Fixed Charges on Book Debts

Banking/Insolvency

Fixed Charges on Book Debts

A Receiver's dream or a Lender's nightmare? Kieran McGarrigle considers the impact of the recent decision by the House of Lords in the Spectrum Plus case for lenders seeking to rely on security over book debt realisations in an insolvency.

A Receiver's dream or a Lender's nightmare?

The House of Lords recently handed down judgement in the long awaited Spectrum
Plus case. Unfortunately, the decision is not good news for lenders as it will restrict, and in most cases bring to an end, the taking of fixed charges on book debts as security for a bank's lending.

In the Spectrum Plus case the House of Lords was asked to determine whether book debt realisations in an insolvency were fixed or floating charge assets. The significance of the distinction is that fixed charge realisations in an insolvency go to the fixed charge holder (normally a lender) and floating charge realisations are generally paid to other creditors and used to discharge the costs and expenses of the insolvency.

For over twenty five years it has been common practice for lenders to take a fixed charge over a borrower's book debts, but to leave the borrower free to deal with the proceeds of those debts in the ordinary course of its business. This type of arrangement was considered to create a valid fixed charge on book debts in Siebe Gorman v Barclays Bank Limited (1979). If the lender had to enforce its security, it would receive the proceeds of any book debt collections in priority to other creditors.

Validity

Over recent years there has been considerable doubt about the validity of such charges. In order to create a valid fixed charge, the lender requires (among other things) control over the assets that are subject to the charge. If a borrower grants a fixed charge to a lender, yet retains control of any book debt realisations and utilises the proceeds in the ordinary course of business, how could the fixed charge be valid?

This question was considered by the House of Lords in Spectrum Plus and the response was unanimous - such fixed charges are no longer valid. It is still conceptually possible to create a fixed charge over book debts realisations where:

• the book debts are assigned to a lender;
• the lender requires the borrower to pay the book debt realisations in reduction of the its outstanding debt;
• the lender requires the borrower to pay the book debt realisations into a blocked account; or
• the lender requires the borrower to pay the book debt realisations into a separate account with another bank over which it takes a charge.

In order to create a valid fixed charge on book debts, the lender must therefore have actual control over the book debt collections. For many businesses, their book debt collections are necessary for working capital. To pay the collections into a blocked account or to be unable to use the collections would starve many
businesses of essential cash.

Certainty

Now that the highest court in the land has had its say, the Spectrum Plus case is the final chapter in a long running legal saga which started in 2001. The judgement provides some certainty for banks and business recovery professionals such as receivers and liquidators. It should be welcomed for this. Since the uncertainty about the validity of fixed charges on book debts first surfaced in 2001, many insolvencies have been paralysed because receivers and liquidators did not know who was entitled to receive the proceeds they had collected from book debts.

A lender who has the benefit of a fixed charge on book debts can no longer
claim any entitlement to book debt realisations unless it actually exercises control over the book debt collections. Receivers and liquidators can now close out any insolvencies where they have been sitting on book debt collections since 2001 but were unsure about who was entitled to them.

Over recent years there has been a significant increase in factoring and invoice discounting as lenders battled to keep control of book debt collections in an insolvency. For those lenders who have not jumped on this bandwagon, the decision in Spectrum Plus could leave them exposed in an insolvency.

Kieran McGarrigle is an Associate in the firm's Corporate Department specialising in all aspects of corporate recovery/insolvency and recently advised the liquidators of Desmond & Sons Limited and the receivers of Answercall Direct Limited. Kieran can be contacted at kieran.mcgarrigle@lestrangeandbrett.com

Quote: ......lenders exposed