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Chapter 40
February 2006
PART 4
Company
A secured creditor, in relation to a company, means a creditor of the company who holds in respect of his/her debt a security over property of the company [note 1]. Security means, in relation to England and Wales, any mortgage, charge, lien, or other security [note 2].
In Re Paramount Airways Ltd [1990] BCC 130 the right of an airport to detain an aircraft under the Civil Aviation Act 1982 was held to be security in the form of a lien or charge under s248 (b). The following description of a security submitted by counsel for the administrators was adopted: -
‘Security is created where a person (‘the creditor’) to whom an obligation is owed by another (‘the debtor’) by statute or contract, in addition to the personal promise of the debtor to discharge the obligation, obtains rights exercisable against some property in which the debtor has an interest in order to enforce the discharge of the debtor's obligation to the creditor’.
Bankruptcy
In bankruptcy, a debt is secured to the extent that the person to whom the debt is owed holds any security for the debt (whether a mortgage, charge, lien or other security) over any property of the person by whom the debt is owed [note 3].
A lien on books, papers and other records is not included in the definition of security, except to the extent that they consist of documents which give a title to property and are held as such [note 4]. See paragraph 40.75 for further information on liens.
40.46 Hire-purchase and similar agreements
The term security as defined in the Act [note 2] [note 3] does not include the owner’s rights under a hire-purchase, conditional sale, chattel leasing or retention of title agreement. The status of these creditors is discussed at paragraphs 40.109 to 40.114.
40.47 Landlord’s right of re-entry
A landlord’s right of re-entry is not to be regarded as security [note 5]. The landlord’s position is discussed further at paragraphs 40.116.
Any security provided by a third party who has guaranteed a debt is not classed as security in relation to the company or bankrupt because it is not part of the company's or the bankrupt's property [note 6].
TYPES OF SECURITY
COMPANIES
(May 2008)
A ‘debenture’ is a written acknowledgement of a debt by a company, usually under seal, containing provisions as to the payment of interest and repayment of principal. It does not necessarily provide for security but usually does so by specifying security in the form of a charge over the company’s assets. Debentures given by companies are usually secured by a floating charge or a fixed and floating charge. A company can create more than one debenture which, unless specified otherwise, rank in order of priority according to the dates on which they were created.
A ‘charge’ is a binding liability to pay laid upon a particular asset. Unlike a mortgage (see paragraph 40.60) it does not give the chargee a proprietary interest in or possession of the charged property.
40.50 Power of company to create charge
The power of the company to create a charge is given under its memorandum of association [note 7].
The charge may still be valid if the company has exceeded its powers in creating the charge. For the document to be properly executed, the person who signed it should have had the power to do so on behalf of the company. Where the document was signed by the director(s), or someone authorised by them to do so, and provided that the chargeholder acted in good faith, the charge will be valid even if the director(s) exceeded their powers.
The director(s) may be personally liable in an action for misfeasance or breach of duty if they caused the company to act outside the scope of its objects.
It is the company’s duty to send for registration all charges it creates [note 8]. A charge is void against the liquidator, administrator or any creditor if it is not registered with the Registrar of Companies within 21 days of its creation. For the purposes of registration ‘charge’ includes mortgages [note 9]. Where the charge is against property overseas the 21-day deadline can be extended to take account of reasonable postal delays [note 10].
The right of a creditor to recover his/her capital sum and interest from specific assets is termed a ‘fixed charge’.
A fixed charge attaches from the moment of its creation to the particular property in question, e.g. building or machinery, and gives the holder of the charge an immediate security over that property so that the company may not sell or otherwise deal with the property without the consent of the charge holder.
A ‘floating charge ’ is defined as a charge which, as created, was a floating charge [note 11].
A description of a floating charge was given in Re: Illingworth v Houldsworth [1904] AC 355 as follows:
‘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.’
Floating charges are commonly granted over current assets, such as stock. It is not a legal charge, as it does not fix on a specific item of mortgagable or registrable property. The holder of a floating charge has no right to possession of the assets covered by the charge until the occurrence of one of the events specified in the debenture which enforces the security, or by some other legally defined event, i.e. crystallisation.
