KEY POINTS Feature ––The still features in corporate finance transactions; it is taken by the financier as a management displacement and realisation mop-up device. ––There seems to be a steady shift towards factoring in receivables financing; yet, factors usually take fixed and floating charges as appendages to factoring agreements. ––Many institutional floating charge scarcely use their power to appoint an administrator due to reputational factors. ––The Parliament’s effort to redistribute in favour of unsecured creditors through the prescribed part fund seems to be yielding marginal fruits for this class of claimants.

Author Kayode Akintola What is left of the floating charge? An empirical outlook

This article provides some empirical insight into the impact of current English The second is the utilisation of the insolvency law on: (i) the continued role of the floating charge in corporate finance floating charge as a mop-up debt realisation transactions; (ii) contemporary lending practices; and (iii) insolvency outcomes. device. Indeed, a realisation was recorded The issues addressed cast a spotlight on how Parliament should legislate for the against no less than 244 floating charges rationalisation of security interests in insolvency. in the empirical data. While this number may appear to be a fractional amount of the

WHAT IS LEFT IS CHARGE?WHAT OF THE AN FLOATING EMPIRICAL OUTLOOK total number of floating charges recorded EMPIRICAL BACKGROUND The empirical data bears out the in the sample, it is important to note that The following analysis is based importance of such security as 1,160 the majority of those floating charges were non data collected from 2,129 in the sample had given a taken as an add-on to other security or companies that entered into floating charge security to their financier; factoring arrangements. Therefore, it seems (1,129) or creditors’ voluntary 704 of these charges were created after that the opportunity to rely on floating (CVL) (1,000) between 2006 and 2011. the Enterprise Act. The bulk of floating charges for realisation in insolvency is These companies have been selected at charges were seen in the administrations significantly hampered by pre-insolvency random. Further, around 1,600 companies (858); this may be due to the fact that lending practices devised as a response in the sample are small companies. The secured creditors are more willing to to current insolvency law. In any event, views of industry experts shared at explore administration than CVLs because such floating charge realisations challenge interviews have also been incorporated it is now easier for a qualifying floating the school of thought that insolvency law into the data. Lastly, the term “factoring” charge holder to initiate an administration has reduced the utility of the charge to a is used in this article as a generic reference procedure, and there is no requirement control/management-displacement device. to receivables finance agreements that to hold a creditors’ meeting as is the In spite of insolvency legislation, the floating are based on the sale and purchase of a case in CVLs. It may also be that some charge is still capable of performing one of company’s receivables. Thus, the term also administrations are initiated in the hope the cardinal functions of security – debt covers invoice finance agreements which of trading – even where there is only a realisation. may properly be described as invoice distinct prospect of realisation. However, discounting. this raises the issue of whether certain FACTORING GROWS administration cases are in fact Often enough, small companies have more THE FLOATING CHARGE LIVES ON with no reasonable prospect of rescue or current than fixed assets. Receivables It is well documented that for over a trading. are a major part of a company’s current century, the floating charge played a The position of these floating charges assets. It is therefore hardly surprising that cardinal role in the provision of debt in the companies’ capital structure is between the decisions in Siebe Gorman & finance to companies. Over the same instructive. Around 90% of these charges Co Ltd v Barclays Bank Ltd and Re Spectrum period, the charge has undergone several were taken with fixed charges as part of Plus, we saw financiers striving to take the statutory metamorphoses raising doubts a . It was observed that this most effective security possible over what on the ability of financiers to rely on the achieved two things for a financier. The is sometimes a company’s most viable . charge as a basis for extending and securing first, and perhaps more apparent, is the Post-Re Spectrum Plus, the conventional view credit. Nevertheless, few will doubt that it utilisation of such floating charges to is that it is unclear how to take an effective is essential for a legal system to recognise appoint an administrator. As will be shown fixed charge over receivables in certain the ability of financiers to take security over in this article, the use of floating charges in transactions, or, alternatively, the exercise of assets which the borrower can dispose of in this manner by financiers is more discreet substantive control by the financier over such the ordinary course of its . than overt. assets could cripple a company’s business.

