UK: Charges over Book Debts and Plant and Machinery since Spectrum

Readers will no doubt by now be familiar with the fact that the "traditional" form of debenture pursuant to which a lender purported to take a fixed charge over a company’s book debts whilst in practice leaving the company free to deal with the proceeds of the debts once received has now been definitively determined by the House of Lords to be ineffective to create the intended fixed charge (see: National Westminster Bank PLC v Spectrum Plus Ltd (2005)). The charge over book debts taken in that form will amount only to a floating charge.

This result is one of great importance to lenders since, in many businesses, the book debts will constitute one of the main items of value in the insolvency of the company and the failure to establish an effective fixed charge over these will mean that the secured creditor’s claim in respect of such debts will be subject to the prior claims of preferential creditors (admittedly a smaller class of creditors since the passage of the Enterprise Act 2002) and the requirement to establish a "ring-fenced" fund for unsecured creditors pursuant to the Insolvency Act 1986, s.176A.

Proposals to reverse the decision of the House of Lords in Re Leyland DAF Ltd; Buchler v Talbot (2004), in the draft Company Law Reform Bill (clause 868) will also nullify the benefit of that decision to a floating charge holder in relation to liquidation expenses, thereby rendering the fixed/floating charge distinction of even greater consequence to secured lenders.

The recent Companies Court decision in Re Beam Tube Products Ltd (2006) illustrates that this distinction is also of critical concern in relation to charges over plant and machinery. The case involved joint administrative receivers seeking directions from the Court regarding the disposition of the proceeds of book debts and of the proceeds of sale of certain plant and machinery.

Blackburne J emphasised the statements of Lord Millett (as a member of the Judicial Committee of the Privy Council) in Agnew v Commissioner of Inland Revenue (2001) that the "hallmark" of a floating charge which distinguishes it from a fixed charge is that, in relation to the assets in question, the company may continue to carry on its business in the ordinary way as far as concerns the class of assets in question. The actual description of the charge in the relevant document as being "fixed" or "floating" will not be determinative of the nature of that charge.

Blackburne J held, as would now be expected, that the debenture security in question, which purported to create a fixed charge over book debts and provided for payment of the proceeds into a "collection account" subject to a floating charge, created only a floating charge over the book debts. It was irrelevant to this characterisation that the collection account was never in fact set up and that a "blocked account" restricting the use of the proceeds was set up some four months later. The Insolvency Act 1986, s.40 gives priority to preferential creditors over a charge which "as created was a floating charge".

It may seem strange that the parties’ conduct after execution of the debenture was relevant and able to be considered by the Court since such conduct would not normally be considered relevant in determining the nature of the rights created. The correct approach in these cases would, however, appear to be that such conduct is relevant if and to the extent it may show that any statement in a debenture about the creation of a blocked account was merely a pretence. As this point was not directly relevant in this case to the conclusion reached by the Court, this is one aspect of the post- Spectrum legal landscape that awaits conclusive determination.

With regard to plant and machinery, Blackburne J made clear that by focussing on Lord Millett’s "hallmark" of a floating charge, it is quite likely that the form of security over plant and machinery utilised in commonly used forms of debenture instrument will be a floating charge only. In Blackburne J’s view, referring also to views expressed by Millett LJ (as he then was) in the Court of Appeal in Re Cosslett (Contractors) Ltd (1998), the approach the court must take is an "all or nothing" approach: either a fixed charge is created over the whole class of assets, or only a floating charge over the whole class. Notwithstanding the description in the debenture of the charge over plant and machinery (and similar items) as a fixed charge, the judge held that the security created was in fact only of a floating nature since it was clear from the circumstances that the company would have freedom to deal with plant and machinery (not comprising fixtures) in the ordinary course of its business.

This case again illustrates the care which lenders need to take in assessing the status of security they contemplate taking and, for receivers, the extent to which the principle now established by Spectrum may affect distribution of company assets (and not just the proceeds of book debts!).  

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.