Thai, Lang --- "Charges over Book Debts in the United Kingdom and Australia: The Way Forward" [2007] MqJlBLaw 13; (2007) 4 Macquarie Journal of Business Law 267

Charges over Book Debts in the United Kingdom and Australia: The Way Forward

LANG THAI^[∗]

Is it possible to create a fixed charge over book debts? This question was recently decided by the House of Lords in National Westminster Bank plc v. Spectrum Plus Limited & Ors [2005] UKHL 41 where the full House was against the idea of a fixed charge on book debts and insisted that only a floating charge had been created. The law in this area is still vague and uncertain in Australia. This article argues that the financiers and the companies should be given the freedom to decide how they wish to structure their charge documents. The article sets out to argue that it is possible to create a sustained workable fixed charge or even a multiple combination of fixed and floating charge over book debts and argues that this would be the only way for both the financiers and the companies to do business together, in respect to the use of book debts as security for a loan. The author explains how this could be possible and how the proposed model would not deny the statutory priority rights of the preferential creditors.

I Introduction

There is considerable debate on whether it is possible to create a fixed charge over book debts and recycling proceeds. Much has been focused on the importance of staying within the strict categorisation of fixed and floating charges^[1] while there is also focus on removing the distinction.^[2] In practice, when a charge is categorised as fixed, the fixed charge holder (usually the lender) has full control over the charged assets and the company (that is, the chargor) is not permitted to deal with or dispose of those assets without the consent of the charge holder. Conversely, when a charge is classed as floating, the floating charge holder has very little control over the circulating charged assets and the chargor company can dispose of any or all of those charged assets without the need to obtain consent. In real terms, a floating charge holder has very little security, especially when the charged assets are book debts and recycling proceeds by which the company deals with them regularly in the ordinary cause of its business. Additionally, the security of the floating charge holder is weakened further when there are preferential creditors^[3] in the equation, who have been given the statutory priority rights.

This matter was recently^[4] considered in the United Kingdom in National Westminster Bank plc v Spectrum Plus Limited and Others [2005] UKHL 41 (‘Spectrum Plus’), where the House of Lords unanimously held that despite the charge being expressed as ‘fixed’, only a floating charge had been created over the company’s book debts. Essentially, the 25-year old decision in Siebe Gorman & Co v Barclays Bank Ltd [1979] 2 Lloyd’s Rep 142 (‘Siebe Gorman’) was overruled. By way of an obita, the House of Lords cautiously expressed that a fixed charge on book debts may be possible if exceptional circumstances are met, but they remained firm on the view that the traditional method of categorising charges is still the preferred approach.

The ruling in Spectrum Plus could potentially have a significant impact in Australia. This is because there is currently no Australian High Court authority on this issue and, because of the historical connection between the two countries, most of the English House of Lords decisions will be taken as highly persuasive despite their non-binding effect.

The writer submits that the decision in Spectrum Plus is slowing down the development of the law in this area. The decision is merely re-iterating the old law, setting back the law that had been developed since Siebe Gorman in 1979 which ruled in favour of a fixed charge over book debts. This article sets out to argue that reforms are necessary in this area and explains how that could be done.

This article is divided into 7 parts. Part II explains what book debts are and the importance of categorising fixed and floating charges. Part III examines why lenders often insist on fixed charges. The history of charges over book debts, both in the United Kingdom and Australia, will be reviewed in Part IV. Part V summarises the current law and provides a case study on the application of the ruling in Spectrum Plus. It also examines the practical and legal implications for both the financiers and the companies. Part VI suggests some proposed reforms to the law by considering a new concept that would allow multiple split charges over book debts and the collected proceeds or in the alternative by considering the removal of the distinction between fixed and floating charges. Part VII is the conclusion.

II Book debt and categorisation of charges

A What is a ‘book debt’?

It may sound very basic to describe ‘book debt’ in this article, but it would assist in understanding why lenders are usually reluctant to accept book debts and recycling proceeds as security. There have been a vast number of cases deciding for and against ‘fixed charges over book debts’ without providing any clear indication of what ‘book debts’ actually meant.

In the commercial world, a ‘book debt’ is also known as ‘accounts receivable’. There is no precise definition at common law. The term ‘book debt’ is not defined in the Corporations Act 2001 (Cth); instead, in reference to ‘a charge over book debts’ the Act defines a ‘charge’ to include a mortgage which is not very helpful in this context.^[5] Over the years and in practice, a book debt is known as a debt owed to a company when goods are sold or services rendered, that is, a book debt is the money that the company is entitled to receive and collect as shown on the accounts and invoices. Gallop J in Re Rex Developments Pty Ltd (in liq) (1994) 13 ACSR 485 at 490 defined a book debt as follows:

… it is an entitlement to payment. Once payment is made by cheque or otherwise, the book debt is extinguished by the payment. Hence the entitlement to the book debt no longer exists… Any other meaning in the present context would be entirely artificial.

