Getting fixed up

Allen & Overy partner Ian Field and banking associate Jennifer Marshall consider the impact that the Privy Council's decision will have on the future of book debt charges

The Privy Council has held that it is no longer possible to have a fixed charge over book debts and a floating charge over the proceeds of the debts if the charger has the right to deal with the proceeds in the ordinary course of its business. This effectively overturns the decision of the Court of Appeal in New Bullas Trading (1994).
The decision in Agnew and Bearsley The Commissioner of Inland Revenue & anor (Re Brumark Investments), which was delivered on 5 June, may be seen as significantly decreasing a bank's ability to take effective security over book debts and may impact on security over other types of contracts and leases.
While not binding in this jurisdiction, the Privy Council decision is highly authoritative, particularly as the decision involved a number of leading members of the House of Lords.
There are various reasons why fixed-charge security is more attractive to a lender than floating-charge security. In particular, certain preferential creditors (including, in respect of particular heads of claim, the tax authorities and employees) and the expenses of a concurrent liquidation are paid out of floating charge realisations in priority to the floating charge holder. For this reason, lenders prefer to take effective fixed security over as many assets of the charger as possible. Where the assets are clearly identifiable and it is commercially acceptable to the charger to provide that the lender must give its consent to any disposals of the assets (for example, in the case of land or large items of plant and machinery), the cases establish that it is possible to take effective fixed-charge security. However, where the assets regularly turn over in the ordinary course of business (as in the case of stock-in-trade), it is unlikely to be feasible in practice to require the consent of the lender to each disposal.
In the case of book debts and other receivables, the charger may be willing for the security document to provide that the charger will not alienate the uncollected book debts without the consent of the lender (for example, by factoring, discounting or selling the book debts). However, as a commercial matter, a charger will usually need to be able to use the proceeds of its receivables in the ordinary course of its business. Previous controversial case authorities have established that a charger's power to deal with the proceeds in this way is inconsistent with a fixed charge, which means that, even if stated to be fixed, a charge may in fact be a floating charge if the charger has the right to deal with the proceeds.
This conflict led to the drafting approach endorsed by the Court of Appeal in New Bullas Trading. The security document in that case purported to take a fixed charge over the book debts themselves, but provided that, prior to enforcement and on payment of the book debts into a specific account in the name of the charger, the book debts were released from the fixed charge and became subject to a floating charge. This did not affect the fixed security on the outstanding book and other debts or the proceeds of those debts. In other words, it was possible to take fixed security over book debts and floating security over their proceeds.
The Brumark Investments decision
The Privy Council considered that the decision in New Bullas Trading was wrong. Although it agreed that a debt and its proceeds are two different assets, they concluded that it makes no commercial sense to separate the ownership of the debt from the ownership of its proceeds; the proceeds are merely the traceable proceeds of the debt and represent its entire value.
This means that if the charge over the proceeds is construed as a floating charge (because of the charger's freedom to deal with the proceeds), the charge over the book debts from which the proceeds are derived will also be construed as a floating charge. It is no longer possible to have a fixed charge over the uncollected debt and a floating charge over the proceeds.
Brief assessment
While the decision in Brumark concerned security over general trading book debts, it is not clear whether the decision is limited to these kind of debts or whether the decision could also impact on any security package involving the capturing of income streams from contracts or other intangible assets (such as securities, where there may be a right to use the proceeds of share dividends prior to enforcement). If the decision does extend beyond short-term trading book debts, it could affect the security taken in project finance, leasing, property, securitisation and shipping transactions. While in these types of transactions the charger is often required to pay the proceeds from the contracts in question into a specified account, the charger is also often permitted to withdraw sums from the account, either freely or subject to retentions.
There are a number of reasons why the security taken over income-producing contracts or other intangible assets in the type of transactions described above should be distinguished from the cases concerning general trading book debts. In particular, the contracts (or other intangible assets) will be specified in the security document and are unlikely to turn over in the ordinary course of business in the same way as book debts tend to. In the case of leases (of both real property and chattels), there is a line of cases, including the 1990 Court of Appeal decision in the Atlantic Computer Systems case, where it has been held that a charge on a portfolio of leases will be a valid fixed charge even if the charger is permitted to use the rental stream under those leases until enforcement. This line of cases was not overturned by the decision in Brumark.
In the context of general trading book debts, their Lordships made it clear in Brumark that it is still possible to take a fixed charge over book debts if the proceeds are paid into a blocked account, with the bank consenting to any withdrawal. However, in many cases this will not be commercially viable, as it will require lenders to monitor carefully the bank accounts and will prevent a company from using the proceeds in the ordinary course of its business. Their Lordships also approved the decision in Siebe Gorman & Co Barclays Bank (1979), where the charger was required to pay the proceeds of its book debts into its ordinary trading account with the lender (which was a clearing bank). Although the debenture in that case placed no express restrictions on the charger's right to draw on the account, the court held that on the proper construction of the debenture, the charger was not free to draw on the account without the consent of the lender; and their Lordships made it clear that it was only on this basis that the decision could be approved.
Although many practitioners and leading academics have long been sceptical of the New Bullas decision, the Brumark decision is important, as it is now clear that many charges over book debts will not have the commercially intended effect. It is possible that the decision will signal a return to factoring and invoice discounting by lenders. It remains to be seen whether the courts will construe the decision as being limited to general trading book debts or whether there will be a rush of cases concerning the security granted over other income-generating contracts. It also remains to be seen what impact the decision will have in the context of the proposed insolvency law reforms, whereby the Crown is to lose its preferential status but administrative receivership is to be severely restricted or abolished.