AVOIDANCE OF CHARGES – COMPANIES ONLY
Charges can be avoided on two grounds:
(Amended August 2014)
The following are the areas on which the official receiver should, ideally, obtain information before instructing the contractor and include on the ‘details of conduct/transaction’ section of the ARIA form (see paragraph 31.4B.9):
A floating charge is a charge on property that is constantly changing in value and identity (for example, stock, book debts and work in progress). Although rare, it is theoretically possible for a fixed charge to be created over changing assets [note 1].
The essential characteristic of a floating charge which distinguishes it from a fixed charge is that the asset subject to the charge is not finally appropriated for the payment of the debt until the occurrence of some future event and, in the meantime, the chargor is left free to use the charged asset and remove it from the charge without the prior consent of the chargeholder [note 2]. When the property passes out of the ownership of the company (due, for example, to the sale of the item), it ceases to be subject to the charge. Conversely, where the company acquires property (due, for example, to the purchase of new stock), that property will become subject to the charge.
A floating charge does not attach to a specific item of property. The holder of a floating charge has no right to possession of the assets covered by the charge until one of the events specified in the charge instrument causes the charge to crystallize [note 3].
The Act contains provisions to ensure that creditors who obtain floating charges in the period leading up to the winding-up do something to deserve the charge and are not simply seeking to convert unsecured debt into secured debt and put themselves into a better position in the event of the winding-up of the company [note 4].
It should be noted that the provisions of the Act dealing with the avoidance of charges also cover charges created in the lead up to an administration. This aspect is not dealt with in any detail in this Part of the chapter due to the non-applicability of this aspect to the work of the official receiver. Suffice to say that the principles and effects of those provisions are largely the same as those relating to compulsory liquidation.
The general principle of the provisions in the Act relating to the avoidance of floating charges is that a floating charge created in the period leading up to the winding-up of the company (see paragraph 31.4B.26) is automatically void unless the charge relates to the provision of new monies, goods or services, or the discharge or reduction of a debt (see paragraphs 31.4B.46 to 31.4B.54) [note 5].
The provisions do not cover fixed charges unless that charge was originally created as a floating charge [note 6]. The granting of a fixed charge may be challenged as a preference (see Part 2 of Chapter 31.4A).
The period during which the creation of a floating charge would be avoided under the provisions in the Act are as follows:
Whether a person is connected or not is relevant at the date of the charge (rather than the date of winding up). If the person subsequently changes status (from connected to unconnected or vice-versa), it will not affect the relevant time consideration.
As outlined in paragraph 31.4B.44, a floating charge granted during the relevant time (see paragraph 31.4B.45) is automatically void except to the extent that there is a corresponding benefit to the company. This is commonly referred to as “new value” The Act provides that new value is the aggregate of [note 10]:
In short, the creditor would be able to rely on their charge (and therefore have a higher priority in the liquidation) to the extent that the charge related to the amount of new value outlined above. Other sums owing under the charge would fall to be dealt with as an unsecured debt.
Crucially, the new value must be given either at the same time as the charge is granted or following the granting of the charge (see paragraph 31.4B.52) to qualify for the exception.
31.4B.47 Goods or services as new value
(Amended August 2014)
The terms “goods” or “services” are not defined in the Act. So far as services are concerned, the service would normally be expected to involve the provision of skill or labour, or the provision of facilities. There is also some doubt as to what is covered by the term “goods”. In the definition given in the Sale of Goods Act [note 14] many forms of consideration which arise in the normal course of business would be excluded.
In the absence of any case law on the matter, it is thought that the terms goods and service should be given the widest interpretation so far as concerns these provisions of the Act. Ultimately, where there is doubt as to whether or not goods or services have been provided it is advisable to seek the advice of Clarke Willmott prior to a formal instruction (see paragraph 31.4B.9).
