Citation(2002) 14 SAcLJ 69
Date01 December 2002
Published date01 December 2002

1 Companies with high turnover and which deal largely on credit terms are likely to have a high value of book debts on their accounts. Instead of leaving these assets ‘idle’, they can be used as an important source of funds to improve liquidity. The debts may be assigned at a discount to factoring houses or given as security to a lender in return for a loan facility. The usual manner of arranging for the latter is to grant to the lender either a floating charge specifically over the company’s book debts or as part of a fixed and floating charge over the company’s entire undertaking with the floating charge covering, inter alia, the borrower’s book debts. The worth of any such security to the lender is a function of two factors. First, it is dependent on the sum that the lender is able to realise from the asset given as security should the borrower default on the loan. Secondly, the lender has to consider the effect of any contractual arrangement or rule of law that permits others to have priority to the assets or proceeds from their sale.

2 Taking a floating charge over book debts exposes the security to risks associated with both these factors. A floating charge leaves the borrower free to deal with the charged assets in the ordinary course of business until such time as the charge crystallises into a fixed charge. This permits the borrower to cause the assets to dissipate by disposing of them prior to crystallisation of the charge. The assets may also be subsequently attached through the acts of other creditors to their benefit and at the expense of the charge holder.1 The borrower may also be free to create subsequent security interests over the asset that rank in priority to the floating charge-holder.2 In addition, even with the presence of a negative pledge3 in the loan documentation, it is possible that the creditor may end up having less priority to proceeds from the charged assets than specified classes of preference creditors pursuant to corporate legislation.4 Legislation

may also render floating charges void as a security in limited circumstances.5 A lender may avert these disadvantages if it is able to arrange for a fixed charge over book debts instead of taking a floating charge over such assets.


3 Debate about the differences between fixed charges and floating charges and the nature, particularly of the latter, has been raging since the late 1800s when the concept of floating charges was first accepted by the courts.6 From that time right up to the late 1970s, it was widely thought that one could not create a fixed charge over circulating assets such as book debts. This arose from the predication that, because one of the listed characteristics of a floating charge is that it must be over assets that were ‘constantly changing from time to time’7 (ie assets that were constantly circulating), security over such assets must take the form of a floating charge.8

4 This assumption was authoritatively discredited in the English case of Siebe Gorman & Co Ltd v Barclays Bank Ltd.9 That case involved a debenture that required the corporate borrower to arrange for proceeds collected in respect of charged debts to be paid into a designated account with the debenture holder. There were also restrictions against disposal of the charged debts by the borrower as well as against withdrawal of sums from the said account without the bank’s consent.10 The court held that the

key distinguishing factor of a floating charge, as opposed to a fixed charge, was the freedom given to the chargor to continue dealing with the charged assets free from encumbrance. While the circulating nature of the charged asset was a necessary pre-requisite to a floating charge, it did not follow that the presence of this requirement precluded the charge from being fixed. It was held that a fixed charge over book debts had been effectively created in that case. The borrower was treated as an agent for the purpose of collecting the said debts and paying them into a designated account under the control of the lender. Subsequent English cases have confirmed the position taken by Slade J in Siebe Gorman and have recognised the possibility of a fixed charge being taken over book debts,11 leaving little doubt now about its validity.


5 Although the issue of whether or not it is conceptually possible to create a fixed charge over book debts has more or less been conclusively resolved by the English courts, there still remains some doubt concerning how such a security should be framed in the debenture so as to ensure that what is created is indeed a fixed charge over the book debts and not a floating charge.

The practical problem

6 A good security arrangement should provide the lender with an acceptable degree of assurance that it can recoup moneys lent through enforcing the security. All the better if this can be done without unnecessarily disrupting the borrower’s business operations. The arrangement in Siebe Gorman summarised above, if entered into, would result in the borrower having to seek the lenders’ permission to utilise collected debt proceeds. This would cause some disruption to the borrower’s operations as smooth cash flow could be hampered by the procedures laid down in relation to the obtaining of such permission. Moreover, cash left in bank accounts (like stock in trade) is a relatively ‘idle’ asset. Keeping the amount of cash to the minimum for operational purposes would enable companies to make more efficient use of their assets. Placing a restriction on the use of funds in any designated account would affect this efficiency.

7 To deal with these issues, parties resorted to arrangements that purported to create fixed charges over book debts per se that permitted the borrower to utilise the collected proceeds in the conduct of its business. Such an arrangement would benefit companies that operated with high turnover and which dealt principally on credit terms, thus generating high values of book debts. The lenders would continue to have a fixed security over book debts. At the same time, the arrangement would also favour the borrowers as they could then freely utilise collected proceeds without much inconvenience.

Developments in Case Law

8 An attempt at such an arrangement was first tested in England in Re Brightlife Ltd12 where the borrower was restricted from dealing with charged book debts without the chargee’s consent but could freely collect the debts and pay them into its own bank account. Hoffman J held that “a right (by the company) to deal in this way with the charged assets for its own account is a badge of a floating charge and is inconsistent with a fixed charge”. The learned judge underpinned his decision on this issue by pointing to the fact that the debenture in Siebe Gorman was construed as, first, requiring the borrower to pay collected proceeds into an account with the lender bank and secondly, prohibiting the borrower from utilising the moneys in the account without the approval of the lender. He then highlighted another case, Re Keenan Bros,13 where there was an express clause in the debenture stating that the borrower could “not without the prior consent of the bank in writing make any withdrawals or direct any payment from the said account”, citing it as a “stronger case” than Siebe Gorman in support of how a fixed charge over book debts should be arranged to achieve the desired effect. Brightlife suggested therefore that a fixed charge over book debts could only be created if there was a corresponding arrangement to restrict the chargor from free utilisation of collected proceeds. The account into which the proceeds were to be paid had to be a ‘blocked’ account.

9 An attempt was subsequently made to circumvent the impact of Brightlife by arranging for the chargee to have the right to prevent the chargor from utilising proceeds from collected debts freely. The effect of such an arrangement was the issue in the case of Re New Bullas Trading Ltd.14 In the earlier cases, the book debts and their proceeds were not expressly treated as separate assets. It was thought that this failure made it difficult to reconcile a fixed charge over book debts with the company’s

ability to deal with the proceeds of those debts. In New Bullas, the debenture made it very clear that book debts and proceeds were to be treated as two separate classes of assets. The lender was to have a fixed charge over the book debts and also took a floating charge in respect of the proceeds of the debt. In addition to the provisions prohibiting dealing in the book debts, the debenture also placed on the borrower an obligation to collect the proceeds of the debts and to pay such proceeds into a designated account with a third party bank. It was also clearly stipulated that the company was to apply any moneys standing in that account in accordance with any directions that might be given by the chargee. In the absence of such direction, however, the proceeds were to be released from the fixed charge and become subject instead to the lender’s general floating charge.

10 Knox J ruled at first instance15 that such an arrangement did not take the charge out of the purview of the principles laid down in Re Brightlife. He held the charge created over the book debts to be a floating charge. His decision was overturned by the Court of Appeal. Nourse LJ, in delivering the court’s judgment, observed that the distinction between book debts and their proceeds was never clearly made out in the other decided cases. Relying on his assertion that security arrangements were to be governed purely by the contract that creates the security, the learned judge ruled that the charge over the book debts was a fixed charge as this was what he found to be the intention of the parties as garnered...

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