404 July/August 2015 Butterworths Journal of International Banking and Financial Law WHAT IS LEFT OF THE FLOATING CHARGE? AN EMPIRICAL OUTLOOK EMPIRICAL FLOATING AN THE OF WHAT CHARGE? IS LEFT Feature

It was predicted that the response to this office holder in insolvency. Typically, such entered into insolvency within one year quandary would be a shift towards factoring surplus is the proportion of purchased of the factoring agreement. There was no (see J Armour, Should We Redistribute in receivables outstanding after the factor indication that these were Insolvency? in J Getzler and J Payne (eds), has recovered the purchase price (finance precipitated by a factor’s improper pressure. Company Charges: Spectrum and beyond provided) and other agreed charges such Indeed, no office holder complained about a (OUP, 2006), ch 9). A total of 528 factoring as interest and termination fees. One factor’s conduct or the terms of the factoring agreements were observed in the empirical interviewee, who is a member of the factoring agreement. Furthermore, the appointment data. While the sale of receivables meets industry, gave the following explanation for of an administrator by a factor is the factor’s the basic desire of companies for finance, it the return of surplus receivables: statutory right as a qualifying floating introduces fragmentation into a company’s capital structure as factoring typically co-exists with a loan or overdraft facility the return of surplus receivables ... resembles the provided by a bank. realisation of an of redemption by the Perhaps, such fragmentation is not ideal for the insolvency-rescue ideology as the which is a component of any secured transaction. office holder will have to deal with more influential stakeholders. If this is the case, “Invoice financiers have an obligation charge holder. It is also worth bearing in the root-cause is not judicial decisions on under the debt purchase agreements mind that certain factors are subsidiaries of the taking of fixed charges over receivables. with their clients to pay an initial clearing banks; thus, it will not be unusual Rather, it is the treatment of floating percentage – say 85% – of invoices and to find that clearing banks and the factoring charges in insolvency. This is so because then to pay the remaining percentage industry have a similar approach to the there would have been no demand for fixed up to 100% less charges once customers treatment of their customers. charges over receivables if the floating charge have paid the invoices… Anything (which is more suited to the financing of collected over and above this must, under THE STRATEGY IN ADMINISTRATOR current assets than fixed assets) was not the terms of the agreement, be passed on APPOINTMENTS vulnerable in insolvency to liquidation/ to the administrator or . We In many respects, the quid pro quo for the administration expenses, preferential cannot keep more than we are due. abolition of administrative was claims, and the prescribed part fund. the provision of a simpler means for secured Another development that was observed So for example if they have advanced creditors to initiate an administration empirically is that in addition to the master £80,000 and recover £95,000 from the procedure through the instrument of a factoring agreement, a factor usually takes a book debts, they will keep £80,000 plus floating charge (see Department of Trade fixed charge over the purchased receivables, any charges – let’s say £4,000 – and and Industry, Productivity and Enterprise: and a floating charge over other assets. pass on the remaining £11,000 to the Insolvency – A Second Chance [White paper, Given that most factors (over 70%) realised administrator to go into the pot for other Cm 5234, 2001]). The question that follows the amounts due to them by relying on creditors in the administration.” is whether the streamlined administration the master agreement, the floating charge procedure has encouraged secured creditors was often used by them to facilitate the While parties are free to contract as they to seek enforcement by appointing an appointment of an administrator. What wish within the confines of the law, from a administrator where they would hitherto is less clear is the rationale behind the conceptual standpoint, the return of surplus have appointed an administrative receiver? taking of a fixed charge over assets which receivables also weakens a factor’s claim to A total of 1087 administrator have already been assigned to the same a valid assignment by way of sale. This is appointments were observable in the financier by way of sale. Prima facie, it because it resembles the realisation of an empirical data. This is broken down as weakens a factor’s claim to a valid outright equity of redemption by the debtor which is follows: 852 appointments were made by the assignment, and strengthens the case for a component of any secured transaction. company or its directors; 210 appointments re-characterising the agreement as a secured The final point to be considered in this were made by a floating charge holder; and transaction. However, the perceived wisdom section is the allegation that certain factors 25 appointments were made by the court. is that such fixed charges are taken to catch force vulnerable companies into insolvency At first blush, the picture that emerges from debts which may fall outside the agreement (see Treasury Committee, Oral Evidence: this data is that there is a low use of the due to a ban on assignment clause in the SME Lending, HC, 204). It was difficult to power to appoint an administrator by floating contracts that gave rise to the debts. substantiate this allegation empirically. The charge holders. However, this should not be It was also observed that many factors reasons for this are varied. For example, only taken as a suggestion that secured creditors routinely return surplus receivables to an 77 companies with a factoring agreement have not come to see administration as their

