Company Law

The provisional liquidator: Insolvency Act 1986, s.135 appointed by the court after the petition
has been presented against Carmen Textile Limited has established that the company has no
more than £30,000 in the company. Before the liquidator can make a decision on prioritizing the
claims by Peisan Bank (PB), Sasha Chartered Bank (SCB) plc and Ms. Pushpam, the issues
highlighted in the case has to be discussed.

Power to Borrow

It is important to decide whether or not the company had the capacity i.e. by virtue of an express
or implied power to borrow, to borrow money, if not it was possible for a loan to be ultra vires
the company and so become void (Charlesworth & Morse, 1999).

However the substantial changes to corporate transaction contained in s.35, s.35A and s.322A of
The Company Act 1985 (CA 85) as substituted by the 1989 Act has abolished the ultra vires rule
whereby the company may borrow money subject to any restriction in its memorandum and
articles of association (Charlesworth & Morse, 1999). Hence, with its power to borrow Carmen
Textiles Limited (CTL) borrowed money on its overdraft from Peisan Bank (PB) to the sum of
£100,000 without the creation of any debentures to secure the loan.

Creation of Debenture secured by a Floating Charge

Debenture is a document executed by the company as a deed in favor of creditor in this case PB,
whereby PB is provided with security over the whole or significantly the whole of the Carmen
Textiles Limited’s undertaking. Normally a fixed charge over fixed assets or a floating charge
over the rest of the company’s assets is created giving the creditor power to appoint an
administrative receiver. The administrative receiver is authorized to collect in the assets, run the
company’s business and dispose of the assets or as part of a sale of the business as a going
concern (Keenan, 2005). This definition find ample authority in the case of Levy v Abercorris
Slate and Slab Co [1887]37 Ch D260 (Chancery Division) and also in the case of British India

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Steam Navigation Co v IRC (1881) 7 QBD 165 (Queen’s Bench Division) his lordship held
that the instrument was a debenture and liable to be stamped as such (Sealy, 1996).

Hence in order to secure the loan borrowed by Carmen Textile Limited, PB insisted the company
to execute a debenture in its favor in April 2004 and it was secured by a floating charge over the
company’s entire undertaking.

A floating charge operates only as a contract and confers to interest of a proprietary nature prior
to crystallization (Abott, at el., 2007). Characteristics of floating charge defined in the case of
Reyorkshire Woolcombers Association Ltd [1903] 2 Ch 284 this case went on appeal to the
House of Lord, under the name Illingworth v Houldsworth [1904] AC 355, 358. include:

(i) that the charge is over a class of assets both present and future

(ii) that the class is one which, in the ordinary course of business, changes from time to
time.
(iii) that the charge leaves the company free to deal with the charged asset in the ordinary
course of the company's business (Sealy, 1996).

Thus a floating charge is an equitable charge on some or all of the present and future property of
the company Royal Mail Co. [1870] L.R. 5 Ch. App. 318 (Charlesworth & Morse, 1999).

Registration of Charges

s.398 CA 1985 declares that a particular of the charge, fixed legal charge or a floating equitable
charge has to be registered within 21 days of its creation in order for it to be valid against the
liquidator or administrator and any creditor of the company (Abott, et al., 2007). The particulars
to be delivered include:

(i) The date of creation of the charge, or of the acquisition of the property subject to the
charge.

(ii) The amount secured.

(iii) Short particulars of the property charge.

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(iv) The persons entitled to the chare.

Hence, a charge has to be registered in order for it to be valid in court or else court will deem it
as void.

In the case of Re Bond Worth Ltd [1980] Ch228, [1979] 3 A11 ER 919 (Chancery Division)
the elements of a floating charge existed and was registrable as such (Woon, 1997). Slade J
held that the document created a floating charge, and that as such it was void for non-
registration as no particulars of the charge had been registered as required by the act, deeming
it to be void against the liquidator (Sealy, 1996).

It is not mentioned that PB registered the floating charge. However, it is assumed that by S.103
CA 1989 (S.416 CA 85) they did disclose on the register at the time the charge was created
(Abott, et al., 2007).

Negative Pledge Clause in the Floating Charge

Floating charge holders commonly insert negative pledge clauses in their agreement with the
company in order to avoid the risk of a later fixed charge obtaining priority of the charge.

