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This dissertation has been submitted by a law student. This is not an example of the work written by our professional dissertation writers.

Published: Fri, 02 Feb 2018

Legal mechanisms which facilitate the debt financing of small corporations

Fixed or Floating? The Future for Small Companies

The tendency in modern scholarly material is to focus on the responsibility of corporations in modern society. There are great rafts of legislation that affect the duties of directors of corporations in areas such as employment, environment, health & safety and tax. The classic paradigm of a corporation was always understood as ‘an association of stockholders framed for their private gain and to be managed by its board of directors solely with that end in view’ . However, ever since the writings of Adolf Berle in the 1930’s there has been increasing recognition that legislative and judicial intervention is required to alter the way corporations interact with other constituents, of particular interest for this work is the focus on the way that smaller corporations interact with their creditors.

This work is largely concerned with the operation of fixed and floating charges which are the typical manner of security that creditors will obtain from corporations to secure repayment of their loan. The aim of the work is to look at the various legal mechanisms which facilitate the debt financing of small corporations and what the future may hold for them. In particular we look at three potential areas law reforms: The necessity of having the statutory and judicial framework which attaches consequences to title as opposed to allowing freedom of contract, between the parties, the increase in credit risk to unsecured creditors and its relationship to secured lending and finally the operation and remit of the Small Firms Loan Guarantee Scheme. These three aspects are all of importance to both the U.K. economy and productivity because if the balance is correctly managed it will encourage entrepreneurialism and enterprise.

The social importance of analyzing these issues has become apparent with rising business failure rates in the U.K. Overall there were 18,122 corporate failures last year, an 11% rise from the previous year , which is part of rising interest rates and high energy prices. In an economy, such as currently exists, where there are a large number of corporate failures every year the debt securing and collecting measures become of the utmost importance to the risk attitude of creditors and their willingness to lend. These have counter-productive economic results and this work intends to analyse some of the familiar flaws of the law on security of debt.

.As I have mentioned this work will primarily concentrate on the development, and necessity for, the distinction between fixed and floating charges. The purpose of doing this is to analyse whether such a distinction is necessary and whether or not we could supplant this with the natural antithesis to the current system: freedom of contract. We will then consider some ancillary issues; firstly, the current statistics on returns for unsecured creditors and the implications for a freedom of contract model. Secondly, the impact and relevance of the Small Firms Loan Guarantee Scheme as a way of improving financing opportunities as an alternative to secured lending. We will conclude by analysing the issues and attempting to provide advice for the future reforms of the law in the area. As we mentioned the agenda of this work is not only to analyse but make prospective suggestions about possible ways forward for law reform.

Fixed or Floating


The way that the common law has developed fixed and floating securities with the former being undoubtedly superior for numerous reasons, as we shall see, has lead to an antagonism between large creditors, such as banks, who seek to get their securities classified as fixed and the judiciary attempting to maintain some kind of logical separation between the two types . The outcome of this can be very important to small companies because of their general position on the penumbra of access to such finance. If large creditors are unable to adequately secure their debt then they may tend not to take any risks on Small Companies or on the flip side unsecured creditors may try and avoid small companies because of their increased risk.

However, first we will look at the genesis of these two-concepts which find no great support in ancient English- Common Law but had to be judicially created. This work is concerned at looking at the future of small companies and the reason for doing the following review is to extract an answer to whether companies are better off whether there are automatic consequences flowing from the type of security or whether intention of the parties ought to be binding.

The Creation and Mutation of the Floating Charge

It is wholly unsurprising to learn the judicial chicanery that pulled the floating charge out of thin-air was borne of commercial necessity in the industrial revolution and is widely traced to the nineteenth-century case of Holroyd v. Marshall . However, the story starts somewhat earlier than this with the Roman law concept of ‘Hypotheca’ . The Roman’s, similar to nineteenth-century England, had struggled with the constraints of the legal concepts of pledge and mortgage as the typical forms of security. However they developed their concept of ‘pignus’, or pledge, so that the borrower could remain in possession of the pledged item and give the creditor a contractual right to take possession in the event that the borrower defaulted .

