An Legal Analysis

Presently, the company can offer its assets either as fixed charge or floating chare to borrow money for its business needs. Book-debts of the company are termed as current assets of a company. A company may borrow from bankers against these book debts [current assets] mainly to pay its creditors [current liabilities]. Until now, it has been well accepted principle that lenders have been able to take a fixed charge over book debts of companies on pre-condition that the proceeds of those debts when realised are to be deposited into a separate escrow account with the bank.

However, in normal practice, banks have also permitted these companies to withdraw from this account and to employ the proceeds realised out of book debts without status of the fixed charge being affected. With this permission, the debtor companies will continue to deal with the proceeds of the charged debts at their liberty. [Own words]. However , in NatWest v Spectrum Plus case , a reputed manufacturer of paints pigments , dyes for the paint industry which went into voluntary liquidation in the year 2001 , the House of Lords held that banks will lose their privilege to a place at the front of the queue for repayment when business crashes.

Thus, this ruling will make the banks to insist for additional securities from the borrowers in the loan process and banks will henceforth be stricter when framing the terms of loans and this could have a severe impact on small business’ liquidity. The banks will be likely to react by prescribing stricter restrictions on the employment of the proceeds of charged debts. As a result, cash flows from the proceeds of these book debts of borrowing companies will no longer be able to act as a probable source of working capital for small businesses as it would worsen liquidity issues.

The impact of the above ruling will be that unless strict controls are prescribed on how these proceeds of the book debts are employed , a charge will be construed to be a “floating charge’ than as a fixed charge and will henceforth lose its rank as priority debt in insolvency proceedings. This research essay analyses what is a charge, what is fixed and floating charge and how recent court judgment will affect the liquidity of the business by treating book debts as floating charges instead of fixed charge in detail. [Own words] CHARGE

A charge is nothing but a security interest made in or over an asset or category of assets by the owner of the asset who is recognized as the “Chargor” in favour of those who have lent money or loan namely the “Chargee” by which it is reciprocally acknowledged that concerned asset shall be earmarked to the release of discharge of a debt or other financial obligations. In this category of business, virtually no transfer of property is involved or transfer of title to the property is made. The chargee’s privileges are proprietary in character but created out of contract and only for genuine consideration.

On the other hand, the chargee’s privileges can be implemented by the sale of property, if warranted, by an order from court. However, in practice, majority of security document specifically empowers the chargee to marshal the property for this intent without actually an application to court. The principle was laid down by Slade J in Re Bond Worth Ltd. FIXED CHARGES: A company can borrow through means of debenture as per the provisions of s738 of the Companies Act 2006 . However, in normal parlance, the word is employed to describe a secured borrowing.

Thus, a security may be offered as a lien to borrowing either in one or both of two dissimilar ways. A fixed charge may be created to secure a debenture. This is almost similar to an ordinary mortgage. If a charge is created on any property, then such charge attaches to the property concerned and such charge will be binding from the time of its creation. Creation of charge over a land is the best example of a fixed charge. However; fixed charges can also be created on other assets also. For instance, there is a possibility of creating a fixed charge on investments made by a company.

This view had been observed in Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] ; Re Keenan Bros Ltd [1986] , over the book debts of a company, a fixed charge can be created provided that when book debts are realised, they should be paid into a separate ‘escrow’ bank account. However, in Re New Bullas Trading Ltd [1993], Knox J had viewed that a charge over the book debts of a company constituted a floating charge. FLOATING CHARGE: The main benefits of the corporate form of business are the capability to create floating charge over its assets.

Under floating charge , a charge on entire assets of the company is created in favour of lender which acts as a lien over the amount advanced by a creditor and at the same time , a business my carryon its activities without any interruptions. A floating charge will not crystallizes until happening of a specific event and this is a unique feature of floating charge. Thus, charge can be legally created over some types of properties like land. However, charge what has been discussed here are al belonging to the category of equitable charges.

Until the creditor has not initiated any action on the charge or till the crystallization of charge, the company is free to handle the property charged. The basic features of floating charge was laid down in “Re Yorkshire Woocombers Association Ltd [Illingworth v Houldswork and another [1904] , ? A floating charge is one which is created over a class of assets either presently available and that may come into existence in future; ? The company is free to administer the business and even sell off the assets so charged in the course of that business of course with the consent of charge holders.

