The characterisation of a charge as fixed or floating can have significant ramifications for the chargee on chargor’s insolvency. This is because the holder of a fixed charge enjoys significant advantage, in terms of the order of priority of distributions to creditors, over a floating charge holder. There are rarely detailed judgments in this area but in Re Avanti Communications Ltd1, the court had to consider the proper characterisation of security over certain assets and confirmed, in a judgment dated 25 April 2023, that it was necessary to adopt a two-stage approach when determining whether a charge is fixed or floating. This is ultimately a matter of law and does not depend on the intention of the parties or the label assigned to the charge by the parties.

Why is this important for recoveries for secured (and other) creditors?

As of date of publication

A fixed charge characterisation would mean a first ranking priority in the distributions, whereas a floating charge characterisation would put the secured creditor behind those creditors who rank ahead of them in the prescribed order of priority. These include: costs and expenses of the insolvent estate, preferential creditors (which now importantly includes the HMRC in respect of certain taxes for insolvency proceedings commenced after 1 December 2020), and the prescribed part2 (the statutory ring-fenced fund for the benefit of unsecured creditors).

If the secured creditors are not repaid in full from the fixed charge proceeds and the proceeds of the sale from the floating charge assets are insufficient to repay all creditors who rank ahead of the floating charge holders, then the characterisation as fixed or floating will make the difference between the secured creditor being paid in full or being left with a shortfall.

So how do we measure whether a charge is fixed or floating?

The court in Avanti proposed a two stage test:

Stage 1: Review the security document and the nature of the assets

At the first stage, the court is required to construe the relevant instrument of charge itself in order to ascertain the nature of rights and obligations the parties intended to grant to each other in respect of the charged assets.

A key factor at this stage is the nature of the assets. A distinction is often drawn in case law between a chargor’s circulating capital (that is, the fluctuating body of assets which change from time to time in the ordinary course of the chargor’s business) and its non-circulating capital. It has been held that assets forming a company’s circulating capital lend themselves more naturally to a floating charge. The opposite applies to non-circulating capital, where the company does not need to sell them, deal with them, or substitute them as part of its ordinary business.

Stage 2: Characterise security by assessing control over the charged assets

At the second stage, the court turns to the characterisation of the charge by considering whether the rights and obligations in respect of the charged assets are consistent, as a matter of law, with fixed charge security or a floating charge security.

The critical question at this is stage is the question of control, which Avanti confirmed is an spectrum: at one end of the spectrum there is total freedom to deal with the charged assets (which is clearly incompatible with a fixed charge) and at the other end of the spectrum is total prohibition on dealing with the charged assets in any way (which is clearly incompatible with a floating charge). The issue, of course, arises where the position is at neither end of the spectrum but somewhere in between. As the judge in Avanti clarified, limited permissions for the chargor to deal with the charged assets are not fatal to its characterisation as a fixed charge and a more nuanced approach to the question of whether a charge is fixed or floating, having regard to all relevant factors and circumstances, should be taken.

As of date of publication

Recharacterisation of a fixed charge to a floating charge and risk of floating charge being set aside

If a charge that has been labelled as a fixed charge by the parties is recharacterised as a floating charge, it renders it susceptible, as with all floating charges, to being set aside if it was created within 12 months before the onset of insolvency (or 2 years if the charge is granted to a connected person) except to the extent that it secured new money3. If a floating charge is avoided then the creditor is no longer a secured creditor but instead an unsecured creditor, ranking significantly lower in terms of priority of distributions.

It is worth noting that the priority rules relating to preferential creditors, and their ranking above floating charge holders, does not apply to a floating charge which is a financial collateral arrangement (FCA) upon the chargor’s entry into an administration. In such a case, the chargor’s preferential creditors will not be paid in priority to the claims of a floating charge holder if that floating charge is created or otherwise arises under an FCA. Similarly, a floating charge that constitutes an FCA is not vulnerable to being avoided irrespective of the timing of its creation pre-insolvency.