Live Session 3 - Charges

Question 1

What is a charge

Answer 1

Interest in a company’s property created in favour of a creditor

Question 2

What is a fixed charge

Answer 2

Charge over assets of a company which are:

1. Ascertained and definite
2. Capable of being ascertained and definite

It attaches to property on creation providing that it is validly registered

Question 3

What will a fixed charge usually cover

Answer 3

1. Land and Buildings
2. Fixed Plant - i.e affixed to fabric of building, such as central heating system
3. IP rights - i.e patents
4. Uncalled share capital

Question 4

What are the effects of a fixed charge

Answer 4

1. That the company is no longer free to dispose of the charged property
2. Will need to seek authorisation of the charge holder before realising the charged property

Question 5

What are the characteristics of a floating charge

Answer 5

1. A charge over a class of assets - present and future
2. Changing from time to time in ordinary course of business
3. Company remains free to carry on business in usual way in relation to assets until crystallisation

Question 6

What type of assets are usually covered by floating charge

Answer 6

1. Stock
2. Non fixed plant & machinery
3. Debtors/ Receivables

Question 7

When can a charge holder appoint an Admin Receiver

Answer 7

If the charge was registered prior to 15 September 2003. If charge was registered after do not have that option and must appoint an administrator

Question 8

What is the distinction between “legal” and “equitable” charges

Answer 8

1. Legal charges are “good against the world”
2. Only legal charge has statutory right to appoint a receiver as set out by Law of Property Act 1925
3. Legal charge will be executed formally in a deed
4. Fixed charges may be legal or equitable
5. Floating charges are always equitable
6. Equitable charges are not good against a bona fide purchaser for value without notice of charge
7. Holders of equitable charges will only be able to appoint receiver where their charge gives them a contractual right to do so
8. Equitable charge will be executed in a less formal way, i.e signed contract or by deposit of title deed.

Question 9

What charge holder owes a duty to preferential creditors

Answer 9

Holders of fixed charge has no duty to pay prefs in priority to itself.

A receiver appointed by floating charge holder does have a duty to pay preferential creditors in priority to appointer.

Question 10

Does an administrator need to apply to Court to pay prefs in priority to floating charge holders

Answer 10

No - preferential debts have priority to floating charge debts and administrator is authorised to pay these in without needing to obtain court approval

Question 11

When is a floating charge invalid

Answer 11

1. When it was created within 12 months of application for administrator or date of commencement of liquidation. AND
2. Created at a time the company was insolvent, except to the extent that fresh consideration is provided for it.

Fresh consideration will often have been provided by the bank merely by turnover of the company’s bank account.

Question 12

Is a floating charge valid if it is given to a connected party

Answer 12

If charge is given to a connected party, it is considered to be invalid if it was granted in a two year and there is no requirement that the company should be insolvent at the time the charge was granted.

Note that this only applies in administration and liquidation, not administrative receivership.

Question 13

What advantages are there for a lender by taking a fixed charge over book debts

Answer 13

1. Book debts may be only assets that are readily realisable by a receiver - provide a good source of liquidity for early distribution.
2. Fixed charge assets are not subject to:
   - Claims of prefs
   - Prescribed part deductions

Note: In exam should assume that debenture creates a floating charge over book debts

Question 14

Why are book debts typically given a floating charge

Answer 14

They are constantly changing

Question 15

How is a fixed charge given to book debts

Answer 15

Company can assign book debts to fixed charge holder which prevents debtor company from dealing with book debts so that they are preserved for the benefit of security holder

Question 16

What is a Negative Pledge

Answer 16

Companies can issue fixed and floating charges, it is important to know how they rank.

Banks may make it a condition that company does not create charges ranking in priority to its own.

Negative pledge therefore is that a floating charge holder requires that no subsequent fixed charges are created in priority to its own floating charge.

Question 17

How is a negative pledge validly created

Answer 17

Negative pledge should be provided to Companies House as the registration of a floating charge does not constitute proper notice of the terms and conditions of security.

Exam point: State the administrator/ charge holder should check whether any deed of priority or negative pledge has been registered.

Question 18

When is a charge validly created

Answer 18

Fixed and floating charges must be registered at Companies House within 21 days of creation for them to be valid.

If not, they are void against:

• Liquidator
• Administrator
• Any creditor

Question 19

What constitutes a floating charge when informally drawn up

Answer 19

Court will look at wording. ROT clauses that purport to attach to the proceeds of sale will be void if not registered.

Question 20

Whose responsibility is it for the charge to be registered

Answer 20

In theory obligation of the company (via directors) to register charge.

In practice, the banks/ lenders solicitor will do so.

Question 21

When could a fixed charge be challenged as a preference

Answer 21

If it has been registered within 6 months of commencement of insolvency proceedings it could be challenged as a preference.

Question 22

What conditions must exist to challenge a fixed charge as a preference.

Answer 22

1. Company was insolvent at the time charge granted
2. There was a desire to improve the lenders position.

Note: if charge granted to prevent bank from calling debt or taking enforcement actions, the desire to improve the banks position is not present.

If the directors motive in granting the charge was to reduce their exposure under personal guarantees, desire to improve the banks position is present

Question 23

How do fixed charges rank in priority to each other

Answer 23

1. Fixed charges over land rank in order of registration at the LAND REGISTRY - NOT Companies House.
2. Fixed charges over other assets rank in order of CREATION - NOT in order of registration at Companies House.

Question 24

What do fixed charge holders receive from realisation of assets?