The term ‘book debt’ refers to a circulating asset in the sense that it is not constant. On some days, a company may have book debts that are worth thousands or millions of dollars, and on other days, the same company may have book debts with a total value of few hundred dollars. This fluctuating nature can happen when a company has collected the proceeds and is yet to issue more invoices to customers and clients. In simple term, book debts and recycling proceeds can be ‘dried up’ when a company is not actively trading.

B Definition of fixed and floating charges

A charge is an important structure in the financing of the company debts. It can either be a fixed charge or a floating charge depending on the nature of assets being used as security; and the way to understand how charges are categorised, in the traditional sense, is through the definition of fixed and floating charges.

A charge is fixed when the charge attaches to the specified fixed assets owned by the company such as land, machinery, plant and equipment. The fixed charge can attach to existing fixed assets as well as future fixed assets provided they are specified in the charge documents.^[6] The characteristics of a fixed charge are these:

• The chargor company is not permitted to dispose of, assign, recharge or otherwise deal with those fixed assets in any form or shape without the prior consent of the lender (ie, the fixed charge holder). Therefore, the lender has control over the specified fixed assets;
• When a fixed charge is created, the fixed charge holder has an immediate proprietary interest in the assets in equity subject to any prior existing interests where notice has been given and agreement has been reached;
• When the company becomes insolvent, the fixed charge holder can exercise its rights to acquire legal possession of those assets without having to share with other creditors other than the creditors whom notice and consent have been given prior to insolvency;
• A fixed charge is ranked in accordance with the date of registration (or in some cases, in accordance with the date of creation). In most cases, the same assets may not be subject to two different types of charges, but if they are, then a fixed charge is usually ranked ahead of a floating charge.

A floating charge is more or less the opposite of a fixed charge. It hovers over the circulating assets, for example, stock in trade (and perhaps book debts included). When comparing with the characteristics of a fixed charge and when the company only has circulating assets to offer as security for a loan, the company would most certainly prefer to grant a floating charge, whereby the characteristics of a floating charge are these:

• The company can continue to use its circulating assets to trade and dispose of in the ordinary cause of its business without the need to obtain consent from the lender;
• The floating charge will only become fixed when crystallisation occurs (usually on insolvency, specified defaults, a term of the charge has been breached or on other similar events).

A floating charge is carefully described by Romer LJ in Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284 at 295, which has received very wide acceptance^[7]:

… I certainly think that if a charge has the three characteristics that I am about to mention it is a floating charge: (1) If it is a charge on a class of assets of a company present and future; (2) if that class is one which, in the ordinary course of the business of the company, would be changing from time to time; and (3) if you find that by the charge it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class of assets I am dealing with.

Further, Lord MacNaghten of the House of Lords in Illingworth v Houldsworth [1904] AC 355 at 358 drew the following distinction:

I should have thought there was not much difficulty in defining what a floating charge is in contrast to what is called a specific charge. A specific charge, I think, is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined; a floating charge, on the other hand, is ambulatory and shifting in its nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp.

III Lenders preferring fixed charges

There are at least four reasons why a lender would prefer a fixed charge over book debts than a floating charge:

1. As seen from the above discussion, an important difference between a fixed charge and a floating charge is the control/consent factor. In a fixed charge, the financier has control over the assets and the company must obtain prior consent to deal with those assets. In a floating charge, the control vests in the company; it can deal with the assets, including disposal thereof, without seeking consent of the lender. The fixed charge therefore confers greater security to the lender as soon as it is created. The floating charge, on the other hand, does not at all provide any security until that charge becomes fixed through crystallisation, and even then there may be nothing left for the lender to take in the final process.

2. The next reason involves the preferential creditors – the preferential creditors usually have a statutory right to be paid in priority over the floating charge holder. Examples of the preferential creditors are the employees, the taxation office and other government bodies. Sections 433, 556 and 561 of the Corporations Act 2001 (Cth) set out the priority rights of the employees ahead of the floating charge holder; the employees' entitlements will be paid out first, including unpaid wages, superannuation contributions and leave entitlements. Section 215 of the Income Tax Assessment Act 1939 (Cth) requires the receiver to notify the Commissioner of Taxation of his or her appointment. Section 215 then empowers the Commissioner to require the receiver to set aside a sum sufficient for the payment of income tax for which the company is liable. A fixed charge is not affected by these statutory rules and is therefore more attractive to the lender.

