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CORPORATE LAWS (Company Law,LLP,SEBI,Competition etc..)





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By : puneet khanna
On : 30 September 2009

charge ?

 when a floating charge become fixed it has a priority over subsequent charge.is there  any exception?like prefrential creditors.please explain. 

 

By : Nirav Pankaj Shah
On : 06 March 2010

Re:

 Kinds of Charges

A charge on the property of the company as security for debentures may be of the following kinds, namely :

  1. fixed or specific charge;
  2. floating charge.

Fixed or Specific Charge

A charge is fixed or specific when it is made specifically to cover assets which are ascertained and definite or are capable of being ascertained and defined, at the time of creating charge e.g., land, building, or heavy machinery. A fixed charge, therefore, is against security of certain specific property, and the company looses its right to dispose off that property as unencumbered. In other words, the company can deal with such property, subject to the charge so that the charge holder gets priority over all subsequent transferees except a bona fide transferee for consideration without notice of the earlier charge. In the winding-up of the company, a debenture holder secured by a specific charge will be placed in the highest ranking class of creditors. “A specific charge is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined” [Lord Macnaghten in Illingworth & Another v. Houldsworth & Another, (1904) 73 L.J.CH. 739].

The plant and machinery of a company embedded in the earth or permanently fastened to things attached to the earth became a part of the company’s immovable property and therefore apart from the registration under the Companies Act, registration under the Indian Registration Act would also be necessary to make the charge valid and effective. [Official Liquidator v. Sri Krishna Deo, (1959) 29 Com Cases 476 : AIR 1959 All 247 and Roy & Bros. v. Ramnath Das, (1945) 15 Com Cases 69, 75 (Cal)].

A construction company’s washing machine which was in use at the site was declared under the terms of the contract to be the employer’s property during the period of construction. This was held to have created a fixed charge and not a floating charge on the machine because the machine was only one fixed item and was not likely to change [Cosslett (Contractors) Ltd., Re, (1996) 1 BCLC 407 (Ch D)].

Floating Charge

A floating charge, as a type of security, is peculiar to companies as borrowers. A floating charge is not attached to any definite property but covers property of a fluctuating type e.g., stock-in-trade and is thus necessarily equitable. A floating charge is a charge on a class of assets present and future which in the ordinary course of business is changing from time to time and leaves the company free to deal with the property as it sees fit until the holders of charge take steps to enforce their security.

“A floating security”, observed Lord Macnaghten in Government Stock Investment Company Ltd. v. Manila Rly. Company Ltd., (1897) A.C. 81, “is an equitable charge on the assets for the time being of a going concern. It attaches to the subject charged in the varying condition in which it happens to be from time to time. It is the essence of such a charge that it remains dormant until the undertaking charged ceases to be a going concern, or until the person in whose favour the charge is created intervenes”. The same learned judge observed in Illingworth & Another v. Holdsworth & Another, (ibid) . “A floating charge is ambulatory and shifting in its nature hovering over and so to speak floating with the property which it is intended to affect until some event occurs or act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp”.

It is clear from the above observation that a floating charge is an equitable charge which does not fasten on any specific property, but covers the whole of the company’s property, whether it is or is not subject to a fixed charge. Upon the happening of any of the events set out in the deed of the floating charge, it crystallizes or becomes fixed and thereafter the assets comprised in the charge are subject to the same restrictions and affected in the same manner as under a specific charge. [Union of India v. Coorg Estates Ltd. (1963) 2 Comp. LJ 164 (Ker-DB)].

When the floating charge crystallises it becomes fixed and the assets comprised therein are subject to the same restrictions as the fixed charge. It was said in Maturi U. Rao v. Pendyala A.I.R. 1970 A.P. 225, “the essence of a floating charge is that the security remains dormant until it is fixed or crystallised”. But a floating security is not a future security. It is a present security, which presently affects all the assets of the company expressed to be included in it. On the other hand, it is not a specific security; the holder of such charge cannot affirm that the assets are specifically mortgaged to him. The assets are mortgaged in such a way that the mortgagor i.e. the company can deal with them without the concurrence of the mortgagees.

The advantage of a floating charge is that the company may continue to deal in any way with the property which has been charged. The company may sell, mortgage or lease such property in ordinary course of its business if it is authorised by its memorandum of association. In Re. Borax Co., (1901) 1 CH 325, it was held that a company may sell the whole of its undertaking if that is one of the objects specified in its memorandum. Unless specifically precluded, the company can create fixed charge subsequent to floating charges over the same property [Wheatly v. Silkstone & High Moor Coal Co. Ltd., (1885) 54 L.J. Ch 78].

In Smith v. Bridgend County Borougn Council (2002) 1 BCLC 77 (HC), the agreement was held to constitute a floating charge, in so far as it allowed the employer, in various situations of default by the contractor, to sell the contractor’s plant and equipment and apply the proceeds in discharge of its obligations. A right to sell an asset belonging to a debtor and appropriate the proceeds to payment of the debt could not be anything other than a charge. It was a floating charge because the property in question was a fluctuating body of assets which could be consumed or removed from the site in the ordinary course of the contractor’s business.

