- Taking Security in England and Wales
- May 6, 2003
- Law Firm: Buchanan Ingersoll, Professional Corporation - Pittsburgh Office
In general, the laws of England and Wales provide a creditor friendly environment in which lenders may take security from English companies. It is possible to take a single security document which will secure all liabilities, present or future, including contingent liabilities under guarantees and monies outstanding from time to time on fluctuating accounts. There are few technical requirements or registration formalities and the insolvency laws provide a considerable degree of protection and priority to the holders of security as against other creditors. This article gives a brief overview of some of the more important issues to be considered when taking security in England and Wales. It concentrates on the types of security which may be created and the rights which a secured creditor holds as a result. It does not deal with more technical aspects of the structuring of the lending itself or the tax treatment of these types of transactions.
This article deals primarily with security taken over companies incorporated in England and Wales which have assets situated in England and Wales. It is important to bear in mind that the British Isles contains a number of different jurisdictions such as, England and Wales, Scotland, Northern Ireland, the Republic of Ireland, the Isle of Man and the individual Channel Islands. Although many features of the law relating to security are common across these jurisdictions, they have distinct legal systems and local law advice will almost always need to be taken in relation to transactions which have a substantial connection with one of these jurisdictions.
Different Business Models
As is the case across the world, there are a number of different ways in which business may be carried on, such as sole proprietors, partnerships, unincorporated associations, unlimited companies, companies limited by guarantee and limited companies. Since the vast majority of substantial businesses in England and Wales are carried on by limited companies, the rules which are outlined in this article are those which relate to limited companies.
The Best Security
As explored in more detail below, the overall aim of a lender operating in England and Wales will be to obtain a full security package over all the assets of a company. Taking security over all or substantially all of the assets will enable the lender, if default occurs, to appoint an administrative receiver. An administrative receivership is seen as the most effective way of a lender, or more accurately an insolvency practitioner appointed by the lender, taking "control" of the relevant business and selling it as a going concern with as little damage as possible being done to that business by the onset of the insolvency of the relevant borrower.
How Is the Security Package Structured?
First, it is important to recognise that under English law there is a distinction between fixed and floating securities. The distinction is important for a number of reasons. First, floating security is more vulnerable to attack by a liquidator or other interested parties under the Insolvency Act 1986. Second, in general, a borrower has greater freedom to deal with its floating charge assets as opposed to its fixed charge assets during the ordinary conduct of its business. Third, when security is enforced, there is a statutory priority for paying out creditors. Broadly, this means that those paid out first are those holding fixed security, then so-called "preferential creditors" (such as the tax authorities and employees in relation to certain levels of wages), third the holders of floating security assets and fourth the creditors.
For these reasons, lenders have traditionally sought to obtain as much fixed, as opposed to floating, security as possible. In general, it is practical to take fixed security over those assets of a company which are not frequently dealt with in the day to day conduct of its business. For example, its land, shares held by it in other companies, insurance policies and intellectual property rights. There has been a considerable legal debate as to whether or not lenders can take effective fixed security over book debts or accounts receivable. As will be seen later, one of the main distinctions between fixed and floating security is the ability of the holder of the relevant security to control the way in which assets subject to the security are dealt with by the relevant borrower. Therefore, it is considered possible to create fixed security over book debts or accounts receivable provided a sufficient degree of control is exercised over those book debts and the proceeds derived from them. How this is achieved in an individual transaction, taking into account the banking arrangements and cash flow needs of the relevant business, is often a difficult area.
What is a Floating Charge?
Leaving aside book debts or accounts receivable, it is recognised that there are certain classes of assets such as inventory, equipment, office furniture and the like over which it is not possible to take effective fixed security. Nevertheless, English law does recognise effective security, termed floating charges, over such assets. The classic description of a floating charge is that:
- First, it is a charge on a class of assets, present and future.
- Second, that class is one which in the ordinary course of a business would be changing from time to time.
- Third, it is contemplated that until some step is taken by the lender, the borrower may carry on its business in the ordinary way in relation to that particular class of asset.
Security over contractual rights is usually achieved by taking an assignment of the benefit of the relevant contract. Since English law requires security to be capable of redemption, the assignment will be subject to a proviso that there will be a reassignment to the borrower on discharge of the security. Such an assignment will create fixed security and if it is linked to notification of such assignment to the other parties to the relevant contract, the lender will obtain certain rights against such parties, including most importantly, the right to receive direct money payable to the borrower under such contract. The question of rights of set-off in relation to such contractual payments is an area which requires careful evaluation.
Most types of security which a company creates must be registered with the Registrar of Companies for England and Wales within 21 days after the date of creation of the relevant security. The list of categories of security which are registrable is contained in Section 396 of the Companies Act 1985 and has certain anomalies. Not all types of security are registrable, so that charges over shares do not need to be registered.
However, it is likely that a charge over shares will include a charge over dividends and other monies payable under the shares and so will be caught by one of the other headings of Section 396. Such a heading is charges over book debts. "Book debts" is not statutory defined and it remains an open question whether it extends to certain classes of monetary asset such as proceeds held on trust in subordination arrangements. As with charges over shares, the prudent course is to register these.
Separate rules and a different registry system, apply to land and interests in land. There are also separate rules and registries for other types of assets such as aircraft, ships and intellectual property rights.
The rules relating to priority of different security packages held by lenders and other creditors are complex and beyond the scope of this article. Questions of priority turn on many issues such as the type of asset involved, the date of creation of the security, the date of its registration, which parties are on notice of the security and whether the debt it secures revolves. In practice it is best to regulate the rights and entitlements of a number of secured lenders by a priority agreement.