3. There is a potential for a floating charge to be invalidated, for example, under s 588FJ (and to some extent s 566) of the Corporations Act 2001 (Cth). Section 588FJ provides that a floating charge created within six months prior to the commencement of the winding up may be declared void and invalid against the company's liquidator. This may be rebutted if the lender can prove that the company was solvent immediately after the charge was created. The aim is to deter companies, on the verge of insolvency, from distributing their assets by way of granting floating charges in favour of particular creditors so as to remove those assets from the control of the liquidator. The lenders generally do not have actual knowledge of the internal management of the companies. They have no way of knowing for certainty that after a floating charge is created that the company will continue to trade in business and will continue to maintain its liquidity for at least the next six months. It is therefore safer for the lenders to insist on fixed charges if possible as fixed charges are not affected by s 588FJ.

4. The fourth reason that a fixed charge is preferred over a floating charge is by examining the nature of book debts. When comparing with other circulating assets, such as the tradable goods on the supermarket shelves, book debts are perhaps the most undesirable type of assets for use as security. The real difference is that the tradable goods on the shelves are usually stocked up regularly and may be easily inspected by the charge holder (ie, the lender) to ensure that most of those tradable goods are still in the same quantity and volume as when the charge was created. So there is some assurance for the charge holder when deciding to accept a floating charge over the tradable goods. Book debts, on the other hand, are only an entitlement to payment from the debtors whom the company has supplied services, for example, repairs to computers. The lender will not be able to tell whether the company is trading profitably by simply walking passed the store and looking in. The lender has to ask the chargor company on a regular basis for an update, for example: How many book debts are remaining and in what amounts? How many book debts have been generated during this month? Answers to these questions are important to the lender to ensure that the volume of book debts is still the same as what it was when the charge was created. The lender may not have the right, however, to interrogate this way if only a floating charge was created. It is therefore safer to insist on a fixed charge when book debts are involved.

It should be noted that not all companies own valuable fixed assets to be used as security. In keeping up with the constant changes in technologies and in an attempt to reduce taxes payable on the taxable income by claiming more on deductions, many companies now tend to move towards long-term leases or hire-purchase agreements on things such as machinery, vehicles and equipment for business. For these reasons, there are companies that only have book debts and collected proceeds on offer for security.

The reality is, the lender wants fixed security and the company wants freedom to deal with book debts and proceeds in the ordinary course of its business. The company would not want the collected proceeds to be frozen or restricted until the charge is released. Is there a compromised solution? This is precisely why, case after case, the lenders have attempted to overcome this difficulty by expressing their charges as ‘fixed’, simply to assist their clients and get on with the business. Regrettably, as discussed in the following cases, the rigidity in the law has not made it possible for lenders and companies to bridge this commercial dilemma. The writer suggests some reforms which are discussed later in this article.

IV History of charges over book debts

A The United Kingdom position

1 Siebe Gorman^[8] charge

Siebe Gorman was the first case in history where the Court declared that it was possible to create a fixed charge over book debts. The charge document in that case was expressed to create a fixed charge over the company’s book debts. A clause provided that the company ‘… shall pay into [the] account with the bank all monies which it may receive in respect of the book debts and other debts hereby charged and shall not without the prior written consent of the bank in writing purport to charge or assign the same in favour of any other person …’^[9]

The arrangement was that the collected proceeds were to be paid into a joint account with the bank (ie, the chargee) and the company was free to use those proceeds in the ordinary course of its business. There was no requirement that the company must obtain consent when making withdrawals. It was clear that the bank had a right to block the company from making withdrawals, but that right was never exercised.

Slade J in the Court of Appeal held that the bank had an express right to block the company (ie, the chargor) from making withdrawals and that express right alone was sufficient for the charge to operate as fixed.

Subsequent to that case, many banks and financiers adopted the same language in their standard charge documents.^[10]

2 Re Keenan Bros Ltd^[11]

In Re Keenan Bros Ltd [1985] IR 401 (‘Re Keenan’), the charge document specifically stated that the chargor had a ‘blocked account’ with the bank, that is, the company must not ‘without the prior consent of the bank in writing, make any withdrawals or direct any payment from the said account’.^[12] It was clear that the bank did not have to do anything more for its charge to be fixed because the company could not deal with the proceeds of the book debts without the bank’s written consent. The chargor was required to pay the proceeds of its book debts into the ‘blocked account’ and was permitted to draw on that account only with the consent of the bank. The Irish Supreme Court considered necessary to follow Siebe Gorman and concluded that a fixed charge over the book debts had been created.

It should be noted that the facts in Siebe Gorman could be distinguished from those in Re Keenan. In Siebe Gorman, the term of the charge was that the bank had a right to block the account, but did not do so. In Re Keenan, the account was truly ‘blocked’ and the only way the company could withdraw the proceeds deposited into the joint account was to seek permission. In essence, the court in Re Keenan had consistently followed the traditional method^[13] in categorising the charge to be fixed; it was really not necessary to refer to Siebe Gorman in reaching that conclusion.

