Fixed or floating? The English High Court considers the nature of security granted by Avanti

Summary of decision

• The Company had granted security over certain specified assets to its secured lenders including (i)  a satellite orbiting in space, (ii) equipment used in the operation of the satellite network and ground station, (iii) specific satellite network filings required by various regulators for the business to operate the satellite network and (iv) certain ground station licenses issued by Ofcom to enable the Company to operate those ground stations (the “Relevant Assets”).
• All of the Relevant Assets were subject to purported fixed charges in the security documents.
• The finance documents restricted the disposal of assets by the Avanti group (including the Relevant Assets) other than as permitted in certain exceptions.  These exceptions allowed the Company to make disposals of the Relevant Assets in certain circumstances, without consent of the secured lenders or the Security Agent.   The exceptions included a general ability to dispose of assets at fair market value (subject to a prepayment obligation) and an ability to dispose of assets in certain categories (such as obsolescent assets).  These can be relatively common permissions in financing documents.
• The administrators sought directions from the court as to whether the “fixed” charges should be recharacterised as floating charges on the basis of the various exceptions to the general prohibition on disposals.
• The court decided that the security was fixed rather than floating, on the basis that the ability of the Company to deal with the Relevant Assets was strictly limited, even if disposals were not completely prohibited.[1]  

Who cares (apart from finance lawyers)?

There are three key groups of people who will be interested in this decision:

• Secured lenders care because all net proceeds from the sale by the administrators of fixed charge assets will be paid to them as secured creditors, whereas proceeds from the sale of floating charge assets will not be paid to the secured lenders unless and until all of those creditors who rank ahead of them in the prescribed insolvency waterfall have been paid in full.  Those creditors who rank ahead of floating charge holders include the administrators (for the costs and expenses of the administration), preferential creditors (e.g. HMRC for certain taxes and certain employee and pension claims), and the statutory ring-fenced fund for the benefit of unsecured creditors (the “prescribed part”).  If secured creditors are not repaid in full from fixed charge proceeds and the proceeds of sale from the floating charge assets are insufficient to repay all creditors in the insolvency waterfall who rank ahead of the remaining secured debt, then the reclassification of a fixed charge as floating will make the difference between the secured lenders recovering their secured debt or being left with a shortfall.

• Preferential and unsecured creditors certainly care because, as mentioned above, if security is characterised as fixed then proceeds from those assets will be out of their reach and will be paid to the secured lenders instead.  On the other hand, if that security is deemed to be floating, then preferential and unsecured creditors may receive a better (and possibly unexpected) return.

• Administrators care because it could influence their decision whether to seek directions from the court about recharacterisation of fixed security as floating in future administrations, particularly where the security is over high-value, non-circulating assets where there is no obvious permission allowing the charger to deal with the assets freely.  

The Court’s approach to determining fixed vs. floating security

In his judgment, which was handed down on 25 April 2023, Mr Justice Johnson carefully analysed the common law position on characterisation of fixed and floating security.  Echoing the approach taken by the court in previous cases, he confirmed that it was necessary to adopt a two stage approach when determining whether security is fixed or floating:

• First stage:  The court must first construe the relevant security documents to ascertain “the intention of the parties from the language they have used.  But the object at this stage of the process is not to discover whether the parties intended to create a fixed or a floating charge.  It is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets”[2] .
• Second stage: the court must then consider categorisation (or characterisation).  “This is a matter of law and does not depend upon the intention of the relevant parties or the label which the parties have attached to the relevant instrument of charge”.  It requires close consideration of the nature and extent of the chargee’s control of the assets in question. 

The judge went through the authorities on recharacterisation of fixed charges including Re Brumark Investments Ltd [3] and Re Spectrum Plus Ltd [4] in detail.

