Charges and Security — SQE1 FLK1 Business Law and Practice

A lender advances £2 million to a haulage company and takes a charge over all its receivables. The deed calls that security a first fixed charge, in those words, on every page. In practice the company collects its own debts, banks the money in its ordinary current account, and draws on that account for wages, fuel and repairs. Nobody at the lender ever asks to see it. The company is now in liquidation. Fixed, or floating?

Floating. And that single word moves the lender from the front of the queue to somewhere near the back. This is Charges and Security, the topic where the label on the document is worth nothing and control is worth everything. Keep the haulage company with you. We come back for it twice.

Here is the route. What fixed and floating charges are, and the control test that separates them. Then crystallisation, and where a floating charge sits in the queue. Then registration, and the 21 days you cannot miss. Then priority between competing lenders, and enforcement. Then the section that voids floating charges taken on the eve of insolvency. And, at the end, guarantees.

Start with why security exists at all. A company borrows. The lender's fear is simple: default, and it joins every other unsecured creditor in a queue for whatever is left. Security answers that fear. It gives the lender rights over identified assets, so it can enforce against those assets instead of competing for scraps. Which is also why secured money is usually cheaper money.

Two kinds of charge matter, and in practice you meet both in the same document, a debenture. A fixed charge attaches to specific, identifiable assets, and the company cannot dispose of them or deal with them without the lender's consent. The lender has control. Land and buildings. Named items of plant and machinery. Intellectual property. Shares in a subsidiary. A business holds those things rather than trading them.

Now the case that governs this whole topic. A bank took a charge over a company's book debts and called it fixed. The company was free to collect those debts and pay the proceeds into its ordinary current account, which it drew on as it pleased. The House of Lords held the charge was floating.

Substance, not label. That is Re Spectrum Plus, from 2005. And the practical lesson is exact: for a fixed charge over book debts, the proceeds must go into a blocked account that the lender controls.

So try the mirror image. A finance company lends to a printing business against a charge over its book debts. Every sum collected must be paid into a designated account with the finance company. Nothing may be drawn from it without written permission, and permission has twice been refused. The account is reviewed monthly. And the deed calls the charge floating. Fixed, or floating?

Fixed. The label was wrong the first time and it is wrong this time. Ask one question and one only: can the company deal with the asset without reference to the lender?

Which brings us to what a floating charge actually is. The classic description comes from Re Yorkshire Woolcombers Association, in 1903, and it has three marks. One, the charge is over a class of assets, present and future. Two, that class changes from time to time in the ordinary course of business. Three, until some step is taken the company may go on dealing with those assets. Stock. Raw materials. Work in progress. Cash at bank.

A floating charge does not float forever. It crystallises. It becomes fixed and fastens on whatever assets the company owns at that moment, and the freedom to deal is over. Four events do it automatically: the commencement of winding up, the appointment of an administrative receiver, the appointment of an administrator, and the company ceasing to carry on business. Beyond those, the instrument can add its own triggers. A written notice. A breached borrowing limit. A defaulted covenant.

Here is where candidates slip. A power to crystallise by notice is not crystallisation. Suppose the instrument lets the bank crystallise by written notice after a default. The company misses three payments. The bank demands the whole facility back. But it never sends the notice. The charge still floats. Default is not a crystallising event, a demand is not a crystallising event, and a power has to be exercised.

Which matters, because of where a floating charge sits in the queue. Out of an asset caught by a fixed charge, the fixed chargee is paid first. Everything else is floating charge property, and it goes out in a set order. The expenses of the winding up. Then the ordinary preferential debts, essentially employees' wage arrears and pension contributions. Then the secondary preferential debts, which since 1 December 2020 include HMRC for the tax deducted from wages and for VAT.

Then the prescribed part, ring-fenced for the unsecured creditors under s.176A of the Insolvency Act 1986. That is 50% of the first £10,000 of floating charge realisations, plus 20% of the rest, capped at £800,000. Only then is the floating chargee paid. After it, the ordinary unsecured creditors, and last, the shareholders. Count the layers. A floating charge is real security, but four things stand in front of it.

Back to the haulage company. Its lender advanced £2 million and believed it held first place. It is a floating chargee. So it queues behind the liquidation expenses, behind its employees' wage arrears, behind HMRC, and behind the slice ring-fenced for the trade creditors. All because nobody blocked the account.