3 New Bullas^[14]

The court in Re New Bullas Trading Ltd [1994] 1 BCLC 485 (‘New Bullas’) took a radical approach and extended the concept in Siebe Gorman to allow a split charge over book debts and proceeds. The decision was equally controversial.

In that case, a charge over book debts was created in favour of a lender that was not a bank. The company borrower was required to pay the proceeds of the book debts into a specified bank account held jointly with the lender. The Court of Appeal took the view that the uncollected book debts and the proceeds of those book debts were two different assets. The charge in question effectively created two different charges: a fixed charge over the uncollected book debts and a floating charge over their proceeds. The reason was that the charge only prohibited the company borrower from disposing of the uncollected book debts (the fixed charge component) but allowed the company borrower to draw on the account and use the proceeds in the ordinary course of its business (the floating charge component).

The Privy Council in Brumark was very critical of the approach in New Bullas.

4 Brumark^[15]

Agnew v Commissioner of Inland Revenue [2001] UKPC 28; [2001] 2 AC 710 (also known as ‘Brumark’) started in New Zealand and was subsequently appealed to the Privy Council in the United Kingdom. The case is no longer relevant in New Zealand because of the enactment of its Personal Property Securities Act 1999 which came into force on 1 May 2002, which is discussed later in this article. Nonetheless, it may still have some relevance in common law countries that do not have a similar legislative enactment, such as Australia and the United Kingdom.

On appeal in 2001, the Privy Council agreed with the New Zealand Court of Appeal^[16] that if the borrower was free to deal with the uncollected book debts and was, in the ordinary course of its business, free to withdraw them from the security without the consent of the chargee, the charge was very much a floating charge, both on book debts and the collected proceeds.

The charge documents were substantially similar in form to those in New Bullas. The lender was hoping that the same rule in New Bullas would apply, despite its awareness of the controversy raised by lawyers and academics.^[17] In Brumark, the important terms of the charge documents were these:

• The uncollected book debts were expressed to be subject to a fixed charge;
• The borrower was allowed to deal with the book debts in accordance with any directions which might be given by the lender and, in the absence of such directions, to deal with the book debts only in the ordinary course of getting them in;
• The proceeds of the book debts were to be paid into the borrower’s own account and if, directed to do so by the lender, into the designated joint account.
• The proceeds collected from the book debts would be “released from the fixed charge” and be subject to the floating charge.

Evidence revealed that the lender had never exercised its right of direction with respect to the uncollected book debts and had never demanded the collected proceeds to be paid into the designated joint account. Essentially, provided the book debts/proceeds were used in the ordinary cash flow manner, the company borrower assumed control from the time a book debt was generated to the time the proceeds were dissipated.

There were two main issues in that case. The first was whether the charge over book debts was fixed. Lord Millett, who was the leading judge in the Privy Council, adopted a simple approach, stating that a charge is to be determined by the two following tests, regardless of the fact that it has been expressed as fixed:

(1) You must examine the charge to determine the nature of the rights and obligations of the parties in relation to the charged assets; then

(2) You must categorise the charge based on those rights and obligations and the law that is applicable in the categorisation. [at 725]

Lord Millett noted the two steps in the tests: the construction of the charge documents; and then the categorisation of the charge in accordance with the well established rules of categorisation. By way of reviving the importance of categorising fixed and floating charges (which was watered down by the Court of Appeal in New Bullas), Lord Millett re-iterated the significance of Romer LJ’s judgment in Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284,^[18] and referred to it as ‘the most celebrated, and certainly the most often cited description of a floating charge’ [at 719] (discussed above).

To emphasise the point further, Lord Millett stated ‘it is not enough to provide in the debenture that the account is a blocked account if it is not operated as one in fact’ [at 730]. He referred to what is known as the control test:

If the chargor is free to deal with the charged assets and so withdraw them from the ambit of the charge without the consent of the chargee, then the charge is a floating charge. But the test can equally well be expressed from the chargee’s point of view. If the charged assets are not under its control so it can prevent their dissipation without its consent, then the charge cannot be a fixed charge. [at 723]

The second issue was in reference to New Bullas. The Privy Council ruled that the decision in New Bullas was fundamentally wrong and must not be adopted [at 721-725]. While book debts and proceeds are two separate assets, the Privy Council made it clear that the proceeds of the book debts are dependent on the book debts being generated that treating the proceeds of those book debts as separate from the book debts was not possible:

a debt and its proceeds are two separate assets, however, the latter are merely the traceable proceeds of the former and represent its entire value…. It is worthless as a security [if it is on its own]…. Any attempt … to separate the ownership of the debts from the ownership of their proceeds … makes no commercial sense. [at 729]

The Privy Council concluded that the company was free to deal with the charged assets and also free to withdraw them from the security without obtaining consent from the lender. This was sufficient to constitute a floating charge over the entire book debts/proceeds package.