The hypothec was rejected by the English judiciary in the eighteenth century case of Ryalle v. Rolle . In that case the court had held that ‘If a man gives an hypotheca or pignus with a condition that, if the money is not paid at a day, the pawnee shall enjoy the goods at such a price, that is not in the nature of a pawn, but a sale’ . It was felt that delivery of the item was essential to the idea of a pledge. The other type of security available was a mortgage but this required the particular assets to be identifiable and for the person to have an interest in that property. In a large corporation where assets were continually changing this was a near impossibility to achieve . Thus delivery is essential to pledge and actual and continuing ownership being essential to mortgage then preceding Holroyd there was no practically effective way of securing debt for corporations that were driving the industrial revolution.

The type of transformation that Roman Law had undergone, i.e. a modification of the concepts of pledge and mortgage, seemed unlikely because the judiciary was going through an era of extreme legal formalism , the authorities were extremely clear; both institutional writers such as Bacon and precedent in the courts made it clear that ‘title of future property would not pass at law without a new act of transfer by the grantor when it came into his possession’ .

In Holroyd the facts were such that a debtor had assigned pieces of property from their mill into a trust in favour of the creditor. The purported remit of the trust was to have prospective force in that it attempted to cover any materials that might be brought onto mill which could then be used as security in addition to or substitution for the original items transferred. To modern writers this set-up will look strikingly similar to the arrangement under a floating charge. As we saw, strict law wouldn’t allow this and at first instance and the first appeal the formalism of the common law was adhered to by then Lord Chancellor Lord Campbell. However, the second hearing of the appeal was after the death of Lord Campbell who was replaced as Lord Chancellor by Lord Westbury .

In the second hearing of the case the court’s drew on principles from the equity court’s to justify what was in effect a rather large departure from previous law. Lord Westbury, giving the lead judgement, stated in the most crucial passage:

‘If a vendor or mortgagor agree to sell or mortgage property, real or personal, of which he is not possessed at the time, and he receives the consideration for the contract, and afterwards become possessed of property answering the description in the contract, there is no doubt that a court of equity would compel him to perform the contract, and that the contract would in equity transfer the beneficial interest to the mortgagee or purchaser immediately on the property being acquired’

Pennington makes the point here that whilst Lord Westbury gave the lead judgement there was a slightly different attitude portrayed by the judgement of Lord Chelmsford, which achieved the same result but by a different manner . Lord Westbury’s dicta, above, implies that a beneficial interest would be transferred in the event of specific implement in a court of equity. However, Lord Chelmsford’s views were that ‘the moment the property comes into existence the agreement operates upon it’ or in other words the act of acquiring subsequent property automatically creates a beneficial interest, the contract self-executes . The striking thing about the judgement is the surprising lack of rationale for why equity would allow this result , this clearly exemplifies that the courts were in effect creating new law to suit commercial interests which required the law to keep-up with the relatively newly created statutory creature; the corporation.

The effect of this decision is argued to have become a commercial reality almost immediately and earlier versions of what we would consider to be floating charges started to appear however it was not for a further 17 years and the decision of In re Colonial Trusts Corporation that the term ‘floating security’ would come to be used by the courts and in the interim period the courts were not quick to entrench Holroyd. In King v. Marshall and Re British Provident Life and Fire Assurance Society, Stanley’s Case the courts rejected the attempted securitisation of future property being respectively; calls to shareholder / trade debts and uncalled capital. This was not an isolated trend and there were a number of other such cases which seriously called into question the substantive effect of Holroyd .