Certain events cause crystallisation of a floating charge;
Crystalisation takes place on the occurrence of those events even though nothing to this effect is stated in the debenture and even if it is contrary to what is stated in the debenture [note 12].
In addition, the parties to the charge can agree contractually that a floating charge, created by a debenture, may be crystallised into a fixed charge by intervention of the debenture holder, since crystallisation is not only caused by operation of law [note 13]. Most commonly this intervention will take the form of the appointment of a receiver out of court by the debenture holder acting under powers contained in the charge instrument; but it may take other forms, e.g. the service of a notice converting the floating charge into a fixed charge in respect of specified assets.
It is usual for the parties to a charge to specify expressly whether a charge is to operate as a fixed charge or a floating charge, either generally or in relation to particular charged assets or classes of charged assets. However, an express stipulation is not necessarily conclusive as to the true nature of the charge. A charge expressed to be a fixed charge may be construed by a court as operating as a floating charge in spite of the description. A court will construe a charge according to its substance, and not its form, to determine whether the true or real nature of the charge is fixed or floating [note 13].
In Re: Hi-Fi Equipment (Cabinets) Ltd [1998] BCLC 65 Harman J defines the phrase ‘fixed plant and machinery’ as those being firmly fixed to the company premises. He also discussed the status of motor vehicles and concluded they would not be covered by a fixed charge.
40.56 Valid charges over book debts
Whilst it is possible to create a valid fixed charge over book debts, to be effective the fixed charge security depends on the way the security agreement ensures that the charge over the book debts is fixed. It is not easy to reconcile the company’s need to continue to collect and use the proceeds of book debts for its own business purposes which the lender’s wish to, in effect, escape the provisions of section 175(2)(b) of the Insolvency Act 1986 which gives preferential claims priority over the claims of floating charge debenture holders by attempting to subject the book debts to a fixed charge.
In the case of National Westminster Bank PLC v Spectrum Plus Limited (in voluntary liquidation) and others [2005] UKHL41 four ways were suggested to ensure that a charge over book debts was fixed;
In practice, the majority of situations of fixed charges being claimed over book debts the official receiver is likely to encounter will involve the company’s collection of the book debts, the payment of the proceeds of realisation into an account operated for the company by the bank debenture holder and then the company’s drawing on that money for use in its business. These are characteristics of a floating charge, not of a fixed charge, notwithstanding the description of the charge as being a fixed charge security. As such, the charge should be treated as if it were a floating charge, not a fixed charge, and the proceeds of the collection of book debts, and other assets which the company may have been permitted to deal with in the same way, should be subject to the claims of the preferential creditors [note 14].
It is suggested that in such cases, before applying the proceeds of the book debts in this way, official receivers, when acting as liquidator, should write to the charge holder notifying this view, with reference to this judgment, just in case an alternative view is taken by the debenture holder. In cases of difficulty, reference should be made to Technical Section.
As a general rule a charge created earlier would rank in priority for payment before a charge created later. A fixed charge is usually payable before any floating charge [note 15].
The priority of the charges may be changed by a ‘deed of priority’ agreed between the company and the holders of the charges affected by the change in priority. The deed of priority would be effective even where it resulted in a floating charge taking priority to an earlier fixed charge [note 16].
40.58 Priority for distribution purposes – distribution made before 4 March 2004
(June 2008)
The funds from the realisation of assets covered by a floating charge, where the winding-up order and the distribution were made before 4 March 2004, were available for the payment of costs and expenses of liquidation and to pay the company’s preferential creditors before being used to repay the creditors holding the floating charge. [Note 17] [Note 18]
40.58A Priority for distribution purposes – distribution made after 4 March 2004 but winding-up order made before 6 April 2008
(June 2008)
Following the decision in Leyland DAF Ltd on 4 March 2004 [Note 19] the funds from the realisation of assets covered by a floating charge were no longer available for the payment of the costs and expenses of a liquidation except insofar as they were incurred in realising and preserving the assets subject to the charge and the liquidator’s remuneration for this work in accordance with the relevant regulations in force at that time. Such funds were however available to pay the company’s preferential creditors before being used to repay the creditors holding the floating charge. (See Chapter 36A, paragraph 36A.66).
