A sequel to the Avanti Spectrum

There are few judgments concerning the proper characterisation of security and even fewer dealing with security over intangibles in the age of the internet and Industry 4.0.  In this relative desert of jurisprudence, we are pleased to report on the recent ruling of Judge Baister in the case of UKCloud Limited (UKCloud)¹…. emerging like an oasis from the heat haze. 

Handed down on 24 May 2024, the ruling followed an application for directions² made by the Official Receiver in connection with the compulsory liquidation of UKCloud a specialist cloud-based service provider to public sector and private sector organisations across the UK.  DLA Piper³ acted for the Official Receiver on the application and in relation to the compulsory liquidation of UKCloud.

The question before the court was whether a debenture granted by UKCloud to Harbert Specialty Lending Company II SARL (Harbert) properly took effect as a fixed charge over the internet protocol addresses held by UKCloud. 

For the benefit of those unfamiliar with this asset, internet protocol addresses are the unique identifying number assigned to every device connected to the internet. Given the nature of UKCloud’s business and the necessity for remote servers to be accessed by clients and customers to servers located in data centres, they were a critical part of the assets of UKCloud and infrastructure of the business. The Official Receiver determined that the internet protocol addresses had material value that could be realised for the benefit of the estate.

In giving his judgment, having heard submissions from Counsel for the Official Receiver⁴, Judge Baister considered the authorities on contractual interpretation of charging provisions and the characterisation of fixed and floating charges. Judge Baister was ultimately not persuaded by Harbert’s argument in favour of a fixed charge, ordering that the charge created over the internet protocol addresses took effect only as a floating charge.

Harbert’s position by reference to the debenture was that the following charging provision captured by way of a first fixed charge the internet protocol addresses:

“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 proposition was that “authorisations” (which caught within it “registrations” pursuant to the interpretation of that word set out in the debenture), included the relevant internet protocol addresses as a registration at the registry RIPE⁵; being the body who had issued the internet protocol addresses held by UKCloud.  Judge Baister accepted that such drafting was capable of charging the internet protocol addresses.  This was consistent with the finding in Avanti⁶ that assets that were in their nature registrations, were capable of being subject to a fixed charge, however, this was not the end of the analysis as to the correct construction of the Harbert debenture.

All or nothing approach to charging provisions

The Official Receiver had raised concerns with Harbert as to the impact of the proposed wide construction of the charging provision and the risk of unintended consequences.

Harbert argued that Judge Baister was not limited to construe the charging provision on an “all or nothing” basis. Ultimately, Judge Baister held that he was bound by precedent to construe the charging provision in that way, in doing so, affirming the dicta of Blackburne J in Re Beam Tube Products Ltd⁷ that “either the clause creates a fixed charge over all of the assets to which it refers or it creates a fixed charge over none of them.”

The case law - fixed or floating charge

In applying the facts and the nature of the internet protocol addresses to the case law concerning security characterisation, the Judge gave full consideration to the common characteristics of fixed and floating charge security.  The Judge started by considering whether the internet protocol addresses were part of UKCloud’s circulating capital or a fluctuating asset or body of assets. These are the common tests used in the authorities to determine whether the asset is more likely to be associated with a floating charge. The Judge found it difficult in this case to apply those characteristics to the relevant asset, ultimately resolving that in applying those authorities to the facts, the point was inconclusive. 

He did however then consider whether, for the purposes of a fixed charge, sufficient control was exercised by Harbert.  In doing so the court analysed the “real” practical control exercised over the asset and the contractual mechanisms employed for control.

Baister J refused to accept that contractual control mechanisms in the debenture automatically meant that as a matter of practice, Harbert exercised the necessary control over the assets. The judgment makes it clear that the absence of any evidence of the practical control required for a valid fixed charge, carried significant weight in the analysis of the nature of the security.  Additionally, post-contractual conduct is (and has always been) a matter of great importance when it comes to assessing whether a chargeholder holds the benefit of a fixed charge. 

In the Judge’s assessment on the issue, he found that a contractual undertaking taken in isolation is unlikely to be sufficient to demonstrate the necessary level of control required for a security interest to be classed as a fixed charge. The Judge was therefore in agreement that “if a stipulation in the charging documents is not adhered to in practice, the agreement may be held to be a sham and characterised as a floating charge”.⁸

The Judge held that UKCloud was at all times able to carry on its business and deal with the internet protocol addresses without the consent of Harbert, as such the charge was only said to take effect as a floating charge.

Key Takeaways

Given the continued erosion of the value of floating charge security held by secured creditors, the case highlights the continuing necessity that secured creditors carefully consider the valuable assets which they intend to rely upon to make a recovery following a borrower default.

Careful drafting of the charging provisions and the implementation of practical controls over fixed charge assets must remain a key focus for lenders if they are capture assets under a fixed charge.

As demonstrated by both this case and the case of Avanti, the proliferation of intangible assets as we move deeper into Industry 4.0, represents a risk and opportunity for the secured lender community. Pro-forma security documents and “standardised” lender methodologies may not deliver the secured position lenders intend.

As at the time of writing, Harbert has yet to confirm whether it intends to appeal this judgment.