However, the decision was followed in Re Panama, New Zealand and Australian Royal Mail Co. which built upon Holroyd but by way of distinguishing previous decisions the court concentrated on an interpretation of the wording of the debenture document. It found that a debenture which created a security over its ‘undertakings’ was argued by Sir G.M. Giffard, L.J. to operate in the following manner:

‘I take the object and meaning of the debenture to be this, that the word ‘undertaking’ necessarily infers that the company will go on, and that the debenture holder could not interfere until either the interest which was due was unpaid, or until the period had arrived for the payment of his principal, and that principal was unpaid’

This case was followed a number of times so that these securities sui generis, at that time, became to be regularly recognised by the courts so that debentures creating charges over equivalently wide and prospective property were given force by the courts . In both Re Florence Land and Public Works Co. ex parte Moor and In re Colonial Trusts Corporation, above, the lead judgement was given by Jessell, M.R. who made the first reported use of the term ‘floating security’ which he defined as ‘ “a charge upon assets for the time being”, leaving the company to deal with them as they think fit till they are stopped either by a receiver or a winding-up’ . These decisions established floating charges as a feature of the commercial and legal landscape.

However, as with any judicially created concept which becomes an established part of our common law, the exact dimensions and nature of a floating charge have never been made explicit from this date onwards there has been hesitancy to provide an authoritative definition and whilst undoubtedly the commercial pressure that lead to creation of the ‘floating security’ by the judiciary did have it’s drawbacks for example Lord Macnaghten stated as early as 1896 that ‘Everybody knows that when there is a winding-up, debenture holders generally step in and sweep off everything. And a great scandal it is.’ . Lord Macnaghten was referring to the defeating of unsecured trade creditors by debenture holders but there were other flaws such as the distinction between fixed and floating securities which were unclear. These problems have lead to a steady stream of cases challenging the concept and its full dimensions from the late nineteenth century to modern day. We shall pick out the highlights of this development, which inevitably involved a degree of mutation from the key aspects identified in the preceding cases.

The dominance of debenture holders was growing and it is clear that parliament felt that some amelioration of the power of security-holders was required and they passed the Preferential Payments in Bankruptcy Amendment Act 1897 which created a class of ‘preferential creditors’ such as employees and crown creditors priority in distribution of the assets over security holders. Further statutory interventions in the Companies Act 1900 also required registration of a ‘floating charge’ and for the invalidation of them if granted shortly before insolvency proceedings. There was a general reservation over the operation of the floating charge after Florence and Colonial Trusts and Lord Macnaghten among many had expressed his feeling that the law ought to be changed. The fact that parliament refused to give an authoritative definition of a floating charge, however, begged the court’s to determine what is a floating charge?

However, this question is deceptively similar because there is a loose distinction to be made between what is widely understood as being a floating charge and what the jurisprudential concept of a floating charge ought to be? We will attempt to analyse both aspects. Shortly after the 1897 act the seminal defini tion of a floating charge was given in the ubiquitously quoted judgement of Romer LJ In re Yorkshire Woolcombers Association Limited. Houldsworth v. Yorkshire Woolcombers Association Limited :

‘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’

Whilst these subjective easily ascertainable aspects became the hallmarks of a floating charge in the early twentieth century the theory and complication of other aspects created its own uncertainties. In particular Pennington draws attention to the difficulties in the license jurisprudence . Stemming from a passage of Jessel M.R. in Re Florence that implied that a floating charge holder gave an implied license to the corporation to use and dispose of it’s assets as it saw fit certain courts took this as the position of a floating charge . Whereas others subscribed to a crystallisation-event thesis which meant the charge didn’t attach until that event had occurred . The problem was with the latter the floating charge-holder is not protected from ultra vires acts or attempts to destroy the investment of the security-holder.. There are drawbacks to both positions however because with a licence there would be problems were a company is wound-up for purposes of merging because in effect that would be revocation of the licence.

However, interestingly by the early-twentieth century what had in effect occurred was the judicial creation of what was in effect a Roman hypotheca, except rather than a contractual right that the hypotheca conferred it was a real right for the security holder . However, again commercial pressures began to exert their effect on the law as they had done in the nineteenth century. Statutory Intervention had altered the playing field so that preferential creditors could defeat the holders of floating charges and commercial pressures were thus looking to thread the needle and return to the debenture-holder’s hegemony. An obvious way of doing this was to draw securities that were specific charges but that still allowed flexibility for the borrower to carry on without much encumbrance, as a specific charge would have priority to preferential creditors . Thus throughout the twentieth-century and the early twenty-first century there has been a focus on the distinction between fixed and floating charges.

