In the recent case of Re Avanti Communications Limited (in administration)[1] (Re Avanti), the court considered the nature of fixed and floating charges. Whether a charge is fixed or floating has implications for both lenders and administrators in terms of determining to what extent a chargor can recover from the charged assets and to what extent a borrower can deal with its assets.
Background of case:
In Re Avanti, the administrators applied to the court to determine whether certain assets were subject to a fixed or floating charge pursuant to debentures granted by the relevant company. As all net proceeds from the sale of fixed charge assets are paid to secured creditors, and proceeds from the sale of floating charge assets are not paid to secured creditors until those who rank ahead of them under English insolvency law (such as administrator’s costs and HMRC) have been paid in full, the characterization of the charge was crucial for determining whether the secured lenders would recover their secured debt in full. If the charges over the assets were fixed, secured creditors could recover the amount owed to them. If the charges were determined to be floating, HMRC would rank as a preferential creditor with respect to certain taxes due by the insolvent company and would receive a portion of the proceeds from the sale of the assets.
The finance documents in question contained a restriction on the disposal of the relevant assets with certain exceptions, for example an exception allowing the company to dispose of obsolete assets. Exceptions are commonly negotiated in finance documents where certain assets are dealt with by a company in its ordinary course of business or circulating capital (such as inventory).
Two-stage test:
In determining whether the assets in question were subject to a fixed or floating charge, the Judge applied the two stage test set out in Agnew v Commissioners of Inland Revenue[2].
At the first stage, the court must determine the intention of the parties and which rights and obligations were intended to be granted with respect to the relevant assets.[3] At the second stage, the court then determines whether as a matter of law, irrespective of the intention of the parties, the assets are fixed or floating, with this analysis requiring consideration of the degree of control the chargor has over the relevant assets. In this particular case, although there were exceptions to the prohibition on asset disposals, the exceptions were restrictive and did not allow disposal in the ordinary course of business, which would indicate a floating charge. Although disposals were permitted in certain circumstances, the restrictions were strictly limited. In this second stage, there is a clear distinction between assets that form part of a company’s circulating capital and assets that although they form a class (such as, for example, machinery), are not fluctuating. Assets that form part of a company’s circulating capital are more likely to be subject to a floating charge, and assets that do not fluctuate are more likely to be subject to fixed security. The ability of the company to deal with a certain class of assets does not mean these assets are subject to a floating charge – it is a matter of the degree of control that the company can exercise over the relevant assets.
Impact of case:
This case clarifies that a complete prohibition on the ability of a company to dispose of the charged assets is not required for the court to determine the assets are subject to a fixed charge. Any exceptions must be clearly drafted when a chargee is seeking to take fixed security over the relevant assets.
If you have any questions about this post, please contact Drew D. Salvest, Natalie A. Stewart, Rebecca Green any of the attorneys in our Banking and Finance Industry Group or the attorney in the firm with whom you in regular contact.
[1] Re Avanti Communications Limited (in administration) [2023] EWHC 940 (Ch)
[2] Agnew v Commissioners of Inland Revenue [2001] UKPC 28
[3] Re Avanti Communications Limited (in administration) [2023] EWHC 940 (Ch) at [26]