Fixed charges against book debts and blocked accounts

By Graeme Gurney and Olivia Maloney.

Key Points:
A recent English decision has shed some new light on the question of whether a fixed charge security can be taken over book debts. In short, a greater degree of control by the chargee is required.

Background

How can financiers take security over book debts? By way of background, here's a brief summary of the law to date.

The effectiveness of a specific charge over present and future book debts as circulating assets was first upheld in the 1979 decision of Justice Slade in Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyd's Rep 142 and later in the 1986 decision of the Supreme Court of Ireland in Re Keenan Bros Ltd [1986] BCLC 242.

In Siebe Gorman, the debenture stated that the charge on book debts was fixed. However, while the terms of the debenture required the borrower to pay book debt proceeds into its account with the bank and not to charge or assign them, it did not prohibit their use in the ordinary course. The debenture did, however, require the borrower to execute a legal assignment of the book debts if requested. Justice Slade in Siebe Gorman concluded that the debenture provided the bank with sufficient control over book debt proceeds to justify characterising the charge as fixed notwithstanding that proceeds could be dealt with in the ordinary course. In this case, the court focussed on the presumed intention of the parties.

The English Privy Council tested Siebe Gorman in its decision in Agnew and Bearsley v The Commissioner of Inland Revenue and others; Re Brumark Investments Limited [2001] 2 AC 710. In that case, the Privy Council held that notwithstanding the fact that a charge over uncollected book debts was stated to create a fixed charge, it took effect as a floating charge where the chargor retained the ability to deal with the book debts and their proceeds in the ordinary course. In that case, the Privy Council disagreed with Justice Slade in Siebe Gorman and concluded that there was not sufficient control to characterise it as a fixed charge.

As the Privy Council's judgment in Brumark was, strictly speaking, only of persuasive authority in England, banking circles have been waiting for the decision to be tested by English courts.

This happened recently when the High Court of England and Wales handed down its decision in Spectrum Plus Limited [2004] EWHC 9 (Ch) ("Spectrum"). In that case the National Westminster Bank plc applied for a declaration that a debenture granted by Spectrum Plus Limited (in voluntary liquidation) in favour of the Bank created a fixed charge over Spectrum's book debts, and for an order that the liquidators account to the Bank for proceeds from realisation of those book debts. The respondents to the application were Spectrum and its liquidators, the Customs and Excise Commissioners, the Inland Revenue Commissioners and the Secretary of State for Trade and Industry.

The account

Spectrum opened an account with the Bank and obtained an overdraft facility of £250,000 for the purpose of providing working capital for the business of Spectrum. By a debenture dated 30 September 1997, Spectrum created a charge, expressed to be "by way of specific charge" in favour of the Bank over its book debts in order to secure moneys due from Spectrum to the Bank.

The obligations of Spectrum, contained in clause 5 of the debenture, were as follows:

• to pay the proceeds of any book debt into Spectrum's account with the Bank;
• not to sell, factor, discount or otherwise charge or assign the book debt in favour of any other person or purport to do so without the consent of the Bank; and
• if called on to do so, to execute legal assignments of such book debts.

The Bank advanced to Spectrum £200,000 and debited the account accordingly. While the overdraft facility varied from time to time, Spectrum's account was never in credit. The proceeds of the book debts were collected by Spectrum and paid into the account with the Bank, thereby reducing the overdraft, and Spectrum drew on the account as and when it need to do so thereby increasing the overdraft.

Spectrum went into voluntary liquidation owing the Bank £156,554. Its liquidators collected and realised book debts to the value of £113,484 but refused to account for them to the Bank. The Bank sought a declaration that the debenture created a fixed charge over Spectrum's book debts and the proceeds on realisation and an order that Spectrum's liquidators account to the Bank in respect of those proceeds.

Fixed or floating charge?

The debenture in Spectrum was on similar terms to that in Siebe Gorman. In Spectrum, the court re-examined the Siebe Gorman case to decide whether Siebe Gorman type debentures created fixed or floating charges over book debts. In deciding this issue, the court considered the three part test set out in Brumark, being:

1. the nature of the rights and obligations which the parties intended to grant each other;
2. whether it was the intention of the parties that the charged assets should be under the control of the company or the charge holder; and
3. whether such an intention was consistent with the nature of the transaction as described by the label the parties had put on it.

In relation to first limb of the test, the account to which Spectrum was obliged to pay the proceeds of any book debts was an ordinary current account with a clearing bank, with no express restrictions on the operation of the bank account.

On the issue of control under the second limb of the test, the court concluded that it was clear that the book debts were under the control of, and available for use by, Spectrum in the ordinary course of its business as long as Spectrum abided by the terms of the overdraft.

Under the final part of the test, the Vice-Chancellor considered whether the intention of the parties was consistent with the nature of the transaction. Clause 2(v) of the debenture charged the book debts "by way of specific charge". However, that was not consistent with the rights and obligations granted and imposed by clause 5. The court found that Justice Slade erred in his decision in Siebe Gorman, and instead found that the charge over book debts granted by Spectrum to the Bank could only be characterised as a floating charge and the rights of the parties had to be ascertained as such.

Leave to appeal has been granted to the Bank.

Implications for Australian practitioners

Pending the outcome of the appeal, the authorities referred to above, although only of persuasive authority in the Australian context, would suggest that:

• a chargee must be in "control" of the proceeds of book debts if the charge is to be classified as fixed; and
• that a bank will have difficulty asserting that a charge on book debts is fixed, if the borrower is in fact permitted to deal with the proceeds in the ordinary course of business.

To satisfy the Brumark "control" test, a chargee:

• should require the proceeds of book debts to be paid into a blocked account with the charge holder, ensuring that the chargee controls all book debt realisations; or
• alternatively, may authorise the chargor to collect the book debts as its agent, provided that the proceeds that are collected are for the chargee's account and not for the benefit and use of the chargor.

For further information, please contact Graeme Gurney.