5 Spectrum Plus^[19]

In 1997, National Westminster Bank (the ‘bank’) provided an overdraft facility of £250,000 to Spectrum Plus Limited (the ‘company’) to be used as working capital. The overdraft facility was secured by a debenture which purported to create a fixed charge over all present and future book debts. The charge was in a similar form to the charge in Siebe Gorman. That is, the charge prohibited the company from selling, factoring, discounting or otherwise disposing of its uncollected book debts without the prior consent of the bank. The charge required the company to pay the proceeds of the book debts into an overdraft account held with the bank, but with an understanding that the company was permitted to draw freely on the account for its business purposes. While the overdraft facility varied from time to time, the overdraft account was never in credit.

The company went into liquidation in October 2001. The liquidators realised the proceeds in the sum of £113,484 from the book debts and refused to hand over to the bank. The bank was owed £165,407 and the Crown as preferential creditors were owed £16,136. The bank applied to the court for an order that the debenture created a fixed charge over the company’s book debts and thereby the proceeds collected should be handed over. The Crown creditors^[20] joined in the proceedings as respondents and argued that Siebe Gorman was wrongly decided and that the debenture had merely created a floating charge.^[21]

This matter was appealed all the way to the House of Lords where it was decided in June 2005 that only a floating charge had been created.

(a) First instance decision^[22]

Morritt VC of the English High Court declined to follow the two Court of Appeal's decisions - Siebe Gorman and New Bullas^[23] - and held that a floating charge was created over the company’s present and future book debts.^[24] The charge did not impose any restriction on how the company was to withdraw from the overdraft account held with the bank. The company was free to withdraw the collected proceeds. These were sufficient reasons for deciding that the charge was floating.

(b) Court of Appeal^[25]

The Court of Appeal reversed the first instance decision and unanimously held that the charge was fixed. The focus was on the intention of the parties. It was decided that as a matter of precedent the Court was bound by its earlier decisions in Siebe Gorman and New Bullas.

(c) House of Lords^[26]

The House of Lords unanimously overturned the Court of Appeal’s decision and held that the charge created, although expressed as fixed, was only a floating charge in all respects. Two important issues were discussed in that case: (1) whether the charge, which was similar in form to Siebe Gorman, was fixed or floating; and (2) whether prospective overruling of Siebe Gorman would be allowed. Further, the court briefly considered circumstances that a fixed charge might be possible.

(i) Floating charge over book debts

Three leading judgments were provided on this point (Walker LJ, Scott LJ and Hope LJ). Walker LJ considered the history of the charges and the ‘essential difference between a fixed charge and a floating charge’^[27]. He expressed the view that, for a fixed charge to be created over book debts the charge must prohibit the chargor company from making withdrawals from the account except with the ‘active concurrence of the chargee’.^[28] He emphasised that a charge can only be fixed if the restriction is active and is observed in practice; in the present case there was no such evidence for that to be so. The bank did not on any occasion prevent the company from withdrawing the proceeds of the book debts from the account held with the bank. According to Walker LJ, the labelling of the charge document ‘cannot be decisive if the rights created by the debenture… are inconsistent with that label’.^[29] He stated that ‘Slade J [in Siebe Gorman] did not correctly construe the debenture which was before him in that case and his decision on its construction has had surprisingly far-reaching consequences’.^[30]

Scott LJ set out his judgment in two parts: (i) determine what test should be used to categorise the charge; and (ii) using that test, how should the charge in the present case be categorised. His approach was substantially similar to that in Brumark. He considered the “control” test as important for identifying a fixed charge from a floating charge, but did not explain the degree of control required by the bank:

The judgment of Lord Millett [in Brumark] held that the critical feature which distinguished a floating charge from a fixed charge lay in the chargor’s ability, freely and without the chargee’s consent, to control and manage the charged assets and withdraw them from the security.^[31]

He went on to define what a floating charge was by pointing out the three ‘essential characteristics’^[32] as discussed earlier. He concluded that the charge documents had no restrictions on the company's right to make withdrawals from the overdraft account up to the overdraft limit. That is, the company was not required to ask for consent nor was it required to notify the bank when a withdrawal was made. Provided the dealings were in the ordinary course of business, the company had much freedom and control in its right to make withdrawals. The charge was created in 1997 and the bank had not once prevented the company from making withdrawals on the overdraft account. In effect, the charged assets were under the control of the company and not the bank. On these reasons, the company had granted only a floating charge.^[33]

Hope LJ considered the ‘blocked account’ test - when a customer was entitled to draw on the account whenever it wished within the overdraft limit, then the account was not a blocked account. He agreed with the other judges that the collected proceeds deposited into the account were subject to a floating charge only.

The House of Lords decided that the decision in Siebe Gorman was wrong and must be overruled. The overruling was not on the basis that the Court of Appeal had incorrectly applied the law, but on the basis that the Court had incorrectly construed the charge to be fixed.

