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The Floating Lien and the Preference Challenge: Some Guidance from the English Floating Charge, 8 B.C.L

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Boston College Law Review Volume 8 Article 4 Issue 2 Number 2 1-1-1967 The loF ating Lien and the Preference Challenge: Some Guidance from the English Floating Charge David W. Carroll Follow this and additional works at: http://lawdigitalcommons.bc.edu/bclr Part of the Bankruptcy Law Commons Recommended Citation David W. Carroll, The Floating Lien and the Preference Challenge: Some Guidance from the English Floating Charge, 8 B.C.L. Rev. 243 (1967), http://lawdigitalcommons.bc.edu/bclr/vol8/iss2/4 This Article is brought to you for free and open access by the Law Journals at Digital Commons @ Boston College Law School. It has been accepted for inclusion in Boston College Law Review by an authorized editor of Digital Commons @ Boston College Law School. For more information, please contact [email protected]. E OAIG IE A E EEECE CAEGE: SOME GUIACE OM E EGIS OAIG CAGE AI W. CAO I. IOUCIO England has been wrestling with floating charge problems for ninety-seven years, and this experience may be helpful in dealing with the developing conflict between the U.S. Bankruptcy Act' and the floating lien provisions of the Uniform Commercial Code. The English floating charge and the American floating lien have nearly identical characteristics. Both security clauses may encompass all or any part of the debtor's assets, including assets acquired after the date the security is created. The collateral may be used as security for past, present, and future advances by the creditor. The debtor can pass good title to the encumbered assets to a bona fide purchaser for value in the ordinary course of business prior to the commence- ment of insolvency proceedings. An examination of both the English and American treatment of the problem makes it obvious that there can be no assurance that a floating charge or lien will provide satisfactory collateral. In England, the courts and Parliament have imposed so many restrictive prefer- ence and priority rules that the floating charge has been substantially emasculated. In the United States, there have not been enough author- itative decisions to reach any conclusions as to the interaction of the Bankruptcy Act and the Code. Articles on this subject vary greatly in their suggestions and offer no real solution to the confused lender.' The central issue in the Bankruptcy Act-Commercial Code con- flict is whether the floating lien is prejudicial to the interests of unse- cured creditors. At the time of bankruptcy, there is an irreconcilable conflict between the floating lien creditor and the general creditor, but it is submitted that this is not the proper time to recognize the existence of a conflict. The appropriate time is the date of the creation and per- fection of the floating lien. Most credit men are very pessimistic about the position of the general creditor in bankruptcy and this pessimism is supported by experience. Therefore, even assuming that a debtor .S., Oh Stt Unvrt, ., Oh Stt Unvrt, 4 prntl Snr trr n , Inttt f Adntrtn, r, r. 1 0 Stt. 44 (88, ndd, U.S.C. $ 0 (64. 2 S Cnt, h Cd n th nrpt Crt: S Snfnt Cnflt f l, 8 .C. Ind. & C. v. 0 n. (66, fr pltn f f th rtl. It hld b ntd tht lthh thr r tll n thrttv dn, thr h bn rfr dn hh h d rt dl f nrn. In r rtlnd ppr blhn C., 2 nr. p. (4th d. 622 (. Or. b. , 66. 24 BOSTON COLLEGE INDUSTRIAL AND COMMERCIAL LAW REVIEW was insolvent or in serious business difficulty, it would be reasonable to believe that general creditors would not be opposed to allowing a float- ing lien at least to the extent of any new funds given and legitimately used by the debtor. It may even be argued that the general creditors would be willing to consent to a floating lien for an amount in excess of new value given, if the floating lien was part of a bona fide effort to keep the business going and avoid bankruptcy. No general creditor, however, would consent to a floating lien designed to give a fraudulent preference to a creditor. For example, let us assume a fairly common situation. The principal supplier