Australia: Charges Over Company Book Debts

• A UK appeal court decision has reversed a recently decided case regarding security over book debts. The ramification for Australian lenders is continued uncertainty.

A company executing a charge over its assets will commonly include its present and future book debts. With the existence of Corporations Act 2001 sections like 433, 443E and 556, there are motives for ensuring that the charge over book debts is fixed rather than floating, especially if book debts make up a significant proportion of the company’s assets.

The creditor’s ability (or the ability of its draftsman) to do this with certainty has been clouded by a number of decisions from English and Australian courts that has recently led one English Court to confess that the area of law is unsatisfactory and that legislative guidance may be the answer.

Graeme Gurney and Olivia Maloney’s article in our March edition of Insights discussed a recent decision of the English High Court that found a charge over book debts described in the debenture as fixed, was in fact a floating charge.

Since that article, the decision of the High Court has been reversed by the English Court of Appeal in National Westminster Bank plc v Spectrum Plus Ltd [2004] EWCA Civ 670, a reversal which reflects the uncertainty plaguing this area of law.

Decisions in Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] Lloyd’s Rep 142 and Re New Bullas Trading Ltd [1994] 1 BCLC 485 opened the doors to banks and other lenders to create a fixed charge over the present and future book debts of the company, while preserving the company’s ability to use the proceeds from book debts in its ordinary course of business.

More recently the English Privy Council in Agnew and Bearsley v The Commissioner of Inland Revenue; Re Brumark Investments Limited [2001] 2 AC 710 held that the decision in New Bullas was wrongly decided, and held that nothing short of a clause preventing the company from dealing with those proceeds for its own benefit was adequate.

While persuasive, Privy Council decisions do not bind English courts, and though the English High Court in National Westminster Bank plc v Spectrum Plus Ltd & Ors [2004] EWHC 9 (Ch) followed the reasoning of the Privy Council, the Court of Appeal did not and found itself bound to follow the decision in New Bullas, and approved of the decision in Siebe Gorman.

Besides the binding effect of New Bullas, the Court of Appeal also held the charge was a fixed charged on the basis that when proceeds from book debts were deposited into an account with the Bank, title to those proceeds passed to the Bank and the company was left merely with a contractual right to draw on the proceeds.

Interestingly the Court of Appeal held that even if that analysis was not correct, then the Siebe Gorman debenture had, by customary usage, acquired the meaning and effect of the fixed charge that had been attributed to it.

While the Court of Appeal decision in National Westminster has, for the time being, left English lenders with some form of assurance that fixed charges over book debts in the Siebe Gorman form will be upheld, it is a shaky assurance, partly because members of the Privy Council are also members of the House of Lords (England’s highest appeals court), and partly because of the grounds that were relied on by the Court of Appeal. Australian courts have tended to be more pragmatic than English courts, looking at the practical or commercial effect of a clause to construe it.

In the High Court in United Builders Pty Ltd & Another v Mutual Acceptance Ltd (1980) 144 CLR 673, Justice Stephen in a minority decision commented (it was not these comments with which the rest of the court disagreed with him) that unless a charge over assets such as stock in trade or book debts is permitted to float, rather than fasten upon them once and for all when created, the company will be unable to carry on business. His Honour said that the intention of the parties that, despite the charge, the company should still continue to carry on business, leads to the conclusion that the charge is a floating charge.

In Mullins v R (1994) 13 WAR 288, the Full Supreme Court of Western Australia declared that Siebe Gorman did not in accord with Australian authority. While recognising the possibility of a properly drafted instrument creating a fixed charge over book debts, the Full Court found that charge to be floating because its terms envisaged the proceeds of the book debts being used in the ordinary course of the company’s business and was therefore inconsistent with the nature of a fixed charge. In Whitton v ACN 003 266 886 Pty Ltd (Controller Appointed ) (In Liq) (formerly Boswell Printing Pty Ltd) [1996] 42 NSWLR 123, Justice Bryson adopted the approach in New Bullas and held that the charge in that case was fixed in relation to uncollected book debts, and floating as to the realised proceeds.

Both decisions, however, pre-date the Privy Council’s decision in Agnew, and are persuaded to some extent by the decision in New Bullas. The Privy Council looked at the practical effect of the debenture and said the proceeds cannot be at the disposal of the company. It also held that it would be sufficient if the proceeds of book debts were required to be paid into a "blocked account" with the Bank, but would only suffice if it operated like a blocked account in fact.

The irony is that while the Privy Council thought the Siebe Gorman clause created an account that operated as a blocked account, the Court of Appeal in National Westminster did not, and yet still upheld the clause as creating a fixed charge.

If the Court of Appeal decision in National Westminster is appealed to the House of Lords, banks and chargees will receive some clarity in this area. A House of Lords decision is likely to be very persuasive in Australian courts.

Until then, banks should reconsider their standard form debentures if they intend to create fixed charges over a client’s book debts. The essential element is the amount of control the banks have over the proceeds of book debts. The Privy Council in Agnew suggested two mechanisms that created sufficient control:

• the bank to appoint the company as its agent to collect the debts for its account and on its behalf; and
• require the proceeds of the debts to be paid into a blocked account with the bank.

In both cases it is crucial the bank/chargee retain control over the use of the proceeds, and the chargor is not free to use the proceeds as they please. Any level of control short of that will open up the debenture to potential challenges of its validity as creating a fixed charge.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.