Floating Charge Issues - Case Study Example

FLOATING CHARGE Question: Marina and Mortimer are the sole shareholders and directors of Imitation Furs Ltd. In order to expand their business they applied for a loan from Easy Bank Plc. Easy Bank Plc agreed to grant a loan of ' 500,000 to Imitation Furs Ltd, to be secured by a floating charge over the company's stock in trade. The charge was created on the 1st of July 2007. However, in February 2008 it was discovered that the company's solicitor had failed to register the charge. In April 2008 Marina and Mortimer applied for a further loan of ' 50,000 from Finance Co Ltd. Finance Co Ltd granted the loan to Imitation Furs Ltd to be secured by a floating charge over Imitation Furs Ltd's undertaking. A search at Company's House had not revealed any other existing charges. This floating charge was registered on the 24th of April 2008 at Companies' House, the same day it was created. In October 2008 Marina and Mortimer also decided to double their orders for polymeric fibers with Synthetic Fibres Plc, needed for the production of fake furs. Synthetic Fibres Plc insisted on a reservation of title clause in all contracts for future supplies of polymer fibers. In November 2008 Synthetic Fibres Plc made a delivery of '30,000 worth of polymeric fibres to Imitation Furs Ltd. Following the advice of their accountants on the 18th of March 2009, Imitation Furs Ltd is now in insolvent liquidation. The liquidator of Imitation Furs Ltd seeks your advice on the following points: a. The validity of the charges created in favour of Easy Bank Plc and Finance Co Ltd b. The goods supplied under the reservation of title clause Answer: To come up with an answer to the question, it is necessary to define first the meaning of floating charge and reservation of title clause (or simple retention of the title clause), where, when and how they are used, who can use, and the extent of their use. This paper will first begin with the discussion on the floating charge on the first part and the discussion of the simple retention of title clause on the second part. The discussion and conclusion will be based available scholarly works and decided cases relevant to the topic from reputable sources in the internet in answering the question. Floating Charge, Defined A floating charge is a mortgage, debenture or other security documentation, is likely to create charges over particular assets as security for borrowings or other indebtedness. There are essentially two types of charge, floating and fixed. A floating charge is appropriate to assets and material which is subject to change on a day to day basis, such as stock. Individual items move into and out of the charge as they are bought and sold in the ordinary course of events. The floating charge crystallizes if there is a default or similar event. At that stage the floating charge is converted to a fixed charge over the assets which it covers at that time. A floating charge is not as effective as a fixed charge but is more flexible.1 History of Floating Charge Floating charge has its roots from the United Kingdom.2 Historically, there is no legislation and no judicial decision that was a genesis of a floating charge, and the nature of the chargee's interest in the charged assets (or fund assets) remains doctrinally uncertain. The earliest descriptions were given by Lord Macnaghten in two cases.3 First, In Government Stocks and Other Securities Investment Co Ltd v Manila Rly Co [1897] AC 81 at 86 he said: "A floating security is an equitable charge on the assets for the time being of a going concern. It attaches to the subject charged in the varying condition in which it happens to be from time to time. It is the essence of such a charge that it remains dormant until the undertaking ceases to be a going concern, or until the person in whose favour the charge is created intervenes. His right to intervene may of course be suspended by agreement. But if there is no agreement for suspension, he may exercise his right whenever he pleases after default." Later in Illingworth v Houldsworth [1904] AC 355 at 358 he stated: "...a floating charge ... is ambulatory and shifting in 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." A description was subsequently given in Re Yorkshire Woolcombers Association [1903] 2 Ch 284, and despite Romer LJ clearly stating in that case that he did not intend to give a definition of the term floating charge, his description is generally cited as the most authoritative definition of what a floating charge is: it is a charge over a class of assets present and future; that class will be changing from time to time; and until the charge crystallises and attaches to the assets, the chargor may carry on its business in the ordinary way. When conducting a recent review of the authorities, in keeping with that tradition, in National Westminster bank plc v Spectrum Plus Limited and others [2005] UKHL 41, the House of Lords elected instead to describe the essential characteristic of a floating charge rather than define it, and they described it thus: "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." Floating Charge, How It Works Under the UK company