Floating Charges Under English Law and Their U.S. Counterparts: A Comparative Insight for Cross-Border Lenders

What Is a Floating Charge?
Floating charges have a long pedigree going back to ancient Rome but started to gain traction in the English legal system in the 19^thcentury. They were created so creditors could take security over assets that were not yet acquired by the debtor (i.e., future property), as long as the debtor was not an individual. The finance market eventually evolved so security documents would need to capture all present and future assets of the debtor while still allowing the debtor to dispose of assets in the ordinary course of business. Thus, the floating charge as we know it today was created.

There are three key characteristics that create a floating charge:

• It is over a class of present and future assets;

• The class is continuously changing due to the company’s business; and
• Until crystallization, the company can deal with those assets as it sees fit (without the charge-holder’s consent).

Typical types of assets that would fall into a well-drafted floating charge include money in bank accounts, inventory, receivables and raw materials. Unlike a fixed charge, the debtor retains control over the asset until a crystallization event occurs.

There has been much discussion over the centuries about what classifies as a fixed charge as opposed to a floating charge, but the House of Lords decision in 2005 for Re Spectrum Plus Ltd is considered the definitive authority (clarified by Avanti Communications Ltd). The House of Lords decided that the main distinction between a fixed and a floating charge is control over the asset, not how the security document classifies the charge. In this scenario, the company was required to pay certain collected debts into a bank account which the debenture declared was being held as a fixed charge. However, the debtor was able to freely use the proceeds in that bank account in its ordinary course of business. Even though the bank account was stated to be secured by way of fixed charge, since the debtor could freely use the funds, it was decided that the creditor instead held a floating charge over the account. To have a fixed charge over a bank account, a creditor needs to have control over the bank account. Therefore, it will need to be a blocked account either administered by the creditor or an account used by the debtor solely with permission of the creditor, which, depending on the specifics to the transaction, may not be commercially practicable.

The 2023 decision of Avanti Communications Ltd took a more nuanced approach than Re Spectrum Plus Ltd. While the same characteristics applied, it was noted that while (1) and (2) above are common features of a floating charge, they are not definitive. The distinguishing feature of a floating charge is (3) being the level of control the charge holder has over the assets.

Since a floating charge can be taken over fluctuating and future assets, it rapidly gained in popularity. However, since the party who takes a floating charge tends to be a bank or other experienced lender, floating charges also attracted criticism because it was thought that on insolvency, floating charges would allow such creditors to sweep up all assets of the debtor, leaving nothing for unsecured and/or trade creditors.

Protections for Unsecured Creditors
In response, Parliament introduced the concept of preferential creditors. In an insolvency scenario, creditors with a fixed charge would be paid out first out of the proceeds of the fixed charge. Next, preferential creditors would be paid. These include unpaid employee wages and certain taxes. The floating-charge holders come next in the waterfall ahead of all unsecured creditors and shareholders.

Another way unsecured creditors were protected was by the introduction of mandatory registration of charges. A company has 21 days after entering into the charge to register a security interest at Companies House (an easily accessible and searchable database). If a security interest, including a floating charge, is not registered within the timeframe, the charge will be void against the administrator or liquidator in an English insolvency process. This prevents the creation of secret charges. Before an unsecured trade creditor decides to contract with a company, they can search the database at Companies House to see what security interests would rank ahead of them in an insolvency. This will even tell them if there is a floating charge registered against the company.

Floating charges can be taken only over property legally and beneficially owned by the debtor. Therefore, any assets held on trust would not be captured in a floating charge. Trade creditors who are worried about the potential insolvency of a company can negotiate a retention of title for the asset they are selling, so the title passes to the debtor only once the trade creditor has been paid.

What Is Crystallization?
Debtors can freely use and dispose of floating-charge assets until a crystallization event occurs. There are a few mandatory crystallization events that occur by operation of law (usually concerning insolvency), but the crystallization events that most concern parties in a financing transaction are included in the security document and imposed by contract. Some of the main ways a floating charge can be crystallized pursuant to a security document are by:

• a breach of a covenant or event of default in the underlying financing agreement;

• the start of insolvency or winding-up proceedings;

• the appointment of an administrator or receiver;

• ceasing to trade; or

• the disposing of the floating-charge assets other than in the ordinary course of business.

