IP addresses ruled floating charge under loan security agreement

The case, known as Re UKCloud, deals with the categorisation of digital assets in an ever-growing digital economy and reflects the evolving nature of asset security in the digital era. It relates to the insolvency of UKCloud Ltd, which provided cloud computing services to central government departments and local authorities, giving those clients use of Internet Protocol (IP) addresses. In 2020, the company raised finance from a lender and granted it a debenture, a form of security to the lender for its loan. The company was later placed into liquidation.

The case was filed by the official receiver (OR) who is the liquidator of UKCloud, seeking the court’s directions on whether the debenture gave the lender the benefit of fixed or floating charges over the IP addresses. The court concluded that the IP addresses, despite their static nature, were secured assets subject to a floating charge instead of a fixed charge as argued by the lender.

The court decision provides useful guidance to businesses looking to charge intangible assets, such as IP addresses. For lenders to companies providing cloud services or intellectual property rich businesses, it serves as a reminder to carefully define emerging types of digital assets and assess their appropriate classification - either as fixed charge or floating charge. The judgment is also useful for advisers when considering whether security has been granted over what might be thought of as “windfall assets”, where such assets were not necessarily at the forefront of the parties’ minds at the time of the granting of the security.

More importantly, in addition to considering the nature of asset security, the ruling highlights the importance for lenders to implement and enforce the control provisions in their security documents over assets intended as fixed charge security. In this case, the court found that the lender had not exercised sufficient control to evidence a fixed charge over the IP addresses. It confirmed that this is the determinative factor for creating a fixed charge over such assets, even though the assets are not part of the company’s circulating capital and did not fluctuate, which is a common characteristic of a floating charge, and the lender had intended for the security to be a fixed charge in the debenture.

Whether secured assets are subject to a fixed charge or a floating charge is particularly relevant in light of the reintroduction of ‘Crown preference’ in insolvency, which  changes the order of payments on insolvency  making the HM Revenue and Customs (HMRC) a second-ranking preferential creditor in respect of certain taxes.

Why fixed charge security matters

It was necessary for the court to categorise the charge as the lender in this case was likely to suffer a shortfall in the liquidation following the sale of the assets of UKCloud. If the charge had been fixed, then the proceeds of the sale of the IP addresses would have been paid to the lender. However, as the charge was classified as floating the proceeds will first be used to pay expenses of the liquidation process and other items, such as pension contributions, salaries and certain taxes to HMRC, which rank ahead of a floating charge in the insolvency waterfall, and the lender will then receive any surplus.

IP addresses as secured assets

IP addresses have been compared to a postal address for a property; they allow data to travel through a network and arrive at the intended destination. Groups or “blocks” of IP addresses are held by responsible organisations, such as UKCloud, and registered with the relevant regional internet registry. The terms of registration set out that the responsible organisation does not own the IP addresses and restrict its ability to assign any rights without the registry’s consent.

In the judgment, the court firstly considered whether IP addresses were assets charged by the terms of the debenture. Whilst not expressly referenced in the security document, the lender purported to create a first fixed charge over “all licences, consents and authorisations … held or required in connection with the [UKCloud’s] business”. After considering the meaning of each word and the specific nature of an IP address which is not owned by UKCloud, the judge concluded that the “natural and ordinary meaning of the language used… [and] in particular ’authorisations’” did demonstrate an intention to create a fixed charge over the IP addresses. “But that was not the end of the matter,” added the judge.

Evidence of control is the determinative factor for a fixed charge

Debentures often label the charges created within them as “fixed” or “floating”, and whilst those labels are a useful guide to the security the parties intended to create, they are not conclusive.

Applying the two-step test under case law, to determine if a charge is fixed or floating the court must first gather the intentions of the parties from the language they used to establish the rights and obligations which the parties intended to grant each other in respect of the charged assets, and then second, categorise the charges and determine whether the charged assets were intended to be under the control of the company or the charge holder.

After considering the distinctions between fixed and floating charges drawn out in established case law, the court considered the nature of IP addresses and whether they are capable of being subject to a fixed charge or can only ever be the subject of a floating charge. The court considered whether IP addresses formed part of UKCloud’s “circulating capital” or were part of a “fluctuating body of assets.” The court recognised that there is no hard or fast definition of such assets and said that any such assets would be recognised by their disposal and replacement during the normal course of business.

The judge, therefore, ruled that IP addresses were not part of the company’s circulating capital and did not fluctuate, because UKCloud was not able to trade the IP addresses in the ordinary way, and there was little over which the lender could exercise control. The judge found it hard to see how the control mechanisms in the debenture, which the lender relied upon, could be operated in practice at all.

However, being part of a company’s circulating capital is only one characteristic commonly associated with the creation of a floating charge. Its absence does not automatically mean a fixed charge has been created.

The absence of control was held to be the decisive factor in this case. Following a “nuanced approach” established in the case of Re Avanti, the judge noted that the debenture imposed restrictions but also permitted disposals. The critical issue was the nature and extent of that control ranging from total freedom to act to a total prohibition on dealings of any kind. In practice, the lender could not evidence that it had exercised or enforced any of the control mechanisms within the debenture, and the judge commented that sometimes “the absence of evidence is as powerful as the presence of evidence.” Therefore, the security of the IP addresses is a floating charge.