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LECTURE 12 Secured Financing
LECTURE 12 Secured Financing
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a present right to have the security made available, but only that
there should be a right in the future by agreement, such as a
license, to seize the goods, there will be no charge.
6 What is a Charge under Pakistani law
• Sec 100 CA 2017. Requirement to register a mortgage or
charge.—
• (1) A company that creates a mortgage or charge to which this
section applies must file the specified particulars of the mortgage
or charge, together with a copy of the instrument, if any, verified in
the specified manner, by which the mortgage or charge is created
or evidenced, with the registrar for registration within a period of
thirty days beginning with the day after the date of its creation.
• (2) This section applies to the following charges—
1.(a) a mortgage or charge on any immovable property wherever
situate, or any interest therein; or
2.(b) a mortgage or charge for the purposes of securing any issue
of debentures;
3.(c) a mortgage or charge on book debts of the company;
4.(d) a floating charge on the undertaking or property of the
company, including stock-in-trade;
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7 Charges are creatures of equity
8 Fixed and floating charges
9 The two types of company charges
1 Fixed charge
2 • Attaches to a particular asset or assets that are individually
specified
• The company cannot dispose of these assets without the
permission of the chargee
3 Floating charge
4 • Attaches to a “shifting fund of assets” which changes from time to
time
• The company is free to dispose of the charged assets in the
ordinary course of business
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11 Re Yorkshire Woolcombers Association [1904] per Romer LJ
I certainly do not intend to attempt to give an exact definition of the
term “floating charge,” nor am I prepared to say that there will not
be a floating charge within the meaning of the Act, which does not
contain all the three characteristics that I am about to mention, but I
certainly think that if a charge has the three characteristics that I am
about to mention it is a floating charge.
(1.) If it is a charge on a class of assets of a company present and
future;
(2.) if that class is one which, in the ordinary course of the business
of the company, would be changing from time to time; and
(3.) if you find that by the charge it is contemplated that, until some
future step is taken by or on behalf of those interested in the
charge, the company may carry on its business in the ordinary way
as far as concerns the particular class of assets I am dealing with.
12 Illingworth v Houldsworth ( 1904)
• ‘A floating charge is ambulatory and shifting in its nature, hovering
over and so to speak floating with the property which it is intended
to affect until some event occurs or some act is done which
causes it to settle and fasten on the subject of the charge within its
reach and grasp’
• It is a present security and NOT a Future security….
• Floating charge can extend to future and current property.
• But not on the proceeds of those Goods/ property!!
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• But not on the proceeds of those Goods/ property!!
13 Crystallisation of floating charges
• Until a floating charge crystallises a company can continue to deal
with the assets that are subject-matter of the security in the
ordinary course of its business.
• Debentures( the contract that creates the Charge) specify the
conditions upon which crystallisation occurs, normally default by
the company on its debts or presentation of a winding-up petition.
• When a floating charge crystallises into a fixed charge, it attaches
to the existing assets of the company within the ambit of the
charge at the relevant time and, unless the debenture stipulates
the contrary, all such assets that are subsequently acquired.
14 Crystallisation of floating charges
15 Example of a Crystallization event
• So lets assume there is a Company which has Land worth 1m£,
and machinery worth .5m £
• And it creates a Fixed charge of .7M £ on the land on the 1st of
February.
• And 1st Floating charge worth .3 m£ on the Machinery on the 1st
January.
• Their debenture states that the floating charge will crystalize upon
any change in financial circumstances or insolvency
• And 2nd Floating charge worth .5m£ on the 10th of January.
• This charge contains a term( the crystallization event term)
regarding change of management.
• The change of management takes place on the 5th of Feb.
• By the 31st of March, the company’s financial situation goes from
bad to worse and the company declares insolvency.
• How will the insolvency water fall look like now?
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16 Theoretical Justification?
• It is a fixed charge but accompanied by a license by the Chargee
to allow the charger to continue to use the property/ assets. ??
Strong academic opinion on this
• Not accepted as such by The courts. They have identified Floating
charge as a unique Charge and NOT the same a Fixed charge.
• What’s your take?
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• What’s your take?
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17 The test to distinguish types of charges
Lord Phillips MR in National Westminster Bank v Spectrum
Plus [2004]:
• “Initially it was not difficult to distinguish between a fixed and a
floating charge.
• A fixed charge arose where the chargor agreed that he would no
longer have the right of free disposal of the assets charged, but
that they should stand as security for the discharge of obligations
owed to the chargee.
• A floating charge was normally granted by a company which
wished to be free to acquire and dispose of assets in the normal
course of its business, but nonetheless to make its assets
available as security to the chargee in priority to other creditors
should it cease to trade.
• The hallmark of the floating charge was the agreement that the
chargor should be free to dispose of his assets in the normal
course of business unless and until the chargee intervened. Up to
that moment the charge floated.’’
