UKCloud Ltd - lenders are reminded to demonstrate actual control over assets subject to fixed security

In UKCloud Ltd (Re Insolvency Act 1986) [2024] EWHC 1259 (Ch), the court was again faced with the age-old question of categorisation of a security interest but this time in respect of a new type of asset, internet protocol (IP) addresses. Could fixed charge security be taken over IP addresses and, if so, was it taken here?

Holding that the IP addresses could be the subject of a fixed charge (and did – just about – come within the scope of the fixed charge provisions in the debenture in question), the court nevertheless held that the charge was in fact floating because the chargee had not in practice exercised any degree of control over the assets (despite the existence of provisions in the debenture which, theoretically, enabled it do so).

Background

The liquidator of UKCloud Ltd (the Company) applied to the court for directions as to whether a debenture granted by the Company to its lender (Harbert European Speciality Lending Company II SARL, Harbert) in 2020 created fixed or floating security over the Company’s IP addresses. Those IP addresses were freely allocated by the Company to its customers in the course of it providing cloud computing services to them. When the Company was insolvently wound up by the court in 2022, the IP addresses were sold and the sale proceeds held by the liquidator pending the outcome of this application: if Harbert was found to have a valid fixed charge over the IP addresses, it would receive the full amount recovered, but if Harbert had only a floating charge, then the sale proceeds of the IP addresses (subject only to floating security) would first be used to settle expenses incurred in the liquidation, with Harbert’s claim as a floating charge holder ranking further down the distribution waterfall.  

The nature of fixed and floating charges

In Re Spectrum Plus Ltd [2005] UKHL 41, [2005] 2 AC 680 (Re Spectrum), the court determined that under a fixed charge “the assets charged as security are permanently appropriated to the payment of the sum charged”. It is therefore necessary for a chargee to have sufficient control over the charged assets, with consent required from that chargee in order for the chargor to deal with the assets. The question of what degree of control is required was revisited in Re Avanti Communications Ltd [2023] EWHC 940 (Ch), which we looked at last year. In Re Avanti the High Court held that near-total (but not complete) control of an asset (e.g. by way of advance permission for limited disposals in certain circumstances) could still be sufficient to constitute a fixed charge. 

In contrast, under a floating charge, consent to deal with the charged assets is not needed: “the chargee has a proprietary interest, but its interest is in a fund of circulating capital, and unless and until the chargee intervenes (on crystallisation of the charge) it is for the trader, and not the bank, to decide how to run its business” (Re Spectrum). In Re Yorkshire Woolcombers Association [1903] 2 Ch 284, a floating charge is explained to be covering a “fluctuating body of assets”, which – in the ordinary course of business – will change from time to time.  

Here the court also considered (and found it was bound by) caselaw supporting the proposition that a clause creating security must be construed as a whole, on an “all or nothing basis”: all assets within the charging clause must be subject to either fixed security or to floating.

(For further background on the nature of fixed and floating charges, see our previous guide: A-Z of banking and finance: F is for fixed and floating charges.)

Decision

The starting point when looking at the nature of any security interest created by a charging document is to look at the language of the document to determine what was intended by the parties. In UKCloud the court found (albeit with some trepidation) that although not explicitly named, the IP addresses were caught by the charging clause at clause 3.2(d) of the debenture which encompassed “all licences, consents and authorisations (statutory or otherwise) held or required in connection with the Company's business or the use of any Secured Asset, and all rights in connection with them” (the Fixed Charge Clause).

The court also found that the IP addresses would not be considered to be part of a “fluctuating pool of assets” or “circulating capital” of the Company, because the Company was limited in what it could do with the IP addresses (it could not sell or dispose of them and then “replenish the gap” as part of the churn of the business). The IP addresses therefore lacked one characteristic commonly associated with a floating charge (but this in itself was not determinative of whether the charge was fixed or floating).

Thereafter, the court then categorises, or characterises, the security interest created, which is a question of law and not of the parties’ intentions. Adopting the nuanced approach set out in Re Avanti, the court considered the level of ‘control’ given to Harbert in the debenture and that which was demonstrated (or rather, not demonstrated) to have existed in practice over the IP addresses, finding that at no point did Harbert exercise control over the IP addresses and nor did it seek to.  The control provisions in the debenture were therefore not adhered to.

The court left open the position of whether the application of the “all or nothing” test meant that the Fixed Charge Clause created only floating security (either because the nature of the other assets captured by the Fixed Charge Clause meant that they could not be subject to a fixed charge or because the breadth of the asset classes which fell within the scope of the clause would capture assets which the parties had not intended to capture in a fixed charge (such as Windows software licences)). Nonetheless the decision is a useful reminder to the draftsperson to be live to the temptations and dangers of expansive drafting.

Key takeaways

The decision provides three points of importance for lenders:

1. Interpretation of the Fixed Charge Clause would have been easier if the debenture had referenced IP addresses as an asset class (and even more so if the relevant IP addresses had been specifically identified in a schedule to the debenture). Active consideration should be given to which assets are to be subject to fixed charge security and which are to be left to the sweeper floating charge.
    
2. In a similar vein, care must be taken in ensuring that assets are not mixed within a single charging clause: where there is doubt as to whether fixed security can be taken over a particular type of asset, best to err on the side of caution and place it within its own charging clause.
    
3. Not only should a charging document explicitly state that the security interest it intends to create is “fixed”, but lenders must also demonstrate tangible control over those assets which are subject to that fixed security. Although the UKCloud case does not set out what sufficient “control” over IP addresses would look like, in practice we would expect to see lenders communicating regularly and clearly with borrowers and holding them to the terms of the control provisions set out in the security document.