Fixed charges on book debts
Mike Griffiths reviews the likely impact of the Brumark judgement on fixed charges on book debts.
There are two main ways in which companies can borrow on security, either by way of either a fixed or a floating charge.
Traditionally, fixed charges were secured on fixed assets, such as a warehouse or an office block. Floating charges were over assets which, of their nature, the directors had to be free to deal with on a day to day basis - assets such as raw materials, work in progress, finished products and book debts.
However, in the 1960s efforts were made by lawyers to create fixed, rather than floating, charges over book debts. The reasons for this were twofold.
First, the ratio of preferential creditors over unsecured creditors in the average liquidation was increasing. Therefore the greater the amount that the lender could have protected by a fixed charge, the better the position it would be in.
Second, the banking practices of invoice discounting and factoring were being developed. Very simply the process might be described in this way: a manufacturing company supplies goods to a customer. At the same time it sends the customer an invoice in respect of the transaction.
However, it might be some time before the invoice is paid. Therefore to ease cash flow problems the company has cut a deal with an invoice discounter. It sends a copy of the invoice to the discounter.
Immediately it pays, say, 70% of the value of the invoice to the company. When ultimately the company is paid by its customer it pays off the discounter together with some commission on the 70% paid.
To provide the discounter with some security, it is given a fixed charge over the outstanding book debts owing to the company. Then, if the company goes into liquidation, the discounter can claim the debts directly from the company's customers.
Few Early Misgivings
When this practice was first developed, a number of academics questioned whether conceptually it was possible to have a fixed charge in these circumstances.
However, in the early days the courts did not appear to share these misgivings. The first time that the possibility of a fixed charge existing in law over book debts was considered by the courts was in Siebe Gorman & Co Ltd v Barclays Bank  Ll.L.R 142.
Here the debenture stated that the charge on book debts was fixed. It required the borrower to pay any receipts under the book debts into a designated bank account and prohibited the borrower from doing anything to charge or assign these sums. Slade J held that the debenture gave sufficient control to the bank as to make the charge fixed.
This was further developed by the Court of Appeal in Re New Bullas Trading Limited  1 BCLC 485. Here the lender was 3i plc rather than a bank. The charge enjoyed by the lender was expressed to be a fixed charge so long as book debts were owing to the borrower.
The borrower had then to pay the proceeds into a specified bank account whereupon the security held by the lender would be simply a floating charge. The Court of Appeal felt that such a hybrid fixed and floating charge was possible. This decision was severely criticised by a number of academic writers.
Change of Tack
But it remained good law until Re Brumark Ltd  AC 710. In this case, which concerned an appeal from New Zealand, the Privy Council stated that a debenture purportedly created in the same way as that in Re New Bullas, and which effectively left the company free to collect in the debts and then use the proceeds in the ordinary course of business, could be no more than a floating charge.
Lord Millett, in delivering the judgement of the Privy Council, said that in his view Re New Bullas had been wrongly decided: “A restriction on disposition which nevertheless allows collection and free use of the proceeds is inconsistent with the fixed nature of the charge”.Interpretation of Law
The status of the Re Brumark judgement has to be considered. Being a decision of the Privy Council, it is strictly of no more than persuasive authority in the English courts.
However, it is suggested that Re Brumark accurately reflects the law. The members of the Privy Council are members of the House of Lords and there is little doubt that at the present time the House, as it is currently made up, would follow the decision of the Privy Council in Re Brumark.
Moreover, the Inland Revenue and HM Customs and Excise have also indicated that they view Re Brumark as being a correct statement of the law. A liquidator would be very ill-advised to pay out on a charge worded in the Re New Bullas manner as though it were a fixed charge.
The Vice Chancellor has recently considered charges on book debts in Re Spectrum Plus Limited  EWHC 9 (Ch). In this case we have a debenture expressed in similar terms to those used in the Siebe Gorman case.
It required the company to pay the proceeds of book debts owing to it into a specified bank account and prohibited it from charging or assigning them. It also required the company to execute a legal mortgage of the book debts if requested so to do. The Vice Chancellor held that the charge was no more than a floating charge and that the Siebe Gorman case had itself being wrongly decided.
Consequences for Liquidators
The inevitable consequence of this decision is that liquidators will become increasingly pressurised to pay book debt recoveries to preferential creditors rather than to secured creditors.
It is believed that the decision is being appealed and so it may be some time before a proper degree of certainty is restored to this area of the law. But, at least for the time being, it must be assumed that Siebe Gorman was wrongly decided. If a company has any access to the proceeds of book debts, any charge over them must be floating rather than fixed.
Michael Griffiths LlM - co-editor of Loose on Liquidators and Loose on the Company Director and a member of ACCA's Business Law Committee