40.58B Priority for distribution purposes – winding-up order made after 6 April 2008
(June 2008)
On 6 April 2008 Section 176ZA of the Insolvency Act 1986, which was introduced by the Companies Act 2006, came in to force [Note 20]. This section provides that the liquidator’s general expenses shall, where the unencumbered assets are insufficient to meet those expenses, be paid in priority to the claims of preferential creditors and floating charge-holders, therefore effectively reversing the decision in Leyland DAF Ltd. This section may not be applied retrospectively and therefore applies only to winding-up orders made after 6 April 2008. Where the winding-up order is made following a resolution for a voluntary winding up passed by the company before 6 April 2008 the provisions of section 176ZA of the Insolvency Act 1986 will not be applicable and the guidance in paragraph 40.58A above should be followed.
The Insolvency (Amendment) Rules 2008, which came in to force at the same time, insert rules 4.218A to 4.218E in to the Insolvency Rules 1986, these additional rules restrict the application of Section 176ZA with regard to litigation expenses. The litigation expenses not having the priority provided by section 176ZA until approved or authorised in accordance with rules 4.218B to 4.218E by the preferential creditors, the floating charge holder(s) or the court [Note 21].
Litigation expenses for these purposes are defined as expenses of a liquidation which are properly chargeable or incurred in the preparation or conduct of any legal proceedings, and as expenses in liquidation, exceed, or in the opinion of the liquidator are likely to exceed £5,000 [Note 22]. (See Chapter 36, Part 3 for further details regarding the payment of liquidation expenses).
40.58C Priority for distribution purposes – Prescribed part
(May 2008)
In relevant cases where the charge was created on or after 15 September 2003, there may also be a percentage of any sums realised from assets subject to a floating charge, set aside for distribution to the unsecured creditors, known as the “prescribed part”, before the remainder being used to repay the charge-holder. For further information, see Chapter 36A, paragraphs 36A.72 and 36A.76 [Note 23].
(June 2008)
Where the floating charge is created after 15 September 2003, section 252 of the Enterprise Act 2002 inserts a new section 176A into the Insolvency Act 1986. Where there is a floating charge (created after 15 September 2003) relating to the property of a company in liquidation or administration, or where there is a provisional liquidator or receiver, the liquidator, receiver or administrator, must set aside a prescribed part of the company's net property for distribution amongst the unsecured creditors, before settling the debt to the charge-holder.
However, this provision will not apply in those cases where the liquidator, administrator or receiver thinks that the cost of making such a distribution to the unsecured creditors would be disproportionate to the benefits, in which case an application under section 176A(5) for an order to that effect must be made to the court (see Chapter 5 paragraph 5.36).
Net property for these purposes consist of the assets subject to the floating charge, net of the liquidator’s expenses and remuneration (see paragraphs 40.58 to 40.58B above) and the balance of the claims of preferential creditors, (following the realisation and allocation of any assets not subject to the charge) and such costs as can be applied to the floating charge account (see Chapter 36A, paragraph 36A.74).
Where the company’s net property is below £10,000 in value, 50% of that amount is the prescribed part to be made available to unsecured creditors.
Where the net property is over £10,000 the prescribed part to be made available to the unsecured creditors is 50% of the first £10,000 in value (i.e. £5,000) and 20% of the property in excess of that amount up to the maximum prescribed part of £600,000 (see Chapter 36A, paragraph 36A.87 and Chapter 56, paragraph 56.122).
In the case of Airbase (UK) Limited [Note 24] the question as to whether the floating charge-holder was entitled to claim, for distribution purposes, as an unsecured creditor for any shortfall in their claim (see paragraph 40.34) and hence receive part of the prescribed part, was considered. The court held that the floating charge-holder was not entitled to claim part of the prescribed part in relation to their claim for any shortfall. In making his decision Mr Justice Patten differentiated between unsecured creditors with no form of security and the unsecured claims of secured creditors in application of the pari passu rule with regard to the prescribed part.