In the floating charge created by PB it contains a negative pledge clause similar to the case Siebe
Gorman & Co Ltd v. Barclays Bank Ltd [1972] 2 Lloyds Rep. 142 (High Court, England)
restricting the right to create further charges or securities which would rank in priority to or pari
passu with its floating charge, allowing it to crystallize the charge by the service of notice on the
company on the first day of such proceedings.

Hence this clause restricts the company on such proceedings without the consent of PB
(Pennigton, 1995).

Wrongful Trading & Creation of Fixed Charge

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Insolvency Act (IA) 1986, s.214 wrongful trading does not require proving intent to defraud.
However if the Directors knowing that they face insolvent liquidation and still continues to trade
without commencement of winding up of the company he risks having to contribute to the debts
of the company, in the case of Re Produce Marketing Consortium Ltd (No 2) [1989] BCLC
520 (Chancery Division) which was the first decided reported case under IA 1986 s.214 where
Knox J, held the two directors of the company liable for wrongful trading (Sealy, 2001).

Similarly in the case the company continued trading with huge losses between April 2004 and
January 2005 and moreover in breach of its undertaking the company borrowed £100,000 from
Sasha Chartered Bank (SCB) plc. The decision made by the company can be considered as an
intention to defraud the creditors and may fall under IA 1989 s.213 fraudulent trading where the
company’s purpose maybe to deceive its creditors in order to get the loan. Re Patrick & Lyon
Ltd [1933] Ch 786 (Sealy, 1996).

The company which has given a floating charge over its assets to one creditor can later give a
fixed charge to another creditor over part of those assets however a negative pledge in the earlier
floating charges can restrict creation of other charges. In the case of Re Castell & Brown Ltd
[1898] 1 Ch 315 (Chancery Division) the company issued debenture secured by a fixed charge
while a negative pledge was in existence in the earlier debentures secured by floating charges
(Sealy, 1996) . The mentioned case overruled the fact that fixed charges cannot be created when
there is a negative pledge in the earlier floating charges.

The loan taken from SCB plc was secured by a charge over the company’s factory. This is
considered as a fixed charge (legal charge) as the charge is created on a fixed asset. A fixed
charge is restricted to be dealt with or dispose of without the consent of the creditor. In this case
it is assumed that the fixed charge has also been registered before 21 days of its creation hence
making it valid.

Winding Up of the Company & Crystallization of Charges

According to Companies Act 1985 ss201 -205, liquidation or winding up is a collective

insolvency process leading to an end to the existence of a company (dissolution). A liquidator is

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appointed to distribute the proceeds to the creditors in the order of priority after covering his
expenses (Goode, 2005).

There are two methods of winding-up which are:

(i) A compulsory winding-up by the court.

(ii) A voluntary winding- up, which may be either a member’s winding-up or a creditor’s
winding-up (Keenan, 2005).

A compulsory liquidation is usually initiated by a creditor’s petition. A secured creditor may

petition but will normally rely on his security so that the petitioner is almost always an unsecured
creditor. Prima facie, a creditor whose debt is presently due and who cannot obtain payment
normally has a right as between himself and the company ex debito justitiae to a winding-up
order (Charlesworth & Morse, 1999). Re Chapel House Colliery Co. (1883) 24 Ch.D. 259, CA;
Gardner & Co. v. Link (1894) 21 R. 967 (Charlesworth & Morse, 1999)

The Insolvency Act 1986 provides that certain unsecured creditors are to be regarded as
preferential creditors for the money they are owed. The company’s employees are considered as
preferential creditors whereby one of the main preferential debts is wages and salaries of
employees due within four months before the relevant date, up to a maximum of £800 for each
employee (Keenan, 2005).

The company’s secretary Ms. Pushpam who was owed £3000 in unpaid salaries for two months
instituted proceedings against the company in February 2005. In the late March she served a
winding-up petition on the company whereby a winding-up order was granted at the end of May.
Here the court winding up order was granted when they acknowledged the petitioner had the
right to present the petition and as one of the grounds set out in the Act as justifying a winding
up has been made out (Woon, 1997).

A floating charge will crystallize into a fixed equitable charge on the winding up of the
company, the appointment of receiver, the company ceases Re Woodroffes (Musical
Instruments) Ltd [1986] Ch 366 and when such other occasion as maybe contained in the

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relevant debentures eg: failure to repay the loan on demand or notice being given to the
company which leads to ‘Automatic Crystallization’ (Stamp, 2001).