Butterworths Journal of International Banking and Financial Law July/August 2015 405 Biog box Feature Kayode Akintola is a barrister conducting doctoral research at the University of Nottingham. Email: [email protected]

remedy of choice for maximising value. A office holder creates this fund by redistributing administrators to trade meaningfully. Thus, closer inspection of the 852 administration assets secured by floating charges taken after administrators who want to trade would have appointments that were made by the company the commencement of the Enterprise Act. It to scale the hurdle of obtaining a court order or its directors revealed that secured creditors is worth considering whether this provision to dispose of non-floating charge or hire- were actively involved in such appointments. delivers any meaningful insolvency value to purchase assets where such assets exist. Once it was perceived that the company’s unsecured claimants. business was running into difficulty, the 704 post-Enterprise Act floating charges CONCLUDING THOUGHTS secured – usually a clearing bank were observed in the empirical data. Of this This article has provided selected evidence on – engaged an to number, only 95 prescribed part funds were the impact that redistributing assets covered conduct an audit of the company’s business. established by office holders. Indeed, while by a floating charge in insolvency could have The verdict of the audit being insolvency, there was a gross return of around £120,367,305 on the behaviour of financiers pre-insolvency, the then encouraged to unsecured creditors, the prescribed part and insolvency outcomes. For example, where the company to appoint the insolvency fund contributed around £5,430,834 to gross the fragmentation of a company’s capital practitioner as administrator. In other words, unsecured creditors’ returns (less than 5%). The structure prevents the operation of the where the appointment was not made by the prescribed part distribution pales even further prescribed part provision, it would seem that secured creditor, the company would have when the actual return to each unsecured the redistributive policy under the Insolvency appointed an insolvency practitioner the creditor is considered. It is however more Act is self-defeating. Surely, such policy needs

WHAT IS LEFT IS CHARGE?WHAT OF THE AN FLOATING EMPIRICAL OUTLOOK creditor approved of. convenient to analyse the reasons for the low to be revisited. The rationale behind this discreet use of the prescribed part provision. In any Finally, the prevalence of factoring approach to administration appointments event, case law suggests (more on principle agreements in a company’s capital structure by secured creditors is the reputational risk than pragmatism) that regard should be can no longer be ignored in insolvency. of making such appointments. According to hard to the position of the general body of It is suggested that there is a need for one interviewee who advises clearing banks: unsecured creditors as opposed to the fact office holders and their advisers to start that the distribution to each creditor would taking a closer look at the veracity of “My experience of most lenders is that be a pittance (see Re International Sections Ltd these agreements as they routinely do they do not want to appoint because it will [2009] EWHC 137 (Ch)). when faced with a security agreement. come into their figures and will be seen to The fragmented capital structure of many As discussed in this article, the operation be doing things the government might not companies meant that the floating charge was of such agreements, particularly the want them to do. So far better to say to the not primarily relied upon by financiers for return of surplus receivables, raises company, ‘I am going to pull your finance, realisation. Thus, where the financier is paid the issue of whether as a matter of law, so you have a real problem with wrongful in full under a master factoring agreement or such transactions are in fact secured trading, so you are going to have to fixed charge, he would not have a claim under transactions. The practical difficulty appoint and as long as you appoint MR B, the floating charge, and as a result, there with this proposition is that the returned then that will be fine; if you do not appoint would not be any net within the surplus improves the prospects of recouping Mr B, then we will appoint Mr B.’ And I meaning of s 176A(6), Insolvency Act, 1986. insolvency expenses and meeting the think most companies will do that.” This is a clear example of how insolvency claims of other creditors. Nevertheless, legislation affects lending practices thereby it is accepted that in deciding whether a This strategy is perhaps justified by the creating inefficient insolvency outcomes. transaction should be re-characterised as scrutiny the bank-lending industry came under Further, it is not unusual to find lenders a secured loan, it is not enough to look at through the recessionary period. What is more having pre- and post-Enterprise Act floating what was agreed between the parties; it is important, however, is that in so far as lenders charges; the former which is immune to the also important to consider the substance or do not put improper pressure on otherwise prescribed part provision being used as a operation of the agreement. n viable companies to appoint an administrator, realisation mop-up device. this strategy seems to have a neutral effect in Other reasons encountered for the low terms of insolvency outcomes. use of the provision are insufficient floating Further Reading charge assets held by these small companies, ––Fixed and floating charges: the Great DOES THE PRESCRIBED PART LOOK and applications by office holders not to British Fund-Off? [2015] 1 JIBFL 3. THE PART? apply the fund on the ground that the cost of ––Ban the ban: prohibiting restrictions The Enterprise Act introduced the prescribed making a distribution to unsecured creditors on the assignment of receivables [2015] part fund against the backdrop of the abolition would be disproportionate to the benefits. It 3 JIBFL 136. of Crown preference as a means to divert is arguable that lack of ‘floating charge assets’ ––LexisNexis Loan Ranger blog: insolvency value to unsecured creditors. The would have a knock-on effect on the ability of Reforming the law of security.

406 July/August 2015 Butterworths Journal of International Banking and Financial Law