Opinion

The Lords’ decision concerning fixed and floating charges has put the banks on the back foot

The decision of the House of Lords in National Westminster Bank v Spectrum Plus earlier this year has caused controversy in banking circles, with suggestions that it is “uncommercial”. In reality, though, the House of Lords had no choice but to decide as it did. The problem with which it was concerned was caused by legislation, hence it can only be cured by legislation.

It was the English courts that took the lead in enabling lenders to take security over all the present and future assets of a company. If the assets charged cannot be disposed of by the company without the creditor’s consent, the charge is fixed. If the company has the authority to dispose of the assets free from the charge, the charge is floating. Spectrum Plus confirmed that, if a lender takes security over receivables and does not control the use of their proceeds, the lender’s charge is floating even if it is described as fixed.

Originally, the distinction between fixed and floating charges was only relevant to the company’s authority to dispose of the assets concerned. There was no other difference between them and they were both equally effective in the company’s insolvency. The reason that the distinction is now so important is that legislation has created an artificial division between fixed and floating charges in a company’s insolvency. Certain liabilities of the company are payable out of floating charge assets (but not out of fixed-charge assets) in priority to the secured creditor. These liabilities include claims of preferential creditors (mainly employees), a certain percentage of claims of unsecured creditors and also the expenses of an administrator of the company. As a result, it is no wonder that lenders are keen to ensure that they have a fixed charge over receivables.

The Spectrum Plus case has clarified one issue: that, in an ordinary secured financing, a charge over receivables will be a floating charge because the company is able to use the proceeds in the ordinary course of its business. The clear message from the House of Lords is that artificial mechanisms designed to create some limited form of control by the lender will not work if, in reality, the proceeds can be used by the company in its business.

One major uncertainty remains: the case did not consider the more structured types of transactions (such as securitisations), under which lenders are able to obtain some control over the proceeds of receivables. How much control is required in order to make the floating charge work in such a case is unclear. No guidance was given by the House of Lords and further litigation may be required to clarify this point.

Even if subsequent case law does clarify the position, there will always be an element of doubt as to whether a charge is fixed or floating. The test is necessarily imprecise and the uncertainty will only be resolved if legislation abolishes the requirement to draw the distinction between fixed and floating charges in an insolvency. If this were to be done, it would then focus minds on why any unsecured liabilities other than employees’ preferential claims should rank ahead of secured creditors’. The effectiveness of security in an insolvency has been a fundamental feature of English law for more than 300 years. There needs to be a compelling justification for giving unsecured creditors priority over a secured creditor.

Too many inroads into property rights simply diminish their value and make creditors less prepared to make finance available in reliance on them.

Richard Calnan, partner, Norton Rose