Venture Lending in Israel: Fixed vs. Floating Charge -The Risks of Recharacterization
Intro
Welcome to the fourth installment in our series of articles providing an overview of the various aspects relating to the venture lending industry in Israel, including some of the legal, commercial and regulatory factors that should be taken into consideration by anyone looking to enter into this realm. The main goal of this series is to equip readers with valuable knowledge and understanding of the venture lending landscape in Israel, helping them navigate and capitalize on the unique opportunities it presents, particularly for those looking to become stakeholders in the Israeli startup ecosystem. In our fourth installment below, we provide a high-level overview regarding taking of security in Israel focusing on some of the challenges in maximizing lender priority rights.
Taking Security in Israel
For a security interest to be effective against third parties, such security interest should be properly registered with the relevant authority in Israel.
In general, secured creditors have preference with regard to the property over which they hold a security interest, provided that the charge was duly registered and perfected. Israeli law has a hierarchy between types of security interests, primarily fixed and floating charges, the strongest being a fixed charge over specific assets which provides a nearly absolute preference to the creditor. There are some exceptions to the preference of fixed charge secured creditors – these include certain real property taxes, possessory liens on movable assets, certain liquidation expenses (incurred in connection with the realization of the assets) and in the case of fraudulent conveyance. In addition, a creditor that has valid set-off rights can prevail over a secured creditor who has a security interest over rights of the pledgor, which are subject to set-off.
Fixed Charge vs. Floating Charge
A fixed charge is a charge over a specific set of assets at a certain point in time, whereas a floating charge is a blanket charge over all of the pledgor’s present and future assets, which crystalizes upon the initiation of enforcement proceedings. This distinction is crucial in determining the priority and distribution of proceeds in insolvency proceedings.
While a creditor secured by a fixed charge will be entitled to all of the proceeds derived from the realization of the assets subject to the fixed charge, in accordance with the Israeli Insolvency and Economic Rehabilitation Law, 5779-2018, a creditor secured by a floating charge will be entitled to priority on only 75% of the proceeds derived from the realization of the assets subject to the floating charge, and the remaining 25% of the proceeds will be added to the pool of assets available for distribution among both the secured and unsecured creditors, pro rata.
Typically Pledged Assets
While the floating charge will capture all assets of the borrower existing at the time of enforcement other than assets expressly excluded from such charge, the following assets are typically pledged in the context of an Israeli technology company lending transaction under a specific fixed charge:
Fixed assets (computers, desks, machinery, etc.);
Registered and unregistered intellectual property
Rights under commercial agreements/accounts receivables;
Insurance proceeds;
Bank accounts; and
Equity interests.
It is advisable to include provisions in the loan documents requiring the borrower to notify the lender(s) and/or collateral agent regarding the subsequent acquisition of material assets, including intellectual property, following the closing of the transaction, and allowing for periodic amendments of the underlying fixed charge security agreement in order to pick up such new assets and recognize them as being subject to a fixed charge as opposed to the inferior coverage provided under the floating charge.
Recharacterization of a Security Interest with respect to Bank Accounts and/or Accounts Receivable
In the S.R. Accord vs. the State of Israel, et all. court case from 2022, the Israeli Supreme Court characterized a security interest created over bank accounts and accounts receivable as a floating charge, and not a fixed charge, as opposed to the characterization provided under the respective security agreement. As part of the court's decision, it set out certain indications as to the practical measures that could be taken in order to increase the likelihood that such security interests would be characterized as a fixed charge, as opposed to a floating charge. These key criteria are: (i) the level of control the creditor has over the pledged asset, and (ii) the extent to which the pledged asset is defined with sufficient specificity. Generally speaking, the greater the level of control that the creditor has over the asset in question and the detail in which such asset is specifically identified in the security agreement, the more likely it is that the security interest would be affirmed by the courts as a fixed charge, as originally intended. Ultimately, the court provided indicative guidelines but not clear cut rules.
The measures set forth above are of course subject to the commercial agreement of the parties. It should be noted that, from a practical perspective, it would be uncommon in a typical venture lending transaction to provide a sufficient level of control to meet the court’s test. Moreover, Israeli banks do not sign deposit account control agreements as a matter of policy.
A common approach taken by lenders with regards to Israeli bank accounts, in order to mitigate exposure that may arise from the potential recharacterization of a fixed charge over bank accounts, is to set a limit with respect to the aggregate amount of funds that may be held in such accounts during the term of the loan, with the borrower providing a covenant not to exceed such predetermined limit. It is also common for many US based lenders to insist on a certain amount of cash to be deposited in US bank accounts of the borrower subject to an account control agreement.
About Us
Arnon, Tadmor-Levy proudly stands among Israel’s most prominent law firms, with one of the largest and most respected banking and financial services departments. We have extensive experience in cross-border and other complex financing transactions, representing both lenders and borrowers. Our trusted reputation spans a vast clientele, including leading Israeli and international banks and other financial institutions. Should you have any questions, or are interested in learning more about the various aspects of the Israeli venture lending and private credit industry, please feel free to reach out to a member of our venture lending
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