Company Law

QUESTION:

In August of 2008, “Strapped for Cash Ltd” created a fixed charge over its factory premises  (fixed charge) to secure a loan made by First Bank. In December 2008, Strapped for Cash Ltd created a subsequent fixed charge over the factory premises (fixed charge over the same asset) to secure a loan to Second Bank. This charge was immediately registered in the Companies Registration Office (CRO). (ISSUE) In April 2009, Strapped for Cash Ltd granted a floating charge over its stock to Third Bank. This charge was registered immediately in the CRO. In May 2010, a fixed charge was created over the book debts in favour of Fourth Bank. The charge was also registered immediately in the CRO. The debenture provided that the proceeds of the book debts were to be paid into a special account, nominated by Fourth Bank, and could not be used, even in the ordinary course of business, without the written consent of Fourth Bank. However, no account was ever nominated and Strapped for Cash Ltd continued to use the proceeds of the book debts in the course of its business. In June 2012, a liquidator was appointed to Strapped for Cash Ltd. Several days after the appointment of the liquidator, First Bank realised that its charge had never been registered. It then applied to the High Court for permission to register the charge. Citing relevant case law and statute, discuss the various priority issues which arise from the facts above.

ANSWER: 

Introduction

Whether expressly provided for in the Memorandum/Article of Association or not, a company almost always has an implied power to borrow. If not written, it will be implied. When money is borrowed, or a charge is created over assets, whether fixed or floating, the company issuing the debt is called the chargor whereas the bank is the chargee (charge holder) who doesn’t hold title to the assets, but merely an equitable right to realize the value of them should a crystallizing event occur. A ‘charge’ is an interest (legal or equitable), recognized by law, in company property created in favor of a creditor.

A ‘fixed charge’ is a charge or mortgage secured on particular property, e.g. land and buildings, a ship, piece of machinery, shares, intellectual property such as copyrights, patents, trade marks, etc. A ‘floating charge’ is a charge created on (usually) all the company’s assets both present and future, on terms that the company may deal with the assets in the ordinary course of business.

In light of these introductory remarks, there are 4 identifiable issues in the case at hand. They are; the creation of a subsequent fixed charge over the same asset (factory premises) and failure to register a fixed charge created (priority of creditors), creation of a fixed charge over book debts, non-compliance with requirements to create a special account and continuing use of proceeds of book debts despite prohibition, and the priority of Third Bank versus Fourth Bank.

Issue 1

In August 2008, “Strapped for Cash Ltd” (SFC) created a fixed charge over its factory premises to the benefit of First Bank (FB). However, in December 2008, SFC created a subsequent fixed charge over the same factory premises to secure a loan made by Second Bank (SB). SB’s charge was registered in the CRO, whereas FB’s was not. There are two sub-issues at play here, whether creating multiple fixed charges over the same assets is permissible, and who has priority as a result of the failure to register FB’s charge with the CRO?

i) Issue 1(a)

Creating multiple fixed charges over the same asset(s) is permitted, where no Negative Pledge Clause (NPC) has been included in the debenture documents. An NPC specifies that the company won’t create any additional charges which are equal or in priority of the existing charges already created in favour of the bank, without the first bank’s (chargee’s) permission. This is a contractual promise, and, if broken, leaves the company liable for damages, though this is somewhat of a false assurance as this only occurs after a company has gone into liquidation (become insolvent). In application of the NPC, we are not afforded the specific details of the first agreement between FB and SPC as to whether a NPC was included in the debenture documents. However, if one was, SPC would be open to liability.

ii) Issue 1(b)

On realizing that multiple charges over the same asset are permitted, we must consider whether FB can register the charge, and who ranks in priority as a result of the forgoing conclusion.

Charges must always be registered. Section 99 of the Companies Act 1963 requires almost every type of charge to be registered with the CRO within 21 days of their inception. This is to ensure public availability and knowledge of dealings. Failing to register within the 21 day period leaves the charge void against the creditor of the company. The debt remains valid, however, the security over that debt becomes invalid and although money is still owed to the bank in this case, it may no longer ran in priority above other creditors. Although an application for a charge can be valid after the 21 day period, as seen in the Lombar and Ulser Bank v Amurac case and Re O’Carroll Kent Ltd, this applies when the company is still solvent (generally). Where an application is granted for late registration, it is always done so without prejudice to the rights of the parties acquired during the period between when the charge was created and the date of registration. This formula thus protects SB. This practice is the same in the UK and Australia. Corollary to the conclusion made above, that FB cannot register the charge as SFC is in insolvency and with a presumed lack of a NPC, it would seem that SB, as a result of the proper registration of the CRO, as required under s. 99 of the CA 1963 would rank in priority, with regard to payouts in the case of insolvency.