We have briefly mentioned above the early cases that contrasted fixed and floating securities. The House of Lords Appeal of the Woolcombers Association case was Illingworth v Houldsworth where the court discussed the distinction between fixed or floating charges:

‘A specific charge… is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined; a floating charge, on the other hand, is ambulatory and shifting in its nature’

This overall approach hasn’t really changed and we find similar language in modern courts over 90 years later, for example Millett LJ in Re Cosslett (Contractors) Limited :

‘The essence of a floating charge is that it is a charge, not on any particular asset, but on a fluctuating body of assets which remain under the management and control of the chargor, and which the chargor has the right to withdraw from the security despite the existence of the charge. The essence of a fixed charge is that the charge is on a particular asset or class of assets which the chargor cannot deal with free from the charge without the consent of the chargee. The question is not whether the chargor has complete freedom to carry on his business as he chooses, but whether the chargee is in control of the charged assets.’

Thus by and large the central concept of a floating charge was forged in the early-twentieth century and from the start its raison d’etre was to be more flexible and distinct from a mortgage, or fixed charge in the corporate world. In it’s essentials it remains unchanged, with the central tenet being that ‘where under the terms of the relevant security the chargor has the freedom…to deal and dispose of the assets in the ordinary course of business, the charge will be construed as a floating charge as opposed to a fixed charge’ .

However, in recent years there have been more particularistic debates about whether charges over certain property can properly be called fixed or floating. It is to these debates that we now turn because they represent the modern mutation and controversy of the floating charge. In particular they have focused in upon receivables such as book debts. As Millet LJ pointed out in Cossett, above, what is essential to the designation as a fixed security is the degree of control that the chargee has over the property, in particular it is the purpose and quality of that control which is essential . Thus focus becomes on the nature of the item charged i.e. whether it can be usefully the subject of a fixed charge, that being more favourable to the encumbered floating charge.

In Tailby v The Official Receiver the court made it clear there could be a fixed charge over ascertained book debt. It was, however, inevitable that corporations would attempt to create charges over future book-debts but what was not inevitable was the classification as fixed or floating debt. The leading case for many years had been the Siebe-Gorman case . Slade J. giving the lead judgement referred specifically to the dicta of Lord Macnaghten in Illingsworth above and Romer LJ Yorkshire Woolcombers, and in particular the former. He felt that it allowed a debenture of future book-debts where it is ‘in a form which creates in equity a specific charge on the proceeds of such debts as soon as they are received and consequently prevents the mortgagor from disposing of an unencumbered title to the subject matter of such charge without the mortgagee’s consent’ . However, he did qualify this by stating that the debenture document was different from the norm and ‘the effect of a charge on future book debts in the form more usually employed’ would be to create a floating charge. This was a decision that was immensely favourable to the banks because of the priority of a fixed charge. It was also the first case to recognise a right over future book-debts, however there was always a feeling that this decision was shaky so the banks and other large secured creditors had tried to avoid a case which might go to a higher court . As history would show these concerns were well founded.

The effect of Siebe-Gorman over the next 20 years was always doubtful but remained strong. It was sustained and applied in a number of cases such as Re a Company Ex Parte Copp , In Re Portbase Clothing Limited and Re New Bullas Trading Ltd . One case that seemed to lend significant support to the decision in Siebe-Gorman was the Irish Supreme Court decision in In re Keenan Brothers Limited . The Bullas case is worth mentioning briefly because of its later importance. In that case the debenture drafter had separated uncollected book debts and the proceeds of the book debts so that the latter was subject to a floating charge and the former to a fixed charge.

