Pinpointing the true nature of security – how much control is needed?
The reintroduction of the preferential status granted to HMRC in insolvency proceedings ahead of creditors holding a floating charge and its impact on secured lenders, insolvency practitioners and corporate borrowers has been put firmly into the spotlight following the recent decision in Re Avanti Communications Ltd (In Administration)  EWHC 940.
In Re Avanti, the English High Court re-examined the law on the appropriate characterisation of charges over a company’s assets as either fixed or floating charge security. The decision has confirmed that a fixed charge can be upheld as valid even in circumstances where a borrower has limited scope to dispose of certain of its secured assets.
In this article, we will take a further look at the steps to be followed when seeking to pinpoint the true fixed or floating nature of security and will outline some key takeaways for secured lenders, insolvency practitioners and corporate borrowers to be aware of following this recent decision.
Facts of Re Avanti
Avanti operated in the satellite and broadband services industry providing its services to a range of clients including internet providers, governments and mobile network operators. Amongst other security in respect of borrowings totalling $825.6 million, it had granted two debentures in 2013 and 2017 containing fixed and floating charges. Fixed charges were specifically given over certain assets including a satellite payload and related infrastructure, both tangible and intangible, such as network operation and ground station equipment and ground station operation licences (the “Relevant Assets”).
The Relevant Assets were subsequently sold as part of a pre-pack administration process and an application for directions was sought in order to establish whether the Relevant Assets were charged by way of fixed or floating charges given that the outcome would have a fundamental impact on the proper distribution of the sale proceeds to Avanti’s creditors.
The Two-Step Test
The Court in Re Avanti affirmed that a two-step test outlined in Agnew v Commissioners of Inland Revenue  UKPC 28 should continue to be adopted when seeking to establish the true nature of security interests:
- Contractual Construction
Firstly, the security document should be reviewed to ascertain the nature of rights and obligations intended to arise between the chargor and the secured party in relation to the relevant charged assets as per the specific language used in the security document. The nature of the assets in question and the chargor’s overall business interests should also be taken into account at this juncture.
- Categorisation of Security
After determining which rights and obligations are construed between the parties, the charge must ultimately be characterised as either fixed or floating. This is strictly a matter of law and not of the proposed intention of the parties.
A central aspect of this step, as previously discussed in the leading case of National Westminster Bank plc v Spectrum Plus Ltd and others  UKHL 41, is the question as to how much control the secured party holds over the relevant asset which has been charged.
The nature of the charged assets requires careful examination when conducting this analysis and it is recommended that a key distinction needs to be drawn between:
- assets which are part of a company's circulating capital or stock in trade; and
- assets which are specific and not necessarily fluctuating.
Assets falling within the scope of the first category are most likely to be subject to a floating charge, given that the company ordinarily needs to be in a position to deal with and dispose of them as part of its daily operations.
Assets which align more closely with the second category are more likely to be subject to fixed charge security subject to the degree of control held by the secured party over them.
A nuanced approach
Crucially, the judge in Re Avanti determined that the Relevant Assets were subject to a fixed charge and confirmed that the categorisation of a charge as fixed charge security did not require a total or absolute restriction on disposal of the Relevant Assets. This view contrasts with existing academic analysis of case law which up until now has, in some instances, suggested that only a total prohibition of dealings with a chargor’s assets is sufficient to create a fixed charge over those assets.
Instead, the Court indicated that it would be necessary to determine the degree to which the rights and obligations construed at step one of the two-step test would restrict a chargor’s control over the asset to the extent of rendering it incompatible with a fixed charge.
The ability of Avanti to dispose of the Relevant Assets was deemed to be “materially and significantly” limited, and it was noted that it could not dispose of any of the Relevant Assets in the ordinary course of its business. The Relevant Assets were deemed to be income-generating assets of Avanti and did not form part of its circulating capital or stock in trade which are assets typically subject to the creation of a floating charge.
Re Avanti has reaffirmed the need for clarity and certainty when negotiating the contractual terms of security documents. This approach should ensure that any intended rights and obligations relating to dealings with charged assets are properly reflected.
The distinction between circulating and non-circulating assets of a chargor, and where these might fall under fixed and floating charging provisions should always be carefully considered when it comes to giving and taking security.
Both lenders and borrowers are likely to welcome the decision as it provides clear guidance that a fixed charge does not require complete or absolute control over secured assets on a lender’s behalf.
If you would like any further information or advice, please contact Damian McElholm from the Banking & Finance team.
*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.
Written by Damian McElholm (Partner) and Katherine Grant (Trainee Solicitor).