Void Floating Charges (section 245 Insolvency Act 1986)
Section 245, IA 1986 specifically addresses the issue of a creditor benefitting from a new floating charge for existing debt where no new consideration is provided. It forms part of a wider objective of the IA 1986 to ensure that certain creditors cannot receive preferential treatment from a company that is at risk of, or close to, insolvency.
Section 245 applies where a company is in administration or in liquidation and provides that a floating charge created in the year (or two years, where the floating charge is created in favour of a connected person) before a company's insolvency (the “Relevant Time”) is valid only to the extent of new consideration then or later provided to the company. Therefore, if a floating charge was made during the Relevant Time and it was given in exchange only for prior consideration, for example, to secure only loans previously made, then such floating charge would be invalid.
This section clearly presents no problems for banks which take up security at the time they lend but is obviously a problem where a bank is taking floating charge security to secure existing indebtedness or as security for a guarantee. Where the bank is operating an overdraft, it should be open to it to argue that turnover on an overdraft could amount to new consideration even though the overall level of the overdraft did not increase¹. Most bankers are aware of the provisions of section 245 but it is unlikely that this will prevent them from taking security, simply because it might be invalid if the customer goes into liquidation or administration within 12 months. However, of course the risks remain there.
One point to look out for is where the chargor asks to defer execution of floating charge security for, for example 24 hours because a signatory is away. If the monies are advanced before the security is created, it is vulnerable to an attack under section 245, even if the delay is relatively short. The Court of Appeal made this clear in Re Shoe Lace Ltd, Power v Sharp Investments Ltd.² where it was held that, if the making of the advance preceded the formal execution of the debenture by any time whatsoever, unless the interval was so short that it could be regarded as minimal (the court gave as an example a coffee break), and payment and execution can be regarded as contemporaneous, then the funds cannot have been made available 'at the same time as or after the creation of the charge', so the floating charge could be invalid.
One further consideration for a financier’s lawyer is that section 245 refers to "money paid… to the company". In many group situations, all the money is paid to the parent company and filtered down. If there is a risk of insolvency it might be helpful that the financing arrangements are structured so that cash is advanced to all of the group companies, especially those which have valuable assets which are the subject of a floating charge. Moreover, a cash payment directly to the creditors of the company may well not be regarded as 'paid to the company' within the meaning of section 245(2)(a) although if money is genuinely put at the disposal of the company and, at its direction, is paid to a third party, this might be treated as paid to the company in the same way as by the bank honouring cheques drawn on it by the company.
Where a floating charge is a security financial collateral arrangement for the purposes of the Financial Collateral Arrangements (No 2) Regulations 2003 (SI 2003/3226), then section 245 is disapplied. This potentially benefits the holder of a floating charge over cash or shares. However, in practice, most practitioners consider that, if a floating charge is taken, it will not be possible to satisfy the control requirements needed to bring the floating charge within the statutory definition of 'security interest' for the purposes of the Regulations. As most floating charges give the collateral provider unrestricted use of the collateral, this means that, in practice, very few, if any, floating charges are likely to benefit from the exception.