law, a floating charge is applied to the assets of a debtor-company when a loan was obtained from a creditor-company as a security for the loan just in case the borrower-company will become insolvent or bankrupt. This means the creditor has the right to recover from the proceeds of the property of the borrower in liquidation or receivership proceedings as to the amount of the charge. But unlike fixed charge that attaches immediately to the assets as soon as the charge is created, floating charge only attaches to the asset after it crystallizes. The borrower could still deal with the stocks in the normal course of business even without the permission of the creditor.4 The company is at the same time secured through its assets and them sell or use the assets. For example, if the company received a loan for $100,000 using $100,000 of stock as a floating charge to secure the loan, it is still free to sell the stock. The outcome of this situation is that the charger is free to deal with assets as if they weren't secured (for example, the charger doesn't need the creditors consent to buy or sell assets) but still has the advantage of full security of the assets. This offers business owners a lot of freedom at least more freedom that a typical collateral situation offers.5 The floating charge cannot be normally enforced until it has crystallized. Crystallization usually occurs when a company gets into financial trouble and needs to declare bankruptcy or needs to be sold.6 In National Westminster bank plc v Spectrum Plus Limited and others [2005] UKHL 41, it provides the essential test of whether a charge was a fixed charge related to the chargor's power to continue to deal with the asset. In order to preserve the status of a charge as a fixed one, the bank must exercise actual control over disposal of the asset. If the chargor is able to deal with the asset, such as by drawing from the account in which charged funds are kept, or into which the proceeds of trade receivables are deposited, then the holder of the floating charge does not have effective control. Their Lordships held that as this is inconsistent with the status of the charge as fixed (if the chargor company is able to use the proceeds in the ordinary course of its business without the consent of the charge holder), the charge could only take effect as a floating charge.7 The Problem with Floating Charge The problem with lending money in a floating charge is that it offers no priority for payment in situations such as bankruptcy. For this, reason, floating charges are declared as unsecured charges. Almost all other creditors will have priority before the floating charge in the event of bankruptcy.8 The distinction between fixed and floating charges is of particular importance during receivership or insolvent liquidation (the two are not the same thing). In either event, the assets of the borrower must be applied to paying his debts according to clear priorities. In general, we may say that debts secured by fixed charges will be paid before those secured by floating charges. It is, therefore, very important to the creditors that the status of their charges as fixed or floating is clear. Because of the nature of the floating charge, the priority of the floating charge normally rank behind 1) holders of fixed security (such as mortgage, or fixed charged); and 2) preferential creditors.9 The matter is complicated by the fact there is a category of preferential debts which takes priority after those secured by fixed charges but before floating charge debts. These preferential debts include unpaid taxes and so the Inland Revenue and Customs and Excise have a definite interest if there is any doubt as to a charge status. Suppose an insolvent company owes the same amount in unpaid tax and to a secured creditor but has only enough money to pay one and not the other. The secured lender will be paid in full if the charge is a fixed charge and the tax authority will receive nothing, but if it is a floating charge the tax will be paid in full the priorities will reverse.10 Lastly, in the case of Bondworth [1980] Ch 228, it provides that under the English and Welsh law, there exist what are known as "charges". A charge is a form of security held over property that allows the holder to sell the property under certain conditions. In order to be valid however, charges have to be registered, if they are not they are void and unenforceable.11 Simple Retention of Title Clause The Retention of Title Clause allows for a supplier of goods to transfer possession of goods which have not yet been paid for, for example goods supplied on credit, whilst ensuring that he retains legal and beneficial title in the goods until the buyer pays for them Such a clause should is not used as a replacement for a credit checking system, but it provides an added layer of protection for the supplier in the event that the buyer fails to pay and is in danger of becoming bankrupt or insolvent. The Retention of Title Clause allows the seller to enter the buyer's premises for the purposes of inspecting or removing goods in which legal title has not yet passed (i.e. for which payment has not been made), and places an obligation