Debentures – why be so negative

It is a common misconception that a fixed charge will always take priority over a floating charge regardless of the date that it was created. It is true that, as a general rule and starting point, a fixed charge will take priority over a floating charge even if it was created after the date of the floating charge. However, the inclusion of a negative pledge in the floating charge could give the floating charge priority over a fixed charge that was created subsequently.

A negative pledge is a covenant made by a borrower that it will not create any further security over its assets (subject to agreed exceptions) after the date that it has created security which contains a negative pledge.

For example, a bank (A) has a debenture over all of the assets that belong to a company (B) by way of a debenture (a common form of a floating charge). The debenture contains a negative pledge that B will not grant any further security over any of its assets without the consent of A. The charge is registered at Companies House and therefore would be revealed by a search of the register. B owns a property and after entering into the debenture, B enters into a mortgage (a common form of a fixed charge) with another bank (C). In the event of enforcement proceedings by A, C or any other creditor, the existence of the negative pledge in the debenture could mean that the proceeds of sale of B’s property would be distributed to A ahead of C despite C having a fixed charge . For clarity, in these circumstances, the subject of crystallisation is not relevant.

Inevitably there are issues in relation to notice and the knowledge of the mortgagee when they entered into the mortgage. In other words, did the mortgagee know or should reasonably have been expected to know about the floating charge containing a negative pledge. Since 6 April 2013 it has been mandatory for the negative pledge to be included in the particulars of charge upon registration at Companies House due to the Companies Act 2006 (Amendment of Part 25) Regulations 2013 (SI 2013/600).

Whilst the apparent right to include a negative pledge in a floating charge may seem unreasonable, and defeat the purpose of a fixed charge, at present the enforceability of a negative pledge has not been robustly tested in the courts and there is no solid case law to rebut the enforceability of a negative pledge in a floating charge. In these circumstances, the importance of conducting rigorous and thorough investigations of a borrower company cannot be understated.

John Henry – Associate Solicitor


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