  1. CRYSTALLISATION OF FLOATING CHARGE

A floating charge attaches to the company’s property generally and remains dormant till it crystallises or becomes fixed. The company has a right to carry on its business with the help of assets having a floating charge till the happening of some event which determines this right. A floating charge crystallises and the security becomes fixed in the following cases:

  1. when the company goes into liquidation;
  2. when the company ceases to carry on the business;
  3. when the creditors or the debenture holders take steps to enforce their security e.g. by appointing receiver to take possession of the property charged;
  4. on the happening of the event specified in the deed.

In the aforesaid circumstances, the floating charge is said to become fixed or to have crystallised. Until the charge crystallises or attaches or becomes fixed the company can deal with the property so charged in any manner it likes. The company may even sell its whole undertaking if that is otherwise permissible as per the objects specified in the memorandum.

Although a floating charge is a present security, yet it leaves the company free to create a specific mortgage on its property having priority over the floating charge. In Government Stock Investment Co. Ltd. v. Manila Railway Co. Ltd., (1897) A.C. 81, the debentures created a floating charge. Three months’ interest became due but the debenture holders took no steps and so the charge did not crystallize but remained floating. The company then made a mortgage of a specific part of its property. Held, the mortgagee had priority. The security for the debentures remained merely a floating security as the debenture holders had taken no steps to enforce their security.

Effect of Crystallisation of a Floating Charge

On crystallisation, the floating charge converts itself into a fixed charge on the property of the company. It has priority over any subsequent equitable charge and other unsecured creditors. But preferential creditors who have priority for payment over secured creditors in the winding-up get priority over the claims of the debenture holders having floating charge. Where a receiver is appointed on behalf of the holders of any debentures or possession is taken by or on behalf of those debenture holders of any property subject to charge then payment made in respect of such debt shall, be recouped, as far as may be, out of the assets available for payment of unsecured creditors. (Section 123).

  1. POSTPONEMENT OF A FLOATING CHARGE

The creation of a floating charge leaves the company free to create a legal and equitable mortgage on the same property until the floating charge crystallises. Where such a mortgage is created it has priority over the floating charge which gets postponed. The floating charge is postponed in favour of the following persons if they act before the crystallisation of the security:

  1. a landlord who distrains for rent;
  2. a creditor who obtains a garnishee absolute;
  3. a judgement creditor who attaches goods of the company and gets them sold (But if the goods are not sold and the debenture holders take action in the meantime, the floating charge has priority);
  4. the employees of the company, as well as other preferential creditors in the event of winding-up of the company;
  5. the supplier of goods to the company under a hire-purchase agreement on terms that goods are to remain the property of the seller until they are paid for in full, has priority over the floating charge, whether such hire-purchase agreement is made before or after the issue of the debentures with a floating charge.

Debenture-holders with a floating charge do not, therefore, enjoy the same rights as the secured creditors, for claims against the company. The deed creating the floating charge may, however, contain a clause restricting the power of the company to create charges in priority to or pari passu with it. But even in such a case a person who takes mortgage without notice of floating charge gets priority. But such a contingency can be safeguarded by registering the charge. In terms of Section 126 of the Act, where a mortgage or charge required to be registered under Section 125 of the Act has been so registered, any person acquiring such property or any part thereof or any interest of share therein shall be deemed to have notice of the charge as from the date of such registration.

Restraint on the Power to Create Charges with Priority to a Floating Charge

As the floating charge allows wide powers to the company to deal with its property subject to floating charge, it is common to insert a clause restricting the powers of the company to create charge with priority to or pari passu with it. Thus if the company creates a mortgage in favour of any person who has notice of the floating charge and restriction, such person ranks after the floating charge. But a person who obtains a valid mortgage, and can show either (i) that he was not aware of the existence of the floating charge; (ii) that though he was aware of the charge, he was not aware of the restriction, is entitled to priority by virtue of the legal estate. Furthermore, where a specific charge is created expressly subject to a floating charge, the specific charge is postponed as from the date when the floating charge crystallises by the appointment of a receiver.

Invalidity of Floating Charge

A floating charge remains afloat until a winding up commences, unless it has already crystallised through the intervention of the debenture holders or the creditors. Also a floating charge is valid only against the unsecured creditors, whether in a winding- up or otherwise. But the Act prevents an unsecured creditor to get priority over the other creditors by obtaining a floating charge when he learns that the company’s liquidation is imminent.

Accordingly, Section 534 of the Act provides that a floating charge which is created within 12 months immediately preceding the commencement of the winding up proceedings of a company shall be invalid, unless it is proved that the company was solvent immediately after the creation of the charge. But the charge will be valid to the extent of the amount of any cash paid to the company at the time of or after the creation of, and in consideration for the charge, together with interest on that amount at 5 per cent per annum or such other rate as may be fixed by the Central Government.

 

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