If a floating charge is like a sword hanging threateningly over a debtor’s assets, the crystallization event is when that sword is dropped. In that moment, the floating charge becomes a fixed charge, and the debtor no longer has control to dispose of the asset as it pleases. It is important to note that any assets acquired after crystallization will not fall within the scope of the floating charge, as they were not part of the asset pool at the time it became fixed.

Practical Implications upon Insolvency
Creditors need to be wary about entering into a floating charge without providing new money in exchange. Depending on how close the debtor is to insolvency, it is possible that the floating charge could be set aside and declared as being void up to two years from when it was created (known as the “hardening period”).

While floating charges seem like the greatest invention of equity and a catchall for any of the debtor’s assets, there are large chunks that are taken out of them when a debtor is wound-up. After the fixed-charge holders have been paid, the expenses from the insolvency process will be settled (including the fees and costs of the insolvency practitioner). As mentioned above, certain preferential creditors (including a new class of secondary preferential creditors introduced in 2020, which includes VAT, “pay as you earn”—a method of paying tax at source in England—and Employee National Insurance Contributions due to HM Revenue & Customs) rank in priority to the floating-charge holders. The funds that these preferential creditors receive are taken from the proceeds of assets that are subject to the floating charge. Again, before the floating-charge holders are paid, a prescribed sum (calculated by statute as a percentage of the total-asset realizations) is also taken out of the floating charge to be given to unsecured creditors. The amount that is left over is then distributed to the floating-charge holders. If anything is left after being distributed to the floating-charge holders, the remainder will go to unsecured creditors and shareholders.

An advantage of being a floating-charge holder is that if the creditor has security over substantially all the debtor’s assets, it can, sometimes on demand but mostly on an event of default, enforce its security and appoint an administrator to a debtor (and force the insolvency process) without going through a court process. This will ensure that the floating-charge holder can appoint an insolvency practitioner who will actively consider the creditor’s interests when running the administration.

In the end, having a floating charge is still better than being unsecured, but it may not be as useful as creditors anticipate.

U.S. Law: After-Acquired Property Under Uniform Commercial Code (UCC) Article 9
There is no exact equivalent of a “floating charge” in the United States. However, the law in the United States does allow for after-acquired property to be included as part of the security package. In all U.S. states, secured transactions are governed by Article 9 of the UCC, which provides an efficient, flexible and comprehensive system for creating and enforcing security interests. Under UCC § 9-204, a lender can take a security interest in a general class of collateral that may change over time or may not even exist yet. In fact, UCC § 9-204 contemplates a present security interest in all categories of future personal property and fixtures, with the exception of commercial tort claims.

The key distinction here is that as of the time of execution of the primary security document contemplating such a security package, a security interest can be granted in all presently existing and after-acquired-personal property and fixtures of the debtor, and it is immediately enforceable against the debtor. Attachment (i.e., when a security interest with respect to personal property or fixtures becomes enforceable against the debtor by the secured party) occurs over the presently owned assets as of execution of the security document, and attachment over after-acquired property occurs automatically as such property is acquired. While it is not sufficient to grant a security interest in “all present and future assets,” a description of present and future assets by UCC category, such as “all present and future accounts, goods, general intangibles, investment property” and the like generally is sufficient. Moreover, it is not necessary that the debtor now or in the future must have an ownership interest in the collateral. Any rights whatsoever in the collateral, whether as owner, as licensee, as consignee (even another security interest) will suffice. An interesting difference between the UCC and the English law of charges relates to the debtor’s property interest in the collateral. As noted above, under English law a charge can be granted only in property that the debtor owns. Under the UCC, ownership is not necessary. The debtor simply must have some type of rights or the power to transfer rights. So a debtor that holds a license, sublicense, future interest or rights as consignee can create a security interest in those rights, whatever they may be. There can even be a security interest in a security interest.