PB sent notice to CTL to crystallize the charge on March 2005 due to the suspicion that
proceedings were held against the company this would ‘Automatically Crystallize’ the charge as
the clause in their debenture allowed as such. This was approved orbiter by Hoffman J in Re
Brightlife Ltd [1986]. From the moment of crystallization the charge becomes attached to the
assets of the company at that time (Goulding, 1999). The fact that the floating charge has
crystallized must also be recorded in the Registra (Mead, et al., 2006). Hence it is assumed that
the crystallization of PB’s floating charge was registered.

Validity of Charges & Priority of Charges

Registration does not itself confer priority or give any protection to a charge-holder, although of
course non-registration brings fatal consequences. A legal charge will normally have priority
over an equitable charge, a fixed charge over a floating charge, and as between two equitable
charges., the earlier in time will prevail (Sealy, 1996).

If an earlier charge does not prohibit creating other charges a fixed charge rank over a floating
charge including any earlier floating charges Wheatley v Silkstone and Haigh Moor Coal Co
[1885] (Rush & Oattley, 2006). However if earlier charges prohibits creation of other charges, a
subsequent fixed charge holder will take priority over the earlier floating charge if the third party
had actual notice of the negative pledge. Even though the charge is filed it does not necessarily
mean that its negative pledge clause contents have been filed hence it is not reckoned to third
parties (Woon, 1997) Re Castell & Brown Ltd [1898] 1 Ch 315 (Chancery Division); English
& Scottish Merchantile Investment v. Brunton [1892] 2 QB 700 (Sealy, 1996).

However a floating charge have priority over a fixed charge if subsequent fixed charge holder
have actual notice of a restrictive clause if it has been entered when registering the charge
whereby it raises priority issues on preferential creditors who are in between fixed and floating
charge holders. It was suggested that after the floating charge, the fixed charge should therefore
come after the preferential creditors (McCormack, 2004).

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In the case of SCB securing and registering the fixed charge it can be assumed that when
checking from the registrar SCB did not have notice of the negative clause created in PB’s
floating charge as it might not have been included while registering their floating charge. Hence
in this case SCB will come first as it is proven to be a secured creditor.

As PB holds a floating charge we have to see the avoidance of floating charge in Insolvency Act
(IA) 1989 s.245 which declares that, subject to certain qualifications, a floating charges created
within 12 months prior to the presentation of a successful petition for a winding up or an
administration (This, and not the date of the winding up order is the relevant date) shall be
invalid (Charlesworth & Morse, 1999). It is also said that the charge is invalid only if the
company was insolvent at the time the charge was created, or became insolvent as a result of the
transaction under which the charge was created (Abott, et al., 2007). These statutory provisions
apply only to floating charges (Sealy, 1996).

Prior to IA 1986 it was sometimes possible for the holder of a floating charge to evade these
statutory rules by showing that the charge had crystallized before the date of the successful
issuance of petition for winding up. In the case Re Brightlife Ltd [1986] the court held that the
preferential creditors no longer had any right to be paid in priority to the charge as the debenture
holder had given the company a notice converting the floating charge into a fixed charge a week
before resolution for voluntary winding up (Sealy 1996).

In the case of PB the floating charge was secured in April 2004 and winding up petition was
served by Ms. Pushpam on the company in late March. Hence in accordance to the IA 1989
s.214 the charge is deem to be void as it was less than 12 months since the creation of the charge
and also because it was said that the company was running at huge losses between April 2004
whereby, we can see that the charge was created when the company was facing insolvency.

Hence, as floating charge became void PB became an unsecured creditor.

In case of preferential creditors in this case Ms. Pushpam a fixed charge has the advantage over a
floating charge that it ranks in priority to the company’s preferential creditors in a receivership or
winding up (IA 1986, ss40, 175). In the case of Buchler and another v Talbot and another
[2004], the Amendment Act 1897 s 2 was stated whereby, in the winding up of a company the

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preferential debts should take priority over the claims of floating charge holders. Therefore, since
Ms.Pushpam is liable for her claim before floating charge holders and unsecured creditors
(O’Donovan, 2005).

Conclusion

Considering all the above facts I would advise the liquidator to rank the secured and unsecured
creditors as follows:

1- Sasha Chartered Bank (SCB) plc

2- Ms. Pushpam

3- Peisan Bank (PB)

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