Hong Kong: Banking Law – Charges Over Book Debts may no Longer be Fixed Charges in Hong Kong

In order to obtain finance from banks or lenders, Hong Kong companies will often create a charge over their assets by way of a fixed or a floating charge. In Hong Kong, like in most common law jurisdictions, a charge is a fixed charge if it is a charge over a specific or definite property (e.g. real property or machinery) and the company is restricted as to how it deals with those assets. A floating charge, on the other hand, is a charge on a class of assets, does not attach to any particular assets and allows the company to continue to use those assets in its ordinary course of business.

In the winding up of an insolvent company, it is important to determine whether a charge is a fixed or floating charge as a fixed charge holder will have priority over preferential creditors (e.g. unpaid employees and government) and unsecured creditors; whereas a floating charge holder will rank before the unsecured creditors but only after the preferential creditors.

On 30 June 2005, a House of Lords case, National Westminster Bank Plc v Spectrum Plus Limited & Others [2005] UKHL 41 ("Spectrum Plus"), overruled a 26 year old judgment in Siebe Gorman v Barclays Bank Ltd [1979] 2 Lloyd’s Law Report 142 ("Siebe Gorman") regarding charges over book debts and has a significant impact on the banking and securities industry. The Spectrum Plus case has persuasive authority in Hong Kong.

In Siebe Gorman, it was held that a charge over a company’s present and future book debts was a fixed charge. In Spectrum Plus, the company, Spectrum Plus Limited (the "Company"), obtained an overdraft facility from the bank and granted the bank a debenture to secure all moneys due from the Company to the bank. The terms of this debenture were similar to that of the Siebe Gorman debenture. It was expressly stated that the debenture was to include a specific or fixed charge over the Company’s book debts and the Company could not dispose of or charge the uncollected debts but could deal with its debtors to collect the debts. Once the debts were collected, the Company was required to pay the book debts proceeds into a designated account with the bank.

The Company had gone into liquidation and the bank demanded payment of the proceeds of the book debts from the liquidators believing that the charge created over book debts was a fixed charge pursuant to the long standing decision in Siebe Gorman. However, the Commissioners of Inland Revenue and the Customs and Excise argued that the charge over book debts was only a floating charge and that the proceeds of book debts should be paid to preferential creditors instead.

Although the charge over the Company’s present and future book debts was expressed to be a fixed charge, the House of Lords held that the bank’s debenture only created a floating charge and the Commissioners of Inland Revenue and Customs and Excise had priority over the proceeds of the Company’s book debts.

In order to create a valid fixed charge over present and future book debts, the Court held that the chargor must not be allowed to deal with the book debts and the proceeds, when collected, should be paid into a blocked account with the lender. When the collected book debts are paid into a blocked account, the chargor must not be able to withdraw the money from the account without the lender’s consent. In this case, the Company was required to pay the proceeds of book debts into a current account with the bank and it was entitled to withdraw funds from this account for its business purposes. In order to preserve a fixed charge, the charge holder must not be able to deal with charged assets freely and the chargee (e.g. the bank) must establish it has actual control over the charged assets.

This case is likely to affect forms of debentures currently used by Hong Kong lenders and asset distributions for liquidators, as charges which are similar to those of Siebe Gorman or Spectrum Plus are now floating charges. Lenders should also be careful when taking charges as security and ensure that the appropriate forms of debentures are properly drafted.

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