on the buyer to ensure that the goods which are the subject of the clause are kept separately and are clearly identified as the goods of the seller. Whilst the seller will benefit from the retention of legal title in the goods, the buyer will still bear the risk in the goods and will be obliged to insure them against damage or loss.12 History of the Retention Clause Sometimes retention clauses are referred to as the "Romalpa" clauses, as the first decision dealing with them is named Aluminum Industrie Vaasen B.V. v Romalpa Aluminum Limited [1976] 1 WLR 676.13 It is one of the most heavily studied cases in English Law, and has lead to a forest's worth of litigation14 Unfortunately, it is also famous for being an extremely poor judgment. The facts of the case are as follows: "Romalpa bought a quantity of aluminium foil from the Dutch company Aluminium Industrie using a translated version of AIV's standard contract. Romalpa, subsequently became insolvent and called in the receivers. Just prior to this though, it had attempted to sell off the foil at a low price in order to pay off some of its debts. This money went into a separate bank account. At this point, AIV pointed, rather smugly, to Clause 13 of their standard contract, which stated that the foil remained their property until Romalpa had paid off any and all debts due to them. It also provided that until then, the foil had to be stored separately, and although Romalpa may manufacture products from the foil, title to the products was with AIV as surety, and the same went for any money made from selling the products. Romalpa's receivers argued that there was no provision made for the selling of the foil as is, but AIV asked the court to imply a clause that Romalpa was allowed to resell it, provided that all the proceeds went to AIV. The case went to the Court of Appeal, which is the second highest court in the English Legal System. They looked at the facts and decided that there was an implied term allowing for Romalpa to sell off the aluminium provided the proceeds went to AIV and that therefore there was a fiduciary relationship between the two. What this means is that the retention of title clause - Clause 13, which had only been left in because of a bad translation job - succeeded."15 In a post Romalpa case, the case Bond Worth [1980] Ch 228, Bond Worth were a carpets company and had taken delivery of a consignment of fibres from another company, Monsanto. Both companies then went bust and called in the receivers who began battling over who owned the title to the fibres. Monsanto had included clause in its contract that stated: (a) Equitable and beneficial ownership shall remain with us the sellers until full payment has been received, or until prior resale, in which case our beneficial entitlement shall attach to the proceeds of resale or to the claim for such proceeds, (b) Should the goods become constituents of or be converted into other products while subject to our equitable and beneficial ownership we shall have the equitable and beneficial ownership in such other products as if they were solely and simply the goods."16 Translated out of legalese, this was affectively a Romalpa clause, although it had been refined from the original Dutch translation. Monsanto's receivers therefore claimed that they owned the fibres and the carpets they had been spun into, Bond Worth claimed the opposite. The case went to the High Court. The High Court in the English and Welsh legal system is the court directly below the Court of Appeal, it is therefore in theory bound by its judgments, however, as has previously been noted, Romalpa was poorly decided, and the eminent and intelligent Slade J, realized this. He adopted a very legalistic, but very clever approach to the problem. The judgement: "Under English and Welsh law, there exists what are known as 'charges'. A charge is a form of security held over property that allows the holder to sell the property under certain conditions. In order to be valid however, charges have to be registered, if they are not, they are void and unenforceable. Slade J noted that the Romalpa clause that Monsanto sought to rely on could be considered a charge and that therefore, as it was unregistered, it could not be legally enforced, rendering the clause useless. So, according to the judgment of Slade J retention of title clauses are inherently invalid." It would have been nice if this was the end of it, and in a way, it should have been. Slade J's interpretation of the law is concise and clever. Yes, in theory companies could register their Romalpa clauses as charges and have them enforced, but they would be moved a long way down the receiver's list, far below the point where they would be likely to actually receive any of their money. Unfortunately, there was a problem. Justice Slade was only presiding over the High Court, and the High Court does not have the right to overturn or ignore a judgment of the Court of Appeal. Although the decision was not appealed, when the case next came before a judge, the question would be raised: which judgement should be followed' The case of Clough Mill Lrd v Geoffrey Martin [1984] 3 All ER is the reason why the retention of