The 'Spectrum' Case - April 2005

STOP PRESS

 

Update on National Westminster Plc v Spectrum Plus Ltd & others (the “Spectrum” case)

The validity of fixed charges over book debts

The “Spectrum” case continues to rage on. It is due to be heard by the House of Lords at the end of this month (26th to 28th April) and the panel of their lordships who will hear this case has recently been announced. We believe that the make up of this panel could have a significant effect on the outcome of the case.

Background to “Spectrum”

Case law has been fairly entrenched since the outcome of Siebe Gorman & Co Ltd v Barclays Bank Ltd in the late seventies. This case set the view that fixed charges could be created over present and future book debts provided it could be shown that there was a level of control that precluded the chargor from alienating its book debts. Many lenders have adopted the Siebe Gorman form of security following this judgment.

Case law over the last 25 years has, however, continued to question the legitimacy of Siebe Gorman. Specifically, many Privy Council cases have questioned whether the law was correctly stated in Siebe Gorman. but Privy Council cases are only persuasive case law under English law so this area of law has been crying out for judgment by the House of Lords to settle things once and for all. Spectrum is that case.

Spectrum itself

Spectrum had, as part of a general debenture, granted a charge to the bank over its book debts, in order to secure an overdraft facility. The charge required Spectrum to pay the proceeds of those book debts into a specific account with the Bank and prohibited Spectrum from alienating the uncollected book debts without the Bank’s consent. When Spectrum resolved to go into creditor’s voluntary liquidation, there were book debts with a face value of some £290,000 and an estimated realisable value of approximately £165,000. This was against a debt owed to the Bank of £200,000. The Bank sought to have the proceeds of the book debts paid to it and Spectrum arose following a dispute with the preferential creditors as to whether or not the Bank, as a fixed charge holder, had a right to receive the proceeds of the book debts in preference to the preferential creditors.

The initial hearing found in favour of the preferential creditors and dismissed the Bank’s application for a declaration that the charge over book debts was a fixed charge. This finding was subsequently reversed by the Court of Appeal on two counts. The first one of these turned on the fact that the right of the company to use the bank account was distinct from the obligation of the company to pay the proceeds of the book debts into that account. The second, more interestingly, was based on the premise that to overturn accepted and longstanding banking practice was unconscionable unless the original decision in Siebe Gorman was patently wrong.

The battle lines were, therefore, set for a rematch in the House of Lords.

The House of Lords

Judgment is expected in July of this year. There has been no clear indication of which way the House will go but the recent appointment of the panel to hear the case may give an idea of the outcome.

One member of the panel will be Lord Millett. He provided the leading judgment in the Privy Council case of Agnew v’ Commission of Inland Revenue (also known as the Brumark case) which reasoned that the fundamental characteristic of a floating charge on book debts is that the party granting the charge has an unrestricted right to use the proceeds of those book debts to run the business. If this is the case, then it is difficult to see when a fixed charge can ever been substantiated over book debts, without creating impractical levels of control over both the debts and their proceeds. It is also interesting to note that both the Inland Revenue and Customs & Excise have issued practice statements making it clear they believe Agnew is an accurate statement of the law in this area.

Similarly and in the same vein, Lord Millett has also shown a distaste for leaving the law as it is for the sake of commercial expediency. He has previously proved quick to dismiss a similar “pragmatic” approach put forward by Lord Denning and has made it clear that he does not accept common practice amongst a particular industry as good reason to uphold erroneous law. In his view, if a matter was wrongly decided it was up to the courts to highlight it but for Parliament to correct it and not for the courts to take this responsibility on.

It would seem therefore a growing ground force to “correct” Siebe Gorman.

But where will this leave matters?

The changes created by the Enterprise Act 2002 do arguably minimise the competing interests of preferential creditors and floating charge holders. With the removal of many Crown debts from preferential creditor status, the major preferential creditors will be the employees. This change in status, however, will not affect insolvencies begun before 15 September 2003 and it is estimated there hundreds of millions of pounds are currently held in suspense whilst insolvency practitioners await the outcome of Spectrum.

Equally, the Enterprise Act has created a few surprises of its own which would affect floating charge holders and not fixed charge holders. These include the requirement that a percentage of floating charge realisations be ring fenced for unsecured creditors. In addition, the costs and expenses of an administrator will rank ahead of the floating charge holder. Clearly, both of these rights could have a major impact on any floating charge holder, if they were unable to substantiate their fixed charge rights.

Furthermore, there may also be some scope for holders of fixed charges created after the floating charge, to argue a right to priority, provided they can show they had no constructive notice of that floating charge at the time they took the fixed charge. Practically, this is unlikely to be upheld often but it does raise the question of how these competing priorities may have been dealt with in any deed of priority between the charge holders.

Finally, for the companies granting the charges, there may well prove to be a knock on effect on guarantors. Clearly, if charge holders find their ability to seek redress under a debenture has been limited, they will be looking to other security to make up the deficit; a personal guarantee will begin to look a lot more interesting then.

July may prove an interesting month for businesses and lenders alike.

Katie Ashworth