A new ruling issued by the House of Lords last week places holders of floating charges in a senior position over insolvency-related expenses, including liquidators' costs. The ruling distinguishes between floating charges - where a particular class of changing assets acts as security in a loan - and fixed charge assets that are tied to a specific asset.
Though the ruling bodes well for U.K. whole business securitizations, adding more certainty to structural assumptions, it comes as no surprise to most of the market. The industry had been expecting the move following the changes outlined in last year's Enterprise Act.
"It is key that the secured loan between the issuer and the borrower benefits not only from a fixed charge over specific assets, but also from a floating charge over the remaining assets and undertakings of the borrower," said analysts at Barclays Capital. "Only this allows the trustee to appoint an administrative receiver in the case of insolvency, who will manage the assets (or find alternative management) for the principal benefit of the noteholders and thus (in principle) not become embroiled in the wider insolvency proceedings."
It's important to define the fixed and floating charges as Parliament required preferential debts, such as taxes, to be paid out of the floating charge assets and to an extent diminished the security right of lenders under floating rate charges. "The categories of preferential debts have recently been reduced in the Enterprise Act of 2002, but some of the floating charge assets may now be available to the unsecured creditors in certain circumstances," explained sources at Freshfields Bruckhaus Deringer. "So for that and other reasons, it is still important to categorize what the lender has as being either a fixed or floating charge."
The aim of whole business deals is the ability to run a business through insolvency, as outlined by the new Enterprise Act, which received royal assent at the end of last year. Bonds issued under a whole business structure are a direct or indirect liability of the operating company, which maintains ownership and control of the assets. Bondholders are granted security only on those assets that are securitized under the whole business structure. Deals that securitize financial assets, such as credit cards, loans and mortgages, are structured so that the assets are not available to the bankrupt estate of the operating company. This is typically achieved through a secured loan structure.
Under a whole business structure, the issuer will employ the net proceeds from the issuance of the notes to make loans to one or more operating companies.
The Enterprise Act restricts the ability of lenders to appoint an administrative receiver and grants the holder of a qualifying floating charge the option to appoint an administrator, whose aim is not to manage the assets solely for the benefit of the holder of the floating charge, but to manage the company for the wider creditor community.
The new ruling eliminates some of the uncertainty in how preferential debts, such as taxes, would impact recoveries, as they are firmly subordinate to the fixed charges.
According to Freshfields, under the past ruling, the general liquidation costs that were entirely unconnected with the preferential creditors (or incurred purely for the benefit of the unsecured creditors) were held ahead of the floating charge. The House of Lords last week clarified that floating charges will rank ahead of liquidators' costs and other expenses. Liquidation costs and expenses are not recoverable out of floating charge assets; at least not until the secured debt has been paid in full.
"It is a very helpful decision which goes against the tide of the somewhat anti-floating charge' authorities," said sources at Freshfields. "Although following the Enterprise Act, there will be more enforcement of security through the mechanism of administrations, the decision will be extremely important to lenders in all those situations where they will continue to be able to appoint administrative receivers as set out in the Enterprise Act." The sources noted that there is express statutory power to pay the administrator out of floating charge assets.
All in all, the firmer rules will have little impact on how most whole business deals function. "For real estate companies where there is the risk of significant capital gains tax, the economics might be more viable with the new ruling," said one market source. The source added that, in the past, whole business deal with heavy capital gains tax contingents required significant reserves.