Negative Pledges - Floating Charges Further Devalued
Written by 29th March 2015on
Changes Under The Act
The Companies Act 2014 (the "Act") stipulates that the Companies Registration Office ("CRO") will not be permitted to record details of a negative pledge or the crystallisation events for a floating charge when recording particulars of a charge created by a company.
The delivery of such details to the CRO will have no legal effect except where the charge holder is the Central Bank and the charge is a floating charge to provide or secure collateral.
Position Before Commencement Of The Act
The Companies Acts 1963 to 2013 do not require companies and charge holders to include particulars of a negative pledge (typically, agreements by the company not to borrow from, or create security in favour of, any person other than the charge holder) with the particulars of registerable charges that are required to be delivered to the CRO. Nonetheless, solicitors have developed a practice of including negative pledge particulars whenever notifying the CRO of a floating charge created in favour of a client. This practice has resulted from court decisions that the granting of security should be considered to be within the ordinary course of business of a company thereby permitting a company to create a fixed charge even after giving a floating charge. In such circumstances and where the floating charge prohibits the company from doing so, the floating chargeholder merely has recourse to the company for breach of covenant.
The solicitor's objective in delivering particulars of the negative pledge for registration by the CRO is to put potential lenders on notice that the company is not permitted to create further security. If the subsequent lender has actual notice (as opposed to mere constructive notice) of a negative pledge in a floating charge and proceeds to take a fixed charge from the company, the subsequent fixed chargeholder cannot use its fixed charge to cause loss to the floating chargeholder. Without actual notice, the lender will take the fixed charge free of the claims of the floating chargeholder because the lender is entitled to rely on the apparent authority of the company to deal by way of creating fixed charges.
The new regime essentially removes the ability of a floating chargeholder to fix notice (via the CRO) on a subsequent fixed chargeholder of the negative pledge. Section 412(8) defines a negative pledge as any agreement entered into by the company and any other person that provides that the company shall not, or shall not otherwise than in specified circumstances:
- borrow moneys or otherwise obtain credit from any person other than the person who is party to the agreement with the company; or
- create or permit to subsist any charge, lien or other encumbrance or any pledge over the whole or any part of the property or undertaking of the company.
Section 412(6) of the Act specifically provides that the CRO will not register particulars of the creation of a negative pledge where such particulars are delivered to it. It also provides that if a charge holder elects to deliver to the CRO particulars of such a negative pledge or the crystallisation events of floating charges, doing so will have no legal effect.
Section 412 (7) excepts the Central Bank from these provisions and particulars of a negative pledge on a floating charge given to the Central Bank for the purpose of providing or securing collateral must be registered by the CRO if delivered to it.
The new regime does not affect the crystallisation of floating charges and, accordingly, any lender seeking to put in place a fixed charge after a prior floating charge is best advised to still seek a letter from the floating chargeholder confirming non-crystallisation of their floating charge.
Lenders ought be best advised to review their lending policies and template security documentation in light of these changes. It is suggested that lenders that previously relied upon floating charges ought to rely upon the legislative changes to insist on “all assets” debentures incorporating fixed charges over suitable assets and floating charge where fixed charges are not legally possible. Alternatively, if a mere floating charge is made available by a borrower the lender might consider incorporating provisions therein that effectively creates a contingent equitable security interest on the date of the charge over specified assets, which interest will attach if the borrower breaches their negative pledge. The old Irish mortgage decision in Re Hurley's Estate (1894) 1 I.R. 488 can be seen as support for this approach.
Following on from the judgement in Re JD Brian Ltd (2011) 3 I.R.244 the above changes under the Act undermine the floating charge in a manner that significantly contrasts with the UK. Given the widespread use to date of mere floating charges in the SME sector, for cost and other reasons, lenders must give consideration as to how their lending policies and security documentation must change accordingly.