The usual remedy in respect of company fixed charges is the appointment of a receiver to realise the security. For full details of appointments of receivers, see Chapter 9 - Action against property of insolvent, Part 3.
Where a qualifying floating charge was created before 15 September 2003 the chargeholder can appoint an administrative receiver see Chapter 9 - Action against property of insolvent, Part 3. The EA2002, restricts the use of administrative receiverships [note 25] and introduces new procedures whereby the holder of a qualifying floating charge in respect of a company’s property may appoint an administrator of the company see Chapter 56 - Alternative Corporate Procedures, Part 1 and Part 2.
APPLICABLE TO BOTH COMPANY AND BANKRUPTCY
The principal form of security encountered in bankruptcy cases (also available in companies) is the mortgage [note 26]. The majority of individuals finance the purchase of property by secured loans from a financial institution.
A mortgage is the conveyance, assignment or demise of any land or estate in it as security for the repayment of money borrowed. The owner (mortgagor) signs a deed (mortgage) that gives the lender (mortgagee) an interest in the property. The term mortgage is applied to the transaction itself, the deeds and the rights of the mortgagee. Mortgages are governed by the Law of Property Act 1925 and must be for a fixed term. The terms of the mortgage are set out in the mortgage deed [note 27].
An equitable mortgage is one originally recognised in the court of equity only but, as a result of the fusion of the courts of law and equity, all courts are now able to exercise that equitable jurisdiction. An equitable mortgage arises where:
40.62 Mortgage to be in writing
With effect from 27 September 1989 any contract for the disposition of an interest in land, i.e. a mortgage or charge, is not valid unless it is in writing, incorporates all the terms agreed by the parties and is signed by all the parties [note 29].
A first mortgage is the main mortgage on the property. Subsequent mortgages can be granted with the first mortgage always taking priority.
Where the debtor defaults on payment of the mortgage, the ultimate remedy is the repossession and sale of the property by the mortgagee.
Where there is a shortfall on the sale of the mortgaged property, the mortgagee becomes an unsecured creditor for the remainder of the debt.
Where a property is sold after the bankruptcy order the mortgagee’s proof must be limited to what was due for principal and interest at the date of the bankruptcy order after deducting the proceeds of the sale [note 30].
This is a charge specifically created as an equitable charge in land and differs from an equitable mortgage (see paragraph 40.61) in that there is no agreement to create a legal charge or mortgage and the chargee does not acquire a proprietary interest in the charged property. The chargee can either sue the borrower or apply to the court for an order to sell the property included in the charge. The chargee does not have foreclosure rights or any statutory powers of sale under the Law of Property Act 1925.
(September 2008)
A charging order is defined as a court order giving a judgment creditor security over specified assets of the debtor (usually freehold or leasehold property) [note 31].
A charging order may be made either absolutely or subject to conditions as to notifying the debtor or as to the time when the charge is to become enforceable, or as to other matters.
The charging order has the effect of, and is enforceable as if it was, an equitable charge (see 40.66) created by the debtor from the date of the making of the charging order or the date when the charge became enforceable. The court by which a charging order was made may at any time, on the application of the debtor or of any person interested in any property to which the order relates, make an order discharging or varying the charging order.
Prior to the insolvency order a solicitor can make an application for a charging order over an insolvent’s property [note 32]. For further details see Chapter 9 - Action against property of insolvent (paragraphs 9.116 to 9.119).
40.69 Enforcement procedure
(September 2008) A creditor is entitled to retain the benefit of a charging order, provided it was made absolute prior to the commencement of the liquidation or bankruptcy [note 33]. The decision whether to discharge a charging order is in the discretion of the court, but the existence of bankruptcy or liquidation proceedings is sufficient cause not to make the order enforceable subsequent to such proceedings where not enforceable at the commencement date [note 34] [note 34A]. Further information on charging orders is provided in Chapter 9- Actions against property of insolvent, Part 4.