Looking at the characteristics of a floating charge (and having gone back to the touchstone of Romer LJ’s description in Yorkshire Woolcombers), Johnson J drew in particular on certain aspects of the judgments in Re Spectrum, including Lord Scott’s speech in that case:

“the essential characteristic of a floating charge… is that the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event.  In the meantime the chargor is left free to use the charged asset and to remove it from the security.”[5]  

In considering the first stage, as part of the analysis described above, the court can look at the labels used by the parties to describe the security, as a guide to what security the parties objectively intended to create.  However, ultimately, the court will be concerned with the nature of the rights and obligations the parties intended to create rather than the labels attached to the security.  The court can also take into account the nature of the assets in question – whether they are circulating or non-circulating.  A fixed charge over “circulating assets” such as stock would paralyse the business of the chargor, and therefore leads to the conclusion that this must not have been the intention of the parties.

The judge explained that in the second stage the critical question is the question of control:  who has control of the asset, as between the chargor and the chargee?  The “essence of a fixed charge is that the charge is on a particular asset or class of assets which the chargor cannot deal with free from the charge without the consent of the chargee.  The question is not whether the chargor has complete freedom to carry on his business as he chooses but whether the chargee is in control of the charged assets” (Re Cosslett (Contractors) Ltd [1998] Ch 495 at [6]). 

Johnson J explained that it is not correct that “only a total prohibition of all dealings and withdrawals without permission is enough to create a fixed charge, or only a total restriction on any disposal of the charged assets by the chargor without the consent of the chargee is sufficient to create a fixed charge”.[6]  

Instead he talked about the sliding scale of control:  at one end of the spectrum there is total freedom of management (which is clearly incompatible with a fixed charge), and at the other end of the spectrum is a total prohibition on dealing with that asset in any way.  Between these two extremes there is a wide range of possibilities.  The judge argued that the case law supports a more nuanced approach than the black and white approach suggested by some legal commentators.  The question that needs to be considered is the degree of control.  A charge will not necessarily be a floating charge simply because the chargor retains some ability under the terms of the security documents to deal with the Relevant Assets. 

Application to the Company

For the first stage of the analysis:

• the court was satisfied that the Relevant Assets were within the scope of the charging clause in the security document;
• turning to the nature of the contractual restrictions and permissions on the disposal of the Relevant Assets under the security documents, the court concluded that there were “considerable restrictions” on the ability of the Company to dispose of the Relevant Assets (as is common in syndicated transactions, the security documents cross-referred to permissions and restrictions under the debt documents and so the court had to consider all relevant documents when analysing the ability of the Company to deal with the Relevant Assets).  In brief:
  • the Company could dispose of Assets for Fair Market Value, provided that proceeds in excess of $1m were applied down the prepayment waterfall, which required prepayment of the loans at 101% of face value; 
  • the Company could also dispose of Assets if the disposal fell within one of the exceptions, being (again in brief):
    • assets having a Fair Market Value of less than $2m;
    • disposals of satellite capacity and associated licences and equipment;
    • disposals of obsolete assets (the “Obsolete Exception”);
    • disposals of assets that were no longer useful in the conduct of the business of the Avanti group.;
    • disposals of licences or sublicences by the Avanti Group in the ordinary course of business.

(the restrictions above being the Restrictions)

Moving to the second stage, the court noted that the Restrictions did not impose a total restriction on the Company from dealing with the Relevant Assets.  However, the Company’s ability to deal with the Relevant Assets was “strictly limited”.  The Relevant Assets were not circulating capital or fluctuating assets.  They formed the “tangible and non-tangible infrastructure owned by the Company, which was used to generate the sources of the Company’s business income.  The Relevant Assets did not need to be sold to generate this income.  In addition to this, the Relevant Assets were all assets which, at least to varying degrees, were inherently difficult to transfer”.

Ultimately, taking into account the nature of the Relevant Assets, the Restrictions and all the circumstances of the case, the judge concluded that it was quite clear that the charges over the Relevant Asset took effect as fixed charges and remained fixed charges at the time of the administration sales.

Has this decision changed anything?

