Company law revision question and answer

In relation to company securities, what is meant by;
i) A floating charge;
ii) Crystallization of a floating charge;
iii) A negative pledge clause?
a) A Floating charge:
This is an equitable charge securing a debenture on the asset of a going concern. Its essence is that it remains dormant until crystallization. In the words of Lord MacMaghten in Illingworth V. Holds worth (1904),“A floating charge on the other hand is ambulatory and shifting in its nature, hovering over and so to speak floating with the property which its intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp.‟

The characteristics of a floating charge were laid down Romer J. in re Yorkshire Wool Combers Association.

1) It is a charge on a class of assets of the company both present the future.
2) The asset belongs to a class that keeps on changing from time to time in the ordinary course of business of the company.
3) The charge remains dormant until crystallization.

Advantages of the Floating Charge;
1) It enables companies with no fixed assets to borrow.
2) It enhances the borrowing capacity of companies with fixed assets.
3) It enables companies to use future asses as collateral.
4) The charge does not prevent the company from carrying on business. It is free to dispose off and acquire new stock.
5) The charge is empowered to appoint a receiver in the event of default.
6) Upon crystallization, the chargee becomes entitled to sell any fixed asset within the reach and grasp of the charge.

Disadvantages of the Floating Charge;
1) The value of the security remains unknown since the company continues to carry on business.
2) A fixed charge created subsequent to the floating charge, has priority in the satisfaction of claims.
3) Certain other interest e.g. landlords distress for rent has priority over floating charges.
4) Under section 31 of the Act, a floating charge created within six months before the commencement of winding up is deemed to be a fraudulent preference and is void.
5) Under section 314 of the Act, a floating charge created within twelve (12 ) months before the commencement of winding up is invalid unless it is proved that the company was solvent immediately after its creation.
b) Crystallization of Floating Charges;
1) A floating charge crystallizes the following circumstances:
2) When the company ceases to be going concern.
3) Upon commencement of recovery proceedings against the company.
4) When a receiver is appointed a debenture holder pursuant to the terms of a debenture or the court on application.
5) Failure to pay the principle or interest when due and payable provided the chargee takes some steps to enforce the security.
6) Occurrence of an event which under the terms of the debenture causes crystallization.
When a floating charge crystallizes it becomes a fixed charge.

A negative Pledge Clause
• This is a clause in a debenture to the effect that the company or borrower will not create a charge in priority to the current one.
• It ensures that the chargee has priority in the satisfaction of claims.

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