The recent judgment of the High Court of England & Wales in Re Avanti Communications Ltd [2023] EWHC 940 (Ch) considers issues arising as a result of the wording of restrictive covenants within security and the type of impact those restrictions can have as to whether the relevant charge is properly characterised as a fixed or a floating charge. The characterisation of the charge as fixed or floating has an important consequence on the distribution of the insolvent company’s assets so this is an important decision for lenders (secured and unsecured) and insolvency practitioners.  Although this is an English decision of the High Court and is, strictly, not binding in Northern Ireland, the facts of the case and the decision of the Court are likely to be persuasive.

 

A borrower’s solicitor will often try to negotiate a level of flexibility to these kinds of restrictions with the lender’s solicitors, the intent being to dilute what are typically (when drafted from a lender’s point of view) absolute restrictions on disposals and other dealings with charged assets. A borrower’s solicitor would, ideally, wish to negotiate a more relaxed form of words which allows for certain permitted disposals and other dealings with the borrower’s charged assets. Those kinds of permissions can be important to give borrowers a certain amount of freedom to deal with their assets and carry on their business in a commercial and practical manner. The key challenge for lenders is balancing the need for robust security that adequately protects their interests with the desire of a borrower for a level of flexibility to be built into the security they are granting. Previous case law on the characterisation of a fixed charge versus a floating charge was understood to require a total prohibition of all dealings and withdrawals without permission.  Re Avanti provides a slight expansion on the current understanding of how the Courts would properly characterise fixed and floating charges and begins to move away, albeit not very far, from the position that a total prohibition on dealing is a necessary requirement for the creation of a fixed charge over an asset.

 

The case centered around assets which were expressed to be subject to a fixed charge under a debenture granted by Avanti Communications Ltd. The assets consisted of a HYLAS-3 satellite, network and ground stations, orbital slots and certain other related assets. The security documents charging these assets included what Johnson J. described as a “thicket of contractual provisions” dealing with permitted disposal provisions relating to the sale of satellite capacity in the ordinary course of business, sales of obsolete assets and a basket allowing disposals up to US$2,000,000 as well as a general provision permitting asset sales provided the consideration received was not less than fair market value and was received in cash or cash equivalents.

 

Avanti Communications Ltd subsequently entered administration and the relevant assets were sold by administrators as part of a pre-pack sale. The case was then brought by the administrators for a determination as to whether the relevant assets were secured by fixed or floating charges at the time of creation and at the time of the pre-pack sale. This in turn would determine whether it was certain preferential creditors or certain lenders, as lead secured creditors, who were entitled to the proceeds of the sale.

 

The Court determined that the assets were subject to a fixed charge and identified several key criteria which needed to be satisfied for a charge to be considered a fixed charge. Firstly, the borrower’s ability to deal with the charged assets must be materially and significantly restricted, meaning that it cannot deal with the assets in the ordinary course of its business. Secondly, the charged asset must not be a part of the borrower’s circulating capital or fluctuating assets which the borrower uses in its ordinary day-to-day business. Thirdly, the asset should not need to be sold to generate income and in fact should be of a nature that makes it inherently difficult to transfer. The Court in Re Avanti determined that the permitted disposal clauses in the security documents provided very limited opportunities to make disposals of the charged assets in particular circumstances and did not allow for disposals in the ordinary course of Avanti’s business.

 

There are, therefore, three categories of assets which emerge from the judgment. Firstly, there are assets which are subject to the absolute control of the lender and where there is an absolute restriction on the borrower’s ability to deal with the assets. We believe it is clear from Re Avanti that only an absolute restriction can provide certainty of a fixed charge. Secondly, there are regularly fluctuating assets which are not compatible with a restriction on dealing and which lend themselves to being subject to floating charges. Thirdly, there are assets which are not part of the circulating capital of the borrower, which do not regularly fluctuate, and in respect of which limited dealings by the borrower may be allowed.

 

It is this third category which creates a grey area where a more nuanced approach is required and where the outcome will likely be decided on a case-by-case basis depending on the nature of the charged assets and on the business of the borrower. The Court placed considerable emphasis on the decision in Re Cimex Tissues Ltd [1994] BCC 626 where it was stated that, “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 … the assets are specific and do not necessarily fluctuate, some liberty to release the charged assets may not be inconsistent with a fixed charge.” This means that permitted disposal regimes will not necessarily be fatal to the characterisation of a charge as a fixed charge, but we would expect that any such permissive regime would still need to impose materially significant restrictions on the borrower’s ability to deal with the charged assets.

 

It is not yet clear whether this will lead to a change to current practice as the Re Avanti decision does not provide a definitive answer on where the tipping point between fixed and floating charges lies when it comes to permitted disposals. And, whilst Re Avanti does give some guidance on factors which the Courts will take into consideration when determining if a permitted disposal regime creates a charge which is fixed or floating, lenders may remain cautious to accept amendments to absolute restrictions on disposals when doing so could call into question if a fixed or floating charge has been created. In practice the answer to the question of whether a borrower should be allowed to deal or not to deal with assets subject to a fixed charge may well likely remain “not to deal”.

 

While great care has been taken in the preparation of the content of this article, it does not purport to be a comprehensive statement of the relevant law and full professional advice should be taken before any action is taken in reliance on any item covered.