Answer 24

Fixed charge holders receive realisations after deductions of costs, expenses & remuneration properly attributable to the fixed charge assets.

Prefs do not have any priority over fixed charge assets and will not be entitled to any surplus, remember, fixed charge receivers high of court determined market value and net sales proceeds.

Question 25

How do floating charges rank in priority to each other

Answer 25

In the absence of a deed of priority, floating charges rank in order of their creation - NOT date of registration at Companies House.

Remember: Preferential creditors rank ahead of floating charge holders

Question 26

What is the order of priority of payments made from floating charge assets

Answer 26

In order of priority:

1. Cost of preserving & realising floating charge assets
2. Office holders fees and expenses attributable to floating charge assets - subject to restriction of entitlement to draw fees on time cost basis which exceed fee estimate.
3. Preferential creditors
4. If floating charge created on or after 15 September 2003, prescribed part for unsecured creditors
5. Principal and interest of floating charge holder
6. Any surplus paid to company acting through directors/ liquidators.

Question 27

What are the categories of preferential claims (6)

Answer 27

Remember Prefs = PREPHW (image: Administrator can’t speak properly will gag).

1. P = Protective awards for failure to consult prior to redundancy
2. R = Redundancy Payment Service to the extent that they have met employees pref claims. They are subrogated to (assume legal rights of) employees
3. E = European Coal & Steel levies
4. P = Contributions to Occupational Pension Scheme
5. H = Holiday Pay
6. W = Unpaid Wages

Note: Redundancy Pay is not a pref claim

Question 28

What are the limits for contractual employment claims

- PHW - Pension, Holiday Pay, Wages

Answer 28

1. Contributions to occupational pension scheme by employees & employer - Goes back 12 months. Max pref claim is 10% of salary during that 12 month period.
2. All holiday pay accrued during past 12 months, up to a maximum of 6 weeks.
3. Remuneration payable to employee for 4 month period to relevant date. Restricted to £800.

Question 29

What is the relevant date for preferential claims

Answer 29

In administration - date on which company enters administration

In receivership - date on which receiver is appointed

In CVA - date the proposal is approved - unless director filed for a small company moratorium in which cast the relevant date is the date filed for moratorium.

Question 30

What SIP applies to a Receivers duty to prefs

Answer 30

SIP 14

Question 31

What are the main aspects of SIP 14 “A receiver’s responsibility to preferential creditors”

Answer 31

1. Emphasises importance of correct categorisation of assets between fixed and floating charges and also the correct allocation of costs between respective pools of realisations.
2. States that where costs can be clearly attributable to one class of charged assets, these should be recorded in the receivers records
3. Where allocation of costs is not obvious, receiver retains duty to allocate costs - he must use professional judgement made with independence of mind and integrity.

Question 32

What must a receiver consider when discharging his responsibility to prefs and allocating costs

Answer 32

1. Objective for which costs were incurred
2. Benefits obtained by those interested in one or other category of asset
3. Whether interest in fixed charge assets is enhanced by factors detrimental to floating charge assets - incur trading losses to protect value of property or book debts subject to fixed charge
4. Has the action taken to sell the company as a going concern resulted in a reduction in the quantum of debts which are preferential due to transfer of employment contracts (enhance return to floating charge).
5. What costs were incurred trading company with a view to selling it - i.e profitable trading may enhance value of floating charge assets, but may also increase value of fixed charge assets.
6. Consider costs incurred complying with statutory duties, i.e reporting.

Question 33

What is the Receivers duty to pay pref creds from floating charge assets.

Answer 33

Prefs are paid in priority to floating charge assets. But, case law means that receiver may be liable to pref creds where his actions have resulted in a reduction of assets to pay prefs.

I.e If trading losses are incurred to improve return to fixed charge assets but has result of reducing assets available to prefs, these losses may need to be made up out of enhanced fixed charge realisations.

Question 34

What should a receiver also consider when selling company as a going concern

Answer 34

That the total consideration paid by a purchaser may not reflect the financial interests of different classes of creditors. Receiver should ensure that he is able to discharge his responsibilities to both fixed and floating chargeholders.

Question 35

What is the Prescribed Part

Answer 35

It is part of floating charge assets that are made available for ordinary unsecured creditors.

Rules only apply where floating charge was created after 15 September 2003.

Question 36

How is the prescribed part calculated

Answer 36

Assets which would have been available to floating charge holders, less:

1. Costs and expenses of realising floating charge assets
2. Administrators remuneration related to realisation of floating charge assets
3. Preferential creditors

Company’s net property available to floating charge:

Prescribed part =

50% of first £10,000
20% of balance over £10,000.

Prescribed part is capped at £600,000.

Question 37

What are the exceptions to the prescribed part calculation

Answer 37

1. Where net property is less than £10,000 and cost of making distribution is disproportionate to the benefits.
2. If the court orders that the cost of distribution is disproportionate to the benefit.

Likely to arise when there is a large number of small value claims. However, court is reluctant to make orders on this basis as even small distribution is better than nothing.

3. Where there are multiple floating charge holders and they may achieve a better return by relinquishing their security and obtaining share in the prescribed part
4. Where CVA or Scheme provides that rule will not apply.

Question 38

When does the prescribed part rule not apply in CVA or scheme

Answer 38

The proposal must state the estimated value of the prescribed part as creditors will want to know that they are being compensated by enhanced dividends for giving up their rights to prescribed part. If prescribed part is more than the outcome of the proposal they will likely reject it.