In conclusion to issues a and issue b, we see that SB ranks in priority over FB as regards the fixed charge over the factory premises, resulting from the failure to properly register the charge with the CRO. FB’s only possible legal recourse may lie in an NPC clause, which we are unsure if one exists.

Issues 2 & 3

The second issue belying this case is whether a fixed charge can be created over book debts, where ‘book debts’ are defined as sums of money due to a business in the ordinary course of its business. The third issue is whether the factual matrix regarding Fourth Bank’s level of control permit the charge to be considered to be a ‘fixed charge over book debts’.

Answering the first issue, Siebe Gorman v Barclays Bank in England confirmed the validity of such devices, with specific conditions attached (see below). This was affirmed in Ireland in Re Keenan Bros Ltd.

As regards the second issue, in Siebe Gorman a special account was to be created for the book debts and the company was supposed to deal or draw from this account only with he express authorization of the Bank. The absence of such in Siebe Gorman was fatal to the lender’s contention that it was a fixed charge. Similarly, despite the documents requiring a special account be created, in Re Keenan Bros, none was ever actually created. Here it was held that the issue of control is the determining factor. It is not satisfactory to just provide in the documents that a special account be created etc., but the actions of the parties must reflect such contentions acutely. As Forde notes, any deviation from this formula is fatal. Supporting this, in Re Brightlife where the book debts did not have to be paid into a special account, the charge was held to be a ‘floating charge’. In Re Holidair, where no express direction was given by the lender as to how to use the funds, the charge was held to be ‘floating’, though this was tainted by Re New Bullas Trading where this was seen not to be fatal where the documents stipulated the charge to be ‘fixed’, though this case has been heavily criticized for not taking into consideration Re Holidair.

Derivation in Ireland comes in the form of Re Wagon’s Drogheda where it was stipulated that the absence of a specified bank account was immaterial where express authorization was required to withdraw/use funds under the charge. On account of this, it seems that the determining factor is not the account specified, but the actual control stipulated in using/withdrawing funds under the charge.

However, Keane notes that on any view, and in light of the difficulties surrounding the fixed/floating charge dichotomy, it would be prudent for lenders to follow as closely as possible Re Keenan Bros, where a special account is to be created and used, and authorizations required to use/withdraw funds, so as to properly cement the charge as ‘fixed’ as opposed to floating.

In applying this law to the facts at hand, although the debenture provided that the proceeds of the book debts were to be paid into a special account, nominated by Fourth Bank, and could not be used, even in the ordinary course of business, without the written consent of Fourth Bank, since no account was ever nominated and Strapped for Cash Ltd continued to use the proceeds of the book debts in the course of its business, the facts in this case run contrary to the requirements in Re Holidair, Re Wagons Drogheda, Re Brightlife, Siebe Gorman and most pertinently Re Keenan Bros. In citing Re New Bullas Trading as authoritative, it may be possible to find that the charge in this case was ‘fixed’, but this case may be seen as an outlier, and on account of the facts here, the charge is in fact likely to be seen as ‘floating’.

Issue 4

It is clear from the facts, and on account of the previous conclusion, that both Third Bank (TB) and Fourth Bank (FB) hold floating charges over SFC’s book debts. At issue is the priority of these lenders.

A crystallizing event has occurred on account of the appointment of a receiver (Nelson & Co v. Faber & Co.).

Section 285(2) of the 1963 Act require that preferential debts be paid off before those debts held as a result of a floating charge.

In line with keane’s determination, although unlikely to be paid at all given the Revenue Commissioner’s stake and those of FB and SB, TB will be a preferential creditor relative to FB, as a result of both charges being registered with the CRO within the 21 days, and by the fact that the date of TB’s charge is prior to the date of FB’s. Such is required under s. 99 of the CA 1963.

Conclusion

On account of the four issues in this case, the creation of a subsequent fixed charge over the same asset (factory premises) is seen to be permissible, and failure to register a fixed charge created (priority of creditors) renders SB, in this case, unable to register, likely on account of the liquidation of SFC. The creation of a fixed charge over book debts is permissible as a result of Re Keenan Bros and non-compliance with requirements to create a special account and continuing use of proceeds of book debts despite prohibition render FB’s TB’s supposed fixed charge a ‘floating’ charge instead. As regards the priority of all creditors, it follows in this order; SB, FB, TB, FB, among the RC’s and other creditors unmentioned in the facts given. 

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