The decision

The House of Lords overturned the decision of the Court of Appeal and held that although it is possible to create a fixed charge over book debts and their proceeds, the charge granted by Spectrum Plus took effect as a floating charge. The decision turned on the freedom of the chargor to use the book debts and their proceeds in the ordinary course of its business.

Background

One year ago the Court of Appeal held that a fixed charge over book debts could be created if the debenture (1) required the proceeds to be paid into an account at the chargee bank and (2) restricted the chargor's freedom to use the proceeds (whether or not the account was operated in that way). The form of debenture in question has been used by many banks for more than 25 years on the basis of the decision in Siebe Gorman & Co. Ltd v Barclays Bank Ltd [1979] 2 Lloyd's Rep 142. In that case Mr Justice Slade held that the charge over book debts took effect as a fixed charge.

Since Siebe Gorman there have been a number of conflicting decisions of the lower courts, culminating in the Privy Council decision in Agnew v Inland Revenue Commissioners [2001] 2 AC 710 (known as "Brumark"). In that case it was held that notwithstanding a charge over book debts was stated to be a fixed charge, it took effect as a floating charge where the chargor retained the ability to deal with the book debts and their proceeds.

A large number of liquidations have been held up pending the resolution of this issue, as liquidators refuse to distribute the proceeds of book debts to preferential creditors in priority to the holders of floating charges. As Privy Council decisions are not binding in English law, the matter was tested in the case of Spectrum Plus Limited [2004] 2 WLR 783. Vice-Chancellor Morritt, agreeing with the approach of the Privy Council in Brumark, found that the judge in Siebe Gorman had erred. On the basis that the terms of operation of the chargor's current account with the bank allowed the chargor to withdraw the proceeds of the book debts for application in the course of its business, he held that the charge was a floating charge. The Court of Appeal, following the decision in Siebe Gorman, held that the restrictions on dealing with the book debts contained in the debenture were sufficient for the charge to take effect as a fixed charge. The Court of Appeal considered that the fact that banks had relied on the Siebe Gorman decision for 25 years required that the construction of the debenture applied by Mr Justice Slade in that case be upheld.

The reasoning of the House of Lords

In the leading judgment delivered by Lord Scott, his honour considered the test to be applied in determining whether a charge is a fixed or floating charge. He noted in particular that the ability of the chargor to deal with the charged assets characterised the charge as floating. In considering how the Spectrum charge should be analysed, the court noted that the proceeds were to be paid into the chargor's current account with the bank, from which the chargor was entitled to withdraw funds provided that the overdraft limit had not been exceeded. The Lords were unanimous in finding that as such the charge took effect as a floating charge.

The House of Lords did not consider that the use by banks of the form of debenture in Siebe Gorman for 25 years was sufficient reason to adopt the incorrect construction applied by Mr Justice Slade. The court noted that as that judgment was a first instance decision, banks and other commercial parties taking security should have been aware that the House of Lords may decide that the case had been wrongly decided.

The Lords were also asked to consider whether their decision that the charge was a floating charge should only take effect prospectively from the date of their judgment. The court held that although they would "never say never" to House of Lords' decisions applying prospectively only, it would require very unusual circumstances before they would be prepared to do so. This case was not such a case.

Given the abolition of Crown preference with the commencement of the Enterprise Act in September 2003, the result is less important than it would have been prior to that time. It is also important to note that the Lords held that it is possible to create a fixed charge over book debts, provided that the proceeds are paid into a blocked account and the appropriate level of control is exercised by the chargee over the account. However, the decision has sounded the death knell for fixed charges over book debts where the proceeds are paid into current accounts.  © Herbert Smith