title clauses still exist in English and Welsh law. Although the reasoning of the judges does make a certain amount of sense, it is clearly a botched job. Nevertheless, you have to work with what you've got. Once again there are two companies, once again they contracted with each other, once again one of them went bust and once again the other one attempted to rely on retention of title clause. The court of first instance followed Bond Worth and held that the clause constituted an unregistered charge and was therefore unenforceable. This was objected to, and the case went to the Court of Appeal, which now had the unenviable task of deciding whether to follow its own judgment or the rather better judgment of the lower court. The Court of Appeal scoured Romalpa and Bond Worth and found a difference. The Bond Worth clause refers to the "equitable ownership" of the goods, the Romalpa, clause does not. The reason for this is that the concept of equitable ownership does not exist outside of systems that derive from the English and Welsh common-law, and therefore, a translated Dutch contract would not be expected to mention it. Leaping on this fact, the court judged that an equitable charge could not be created in the absence of equitable ownership, and that therefore, clauses that do not mention equity are in fact valid and enforceable.17 The Companies Act 2006 At present, the Companies Act 2006 (c. 46) is the statute that regulates the activities of companies in the United Kingdom that includes company charges. Section 860, subsection 1 of the Act provides that a company that creates a charge to which this section applies must deliver the prescribed particulars of the charge, together with the instrument (if any) by which the charge is created or evidenced, to the registrar for registration before the end of the period allowed for registration. Charges as referred in the said Act include but not limited to a floating charge on the company's property or undertaking (section 860, subsection 7, paragraph g) and a charge created or evidenced by an instrument which, if executed by an individual, would require registration as a bill of sale (section 860, subsection 7, paragraph b). If a company fails to comply with section 860,subsection 1 of this Act, an offence is committed by the company. Every officer of it who is in default, and a person guilty of an offence under section 860 is liable to a fine on conviction on indictment, and to a fine not exceeding the statutory maximum on summary conviction (section 860, Subsections 4 and 5). Section 870 of Companies Act 2006 provides the period allowed for registration of a charge created by a company which is 21 days beginning with the day after the day on which the charge is created. Section 874 of the Companies Act 2006 provides the consequence of failure to register charges created by a company. If a company creates a charge to which section 860 applies, the charge is void (so far as any security on the company's property or undertaking is conferred by it) against a liquidator, an administrator, and a creditor of a company, unless that section is complied with. However, this is without prejudice to any contract or obligation for repayment of the money secured by the charge, and when a charge becomes void under this section, the money secured by it immediately becomes payable. Conclusion: Applying the principles laid down in the court decisions and the provisions of the Companies Act 2006, the charge created in favour of Easy Bank Plc is invalid since it not registered. Therefore, Easy Bank Plc has no valid claim against Imitation Furs Ltd. On the part of Finance Co Ltd, the charge is valid since it is registered and the registration was made within the time prescribed which is 21 days. Therefore, Finance Co Ltd has a valid claim against Imitation Furs Ltd in the insolvency proceedings and the Imitation Furs Ltd should pay Finance Co Ltd. In relation to the goods supplied by Synthetic Fibers Plc to Imitation Furs Ltd, it is considered as a charge under section 860, subsection 7 of Companies Act 2006. And even considering said charge is void for failure to register, section 874, subsection 1 of Companies Act 2006 is without prejudice to any contract or obligation for repayment of the money secured by the charge. And when a charge becomes void under this section, the money secured by it immediately becomes payable (Section 874, subsection 3). Applying also the judgement in the case of Clough Mill Lrd v Geoffrey Martin [1984] 3 All ER, Synthetic Fibers Plc has a valid claim against Imitation Furs Ltd. It is because Sysnthetic Fibers Plc has an equitable interest over the polymeric fibers being the owner and the source of the fibers therefore it has a valid claim against Imitation Furs Ltd regardless of whether the reservation of the title clause as a charge is registered or not. Bibliography "Companies Act 2006". ICSA. Retrieved on March 26, 2009 from "Floating Charge". Clickdocs. Retrieved on March 22, 2009 from "Floating charge". Answers.com. Retrieved on March 22, 2009 from "Floating charges". ACCA. Retrieved on March 22, 2009 from Read More

 

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