For money to qualify under the “new value” exception, it would be necessary for the creditor to make a transaction in the manner of a money payment. This does not necessarily have to be cash - it may be a cheque or a direct bank transfer. It is important that there is a real payment of money – it will not be sufficient for the monies to be paid, and then immediately returned to the creditor, nor will an agreement not to press for repayment of a debt qualify as a money payment. In short, the company must receive a money payment that it can keep and use [note 15].
There is no special interpretation to be applied to the term “discharge or reduction of a debt” when deciding whether the transaction constitutes “new value”. It should be noted that the debt discharged or reduced does not have to be one owing to the person obtaining the charge – it may be a debt owed to a third party. The important thing is that the charge is given in consideration of the reduction (see paragraph 31.4B.52).
As well as applying to new money, new goods or services or the discharge or reduction of a debt (see paragraphs 31.4B.48, 31.4B.47 and 31.4B.49 respectively), the extent to which a charge is not avoided (see paragraph 31.4B.46) can also apply to interest payable on the charged debt. The interest should be at a reasonable level and, where it is not, may not be permitted.
An unreasonably high level of interest may also be challenged as a extortionate credit transaction (see Part 6 of this chapter).
So far as new lending or the discharge or reduction of a debt are concerned (see paragraphs 31.4B.48 and 31.4B.49), it is unlikely that there would be any question as to the value of the transaction as each of these would be a straight money transaction. That is, the amount due under the charge should relate directly to the amount lent (or debt reduced) plus any interest payable (see paragraph 31.4B.50).
For goods or services provided as new value, the official receiver as liquidator should be concerned with the actual value of the goods or services at the time of the transaction, and not the price agreed between the company and the chargee [note 16]. Where necessary, the official receiver should consider the use of agents to undertake a valuation (see Chapter 32).
In addition to being for new value, the provision of the new monies, goods or services, or reduction of a debt that led to the creation of the charge, must have been in consideration of the charge. That is, given or paid at the same time as, or subsequent to, the creation of the charge in order for the charge not to be avoided.
So far as new monies, goods or services are concerned, the new value must have been provided directly to the company to do with as it wishes [note 17]. It cannot come with “strings attached”.
The only circumstance where a charge may be created after the transaction would be where there is an equitable charge created by agreement, but formal execution of the charge has yet to take place [note 18]. That said, if the equitable charge is not registered within 21 days of creation it would be automatically void under provisions in the Companies Act 2006 (see paragraph 31.4B.57).
A very short delay between transaction and charge may only be allowed if that delay was so short as to be trifling - even where the delay is not the creditor’s fault. An example of a coffee break between the two events has been given. It does not matter whether the delay was excusable or inexcusable [note 19].
Whilst there is a general principle that any floating charge created over existing debt would be void, it is possible to effectively convert unsecured debt into secured debt in running or ongoing accounts. For example, where a company owes a debt to a creditor, it may give a floating charge to that same creditor in respect of which further lending is granted to validate the charge. Subsequently, when the company makes a repayment to the creditor this payment will be allocated the earlier (newly), unsecured, debt, thereby reducing the proportion of unsecured debt in relation to the secured debt [note 20].
The main effect of the avoidance of the floating charge is that the creditor will, to the extent that the charge does relate to “new value” (see paragraph 31.4B.46), lose his/her status as a secured creditor and charged assets will become free to be dealt with in the liquidation.
The avoidance has no effect on the debt owed, simply that any part of the debt that does not relate to “new value” can not be covered by the floating charge and thus remains unsecured [note 21].
The charge becomes invalid as of the date of the winding-up, rather than back-dated to the date of the creation of the charge prior to the winding-up. Therefore, any payments made under the charge prior to the winding-up are not open to challenge under these provisions, but may be open to challenge as a preference (see Part 2 of Chapter 31.4A).
On the basis of this principle, the avoidance of the charge would end the appointment of any administrative receiver appointed under the charge created in the relevant period (see paragraph 31.4B.45), but would not have any affect on actions taken by the receiver in the interim.
