The importance of careful drafting of security documentation

In two recent decisions, the Hight Court considered the question of whether security granted by a company over certain assets amounted to a fixed charge or a floating charge. In Avanti Communications, the Court had to decide whether assets including a satellite, equipment and some licences issued by OFCOM to operate the satellites were subject to a fixed charge or a floating charge. In UKCloud, the issue was whether a charge over Internet Protocol addresses (IP addresses) was a fixed or floating charge.

These cases have important implications for those involved in the drafting of security documentation, for lenders considering the scope of their security, and for insolvency practitioners appointed over companies where security has been granted over certain assets.

Avanti Communications

Avanti Communications was a company which operated satellites and the sale of various satellite broadband and connectivity services to its customers. Various assets of the company were purportedly subject to a fixed charge in the company’s security documentation.  However, the company retained the ability to dispose of the assets in limited circumstances, and the question therefore arose as to whether the security over those assets was in fact a fixed charge or a floating charge.

Relying on previous case law, the court held that it was necessary to conduct a two-stage enquiry in order to determine whether assets were secured by way of a fixed charge or a floating charge.  First, the court should construe the wording of the security document to determine the nature of the rights and obligations which the parties granted to each other in respect of the charged assets. Second, the court must as a matter of law categorise the nature of the charge (and the label which the parties have put on the charge is irrelevant), with a critical issue being the extent of a charge holder’s control over the charged assets.

In this case, and applying the two-stage test, the Court held that all of the assets in question (including a satellite, equipment and some licences) were subject to a fixed charge. While the company had some (limited) ability under the terms of the security documentation to deal with the relevant assets, this did not in itself mean that the assets were subject to a floating charge.

UKCloud

UKCloud Ltd provided cloud computing services and owned a number of IP licences which enabled it to provide IP addresses to its customers.  UKCloud had granted security over various property, assets and rights to a lender pursuant to the terms of a debenture.  The debenture did not include an express fixed charge over IP addresses, and neither were the specific IP addresses listed in the debenture.  Instead, the debenture included language suggesting a fixed charge over “all licences, consents and authorisations (statutory or otherwise) held or required in connection with [its] business”.  The court was therefore asked to determine whether the IP addresses were subject to a fixed charge or a floating charge, as this affected the priority and distribution of funds in the context of the company’s liquidation.

The court held (but stated that the conclusion was reached “not without misgivings”) that the IP addresses were secured by way of a floating charge and not a fixed charge.  The court concluded that the charge holder did not exercise control over the IP addresses in practice or seek to do so.  The court placed particular reliance on the “all or nothing” principle, meaning that the assets charged by a particular clause of the security document must all be subject to either a fixed or floating charge.  There cannot be some assets subject to a fixed charge and some assets subject to a floating charge within the same charging clause. 

Key Takeaways

These decisions confirm that the court is going to analyse critically the terms of security documentation in order to determine whether the security which has been granted amounts to a fixed charge or a floating charge.  It is therefore important that such agreements are carefully drafted at the outset, with any particularly valuable assets being specifically referenced in the security documentation (rather than relying on generic charging clauses).  If the company is to retain any ability to manage or dispose of the assets in question without consent, this must be carefully limited (although as the decision in Avanti demonstrates, some limited rights for the company to deal with the assets is not necessarily fatal).

Where lenders, borrowers or insolvency practitioners are considering the scope of any security which may have been already been granted over assets and whether it amounts to a fixed or floating charge, a careful analysis is going to be required in order to determine the nature of the charge particularly where the company still has some ability to deal with the asset(s) in question. It will therefore be important to interrogate the extent of the control given to and actually exercised by the parties in respect of the charged assets. The fact that a charge may have been labelled as “fixed” is insufficient if the control over the relevant assets is not in fact exercised.

It should also be remembered that the two cases referenced above are first instance decisions, and necessarily turn on their specific facts. While the judgments give helpful summaries of the current state of the law, it is likely that there will be further developments in this area over the coming years.  This will provide an opportunity for parties looking to challenge the security purportedly granted under a debenture, and give pause for thought to those drafting or reviewing security documentation.