Registration next, and this is the most mechanical part of the topic, which is exactly what makes it examinable. When a company creates a charge, the particulars and a certified copy of the instrument must reach Companies House within 21 days. That is s.859A of the Companies Act 2006. Note how you count: 21 days beginning with the day after the charge is created. A charge dated 15 June has day one on 16 June, and day twenty-one is 6 July. Hold that date.

Who has to file? Not necessarily the company. The company can, the lender can, and so can any other person interested in the charge. That is s.859A(2). In practice the lender always files, because it is the lender's security that dies if nobody does, and it can recover the fee from the company.

Miss the period and the consequence is brutal. Under s.859H the charge is void against a liquidator, against an administrator, and against a creditor of the company. Your secured lender walks into the insolvency as an ordinary unsecured creditor. And there is a sting in the tail: when the charge becomes void, the money it secured becomes immediately payable. The charge does still bind the company itself, which is cold comfort when the company has nothing left.

Is there a way back? Sometimes. Under s.859F the court may extend the period for delivery, on the application of the company or of any person interested. Accident, inadvertence, no prejudice to creditors, or simply that relief is just and equitable. But the order does not disturb rights acquired before the documents actually arrive.

Priority now. Two lenders, one asset, not enough money to go round. The starting rule is first in time, first in right. Two fixed charges over the same machine, and the earlier one wins. It makes no difference which reached Companies House first, because the register of charges is not a priority register. Two floating charges over the same assets, and again the earlier wins. A company that has floated a charge over everything cannot then promote a later one above it.

Now the rule that decides most exam questions on this topic. A fixed charge beats an earlier floating charge over the same asset even though it came later, provided the floating charge has not crystallised. Why? Because until crystallisation the company is free to deal with those assets in the ordinary course, and granting further security over them is dealing with them. The first lender gave that freedom away. Unless it did something about it.

Which is what a negative pledge is for. It is a term in the floating charge forbidding the company to create later security that ranks ahead of it or equally with it. But it binds a later lender only if that lender has notice. And notice is now easy to establish, because the statement of particulars must record whether the charge restricts further ranking security. That is s.859D(2)(c). Since 2013 the instrument itself also sits on the public file.

Two scenarios, opposite answers. Your solicitor searches the file, obtains the instrument, and reads a conventional negative pledge. You now have actual notice, so completing anyway puts your fixed charge behind the bank. Get its consent, or a deed of priority. Now change one fact. The pledge was added later by a side deed nobody filed. You searched, you read, you found nothing. You take without notice, and you keep your priority.

And one more. A charge over registered land engages two registers. Filing at Companies House keeps the charge alive against a liquidator. Priority in the land itself is decided by the Land Registration Act 2002, and by who registered there.

Enforcement. What can a secured lender actually do, and what can it no longer do? Start with the loss. Administrative receivership, where a lender holding a charge over substantially the whole business put in its own officeholder to run it, was taken away by the Enterprise Act 2002. The prohibition is s.72A of the Insolvency Act 1986. It catches every qualifying floating charge created on or after 15 September 2003, with narrow exceptions for capital markets and project finance.

What replaced it suits most lenders better anyway. A qualifying floating charge holder is one whose floating charge covers the whole or substantially the whole of the company's property. It can appoint an administrator out of court, simply by filing the prescribed documents. That is paragraph 14 of Schedule B1. No hearing, no judge.

And do not confuse that with the receiver who survived. A fixed-charge receiver over one specific property can still be appointed, under ss.101 and 109 of the Law of Property Act 1925 or under the charge itself. Narrowed, not abolished.

One trap on selling. Where the charge is by deed, the statutory power of sale arises as soon as the mortgage money falls due. That is s.101. Arising is not the same as exercisable. Under s.103 you must also wait three months after a notice requiring payment, or have interest two months in arrear, or find another breach of the deed.

Now the section that keeps insolvency practitioners busy. Section 245 of the Insolvency Act 1986 invalidates a floating charge created in the run-up to insolvency. Three things to hold on to. First, it bites on floating charges only, which is one more reason to take fixed security where you can. Second, the relevant time is 12 months before the onset of insolvency for an arm's length lender, and 2 years for a connected person.

Who counts as connected? A director, a shadow director, or an associate of a director, and associates include spouses, relatives and partners. So a floating charge to a director's spouse. Connected, or not? Connected. Which means two years, and no need to prove anything about solvency. Against an unconnected lender the liquidator must also show the company could not pay its debts.