? The assets within the class of assets subject to the floating charge which will vary and transform as the company trades. The charge is known as a floating charge since company can able to deal with the charged assets in the ordinary course of business. However, in Re Climex Tissues [1994], it was viewed that thought the company had a qualified authority to deal with the charged properties; the charge was still considered to be fixed one. The crystallization of charges will occur ? A floating charge on the debenture will crystallize on the happening of an event which has been explained in the provisions of the debenture.

There is some vagueness as to whether the materialisings of an event explained in the debenture would thus render automatic crystallisation of the charge or whether the occurrence of the event merely induces the debenture holders to respond to pressure for crystallisation. In Re Mamumewa Transport Ltd [1971], the New Zealand court observed that crystallization could happen automatically on the occurrence of the specific occasion. This observation was approved by obiter by Hoffmann J in Re Bright life Ltd [1986] and confirmed by him in Re Permanent House [Holdings] Ltd [1989].

DISSIMILARITY BETWEEN FLOATING CHARGE AND FIXED CHARGE: There are many oblique differences between fixed charges and floating charges and these dissimilarities have some important aftermaths. These charges are identified in a different way during the terms of the security, during the receivership and on the insolvency of the debtor. For instance, a floating charge is one ? The Chargor, without any obstruction, can handle the assets that are offered with floating charges in the normal course of his business activity.

Crystallization takes place only when there is a default or business ceases to exist. Hence, the value of the security may be deteriorated well in advance when the chargee actually enforces his rights on it. ? It is to be noted that all the fixed charges need not be registered but all floating charges need to be registered compulsorily under Companies Act. ? Costs and expenses of administration and liquidation will have priority over the floating charge. ? An administrator can sell off the assets which are covered under floating charges, without prior approval from the court.

? Preferential creditors rank prior to the floating charge holders in their calls on assets subject to floating charge especially in case of winding up or in liquidation. ? A statutory proportion of floating charge realisations must be set aside for the benefit of unsecured creditors especially in case of insolvency. ? A floating charge may be annulled if it has created no new value in the period immediately leading up to insolvency. No equivalent prevails for fixed charges, which can only be negated if they engross a preference. IS CHARGE IS TO BE REGISTERED:

Companies should compulsorily register the particular of charges with they have created over their property under Part 25 of CA 2006. This is statutory obligation imposed on the borrower’s by the Companies Act. However, it is to be noted that not all the class of charges that has to be recorded. For instance, charges on shares, over negotiable instruments and unpaid vendor’s lien over land which is subject of a contract of sale need not be registered. However, under the CA 2006, all floating charges created by the companies have to be registered compulsorily. RE CROSSLETT [CONTRACTORS] LTD:

Crosslett had entered into a contract for reclamation work with the Mid-Glamorgan County Council. The reclamation work was involved with the washing of huge amounts of coal-bearing shale, and for this reason, it operated two coal-washing plants in the work site. A clause in the contract authorised the council, if the company discarded the work, a] to employ the machineries to finish the work b] to dispose off the plants and employ the proceeds towards the satisfaction of any amount due to it from Cosslett. Unfortunately, the Crosslett abandoned the work thereby leaving it half-finished work and left its plants in the worksite.

Crosslett then went into the hands of administration. In the meanwhile, the council applied to the court demanding the administrator to hand over the plants of Crosslett. The Crosslett contended that the clause in the contract which created the charge which was a floating charge and became void as it had not been registered. In the lower court, Jonathan Parker J held that there was a charge but that it was a fixed charge. However, on appeal, it was viewed that although no charge was created, a floating charge was created and by mere non-registration did not block the way of the Council’s right to enforce.

[My own words] However, it was held by the Lord Millett L J that the charge was nothing but a floating charge. In Agnew v Commissioner of Inland Revenue [ Re Brumark] case , the Privy council observed that in examining a charge agreement to settle on whether it creates a floating or fixed charge , the court’s job is not to detect whether parties proposed to create a floating or fixed charge and then give effect to their intention. The court’s obligation is to find out what rights the parties intended to create and then to decide whether, as a matter of law, those rights form a fixed or floating charge.

In Re Armagh Shoes Ltd, an Irish case, Hutton J viewed that the fact that a document by its express words alleges to create a fixed or specific charge does not stop the court from elucidating the charge as a floating one. The Judge in that case was also ready to deduce from the terms of the charges as a whole that the company had a license to deal with the assets charged in the ordinary course of its business ,even though this was not illustrated. [My own words]. SIEBE GORMAN & CO LTD V BARCLAYS BANK LTD In this case, there was creation of charge over the debentures of a company in favour of bank.

