Purpose
The purpose of s.245 is to prevent an unsecured creditor obtaining a floating charge to secure an existing loan for no new consideration, at the expense of other unsecured creditors.
When does s.245 apply?
The section only applies in a liquidation or administration. Unlike transactions at an undervalue and preferences, section 245 avoids certain floating charges automatically and without the need for the office-holder to challenge the floating charge by bringing legal proceedings (as set out below). However, if there is a dispute between the putative floating charge holder and the office-holder about the application of s.245, legal proceedings may be necessary to determine the dispute.
Which floating charges are void under s.245?
For the floating charge to be invalid:
- The floating charge must have been created within the ‘relevant time’. The relevant time is 12 months preceding the onset of insolvency, i.e. the commencement of administration or liquidation (ss.245(2) and 245(3)(b)).
The relevant time is extended to 2 years in the case of a floating charge granted to a connected person (s.245(3)(a)). (See ss.249 and 435 for definitions of ‘connected persons’ and ‘associates’). - Unless the floating charge was granted to a ‘connected person’ or an ‘associate’ (in which case there is no insolvency requirement), it must be proved that the company was insolvent (on either a cash-flow or balance sheet basis) at the time of the floating charge’s creation or became insolvent in consequence of the transaction under which the charge was created (s.245(4)).
When a floating charge is valid (s.245(2))
Even if the above requirements are met, a floating charge will be valid to the extent that ‘new money’ or other fresh consideration (which can include goods or services) is provided to the company (or existing debts of the company are extinguished) in return for the grant of the floating charge on or after its creation (s.245(2)).
The effect of s.245(2) is that if a floating charge is granted to secure the repayment of a new loan made on or after the creation of the charge, then it will be valid.
An example of when a floating charge would be void is where an existing unsecured creditor is granted a floating charge by a company which is insolvent (as defined above) and the charge purports to secure the repayment of existing monies owed to that creditor. If s.245 did not apply, such an unsecured creditor would thereby improve its position in the order of priority if the company later went into an insolvency procedure, which would be unfair on the company’s other unsecured creditors. However, if (and to the extent that) an existing unsecured creditor provides further credit to the company (or to the extent that any other new credit is given by a new creditor) then that creditor is entitled to have the protection of a valid floating charge.
Overdrafts
Commonly a company will grant its bank a floating charge under a debenture as security for an overdraft on its current account. Much of the potential practical significance of s.245(2) is removed in current account lending cases by the decision of the Court of Appeal in Re Yeovil Glove Co. Ltd. [1965] Ch 148.
In that case, the company’s current bank account was overdrawn by about £67,000 and unsecured. The bank was only prepared to permit continued operation of the current account in overdraft (at a maximum limit of £67,000) if the company granted it a floating charge, which the company did (at a time when it was insolvent). The company then continued to trade for a further 8 months until the bank appointed an administrative receiver to enforce its floating charge and ceased operation of the bank account. During that 8 month period, the company’s account was continuously in overdraft; the company paid about £110,000 into the account from its trading activities, and drew out about £110,000. When the receiver was appointed, the company owed the bank about £67,000 under the overdraft i.e. the same amount it had owed when the floating charge was created. A few months later trade creditors petitioned for the company’s winding up. The liquidator applied for a declaration that the floating charge was invalid as it related to the unsecured pre-charge indebtedness (£67,000 ‘old money’) and not ‘new money’. Only if the liquidator were successful would the unsecured trade creditors receive a dividend in respect of their claims. Otherwise, the bank would receive all of the company’s remaining assets under the floating charge security granted in respect of the overdraft.
It was held that the floating charge was valid for the entire £67,000 overdraft debt owing when the receiver was appointed.
This may seem surprising, given that the result was to change an overdraft for about £67,000 which was not backed by a floating charge into an overdraft for about the same sum which was. The reasoning is as follows:
- Each time the bank allowed the company to draw on its overdraft facility after the floating charge was created, for example by honouring cheques drawn by the company, ‘new money’ was deemed to have been advanced by the bank after the creation of the floating charge; and
- Payments made by the company into its bank account after the creation of the floating charge discharged the oldest pre-charge indebtedness first (i.e. the unsecured £67,000 ‘old money’) rather than the ‘new money’ advanced by the bank post-charge. This is an application of the rule in Clayton’s Case (Devaynes v Noble [1816] 1 Mer. 572) which provides that in the absence of contrary intention, payments into a bank account discharge the earliest advances made by the bank first. Thus, as the company had paid more than £67,000 into the account since the grant of the floating charge, it could be said that all of the pre-floating charge debt of £67,000 had been paid off and that the £67,000 balance on the overdraft at the date the floating charge was enforced by the appointment of the receiver represented new debt i.e. new money advanced by the bank after the date the floating charge had been created.
Miscellaneous points
- Where a floating charge is void under s.245, only the security (and its advantage to a floating charge creditor in the order of priority) is void and not the debt itself.
- Remember also that a floating charge is void against a liquidator, administrator and other creditors if it is not duly registered with Companies House under s.859H CA 2006.
- A floating charge granted to a creditor may also be voidable as a transaction at an undervalue or preference under ss.238 and 239.