18 Why does the distinction matter?
The order of priority of claims ( the Insolvency waterfall)
• Building up from last weeks discussion on unsecured debt
financing, we can now finally see how in the case of an insolvent
company, the different creditors will have priority. Starting from the
top the Fixed charge holders ( the highest priority) to the Debts
owed to Directors ( the lowest priority)
1.Property rights of 3rd parties like Mortgages
2.Fixed charges on Immovable property
3.Liquidation expenses
4.Preferential claims of employees ( and other similar claims like
Taxes etc owed to the HMRC)
5.Floating charge
6.General unsecured claims
7.Contractually deferred debts
8.Interest on all debts that accrues after winding up
9.Debts owed to directors guilty of wrongful trading
19 What is the practical significance of the distinction?
1.In liquidation, a fixed charge has priority over preferential claims,
while a floating charge ranks after preferential claims if the latter
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1.In liquidation, a fixed charge has priority over preferential claims,
while a floating charge ranks after preferential claims if the latter
cannot be satisfied by the other assets of the company.
2.Similarly with liquidation expenses.
3.A floating charge is subject to the prescribed part of assets that
are made available to unsecured creditors .
4. If the assets are at least £10,000, the prescribed part is 50% of
the £10,000 and 20% of the additional assets, up to a maximum
of £600,000.
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Taxes etc owed to the HMRC)
5.Floating charge
6.General unsecured claims
7.Contractually deferred debts
8.Interest on all debts that accrues after winding up
9.Debts owed to directors guilty of wrongful trading
30 The early stages of the litigation
• The High Court held, applying Agnew and declining to follow New
Bullas, that because the charge allowed Spectrum to use the
proceeds of the debts in the normal course of business it must
have been a floating charge.
• The Court of Appeal unanimously found that it was bound by Re
New Bullas and held that where a chargor is prohibited from
disposing of receivables before they are collected and must pay
them into a chargee’s account, the charge must be construed as
fixed.
31 The new approach
• Siebe Gorman was overruled.
• ‘With regret, the conclusion has to be that it is not possible to
defend the decision on any rational basis. It is not enough to say
that it has stood for more than 25 years. The fact is that, like any
other first instance decision, it was always open to correction if the
country's highest appellate court was persuaded that there was
something wrong with it.’
32 The nature of a floating charge
• ‘In my opinion, the essential characteristic of a floating charge, the
characteristic that distinguishes it from a fixed charge, is that the
asset subject to the charge is not finally appropriated as a security
for the payment of the debt until the occurrence of some future
event.
• In the meantime the chargor is left free to use the charged asset
and to remove it from the security. On this point I am in respectful
agreement with Lord Millett.’ Per Lord Scott.
33 Post-Spectrum: When will a charge on book debts be a fixed
charge?
34 Post-Spectrum: When will a charge on book debts be a fixed
charge?
• A third is to prevent all dealings with the debts other than their
collection, and to require the collected proceeds to be paid into an
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• A third is to prevent all dealings with the debts other than their
collection, and to require the collected proceeds to be paid into an
account with the chargee bank. That account must then be
blocked so as to preserve the proceeds for the benefit of the
chargee’s security.
• A fourth is to prevent all dealings with the debts other than their
collection and to require the collected proceeds to be paid into a
separate account with a third party bank. The chargee then takes
a fixed charge over that account so as to preserve the sums paid
into it for the benefit of its security.’
35 Corporate Governance and Debt financing
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Bank influence on the capital structure and corporate
governance of debtor companies
40 Suretyship vs Indemnities
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40 Suretyship vs Indemnities
41 Suretyship
• This means that under a suretyship guarantee the third party’s
liability only arises when the principal debtor defaults.
• The liability is co-extensive with that of the principal debtor, that is,
it is for the same amount, and it cannot be enforced if the
obligation of the principal debtor cannot (for example if it is illegal
or void or released by the creditor).
• If those rights are changed, either by agreement between the
creditor and the principal debtor or because of the conduct of the
creditor, the surety is protected by being discharged.
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42 Primary obligation vs Secondary obligations
• Where the third party’s obligation is primary, this means that it is
independent of that of the principal debtor and arises whether or
not there is default.
• In the case of an indemnity, it is the loss caused by default against
which the creditor is indemnified: if there is no default there will be
no loss.
• In the case of a performance bond or a standby credit, the
obligation to pay arises on demand irrespective of whether a
default has occurred.
• Where the obligation is primary, the third party’s liability is not
usually affected by matters affecting the contract between the
creditor and the principal debtor.
• It is this point that is the principal consequence of the distinction
between guarantees and indemnities, and on which many of the
cases turn.
• Another consequence is that contracts of guarantee must be in
writing and signed by the guarantor to be enforceable
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43 Registration of a charge over an IP at Companies House
•
• In addition, where security taken over IP is granted by a company
or a limited liability partnership registered in England and Wales,
the mortgage or charge must also be registered at Companies
House (in addition to being filed at the IPO).
• If the security interest is not duly filed at Companies House within
21 days from the date of creation of the mortgage or charge, then
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• If the security interest is not duly filed at Companies House within
21 days from the date of creation of the mortgage or charge, then
that security interest will be void against any creditor, liquidator, or
administrator of the security provider, and thus, ineffective (Note:
The 21 day period is extended slightly for mortgages/charges
created outside the UK).
44 Conclusions
• Security law as legal infrastructure to enable lending/ borrowing
• Reasons for getting security
• Creation of security interests vs perfection and registration
• Protection of other creditors via registration requirements and
limits to the priority obtained in liquidation
• Overhauling the whole range of security interests in the future in
lines with the US, Canada, Australia and New Zealand?