Asset-based lending – the benefits

There appear to be mixed feelings about the radical changes currently being introduced to the UK insolvency laws

The changes are aimed in some respects at laying down clearer guidelines to those involved with insolvency work, and in other respects changing the focus of the purpose of certain procedures to allow a fairer system to all creditors. Additionally, in the view of some cynics, another aim is to allow the wheels of commerce to travel a little closer to the hard shoulder of the commercial highway.

As a starting point, the much discussed Enterprise Bill has been brought about to change the Insolvency Act 1986 by the introduction of the Insolvency Act 2000. The idea is to shift the emphasis from a culture of castigating failure to one of promoting rescue and recovery, for example by encouraging the use of moratorium-protected voluntary arrangements and the gradual abolition of administrative receiverships.

Just as clearing banks holding full debenture security were getting used to the idea of holding back on appointing receivers at the drop of a hat and viewing themselves as supporters of the rescue culture, case law threw another obstacle their way. The mention of Brumark sends a shiver down the spine of most clearing banks and insolvency practitioners these days. In brief, the Privy Counsel decision in Brumark has boldly laid down the requirements for a valid fixed charge on book debts.

Much debate has taken place about Brumark, but in short, if a funder wishes to ensure that it holds a fixed charge over book debts and their proceeds, it must control the proceeds by requiring payment into a blocked account beyond the reach of the charger. If this cannot be achieved, it must expect that the debts and their proceeds will become subject to a floating charge, and so on insolvency become available to preferential creditors ahead of the chargeholder. The reality is that most clearers provide their customers with flexible facilities in order for them to run their businesses with minimal interference, resulting in inadequate measures being implemented for their charge to be classed as a proper fixed charge.

Factoring and invoice discounting, once perceived as sources of funding of last resort, are forms of funding largely unaffected by Brumark. Factoring and invoice discounting are forms of asset-based lending, in which the factor acquires its clients’ debts. The difference between factoring and invoice discounting, in brief, is that factoring is a disclosed facility, whereas debtors are informed that the client has assigned its debt to the factor, and debts are paid directly by the debtor to the factor. Invoice discounting is a confidential form of debt purchasing, where the invoice discounter acquires the debts from the client, but the client collects the debts as the undisclosed agent of the discounter.

As debt purchasing results in transfer of ownership of the debts, rather than a charge on assets, the assigned debts fall outside the ambit of any security. Accordingly, in general, the funder is not concerned with demonstrating control as required by Brumark, because ownership rests with the factor.

In practice, most asset-based lenders do take fixed and floating charges over all assets of their corporate clients for two main reasons: first, to enable them to appoint administrative receivers to take control of their client company in order to facilitate an orderly collect out of the debts; and second, as a fallback in the event that there is a shortfall in the collect out of the ledger.

While administrative receivership is a speedy and convenient form of appointment, there is no reason why the new ‘fast-track’ administration proceedings, which are set to replace administrative receiverships, cannot be just as effective in achieving the above aims. Both the above purposes can be adequately served, the drawback possibly being at a slightly higher cost.

The message to lenders is that there is an alternative to the burden of trying to obtain fixed charges on debts – own them instead.