of a company burdened with a large unsecured account discovers that the debtor company is hopelessly insolvent. In order to obtain security and continue profitable operations, the supplier agrees to extend fur- ther credit to the debtor upon receipt of adequate security, .., a blanket floating lien. The principal supplier should not have to furnish much additional capital to keep the debtor's business going beyond the four-month preference period.' After that time has passed, the debtor company is thrown into bankruptcy, and the principal supplier receives payment for the bulk of his account from the realization of the col- lateral. Similar situations can be manipulated by insiders of the in- solvent company. These practices constitute blatant fraud. Regardless of the four-month preference period, the lien should be held invalid, and the lien creditor held personally liable to other secured and un- secured creditors for damages resulting from his fraudulent continua- tion of the business. It is submitted that recognition of this cause of action as a part of the common law tort of fraud' would go a long way toward properly solving the floating lien problem. Moreover, the economic effect of floating liens must be carefully evaluated in any rational determination of their validity. When a debtor obtains a loan, this usually results in the creation of additional credit. For example, laborers will work, tax liability will accrue, utili- ties, services, and goods will be supplied, all as a result of the debtor's apparent solvency. A large portion of this credit may be classified as nonconsensual; that is, the extension of credit was not a conscious extension of credit. No system of recording or notice will protect this class of creditors, and it is at least arguable that this 'class of credi- tors, which is in effect created or enlarged by the floating lien creditor, is entitled to some protection. Obviously, additional credit is created h frnth prfrn prd rfr t th tttr prvn tht n f th prrt fr rdtr t hv "prfrrd" tt tht th trnfr b "d r ffrd ... thn fr nth bfr th fln b r nt [th dbtr] . f th pttn nttn prdn [n bnrpt] . ." nrpt At § 60((, ndd, 64 Stt. 2 (0, U.S.C. § 6( ( (64. 4 S pp. 24 nfr. 244 OAIG IE b rd ln, bt t ld ppr tht fltn ln ld rt th rtt pbl ddtnl rdt. It ld rt r rdt thn pld, b th fltn ln dbtr ld hv bth th lltrl nd th ln t n h bn, hr th pld db tr ld hv nl th ln. A fltn ln ld rt r rdt thn rt ntrt n th ntr f httl rt r lr dv b f th rht f th fltn ln dbtr t frl dp f th lltrl. rthrr, th fltn ln, hl rtn th rtt rdt, t t nll tht th nnnnl rdtr ll b pd n th vnt f nlvn, b th fltn ln rd tr ll t ll f th dbtr t lltrl. Crtnt n rl l tlf vrt, nd t ntl tht th prbl f th vldt f th fltn ln b rlvd. b l pl, hvr, ll dtt th nt f dfnt lttn n th p f th fltn ln. II. E AMEICA OAIG IE A. h nrpt At h t b prbl rn th rpt t th fltn ln nvlv th prfrn prvn f Stn 60( f th nrpt At. 5 h t prvd tht f th trt n bnrpt n rr h brdn f prf n th flln lnt, th prfrn vd bl: ( trnfr f th dbtr prprt (2 t r fr th bn ft f rdtr ( fr n ntdnt dbt (4 b n nlvnt dbtr, th rdtr hvn rnbl t blv th dbtr nlvnt ( thn fr nth f bnrpt (6 hvn th rlt f vn th rdtr rtr prnt f h l thn nthr rdtr f h l. h ntrvr vr th vldt f th fltn ln f n hthr ftrrd lltrl vn fr n ntdnt dbt. h nrpt At d nt dfn ntdnt dbt, bt t ld b rd tht n lltrl rd r thn tntn d ftr rtn f th ln n b ndrd t hv bn vn fr n nt dnt dbt" If In r rtlnd ppr blhn C. nt fl ld b th fdrl rt, r f tn 60 ndd t ll th fltn ln, thn tn 08 f th Cd n b vn fft nd th fltn ln ll rvv th vdbl prfrn prvn. In th 5 64 Stt. 2 (0, U.S.C. § 6(( (64. nrpt At § 60(((, ndd, 64 Stt. 26 (0, U.S.C. § 6( ( ( (64. 7 2 nr. p. (4th d. 622 (. Or. b. , 66. In th , th frt t fnd th Cd n nflt th th drl nrpt At, th rfr rfd t ppl § 08 f th Cd, nd th th fltn ln n tn dftd b th prfrn prvn f th nrpt At. 24 OSO COEGE IUSIA A COMMECIA AW EIEW pt, hvr, rt hv fvrd n ntrprttn f th nrpt At hh prvdd th t l dtrbtn n rdtr, vn f t nr t trn th prpr ltrl nn f th t. S fr, thr hv nt bn n thrttv ppllt rt t r lv th prbl, nd nl fr rnt dn ppr t br n rltn t th bjt." hr r nbr f prCd n hh ln ntnn ftrrd prprt l r phld n bnrpt" vr, th fltn ln prvn f th Cd hv btntll dltd th pplblt f th .
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