The Companies Act, [note 22], contains provisions relating to the registration of company charges. A charge must be registered with the Registrar of Companies within 21 days of its creation (or, 21 days of the date that the charged property was acquired by the company), [note 23] otherwise the charge is void against the liquidator (amongst others) [note 24] (see paragraph 31.4B.62), meaning that the chargeholder would lose the benefit of their security and would be treated as an ordinary, unsecured, creditor.
See paragraph 31.4B.62 for details of the effect of the non-registration of a charge.
When dealing with the liquidation of a company, the official receiver should, in the normal course of events, carry out a search of the register of charges (see paragraph 31.4B.60). Where there is evidence that a charge has not been registered correctly (perhaps, a creditor is stating that they have obtained a charge, or the director has made comments to this effect in the preliminary examination. It could be the case that a creditor has taken action against assets in respect of a charge of which there is no apparent registration), the official receiver should seek the appointment of The Service’s antecedent recovery contractor (see Part 1) to take action to avoid the charge.
Where there is doubt as the validity of the charge, the official receiver should obtain the certificate issued by the Registrar of Companies when the charge was registered (see paragraph 31.4B.59).
The Companies Act specifies the types of charges which must be registered [note 26].
In addition to the company itself, the charge may be registered by any person interested in the charge [note 27]. This is effected by sending the particulars of the charge, together with any instrument (document) by which the charge is created or evidenced, to the Registrar of Companies [note 28]. The Registrar of Companies will enter the particulars of the charge in the register [note 29] (see paragraph 31.4B.60) and issue a certificate [note 30], which is conclusive evidence that the relevant requirements of the Companies Act have been satisfied [note 31].
Where the property is in Scotland or Northern Ireland, it is sufficient to send to the registrar a copy of the certificate issued by the registrar in that other jurisdiction, rather than the instrument proving the charge [note 32].
The registrar is obliged to maintain, in respect of each company, a register of all charges requiring registration under the relevant provisions [note 33]. The register contains the following particulars [note 34]:
These details may be viewed at http://www.direct.companieshouse.gov.uk/. Currently the fee to view the register on-line is £1.
In certain cases the 21 day period for registration is automatically extended, for example where the charged property is outside the United Kingdom and extra time is usually needed to obtain a document proving the charge [note 35] [note 36].
Otherwise the 21 day period may only be extended with the sanction of the court [note 37]. In those circumstances the court would need to be satisfied that the failure to obtain registration in time was accidental and did not prejudice the position of the creditors or shareholders of the company [note 38].
Failure to deliver to the Registrar of Companies, the particulars of a registrable charge within 21 days of its creation may result in a fine for the company and any officers in default [note 39]. Also the charge, so far as it confers security over the company’s property, is void against the liquidator of a company or any creditor of the company [note 40]. If the charge has not been correctly registered, the appointment of any receiver under that charge will be invalid against the liquidator. The debt due to the charge holder is not avoided but it would only rank as an unsecured debt in the liquidation. Where the charge is avoided, the whole of the debt together with any interest due is repayable on demand [note 41].
The charge becomes invalid as of the date of the winding-up, rather than back-dated to the date of the creation of the charge. Therefore, any payments made under the charge are not open to challenge under these provisions, but may be open to challenge as a preference (see Part 2 of Chapter 31.4A).
On the basis of this principle, the avoidance of the charge would end the appointment of any administrative receiver appointed under the charge in the relevant period (see paragraph 31.4B.45), but would not have any affect on actions taken by the receiver in the interim.
If there are errors or omissions in the particulars which were delivered to the Registrar of Companies, then the company or an interested person may apply to court for an order that the error or omission be rectified. This also applies to any charges which have not been registered within the specified time. The court will need to be satisfied that the omission was accidental and had not prejudiced the position of the company’s creditors or shareholders [note 42].
In addition to the requirements to furnish the registrar with details of the charge (see paragraph 31.4B.57), a company must also maintain a register of charges [note 43] which is open to inspection [note 44]. Unlike the provisions regarding registration of the charge, failure to maintain the register does not invalidate the charge - though it can result in a fine for every officer who was in default [note 45].