(ii) Can overruling have prospective effect only?

A subsidiary issue to this case was whether the House of Lords had the power to hand down a prospective overruling of Siebe Gorman. The effect would mean that the current judgment that overrules Siebe Gorman would only apply to future cases and transactions. This was the request of the bank.

The argument was that, many banks and lenders had, since 1979, relied upon the decision in Siebe Gorman in preparing their standard charge forms, which were understood to create fixed charges over their customers' book debts. It was argued that retrospective overruling would have a serious and consequential flow on all of the existing chargees and chargors in the entire nation.

The House of Lords did not see any exceptional circumstances to grant a prospective overruling.^[34] Reasons are these. First, banks and lenders who lend money on the security of company charges are sophisticated lenders and there was no reason for them to think that the decision in Siebe Gorman had lulled them into a false sense of security.^[35] Second, the decision in Siebe Gorman was a single-judge first instance decision and the lenders were aware that such decision should not be relied upon as a definitive ruling as it was always open to the higher courts to overrule it.^[36] Third, if prospective overruling was granted by the court, the result would be that in many of the existing liquidations, the preferential creditors would be denied of their statutory rights to receiving priority payments.^[37]

On this issue alone, Australia is in a similar position. In the case of Ha v State of New South Wales [1997] HCA 34; (1997) 189 CLR 465, the High Court has firmly pointed out that it has no power to overrule cases prospectively; only the Parliament has that power.^[38]

(iii) Can book debts be subject to a fixed charge?

Although, the House of Lords has cautiously expressed that a fixed charge over book debts might be possible under ‘exceptional’ circumstances,^[39] the writer is not convinced that the court is attempting to broaden the law in this area. It may well be said that the House of Lords is merely re-iterating the existing law. According to Hope LJ, one of the four ways in which a charge over book debts could be fixed would be:^[40]

(a) Prevent all dealings with the book debts so that they are preserved for the benefit of the lender’s security. This method would call for a complete assignment of book debts to the lender which may not be acceptable to a company that relies on book debts as working capital.

(b) Prevent all dealings with the book debts other than their collection and require that the proceeds when collected be paid to the lender in reduction of the borrower’s outstanding debt. Similarly, this is unlikely to be acceptable to a company that uses book debts to generate cash flow and as working capital.

(c) Prevent all dealings with the book debts other than their collection and require that the proceeds when collected be paid into an account with the lender. That account must then be blocked so as to preserve the proceeds for the benefit of the lender’s security.

(d) Prevent all dealings with the book debts other than their collection and require that the proceeds when collected be paid into a separate account with a third party bank. The lender then takes a fixed charge over that account so as to preserve the proceeds for the benefit of the lender’s security.

Similarly, Scott LJ put much emphasis on the term ‘control’,^[41] but did not explain the degree of control to be exercised by the lender to ensure a successful blocked account structure. Again, Walker LJ expected a ‘block account’^[42] when he echoed the words of Millett LJ in Brumark where a powerful warning was given in the following terms:

[T]heir Lordships would wish to make it clear that it is not enough to provide in the debenture that the account is a blocked account if it is not operated as one in fact.^[43]

Arguably, the approaches of all three judges are more or less similar. They are all merely re-iterating the existing method of categorising fixed and floating charges by saying that a fixed charge over book debts is possible only if (ie, ‘exceptional circumstances’) the strict categorisation rules have been followed. As explained later in this article, the approach in Spectrum Plus is entirely unworkable.

B The Australian position

The law in Australia is again inconsistent in this area. There is approval for the traditional method of charge categorisation as well as approval for the New Bullas model. Two Supreme Court cases - Hart v Barnes [1983] VicRp 111; (1983) 2 VR 517, (1982) 7 ACLR 310 and Whitton v ACN 003 266 886 Pty Ltd (Controller Appointed) In Liq (1996) 42 NSWLR 123 - are canvassed below to illustrate the inconsistency, both of which are conflicting. There is no High Court decision.

1 Hart v Barnes^[44]

The facts are quite similar to those in Siebe Gorman. Anderson J of the Supreme Court of Victoria applied the control test and concluded that if assets are not under the bank’s control ‘so that it can prevent their dissipation without its consent, then there cannot be a fixed charge’.^[45] The focus was not whether the company had freedom to carry on its business, but whether the bank was in control of the charged assets. His view was that a fixed charge over book debts and proceeds could not be possible and provided his reason:

If it were [held to be a fixed charge] it would mean that there would be brought into existence an ever-increasing fund, being the proceeds of the payment of the book debts, which fund, being the property of the [chargee], would be untouchable by [the chargee] and equally unavailable to the company.^[46]

2 Whitton v ACN 003 266 886 Pty Ltd^[47]

In Whitton, the court followed the New Bullas model. A printing company raised working capital by assigning and charging all its book debts and other assets to a non-bank lender (HFS). The uncollected book debts were expressed to be subject to a fixed charge. The company was described as an agent, collecting the proceeds on behalf of the lender. A clause in the charge document stated that the company was permitted to use those proceeds collected in the ordinary cause of its business. The net effect was a split charge: fixed over uncollected book debts and floating over collected proceeds.

