This analysis addresses the priority dispute between Zambezi Bank’s floating charge and the subsequent fixed charge created in favour of Kabulonga. The central issue is whether a negative pledge clause in Zambezi Bank’s floating charge debenture is effective in preventing Kabulonga’s fixed charge from gaining priority. The outcome is determined by the application of the doctrine of notice, which, based on persuasive English legal authority, requires the subsequent chargee to have actual notice of the restrictive clause itself, not merely the existence of the prior charge.
The Standard Priority Position
In company law, security can be taken over assets through either a fixed or a floating charge. A fixed charge attaches to specific, identifiable assets immediately upon creation, restricting the company's ability to deal with that asset without the chargee's consent. Conversely, a floating charge is taken over a class of assets, such as stock-in-trade, which the company can continue to manage and dispose of in the ordinary course of business until a 'crystallisation' event occurs (Goode and Gullifer, 2017).
The general rule regarding priority is that a later fixed charge will rank ahead of an earlier floating charge over the same asset. This is because the floating charge does not attach to any specific asset until it crystallises. Until that point, the company retains the power to deal with its assets, which includes the power to create subsequent fixed charges that will attach immediately and therefore take priority (Ferran and Chan, 2017). In this scenario, Kabulonga’s fixed mortgage would, under this general rule, have priority over Zambezi Bank’s earlier floating charge.
The Negative Pledge Clause
To counter this general rule and protect their position, lenders who take a floating charge, like Zambezi Bank, will almost always include a 'negative pledge clause' in the debenture document. This is a contractual term that prohibits the borrowing company from creating any subsequent mortgage or charge that would rank in priority to, or equally with, the floating charge without the floating charge holder's consent. If a company breaches this clause, it is a breach of contract with the floating chargee. However, the more important question is whether this clause binds a third party, such as a subsequent lender like Kabulonga.
The Determinative Issue: The Doctrine of Notice
The effectiveness of a negative pledge clause against a subsequent chargee depends entirely on the doctrine of notice. For the clause to bind Kabulonga and postpone its fixed charge, Kabulonga must have had notice of the restriction at the time it took its security. The crucial point, established in English case law, is the type of notice required.
The courts have drawn a clear distinction between notice of the existence of a floating charge and notice of the specific contents of the debenture, such as a negative pledge clause. It is not enough for the subsequent lender to know that a floating charge exists. Even if the charge is registered at the relevant companies registry, this registration only provides constructive notice of the existence of the charge, not its contents. This principle was established in English & Scottish Mercantile Investment Co v Brunton [1892] 2 QB 700 and confirmed in Wilson v Kelland [1910] 2 Ch 306. In Wilson v Kelland, the court held that a subsequent legal mortgagee who searched the register and found a prior floating charge was not deemed to have notice of a restrictive clause within it, and therefore took priority. The court reasoned that it would be an unreasonable burden on commerce to expect every subsequent lender to obtain and read through the entire contents of every prior registered debenture.
Therefore, for the negative pledge clause to be effective against Kabulonga, Zambezi Bank would need to prove that Kabulonga had actual notice of the clause itself. The facts state that Kabulonga knew of the debenture but not the negative pledge clause. In the absence of actual notice, Kabulonga is not bound by the restriction.
Applying this to the facts, Zambezi Bank’s attempt to use the negative pledge clause to gain priority over Kabulonga’s fixed mortgage will fail. Kabulonga had knowledge of the debenture’s existence but lacked actual notice of the specific prohibition on creating further charges. Consequently, the general priority rule applies. Kabulonga’s fixed mortgage attaches to the specific property and will take priority over Zambezi Bank’s floating charge with respect to that asset.
References
Ferran, E. and Chan, C. (2017) Principles of Corporate Finance Law. 2nd edn. Oxford: Oxford University Press.
Goode, R. and Gullifer, L. (2017) Goode and Gullifer on Legal Problems of Credit and Security. 6th edn. London: Sweet & Maxwell.
English & Scottish Mercantile Investment Co v Brunton [1892] 2 QB 700.
Wilson v Kelland [1910] 2 Ch 306.
