12 July 2005
The decision of the House of Lords in National Westminster Bank plc v Spectrum Plus Limited [2005] UKHL 41 (30 June 2005) has important ramifications for the manner in which security is created over book debts.
The decision is not binding in Australia although it is persuasive authority. In the absence of a contrary Australian decision, it may be difficult for a financier to take a fixed charge over book debts other than in those financing transactions where the security provider does not require day-to-day use of the cash flow generated from those book debts for the operation of its business. This in turn will have important consequences on the insolvency of the security provider.
Practical impact of fixed versus floating charge
If a floating charge is taken over the book debts of a company, that charge may still be crystallised and enforcement action taken in accordance with the terms of the charge. So, why then does it matter whether a charge over book debts is a fixed charge or a floating charge?
Under the Corporations Act, in the event of insolvency of a chargor, the priority rights of a chargee to any assets subject to a floating charge will be postponed to the rights of certain other creditors of the chargor, particularly employees - see section 433. Accordingly, if a charge over book debts is a floating charge, this may disadvantage the chargee by limiting its priority rights to a significant asset of the chargor.
Structure currently adopted
Financiers have always faced a dilemma in structuring security over book debts of a company. On the one hand, for the reasons outlined above, a financier wishes to ensure it has a fixed charge over such debts. On the other, generally a chargor will need to use the proceeds of its book debts to ensure it has sufficient cash flow for the operation of its business.
In Australia, the "practical" solution is generally adopted of stating in the charge that a fixed charge is created over the chargor's book debts and including a restriction on the rights of the chargor to transfer or create security or similar rights over the book debts. The proceeds of those book debts are then required to be deposited in an account held with the chargee, with the chargor being given the right to use the proceeds in the ordinary course of its business until such time as the chargee notifies it otherwise.
Concern has been expressed as to whether this creates a fixed or floating charge over the book debts. Although the charge is expressed to be a fixed charge, it has the characteristics of a floating charge - it is created over a pool of assets, the composition of which changes from time to time, and the chargor is given rights to use those assets (or at least the proceeds of them) in the ordinary course of its business. Notwithstanding this concern, it had generally been thought, on the basis of the English decision of Siebe Gorman, that Australian courts would uphold the agreement of the parties that such a charge is a fixed charge. Spectrum Plus has overruled Siebe Gorman.
The Spectrum Plus decision
Spectrum Plus held that if a charge permits the chargor to deal with any proceeds of realisation of book debts in the ordinary course of its business until some further step is taken, the charge over the book debts is a floating charge, irrespective of how the parties themselves may have classified it. If applied in Australia, for a charge over book debts to be a fixed charge the chargee must have control over the charged book debts and the proceeds of those debts. Generally it is expected that this will require those proceeds to be deposited to a blocked account over which the chargee has control, though other structures may be possible.
It will not be sufficient to create a fixed charge if the charge creates a blocked account arrangement but is administered in such a way that this arrangement is not strictly implemented. The English decisions make it clear the courts are willing to look not only at the terms of the charge but also the actions of the parties.
Implications for the future
It is unlikely to be practical in all cases for financiers to require a blocked account arrangement for book debt proceeds of chargors. There may however be alternative procedures that can be put in place that will provide the degree of control that the House of Lords required to exist before a fixed charge will be created.
Financiers need to consider the implications of Spectrum Plus not only in future secured financing transactions, but also in transactions that have already been entered into. Where necessary, "further assurances" clauses in existing securities may be used to require chargors to provide additional security over book debts and the proceeds of those debts to ensure that a fixed charge is held.
Where a receiver has been appointed under any security over book debts careful consideration will need to be given to the distribution of the book debt proceeds.