The company defaulted and the receiver of HFS attempted to recover the full sum from the fixed charge component of the uncollected book debts and from the floating charge which had become fixed as a result of the default and crystallisation.

The issue was whether the charge over the company's book debts and proceeds should be categorised as floating so as to defer the priority rights to the employees. Bryson J acknowledged the similarities in the clauses between New Bullas and the present case and saw no difficulties in creating a fixed charge over book debts while they were uncollected and a floating charge over their proceeds. His view was that the parties had ‘a clear agreement’ and that ‘agreement must prevail’^[48]. In support of that view, he cited a passage from New Bullas that reads:

… just as it is open to contracting parties to provide for a fixed charge on future book debts, so it is open for them to provide that they shall be subject to a fixed charge while they are uncollected and a floating charge on realisation.^[49]

Bryson J acknowledged the long list of authorities that supported a floating charge over book debts, dated back to Tailby v Official Receiver (1888) 13 App Cas 523^[50]. In the end, however, he indicated that book debts and proceeds could be treated independently under a charge and concluded that intention of the parties at the time of creating the charge should be given legal effect. In summation, it is clear in Whitton that intention and freedom of contract are important considerations in deciding how book debts and proceeds are to be placed when using them as security.

V What exactly is the relevant law in this area?

A Summary of the relevant law

In Australia, the law in this area is still vague and uncertain. There is no law that says a fixed charge over the uncollected book debts is unworkable and strictly prohibited (see Siebe Gorman, New Bullas, Whitton), nor is there a law that insists on the creation of a floating charge only (see Spectrum Plus). The uncertainty is displayed in the two English authorities of the highest hierarchy - Brumark and more recently, Spectrum Plus. These authorities have no binding effect on the courts in Australia, but given the historical link between the two jurisdictions, it is likely that they will be regarded as highly persuasive. The law in respect to security over book debts and proceeds may therefore be summarised as follows:

(a) When book debts and proceeds are used as security, the general rule is that they are circulating floating assets and can therefore be subject to a floating charge only. This is in recognition of the fact that the company uses book debts to generate revenues and pay expenses, and because of the fluctuating nature in the book debts, only a floating charge can be created over those assets.

(b) Charges that are expressed to be ‘fixed’ will not prima facie be construed as ‘fixed’ but will be subject to the strict rules of categorisation as described in Yorkshire,^[51] which is reflected in the more recent cases such as Brumark, Hart, and Spectrum Plus. The court will not be concerned with how the charge has been labelled, described or expressed. The court has made it clear from time and time again that the intention of the parties and the conduct of the parties immediately prior to the creation of the charge will not be the core issues in the categorisation process.

(c) It may be possible for book debts and proceeds to be subject to a fixed charge under ‘exceptional circumstances’, for example:

• The need to establish a ‘blocked account’ in which the company borrower is required to deposit the proceeds of the book debts into that account for which such proceeds will be preserved and held in trust for the benefit of the chargee's security. There are, however, conflicting authorities on the degree of blockage required. In Re Keenan and New Bullas, the courts held that a right to block that account was sufficient; while in Brumark and Spectrum Plus the courts insisted on actual and active blockage.^[52]
• The need to show that the charge holder has sufficient ‘control over the uncollected book debts and the proceeds collected. Therefore, some kind of control mechanism is required. The extent or the degree of control is unclear, however. In Spectrum Plus, the House of Lords provides a few examples in defining ‘control’, but those examples do not clearly illustrate what type of control is acceptable and what not.
• The company borrower is required to obtain prior ‘consent’ of the charge holder when making withdrawals on the account. As it stands, it is unclear whether the company is required to obtain consent for each and every withdrawal; or whether it would be sufficient for the company to seek consent once and make as many withdrawals as considered necessary until the charge holder removes that consent.

It seems clear from authorities that the essential elements for a charge to operate as ‘fixed’ are the need for a ‘blocked account’, and the ‘control/consent’ on the part of the charge holder. What is not certain is: How far must the charge holder go in fulfilling those elements so that the charge can be categorised as ‘fixed’ absolutely? Will a mere right to block the account or a mere right to exercise control of the book debts as stated in the charge documents be enough? Or will the charge holder need to prove further that it had in fact blocked the account and had in fact control the flow of book debts and proceeds? As it stands, the opinions of the courts vary considerably. Without saying further on this point, it should be noted that for a charge over book debts to be fixed at law, compliance with the legal categorisation process is still an absolute requirement.