Fact specific and nuanced

The judgment suggests that courts must adopt a nuanced approach based on all the circumstances.  This case has a unique set of facts when you look at the nature of the assets (satellites, ground station equipment and the relevant licences) and the minimal applicability of each of the Restrictions to those classes of asset.  In the first stage of the court’s two stage approach, the nature of the Relevant Assets was relevant to the way in which the court construed the relevant security documents to ascertain the rights and obligations which the parties intended to grant each other in respect of the Relevant Assets.  For example, in relation to the “Obsolete Exception” , the Court found this could not easily apply to many of the Relevant Assets, such as an intangible ground station licence, as it could not easily be said that a licence becomes ‘worn out’.  The Court concluded that the circumstances in which the Obsolete Exception would be available was very limited.

It is therefore clear that whether a charge is fixed or floating will be highly dependent on the specific facts of each case – both in terms of the nature of the assets and the business of the group, as well as the breadth and applicability of the permissions and restrictions on dealing with those assets in the finance documents which allow the company to dispose of or deal with those assets.  

Degree of required control for a fixed charge is not absolute

It is not unreasonable to conclude that, at least in relation to charges over assets which “do not necessarily fluctuate”, this decision has moved the dial back from the approach taken by some legal commentators and makes it clear that in relation to charges over non-fluctuating assets, such as the Relevant Assets in Avanti, there does not need to be a total prohibition on disposals for a charge to be deemed as fixed.  Johnson J twice quoted previous dicta stating “Where the charged property is stock, or book debts - i.e. where the assets are naturally fluctuating - the court will readily conclude that a liberty for the chargor to deal with the charged assets is inconsistent with a fixed charge.  Where, as in the present case, the assets are specific and do not necessarily fluctuate, some liberty to release the charged assets may not be inconsistent with a fixed charge”.[7]  

Likelihood of challenges to fixed security

Will this decision impact the likelihood of administrators seeking directions from the court on or challenging the characterisation of security as fixed?  Potentially.  The cost benefit analysis will most certainly come into sharper focus when administrators are weighing up their duties, namely the cost of seeking such a direction or challenging a claim of fixed security by the secured creditors vs. the likelihood of the court holding that the charge is floating rather than fixed.  This decision may persuade administrators in some cases to decide that seeking a direction or mounting a challenge is not required, or is not in the interests of the creditors. 

Alternatively, this decision may act as an incentive for preferential creditors, such as HMRC, to make their own submissions to the court in future cases.  In the Avanti hearing, the administrators took a neutral stance, identifying the arguments on both sides of the characterisation issue and the lead secured creditors supported the claim that all the Relevant Assets were at the relevant time subject to fixed charge security.  But HMRC, the only preferential creditor of the Company, did not participate in proceedings.

Administration Funding Agreements

Given the uncertainty around the possible risk of recharacterization of the fixed security, the ability to carry out a pre-pack administration and distribute the disposal proceeds prior to a decision from the court on the topic was helped by the use of an administration funding agreement (“the AFA”) between the administrators and the Lead Secured Creditors.

The AFA was designed to protect the position of preferential and unsecured creditors (and the administrators from challenge) in circumstances where some or all of the Relevant Assets were determined to have been secured by floating charges at the time they were sold as part of the pre-pack.  This structure allowed the sale to proceed swiftly, and thereby maximise the value of the assets being sold, whilst affording protection to the administrators against the risk that some of charges over the Relevant Assets may be recharacterised as floating charges post-sale.

If the court had concluded that the assets were subject to a floating charge rather than fixed security, the administrators would have been able to draw funds committed by the Lead Secured Creditors under the AFA facility, in effect clawing back any distributions which should have been paid to the administrators, preferential creditors and/or unsecured creditors under the prescribed part in accordance with the insolvency waterfall rather than to the secured creditors.

Where there is a real question as to recharacterisation an AFA is a useful tool in an administrators armoury.

Hogan Lovells acted for GLAS Trust Corporation Limited as Security Agent in the restructuring of the Avanti Communications plc group.