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Insolvency Series: Floating or sinking?

07 March, 2018Keith Pond

It is my great privilege to have inherited books on banking and banking law from former colleagues.  Amongst my oldest and most prized books are:

Howard, SW, (1947), “Peeps into the Security Department, 2nd edition”, Harrison & Sons, London

and the ever popular

Chorley, (1938), “Law of Banking”, Sir Isaac Pitman & Sons Limited, London


As a warning to students I must note that old books, especially old law books, are apt to become out of date very rapidly and should not be relied upon for a current view of the legal environment.  However, they do contain some enduring points on the subject of the valuation of corporate debentures that create a “floating charge” over the assets of a company as security for bankers’ advances:

  • The value of the security must be easily ascertained (Howard, 1947. P6)
  • Companies giving debentures are often debarred from creating charges over assets that would diminish the value of the bank’s charge (Howard, 1947. p112)
  • Companies can dispose of charged assets in the ordinary course of business as if the mortgage did not exist (Chorley, 1938. P287)
  • The value of the security will depend chiefly on the condition of the company’s business (Chorley, 1938. P288)

Each of these points will be readily recognised by today’s corporate lenders:

  • Floating charge valuation is more of a dark art than an exact science and all a banker can hope for is a consistent source of good information on which valuations can be based.
  • It is better to take fixed charges over assets that can be fully identified, such as book debts, to avoid others doing so and to improve the banker’s position in the creditor hierarchy.
  • Monitoring of company transactions is essential to ensure that failing company directors do not allow assets to leak out of a company in a desperate attempt to keep it afloat.

Failing companies will often have poorly maintained property, equipment and uncollectable debts as cash starvation prioritises spending.


PICTURE BY STUART MILES AT FREEDIGITALPHOTOS.NET

 

The position of the banker’s floating charge is precarious enough in an insolvency but, even so, it has been under further attack for over 30 years:

1986 Insolvency Act

The introduction of the office of Administrator gave floating charge holders a choice when insolvency loomed. They could appoint an Administrative Receiver (AR), responsible only to the holder of the charge OR an Administrator (A), responsible for the best outcome for ALL creditors.

Many banks continued to choose their traditional remedy whilst others saw the way that the wind was blowing and tested the new Administrator scheme.

2002 Enterprise Act

15 September 2003 saw the imposition of the next legislative blow. Under the Enterprise Act no new floating charge could allow for the appointment of an AR. Rather, an Administrator was the only remedy. In theory, this would limit the influence of the bank on the Insolvency Practitioner’s decisions as actions must be in the interests of all creditors. The Office of Fair Trading (now Competitions and Markets Authority) report in 2010 showed that this depended on whether the bank would be fully repaid.

 

 

A second element of the Enterprise Act changes was the creation of a “Prescribed Part”, a fund of roughly 20% of qualifying floating charge proceeds (for charges dated after 15 September 2003) that would be distributed to unsecured creditors and in which the bank would be unable to share, even if it had a shortfall on its debt repayment.

So, as far as valuation and actual value derived from a floating charge is concerned, the legal environment has deteriorated for banks whilst the practical management of company relationships is as fraught as ever.

Why do floating charges persist?  Answers on a Form 395 (formerly Form 47).

References: 

Chorley, (1938), “Law of Banking”, Sir Isaac Pitman & Sons Limited, London

Howard, SW, (1947), “Peeps into the Security Department, 2nd edition”, Harrison & Sons, London

Office of Fair Trading, 2010, The Market for Corporate Insolvency Practitioners, available at: http://webarchive.nationalarchives.gov.uk/20140402142426/http:/www.oft.gov.uk/shared_oft/reports/Insolvency/oft1245

View and read previous articles by Keith Pond in the Insolvency Series.