – The company also has an equity of redemption which is also a property right (so a company charge involves almost a type of shared property right).

There are 2 types of charges:

• Fixed – similar to mortgage in that it prevents chargor from disposing or otherwise dealing with the asset inconsistently with the chargee’s rights

• Floating – For certain types of disposable/revolving classes of assets e.g. raw materials, it is not commercially sensible to have a fixed charge where chargee is in control and company cannot deal with assets in ordinary course of business without express permission. So ingenious 19^th century equity lawyers devised the floating charge. This new device first propounded in Re Panama

Fixed charge

Illingsworth – ‘fastens on ascertained and defined property’

Holroyd v Marshall propounded concept of charge over ‘after acquired’ (future) property. Here it meant fixed charge (but other cases have raised question of floating).

Floating charge

Some judges found concept difficult – surely no security until crystallisation? Only a contract for provision of security? Certainly doesn’t do much for creditor prior to crystallisation.

But confirmed in Evans that floating charge creates immediate, albeit unattached security interest.

The freedom for company inherent in floating charge does not mean creditor is not protected:

Wallace – Term read into agreement that if insolvency occurred, permission to deal automatically cased and floating charged ‘crystallised’ into fixed charge

Government Stocks – Ceasing to trade in the ordinary way is also a crystallising event

Evans – Chargee appointing practitioner to seize assets also a crystallising event

Romer LJ in Re Woolcombers Association 3 characteristics of floating charge:

1. Charge on class of assets of company present and future

2. Class is one which by its nature would change/revolve from time to time

3. If by the charge it’s contemplated that until some future step taken by creditor, company may carry on its business in ordinary way re the relevant assets

This 3^rd characteristic – freedom to deal, is what in the orthodox view is crucial to floating charge.

The fixed/floating charge dichotomy:

To unsecured creditors seemingly they are the same – both take priority, but legislation intervened and distinguished them – now some significant differences which are always sharply in focus:

Establishing a fixed charge

So based on all the advantages of fixed charge, creditors want to establish these:

Not enough for the charge instrument to state ‘fixed’ – objective test.

Notwithstanding one of Romer LJ’s factors being nature of asset, the main factor is ‘control’ (note not the same as possession):

Fixed charge = chargee has control over assets, or chargor prevented from having control over them

Re Cosslett – Council contract failed to vest ‘ownership’ of clean-up machinery in them, court said they had created a security interest. Was it fixed or floating?

Millett LJ – the prohibition on removing the machinery from the site without the permission of an engineer does not establish control for the purpose of preserving the collateral as security, but merely for operational purposes – to ensure the work would be completed.

So must look at objective behind establishing control, not merely whether it has been established.

Perhaps wrong approach, but this is the law.

Is a fixed charge over book debts possible?

Tailby – A charge can be created over book debts

What about a fixed one?

Must establish control over them, but because of revolving nature of proceeds of book debts, how do we do this without stopping company’s vital cash slow?

Early cases allowed this:

• Siebe Gorman – Company required to pay book debts into ‘blocked account’ with chargee bank. Charge said company could not deal with book debts without bank’s permission (even though in fact they did freely withdraw etc – judge missed the point). Held: Nevertheless, fixed charge created.

• Re Keenan Bros – Same facts, and despite delay in opening blocked account held: Fixed charge created.

• (Contrast Re Brightlife – Company forbidden from assigning debts before collected, but could pay them into their own account and could freely draw on it. Held: Floating charge)

These cases gave rise to unorthodox, opportunistic innovations:

• Re Atlantic Computer Systems – Atlantic hired computer systems and sub-leased them to ‘end-users’ for fixed rentals which were subject to ‘fixed charge’. Held: Fixed charge even though Atlantic collected them in and used them in business. By analogy to mortgage – could remain in possession of asset and use it (but CA ignored the fact that Atlantic were not merely using assets, but completely dissipating them. The decision seemed to be based on nature of assets rather than level of control - said charge on sub-leases and rentals was fixed charge as not ambulatory in character, so case wrongly assumed that because charge was over rentals due, it was not about a changing fund of assets and so must be fixed – wrong – unorthodox).

• New Bullas – Chargee 3i had no banking business so could not require payment into own account (like the debenture in Siebe Gorman), so said company’s book debts subject to fixed charge, but company could collect in proceeds, which in absence of instructions from 3i, were subject to a floating charge. No instructions ever given by 3i. Held: Fixed charge validly created over uncollected book debts (This seems to contradict Re Brightlife)

Return to orthodoxy:

• Agnew – Charge identical to New Bullas, but PC Lord Millett said company could collect them in so 3i had no control over them (even though this was supposedly the ‘fixed charge’ stage of the process). He also said Siebe Gorman was correct in law but wrong on its facts – account is only ‘blocked’ if it is actually operated as one (function over form – remember company were freely drawing on supposedly ‘blocked’ account)). PC merely persuasive.

• Re Spectrum Plus – Endorsed Millett’s 2 criticisms. Here Spectrum was granted an overdraft facility by bank in return for purported Siebe Gorman-type fixed charge over booked debts. Bank sought declaration that this was valid in light of Millett’s challenge in PC.

CA – In banking law, every payment into overdraft negated earlier indebtedness (so company were paying in and then lost control of that money – fixed charge)

HOL (7 lords as bank’s counsel asked for prospective ruling only so as not to invalidate the many Siebe Gorman-based purported fixed charges earlier) – Paying into overdrawn account frees up more overdraft for future use by the company (do not relinquish control).

Also followed Millett’s criticism of New Bullas and said must have control of both debts and proceeds for fixed charge.

They said in principle, remains possible to take fixed charge over book debts if these conditions met, and ingenuity of banking lawyers have tried to do this:

• Re Harmony Care Homes – Used New Bullas charge, but did give further instructions re the proceeds – that they be paid into specific account which chargee had mandate over, and exercised that mandate regularly. So sufficient control over both debts and proceeds established for fixed charge.

• (Contrast Gray v GTP – Not actually about book debts but analogous. Company able to access the funds in account (which were held on trust for them) and could freely draw unless clause 3 of agreement triggered by their insolvency – otherwise they could compel GTP to transfer them the funds. They had too much control over funds themselves for it to be a fixed charge – hence floating).

Re Spectrum has not provided all the answers:

What degree of control is necessary for a charge to be ‘fixed’?

Stock in trade:

Theoretically possible to have fixed charge over these too, since main factor is degree of control left to chargee, not the nature of the asset.

But in practice, re both receivables and stock in trade, creating fixed charge is commercially impractical.

Spectrum seems to require level of control of chargee giving consent every time asset disposed of etc which is impractical here.

Also, blanket consent in advance would not do as this would make the charge a floating one.

The only alternatives are therefore: Pledge through constructive delivery to creditor (e.g. field warehousing – stock kept with debtor but segregated from other stock and supervised by agent of chargee). Or acknowledgement that stock in trade held to the order of chargee and proceeds of sale must...