Perfection of After-Acquired Property
Perfection is the process by which a secured party’s security interest in collateral becomes enforceable against third parties. In the case of inventory or accounts receivable, the standard method of perfection is by filing a UCC-1 financing statement with the Secretary of State or similar office in the debtor’s state of organization. In the collateral description of the financing statement, both present and after-acquired property can typically be described using language similar to:

“All assets in which the Debtor now or hereafter has any right, title or interest (or the power to transfer rights), whether now owned or existing or hereafter acquired or arising, including without limitation, all proceeds of any of the foregoing, whether in the form of money or any other type of property.”

Does UCC Article 9 Property Crystallize?
No, since Article 9 considers present and future collateral to be granted under a single security interest, there is no need for an asset to be re-classified from one type of security interest (floating) to another (fixed). Therefore, the concept of crystallization does not exist under the UCC. However, the lender is nevertheless afforded similar protections upon events that otherwise would typically constitute a crystallization event under English law. For example, when a borrower defaults on its obligations under a loan document, the lender may foreclose on assets, which typically means repossess and sell the collateral. If the lender chooses to foreclose on inventory, it may exercise remedies in the inventory that is on the borrower’s books as of the date of default. An event of default does not transform a floating right into the security interest itself as it would under English law, because the security interest already exists. An event of default allows the lender to exercise its UCC remedies with respect to the security interest that is already enforceable and perfected.

Under the UCC, a debtor can continue to deal in its own assets even when a security interest in them has been granted and perfected. This is a key difference between the UCC and the English law of charges. Any limitations on the ability of the debtor to handle, store, repair, administer, sell, lease or otherwise dispose of the asset prior to default is a matter of contract between the debtor and the secured party.

It is for this reason that the concept of a floating-security interest is not recognized in the United States. A mechanism already exists under the UCC to cover future personal property and fixtures. Unlike the floating charge in England, a security interest in present and future assets applies both to individuals and corporate or other juridical entities.

Practical Example of UCC Article 9
A company that manufactures products may obtain a loan from a lender by providing as collateral, among other assets, a general security interest in its inventory. By the very nature of its business, the company’s inventory is ever-changing, with products sold and restocked on a consistent basis. Under English law, the inventory would be pledged separately under a floating charge, as the asset class may vary from time to time and the debtor can dispose of such assets without the lender’s consent. Once a crystallization event occurs, the assets become determinable and therefore fixed, and the lender’s security interest in that fixed class of inventory becomes enforceable. Under the UCC in the United States, the manufacturing company would pledge its products under a U.S. security agreement, whereby the lender’s security interest in the products becomes enforceable against the manufacturing company. On the initial closing of the transaction, the lender would file a UCC-1 financing statement to perfect its security interest against third parties, describing the collateral to include inventory that is presently owned, existing and hereafter acquired (there may be other steps for perfection, as well, depending on the nature of the property). Therefore, as of such date, the lender’s security interest in future assets is established, perfected and enforceable.

Naturally, security arrangements in the United States require considerations beyond the attachment and perfection of a security interest. Priority of competing security UCC interests in the same collateral also needs to be considered, and certain statutory liens, such as tax liens, can arise that complicate the rights of a secured creditor under the UCC. Moreover, U.S. bankruptcy law can intervene to limit the rights of a secured creditor in after-acquired collateral, especially when the debtor’s rights in the collateral arise during the preference period prior to insolvency. However, the general principle remains: under the UCC, a secured creditor can secure rights in a debtor’s present and future personal property and fixtures, even without resorting to a concept of a “floating charge”.

Conclusion
Floating charges are a central element of English secured lending and are frequently documented in an all-assets debenture. Their appeal lies in offering creditors security over future assets, while allowing debtors the freedom to use those assets in the ordinary course of business. However, floating charges’ subordinated status upon insolvency and specifics around crystallization require careful consideration from all parties. When pledging collateral pursuant to U.S. law, future assets are pledged through a more streamlined process under Article 9 of the UCC, which allows for future assets to be pledged in conjunction with present, fixed assets under a single security interest. However, bankruptcy and similar laws relating to insolvency nonetheless can intervene to deprive a secured party of its rights in collateral.

As financing transactions are increasingly cross-jurisdictional, understanding the structural and legal complexities of floating charges and their foreign equivalents are essential. For any advice in this respect, please contact a member of the Pillsbury Finance team.