February 17 2020

Where Did The Floating Charge Come From?

Los Watkins, an MDX Law Lecturer shares a piece of ongoing research into the concept of the Floating Charge and its impact on modern banking law.

The importance of origins

I’ve always found the idea of origins to be interesting, especially in Law. Why do we need a certain law? To stop something happening, or to make something happen? Was it from the Courts or from Parliament?

The Floating Charge is part of the Banking or Company Law and is an extremely important legal concept for commerce today. Almost every business you’ll see or hear about will have had to make use of it, or is doing so presently.

It seems that the idea really came about more from the Courts with Judges sorting out what was seen as a legal problem where there was no legislation to utilise. This is known as Judicial Activism. It becomes highly important when there is a legal issue to sort out and Parliament is otherwise engaged. For instance, during the past couple of years where it was almost wholly occupied with the Brexit debate!

A man with moustache and top hat sprinting with bag of money under his arm

The history of the Floating Charge

Initially, it may help readers outside this field to have a very brief and rather simplified explanation of what the Floating Charge is and how it works.

In order to give security for borrowing, it is usual for a business to allow the lender to place a charge over some assets which they might own. This will either be over all the assets or over a class of assets; only the land, or only the machinery, for example. If this is a fixed charge (essentially a mortgage over buildings, land or other fixed assets) then the business cannot deal in that asset without the lender giving their consent.

However, if a business has its stock as an asset, then this is clearly impractical, indeed, impossible to obtain that permission for every item sold every day. Therefore, there came into existence the concept of the floating charge. This means that the charge can be over stock as a whole, and, before insolvency, it allows the charged assets to be bought and sold during the normal course of business without reference to the charge-holder (the lender). In practical terms, stock can be sold and replaced freely until the charge falls due, for whatever reason, when it ‘crystallises’, or becomes a fixed charge, and the assets can no longer be sold.

References throughout the years

The conception of a charge over stock has a long pedigree, reaching back as far as ancient Rome. It was only really used in England in a vague and rare manner, and was then disapproved of. Cases such as Ryall v Rolle in 1749, followed from legal writers such as Francis Bacon (Maxims of Law, 1630) and John Perkins (Profitable Book, 1545).

In the early 19th Century, the Courts once again considered the issue with the cases of Alexander v The Duke of Wellington in 1831 and Lyde v Mann in 1833. These cases suggested that a charge over property not presently in the ownership of the borrower may be enforced as part of an Equitable view of the case. This approach was followed by other cases in 1839 and in 1842, where Langton v Horton returned to the view that this could be legal.

Becoming a recognised entity

By 1870 there were four crucial elements of what we now know as the floating charge in place:

  1. That there could be a security over the stock in trade of the borrower
  2. That the borrower had the ability to change the nature of that stock
  3. That the charge could be self-effecting (i.e. nothing more needed to be done to make the charge)
  4. That the charge did not become fixed until a certain occurrence (usually the cessation of trading).

At first, not all Judges agreed with this new idea but it slowly became more generally accepted. In 1879, Lord Jessel, the Master of the Rolls himself, first made a specific reference to the floating charge, rather than any of the other forms of words or descriptions which had been used up to that date. This is significant because it is a recognition that a new term was required for this new concept; a thing does not need a name of its own until it is a recognisable entity in its own right.

Then, in 1897, Lord MacNaughton gave the first real comprehensive and modern definition of the constitution of the floating charge as a piece of law. This was followed by Lord Justice Buckley in the 1910 case of Evans v Rival Granite Quarries.

What we now recognise as the floating charge really had arrived.

Courts vs Parliament

This, then, was the view of the Courts. Parliament made no mention of the concept until 1845 in the Companies Clauses Consolidation Act. However, this legislation only applied to a very specific type of Company and the clause was somewhat vaguely drafted.

However, by 1854, Parliament was addressing the situation of charges and how they might work in business. The current legislation now concerned with the Floating Charge is codified in the Companies Act 2006, Part 25, Schedule A1, s.859A.

In conclusion

Taking all this into account, I would say that the need for what became the floating charge was recognised by the Judiciary long before the Legislature. The run of the cases through the early 19th Century clearly show the various elements of the modern concept being brought into being by the pragmatic actions of the Courts.

I believe that in order for companies, for whole industries to grow, it was, and still is, an absolute requirement for them to have access to capital, and for that, there must have been a requirement for security on borrowing.

The use of stock in trade as security gave a flexibility and an access to growth capital that allowed business to grow fast and to utilise all the opportunities given by the Industrial Revolution. Today, that same flexibility and access to borrowing is used by businesses all over the UK who perhaps rent their premises, lease their vehicles and would otherwise have no fixed assets as security for their business loans.

It is, I suggest, not too much of an exaggeration to say that without the Floating Charge, UK business would be in a far different position today.

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