However, in an earlier case there had been a degree of doubt thrown over Siebe-Gorman by the dictum of Hoffman, J in Re Brightlife Ltd . This case was distinguished from Siebe-Gorman – the situation in Brightlife was that book-debts were being paid into an account not controlled by the chargee. Hoffman, J, similar to Slade, J, referred to the dicta of Romer J. however came to a separate conclusion that the debenture couldn’t cover these book-debts. The rationale behind this decision was that, despite a clause in the debenture that Hoffman J self-admittedly described as ‘highly restrictive of the company’s power to deal with it’s debts’ , he believed that ‘a floating charge is consistent with some restriction upon the company’s freedom to deal with its assets’ . He gave a comparative example of a prohibition on creating a further charge which ranks prior or pari-passu with the floating charge. It is hard to assess the impact of this decision. Brightlife is pointed to by a number of commentators as representing ‘a movement away from favouring fixed charges over book debts as established in Siebe Gorman’ but in reality it was distinguished from that and other cases solely on the premise that the company had more freedom in it’s use of the proceeds of book debts. It may be somewhat unrealistic as it is an isolated incident in the period between Siebe-Gorman in 1979 and 2001 when the privy council decision of Agnew v. Commission of Inland Revenue cast serious doubt on the U.K.’s approach to this debate.

We will discuss Agnew below but it as well to be aware that despite the apparent stability of the rule after Brightlife there were rumblings from both academics and abroad that the Siebe Gorman rule was not all it seemed to be. One example is the New Zealand case of Supercool Refrigeration and Air Conditioning v Hoverd Industries Ltd in which Tompkins J. rejected designating a charge over future book-debts as a fixed charge because: ‘…a requirement to pay the proceeds of the book debts into the company’s account without any restrictions on how the company may use the proceeds does not give effective possession of the proceeds to the Bank. It does not, without more, fasten the charge onto those proceeds.’

Furthermore, the UK jurisprudence was criticised because the developments in Siebe Gorman was influenced by the position internationally. In particular Canada had allowed specific charges over book debts for some time and that concept had ‘wormed’ itself into the UK Jurisprudence. However, it was criticised by Canadian scholars for failing to recognise that it didn’t fit with the U.K. wider jurisprudence. Canada had embraced the fixed charge and licence model however, as we know from above, this didn’t fit with U.K. Jurisprudence. The difference in jurisprudence was clear from the Canadian dicta of Nitikman J. in Robin Hood Flour Mills Limited v. Fuller Bakeries Ltd where the court made it clear ‘…even if the debtor used the accounts receivable collected…without these monies going into it’s bank account, whether with or without the acquiescence of the Bank, it did not change the character of the security from a specific floating charge’ . The decision was also criticised by academics such as Berg who criticised the decision in Siebe Gorman as having no real rationale for the conclusion that the debenture had been intended to deprive the company of free use of the book-debt proceeds and concluded that it was ‘unsound in deciding that such a general charge is a fixed charge’

However, the anomalous position came under serious question in the Agnew case which was appealed to the Privy Council from New Zealand. The court in effect made the decision that a document drafted in an extremely similar manner to the Bullas case above was not a fixed charge but a floating charge as it didn’t exemplify the requisite control. It also felt that the artificial distinction between uncollected book debts and the proceeds of book debts could not be logically upheld. This effectively closed this avenue. The final nail in the coffin came in the most recent decision on the issue: National Westminster Bank Plc v Spectrum Plus Limited (in creditors’ voluntary liquidation) & others (Re Spectrum Plus Limited) . In this case Morritt VC, at first instance, made it explicitly clear that Siebe Gorman is not good law:

‘…Siebe Gorman has stood for 25 years with little criticism. It is suggested that most bank’s standard forms are drafted on the assumption that Siebe Gorman was correctly decided and that thousands of liquidations have been conducted on the same assumption… It is with the greatest hesitation and reluctance that I differ from the conclusion of Slade J in Siebe Gorman. Nevertheless I am convinced that it is wrong’

The House of Lords, despite an overturning in the Court of Appeal, upheld the initial decision. Lord Hope rejected the rationale of Slade J. in that he felt that a deposit of funds in the bank of the creditor didn’t provide sufficient control particularly because it didn’t square with general banking principles. He relied on the banking case of Lipkin Gorman v Karpnale Ltd that established clearly that whilst money deposited with a bank is their money, they are under an obligation to repay it on demand. Lord Hope made it explicit, as did Morritt VC that ‘the proper course is for the Siebe Gorman decision to be overruled’ .