Company also borrowed money on bills of exchange and the same was assigned to some third parties. The main question in this case was to be decided was whether the bank had the precedence over the proceeds of the bills and whether bank had a lien over the bills of exchange. The main question centers around the capability of lenders to take cognizance of fixed security cover over the receivables while at the same time facilitating a borrower’s commercial demand to account freely with the cash flows engendered by those receivables in the ordinary course of one’s business.

Slade J held in this case that effective fixed security could be established over book debts where the borrower was authorized to collect the proceeds of the book debts and deposit the proceeds into an escrow account with the lending bank. The above judgment by Slade was widely respected in the business community and was in practice for the last 25 years and moreover Siebe Gorman structure of debenture became well-known as a market standard. However, on 30 June 2005, while reviewing the judgement of Siebe Gorman, the House of Lords overruled the rule established in Siebe Gorman.

Their Lordship viewed that where a borrower collects the receivables that had been already charged and deposits them into an escrow account with the lender, insofar the borrower is at liberty to withdraw on that account in the normal course of its business, the security over the receivables will be identified as floating and not fixed security, whatever the tag given in the security document or the objective of the parties concerned. From the date of Siebe Gorman judgment, the courts have been requested to decide on the various models of security document intended to address variations on the Siebe Gorman topic.

It is to be noted that opposite lines of authority have frequently run counter to commercial usage and in 2001, decisions in Re Brumark Investments and in Agnew v. Inland Revenue which created major uncertainty over the scope of Siebe Gorman standard and warranted an authoritative elucidation of the law. [ my own words, taken from case details in [1979] 2 Lloyd’s Rep 142 (Ch) ] RE NEW BULLAS LTD It is to be observed that the decision given in the case was overruled subsequently.

Since, this case had been frequently cited and referenced in various subsequent cases, it is worthwhile to brief the salient features of this case. Originally, this case was decided on the fundamentals of the contractual liberty of the parties to do what they proposed, in the absence of any opposed arguments relied on public policy. Reaction to the Court of Appeal findings was perhaps the impetus for the later sweeping overhaul and a more tightly reasoned judicial advance to this subject. [Own words].

Knox J observed that the charge was floating charge in its entirety and that as s result, the company’s preferential creditors were given the right in a receivership to priority under IA 1986 s 40 as regards the unrealized amounts. In this, case, the company had executed a security document in favour of 3i plc which supposed to create a fixed charge over book debts, as long as they are outstanding, but when the amounts of debts had been collected and deposited into a particular bank account, [escrow account] the money so collected were released from the fixed charge and became subject to a floating charge.

However, the court of appeal reversed this decision, viewing that there were commercial benefits for both parties in these arrangements i. e. having a floating charge over the proceeds of debts when realized and having a fixed charge over the non-realized debts and parties to the contract were free to agree to such terms and conditions and that the wording of the debenture did have the effect changing the security over the unrealized book debts as a fixed charge. [My own words]. Professor Goode in his “Charge over Book Debts: a Missed Opportunity “ had strongly criticised the above ruling.

According to him, it is impossible to create a separate security interests over a debt and its proceeds: all that is possible to have a single, continuing security interest which shifts from debts to proceeds. If no sufficient control is exerted over the proceeds when realized, then the charge,’as created’ must be construed as a floating charge. This is so since ‘the distinctive character of debts as an object of security is that they are collected and upon such circumstance, they cease to exist. In, Royal Trust Bank v National Westminster Bank Plc also, Professor Goode view had been cited.

In this case, Millet IJ observed that while it is apparently probable to differentiate between a capital asset and its income, it can not be possible to separate a debt or other receivable from the proceeds of its realisation. Decision in New Bullas attracted comments from other academic critics also. Griffin in retort to Professor Goode who criticised the idea that a charge over the book debts and their proceeds must always be of an indivisible nature as ‘misconceived’ one. An identical view was observed in by MacLauchlan in another case also.

In contrary , Worthington while not corroborating the opinion that a book debt and its proceeds amount an indivisible asset , regarded that the wrong conclusion had been reached in ‘New Bulla’s’ since the security arrangement had left the charger free to remove the charged assets from the scope of the security without recourse to the charge. In the event, it is this last observation that has been sustained. The Privy Council , in an appeal from New Zealand in the case subsequently cited , has emphatically declared that New Bullas was wrongly resolved and so it must be taken as having been to all intents and purposes overruled.