REGISTRATION OF CHARGES
Any mortgage or charge against the insolvent’s interest in a property must be correctly executed [note 35]. Where the property comprises unregistered land and the mortgage is capable of registration under the Land Charges Act 1972, then it should be registered at the Land Charges Registry; this is necessary in order to bind purchasers.
Where the property comprises registered land, the mortgage or charge against the property should be registered with the Land Registry (see Chapter 50, Part 3); again, this is necessary in order to bind purchasers.
It is not necessary for a charging order obtained against a company to be registered with the Registrar of Companies even though a charging order has the effect of being an ‘equitable charge’ [note 36].
A bill of sale is an assignment under seal of personal chattels [note 37]. It is a means whereby assets can be disposed of prior to a liquidation or bankruptcy as the legal ownership of those chattels is transferred by a valid bill of sale. The official receiver may encounter bills of sale, also called chattel mortgages, where a bankrupt’s personal belongings have been transferred to a relative or friend, for a consideration, prior to the bankruptcy order, but he retains the use of them.
40.73 Registration of the Bill of Sale
A ‘security’ bill of sale is a bill given to secure payment of money and an ‘absolute’ bill of sale is given for any other purpose. A security bill of sale must be in accordance with the statutory form in the Schedule to the Bills of Sale Act 1878, and be for a sum of more than £30, or the whole debt is void [note 38]. Both types of bill of sale must be registered within seven days of their execution with the Registrar at the Filing and Record Department, Royal Courts of Justice, London [note 39].
The registration requirement was introduced to prevent individuals from secretly disposing of legal ownership of chattels and then raising credit on the strength of their apparent ownership. The failure to register a security bill of sale makes it void. The failure to register an absolute bill of sale makes it void against the chattels remaining in the insolvent’s possession.
(May 2008)
There are several companies currently offering to provide logbook loans, which are essentially a secured personal loan where the debtor’s motor vehicle acts as collateral.
The lender will generally retain the logbook upon advancing the loan, to prevent sale of the vehicle and the debtor will retain possession and use of the vehicle. The debtor is required to sign a credit agreement and a bill of sale. The effect of the bill of sale, once registered, is to transfer the legal ownership of the vehicle to the lender until the loan has been repaid in full within the terms of the agreement. The lender can then register a memorandum of satisfaction by giving evidence that the debt has been discharged therefore returning the legal ownership to the former debtor [Note 40]. See Chapter 63, paragraph 63.29 for more information regarding registration of bills of sale.
These loan agreements are intended to be short term loans and providers generally do not require a credit check to be undertaken, therefore the loans often have very high annual percentage rates, it is not unusual to find logbook loans with an annual percentage rate of over 300%. The official receiver may, where the circumstances of the case justify it, contact the local Trading Standards Office to seek their view as to whether, in the specific circumstances of the case, they would consider the transaction would constitute an extortionate credit transaction within the meaning of the Consumer Credit Act 1974 (see Chapter 31.4B, Part 6, paragraphs 31.4B.121 to 31.4B.136). Details of the local Trading Standards Office can be found on the Trading Standards website at www.tradingstandards.gov.uk.
40.74 Preference and transactions at an undervalue
The official receiver should check that the amount of the loan secured against the property was received by the insolvent in full, particularly where the funds were provided by an associate of the insolvent, as this may otherwise constitute a transaction at an undervalue or a preference [notes 41, 42, 43, 44, 45 and 46].
A lien is a right to retain possession of another’s property pending the discharge of indebtedness [notes 47, 48, 49 and 50]. Generally, a creditor with a right to a lien should be treated as a secured creditor in the insolvency unless the lien is over books, records and papers of the insolvent (and such items are not documents of title). Reference should be made to Chapter 10 - Custody, Preservation and Destruction of Records, Part 6 for guidance concerning the recovery of the insolvent’s records. The official receiver should always ensure that a creditor has a right to claim a lien over the property held when considering the validity of the lien. Should the official receiver be uncertain about the validity of a lien, he/she should seek advice from Technical Section. Details of the types of lien likely to be encountered and how to deal with them are given in Chapter 9 - Rights against property of insolvent, Part 5.
[Back to Part 3 - Set off] [Onto Part 5 - Preferential creditors]