The importance of these decisions is of more general effect than the specific focus of book debts. The case of In Re Cosslett (Contractors) Ltd. showed that the fixed / floating jurisprudence, above, could be applied to analogous situations. in that case it was a charge over plant and machinery on a building site which the chargor had a fairly wide discretion to remove from the site. This decision followed Brightlife and is in line with Agnew and Spectrum. The case-law has greatly fleshed out the exact dimensions of a floating charge.

Legislative Impact

The foregoing only briefly mentioned the Preferential Payments in Bankruptcy (Amendment) Act 1897 however the importance of legislative intervention over the twentieth and twenty-first centuries has largely driven much of the litigation that the foregoing has reviewed. It is therefore apt to briefly analyse the progress of the legislation and its interpretation in the courts because of the large impact. However, in order to get a full picture we have to go back a few years to 1883.

The Companies Act 1883 at section 4 was the first statute to create a group of corporate constituents who were to be preferred, i.e. rank ahead of other creditors. The Act provided that the expenses of administration were to be reserved but after that it was the duty of the liquidator to disburse all ‘unpaid wages and salaries of clerks, servants, labourers and workmen’ before all other debts. Those preferential creditors were to rank equally and the assets were to be apportioned rateably between them. The Preferential Payments in Bankruptcy Act 1888 widened that preferential group to include the Crown in the form of due rates and taxes .

It had been established by In re David Lloyd & Co that ‘…the company ought not, because it has become insolvent or has been minded to wind up its affairs, to be placed in a better position than any other lessee with regard to his lessor’ . In other words a chargee’s rights were of a proprietary nature and were outwith the winding-up process. This had the practical effect of rendering the preferential status virtually impotent a situation which, as we will recall, Lord Macnaghten called ‘a great scandal’ . The law was thus modified by the Preferential Payments in Bankruptcy (Amendment) Act 1897 which provided that these preferential creditors would ‘have priority over the claims of holders of debentures or debenture stock under any floating charge created by such company’ . The overall effect of this change to the law was that ‘thenceforth preferential debts… were to be paid out of the property comprised in a floating charge so far as the non-charged assets were insufficient to discharge those debts. The proprietary rights of a debenture holder were, to that extent, bitten into’ .

The 1897 and 1888 Acts were consolidated by the Companies (Consolidation) Act 1908 but there has been little-to no substantive change to these provisions since that date and they are largely reproduced in the current s.175 Insolvency Act 1986. The definition of preferential debts in that time didn’t change much however there were significant changes to the whole of corporate rescue and insolvency law by the Enterprise Act 2002 which have changed the complexion of floating charges. The main changes are as follows:

  • Administrative Receivership for most purposes was abolished. This was largely done because the procedure was seen as giving too much power to floating charge holders who lacked the incentive to rescue companies . However, they did gain a power to appoint an administrator without a court’s permission. However, the administrator cannot be completely partial as they must act in accordance with a set of objectives set out in the Act. This seen as marrying the best of the Receivership mechanism with accountability to all creditors . The floating charge holder will have a relationship with the bank in administration but the administrator will be statutorily required to take account of all creditors interests.
  • The operation of preferential debt has changed. Firstly, the Enterprise Act abolished the Crown’s preferential status. Secondly, a proportion of floating charge recoveries must be set aside for general unsecured creditors . Whether this means they are giving with one-hand and taking with another remains to be seen.

These changes are some of the more radical since this system’s inception in the Companies Act 1883. Fundamental to its aim was to enhance the position of unsecured creditors and inevitably this has, to use Lord Nicholl’s phrase, ‘bitten into’ the rights of secured creditors but more particularly floating charge holders. There were some concessions that allowed security holders some preference in particular the prohibition on the administrator interfering with the security holder’s ability to enforce the security . However, the point has been made that it is unclear how effective this will be; having abolished administrative receivership then the compan

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