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ACCA Applied Skills · Corporate and Business Law (Global) · Loan capital

Tormen Ltd's debenture contains a clause stating that the company will not create any later charge ranking equally with or ahead of the debenture holder's floating charge. The company later grants a second lender a fixed charge over its warehouse. The second lender knew of the clause. What is the effect of the clause on priority?

The second lender will rank behind the first floating charge. A negative pledge clause protects the earlier floating charge against later chargees who have notice of it, overriding the usual rule that a fixed charge takes priority over a floating charge.

  1. AThe clause has no effect because floating charges always rank behind fixed charges
  2. BThe clause is void because it restricts the company's freedom to borrow
  3. CThe second lender's charge is invalid and has no effect for any purpose
  4. DThe second lender, having notice of the clause, will rank behind the first floating chargeCorrect

Explanation

A negative pledge clause can preserve the priority of a floating charge against a later chargee who has notice of it. Because the second lender knew of the clause, it cannot take priority over the earlier floating charge. The general rule that fixed charges beat floating ones is displaced by this notice. The later charge is not invalid; it simply ranks behind.

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