In the Privy Council appeal from the Court of Appeal from New Zealand Agnew v Commissioner of Inland Revenue [Re Brumark] [2001] , which related to issue of debenture which was closely identical to the New Bullas debenture. In this case , Lord Millet , while delivering the judgment in Agnew observed that the decisive aspect which differentiating a fixed charge from a floating charge depend upon the chargor’s capability and without the chargee’s approval , chargor’s ability to freely to organize and administer the charged assets and remove them from the security.

Thus, the Privy Council took the matter whether the New Bullas had been decided by oversight and the decision in Siebe Gorman was considered in definite terms as Slade J had observed that adequate constraints on the employment to which the chargor could place on the proceeds of collected debt payments to certify that the charge was a fixed charge. [My own words] RE SPECTRUM PLUS LTD (IN LIQUIDATION) The issue was once again discussed in the House of Lords decision in “Re Spectrum Plus Ltd “[in Liquidation] [2005].

In this case, a charge was in existence over current and future book debts, where the chargor was needed to collect and deposit the debts in an escrow account with the chargee bank, but where the chargor was free to withdraw on the account for its genuine business objects provided the overdraft sanction limit was not surpassed was held in law to be a floating charge, even if it was expressed as it was being a fixed charge.

The House of Lords observed that the unrestricted use by the chargor of the proceeds in the account was inconsistent with the creation of fixed charge since it permitted the debt and its proceeds to be withdrawn from the security. Agnew v Inland Revenue Commissioner also known as Re Brumark Investments Ltd and particularly in the words of lord Millet , Brumark had offered security over its book debts to its bank [Westpac] in terms which were impossible to differentiate from that of in New Bullas.

Thus, it was intended to make the debts subject to a fixed charge so long as they were unrealized but a floating charge over the proceeds once they had been collected and received by the company. The company was at it liberty to collect the debts for its own accounts and to employ the proceeds in its business. Unfortunately, Brumark went into liquidation and the receivers collected the outstanding debts. Fisher J viewed at the first instance that as uncollected debts were subject to a fixed charge as the parties had already concurred and as such , not subject to the claims of the Brumark’s preferential creditors.

The New Zealand had declined to adhere the New Bullas, viewed that the fact that the Brumark was at liberty to collect the debts for its own account and so thereby remove them from bank’s security, was not in agreement with the charge being a fixed charge . It was, therefore, a floating charge and the preferential creditors had a prior claim to the proceeds. This decision was confirmed by the Privy Council later. In the above case, Lord Millet viewed that the most renowned and surely , the frequently cited to define what a floating charge was elucidated by Romer LJ In re Yorkshire Woolcombers Association Ltd is as follows:

“I surely do not incline to try to elucidate a perfect definition for the phrase ‘floating charge ‘nor not prepared to comment that there is non-existence a floating charge within the connotation of the Act which does not include all the three new descriptions that I am about to declare, but surely conceive that if a charge has the following three description that I am about to brief, it will fall under the category of floating charge. ? A charge exists on a group of assets of a business or a company either available currently and will be available in future.

? If that class is one which ,in the ordinary itinerary of business of the company , would be altering from time to time and ? If you see that by the charge if it construed that until some upcoming action is taken by or in the interest of those involved in the charge, company may pursue its business in the normal means as far as possible for the specific class of assets. Thus, the above may be construed as description and a definition.

It is to be observed that the two descriptions illustrated first are perfect example of a floating charge since they are not necessarily conflicting with a fixed charge. It is the third feature which is the special characteristic of a floating charge and helps to differentiate it from that of a fixed charge. In case of a fixed charge, it would not be possible for the company to run its business in the ordinary mean without the authorization of the chargee. It is understood that its ability to do so without such approval is inconsistent with the fixed character of the charge.

[My own words] CONCLUSION: The House of Lords viewed that following the Privy Council decision of Agnew in which New Bullas had been held to be wrongly decided, that Siebe Gorman was wrong and should be overruled. Though, the decision in Re Spectrum overruled long standing authority which had been relied upon for many years by other commercial lenders and banks, the House of Lords viewed that it was out of place to depart from the normal conditions in which a decision has backward-looking effect and did not feel that this was a fitting case for a decision that only had prospective effect.

However, the decisions in Re Brumark Investments and in Agnew v. Inland Revenue cases, the decisions led to ambiguity over the scope of the Siebe Gorman principle and warranted a concrete elucidation of the law. Further, Re Brumark case, the borrower was not having banking transactions with the lender. If that is the case, how repayment could be assured to the lender as there was no facility for depositing in an escrow account with the lender.