UK: Fixed Charges on Book Debts: the Saga Continues

Richard Gray discusses the latest instalment on the issue of fixed charges on book debts.

In Brumark, the Privy Council decided that it was possible to have a fixed charge on book debts provided there was sufficient evidence of the parties' intention to give the lender adequate control over the proceeds of those debts. In practical terms in order to demonstrate that intention, as well as the usual restrictions on dealing with book debts (such as a prohibition on assignment or charging) it is necessary for the security to require the book debts to be credited to an account from which no withdrawals are permissible without the chargeholder's prior written consent.

The Vice-Chancellor in the Spectrum case held that charges over book debts that allow borrowers the freedom, as a matter of fact, to collect in and deal with the proceeds in the ordinary course of business (whether or not their accounts are in credit or overdraft) are properly characterised as floating charges, even if the debenture labels them as fixed.

The Spectrum decision is, however, being appealed and R3, the Association of Business Recovery Professionals, has advised caution to its members pending the outcome of the appeal. The appeal looks likely to centre on the fact that in Spectrum the account into which the book debt proceeds were collected and paid was at all times overdrawn. The argument is likely to be put that in this situation the book debt is effectively extinguished when it is paid into the overdrawn account, so that when the borrower redraws monies from the account it is effectively taking a new loan. The bank is likely to argue that this is not the same legal thing as dealing with book debt proceeds in the ordinary course of business. It remains to be seen what view the English Court of Appeal will take on this line of argument.

In the light of the Brumark decision many banks altered their lending practices because of the practical difficulties in establishing a fixed charge over book debts. There has been a move towards invoice discounting arrangements where the lender actually takes an assignment of the underlying book debts, either with or without notice to the relevant debtors. However, this is a security arrangement which is not palatable for many borrowers. As Ciaran McAreavey, a director of Ulster Bank Business Banking, puts it, "the unfortunate knock-on effect of the Brumark decision has been to restrict the capital available, particularly to smaller businesses". Whether a successful appeal in the Spectrum case on the narrow basis referred to would be enough to reverse this trend is questionable.

Looking forward, the importance of the distinction between fixed and floating charges over book debts is likely to be reduced to some extent if, and when, the provisions of the Enterprise Act are extended to Northern Ireland. This is because certain categories of Crown preferential debt are likely to be abolished (diluting the influence of the primary objectors to fixed charges on book debts) and a requirement introduced that a prescribed part of the floating charge proceeds be made available for the benefit of unsecured creditors. Nevertheless, it will remain an important issue in liquidations, both prior to and after any such changes are introduced here.

In an interesting aside to the main debate, in another English decision this year the judge decided that where the proceeds of book debts have been distributed to a debenture holder on the basis that a charge over book debts was fixed, a subsequent liquidator of the company could not claim the proceeds back from the lender on the grounds that the debenture holder had been unjustly enriched. Small comfort perhaps for the lenders!

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