Third, and this is the heart of it. The charge is invalid except to the extent of new value: money paid, or goods or services supplied, at the same time as or after the charge is created. Secure an old debt with a new floating charge and you have secured nothing. Advance fresh money on the day, and the charge stands for that money even inside the window.

Overdrafts complicate that. A bank takes a floating charge when the account is £100,000 overdrawn. The company then pays in £80,000 and the bank honours £85,000 of new cheques. Under the rule in Clayton's Case, money paid in is set against the earliest debits. The old overdraft is gone, the new cheques are new money, and the charge is good for £85,000.

Last piece. A security package is rarely only charges, and guarantees carry two rules worth marks. One. A guarantee is a promise to answer for someone else's default. Under s.4 of the Statute of Frauds 1677 it cannot be sued on unless it is in writing and signed. A telephone call will not do. An indemnity, a primary promise to see the lender paid whatever happens, needs no writing.

Two. Vary the underlying deal without asking the guarantor, and the guarantee is gone. That is the rule in Holme v Brunskill, from 1878. Raise the facility, raise the margin, extend the term, and the guarantor who was never asked walks away. Claiming only the original amount does not save it. Discharge is total.

Fixed where the lender can control. Floating where it cannot. That one sentence is most of this topic.

A word on how SQE1 tests this. You will not be asked to recall a case name or a section number. You get a set of facts, five answers, and one job, which is to pick the best one. So learn the rules. The names in this episode are memory pegs, nothing more.

If you keep only three. Re Spectrum Plus, where a charge called fixed turned out to float because the company could spend the money. Re Yorkshire Woolcombers Association, for the three marks of a floating charge, a changing class dealt with in the ordinary course. And Holme v Brunskill, where varying the loan behind the guarantor's back destroyed the guarantee.

Four traps. One: crystallising early does not promote you. A bank serves its crystallisation notice in March, before a June liquidation. It still ranks behind the employees and behind the prescribed part. For insolvency purposes a floating charge means a charge which, as created, was a floating charge. That is s.251.

Two: delivery to Companies House goes to validity, not to priority. Filing first buys you nothing in the ranking. And once the registrar has issued a certificate of registration, that certificate is conclusive evidence that the documents arrived in time. Under s.859I(6), even proof that the courier was a day late will not unpick it.

Three: not every security has to be registered. Hand the wine over to the lender's own bonded store and you have a pledge, a possessory security, not a charge, and there is nothing to file. Four: the first to give notice wins only in the right contest. The rule in Dearle v Hall governs competing assignments of receivables. It does not decide who gets the machine.

Quick check, and you have already met the date. A solicitor is completing a secured loan. The charge is over a printing press, it is plainly registrable, and it is executed and dated on 15 June. The trainee has diarised the filing for 5 July, reasoning that the Act allows twenty-one days from the date of the charge. Another lender wants security over the same press in July. By what date must the charge be delivered to the registrar?

Three candidate answers. One: 5 July, twenty-one days counted from the date the charge was created. Two: 6 July, twenty-one days beginning with the day after creation. Three: 15 July, the Act allowing one calendar month from creation. Pause here if you want a moment.

The answer is two. 6 July. The period allowed for delivery is 21 days beginning with the day after the date of creation, under s.859A(4). The charge was created on 15 June, so day one is 16 June, and counting twenty-one days lands you on 6 July.

Why the others fail. One counts from the date of creation itself and quietly loses a day. Three treats the period as a calendar month, and it is not, it is a number of days. And the stakes are real. Deliver on 6 July and the charge is safe. Deliver on 7 July and it is void against a liquidator, an administrator and a creditor.

Five things to take away. One: control decides everything. If the company can deal with the asset without asking, the charge floats, whatever the deed calls it. Two: deliver the particulars within 21 days beginning with the day after creation. Miss that and the charge is void against a liquidator, an administrator and a creditor, and the debt falls due at once.

Three: a fixed charge beats an earlier uncrystallised floating charge, unless the later lender had notice of a negative pledge. Four: floating charges queue behind the expenses, the preferential creditors and the prescribed part, and crystallising early will not change that. Five: our haulage lender wrote fixed on every page and still ranks as a floating chargee, because it let the company spend the money. Next time, Business Taxation.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.