(d) It is uncertain whether a split charge is possible; ie whether it is possible to have a fixed charge over the uncollected book debts and a floating charge over their proceeds. The Privy Council in Brumark rejected the view expressed by the Court of Appeal in New Bullas, saying that it was not possible to segregate book debts from proceeds as the latter was dependent on the existence of the book debts. The House of Lords in Spectrum Plus made no comment on this point. The NSW Supreme Court in Whitton supported the New Bullas’ model. It is therefore unclear as to which way the Australian courts will take in the future.

B Approach in Spectrum Plus is unworkable

The writer is not convinced that the ruling in Spectrum Plus is opening a way for a broader and more flexible approach to the creation of charges on book debts. The case re-iterates the need to comply with the fixed/floating charge categorisation. Although definitive language is used in advising on the exceptional circumstances, the House of Lords has not provided any practical advice on how much control that the chargee lender must exercise over the proceeds of the book debts in order for the charge to be qualified as fixed. Scott LJ considered the control test in the context of distinguishing a fixed charge from a floating charge and did not explain the degree of that control. Walker LJ considered the requirement of ‘active concurrence’ in the context of a fixed charge generally without explaining the book debt component. Hope LJ provided four ways in blocking the account to ensure that a charge on book debts would operate as fixed^[53], essentially the idea is that the chargor company can only deposit proceeds but cannot withdraw them. The other four remaining judges^[54] had no significant contribution on this point other than concurring with their fellow judges.

It appears that there is no progress in the law in this area since Siebe Gorman. Collectively, the House of Lords appears to be saying that for a fixed charge over book debts to be legally possible, the traditional rule on charge categorisation is still very much relevant today as it was in 1903^[55], ie. book debts and proceeds must be strictly controlled and regulated by the chargee lender. Under the Spectrum Plus’ ruling, both the lenders and the companies will continue to face difficulties when preparing charges that are intended to be fixed. In commercial reality, the lender wants certainty in the security and the company wants freedom to deal with its book debts and proceeds in the day to day business – the struggle between the two will continue and this is illustrated in the case study in the next part.

C Case study on Spectrum Plus

Imagine a company is in the business of servicing and repairing computers and providing on-site technician support to its customers. The business is operated from rented premises. Most of the operating fixed assets (computers, tools and other equipment) are either on long term hire-purchase or on lease.^[56] The company has overhead expenses, including employees’ wages. It has consistently generated book debts in the sum of $200,000 on any given day over the last 10 years of its trading. Most of the customers have paid on time, so there is no problem in converting book debts into proceeds. The company wishes to expand its business and is in need of a loan of $100,000.

Ideally, the bank prefers a fixed charge over fixed assets, but this is not possible as the company has no valuable fixed assets. Based on the financial statements, the company is making profits annually and has a good reputation, so the alternative for the bank would be to accept a charge over the company’s present and future book debts and the collected proceeds. The important matter now is to decide what type of charge is acceptable to both the lender and the company.

The lender will most certainly refuse to accept a straight-out floating charge on book debts and proceeds. The reasons are clear – the potential risks in a floating charge are numerous, and amongst them are these:

• The company is doing well now, but there is no guarantee that the level of book debts will remain constant for the entire term of the loan;
• There is no certainty that the borrower’s customers will continue to pay their debts on time;
• The interest of a floating charge holder will be postponed to the preferential creditors in the insolvency proceedings;^[57]
• The benefits of a floating charge have eroded over the years through legislation and there is a risk that further erosion is possible;^[58]
• The company may increase its staffing needs during the term of the loan, which means that in the event of insolvency of the company, the employee’s entitlements (wages, holiday pay, long service leave, superannuation) will take priority over the floating charge holder;
• If the company is completely free to use the proceeds collected from the book debts, there is a foreseeable risk that the company may make more withdrawals on the joint account from which the proceeds were paid into, leaving a zero balance or a debit on the account.^[59]

Ideally, the company prefers a floating charge as this would, at law, allow the company to continue to deal with the charged book debts and to use the proceeds freely in the ordinary cause of its business. The company would most certainly refuse to grant a fixed charge if the effect would be to block the proceeds completely to the point where the company is unable to make any withdrawals without asking for consent. The important question is: Is there a compromised solution so that both parties can have a satisfying business relationship?

The ruling in Spectrum Plus is not very helpful to both the lender and the company. According to that case, the parties must choose either a fixed charge or a floating charge, but not both. If a floating charge is chosen, the effect would be those mentioned above. If a fixed charge is chosen, both the lender and the company must comply with the following criteria concerning the collection of the proceeds:

• A joint ‘blocked account’ must be established to ‘control’ the collection of the proceeds, in that the company can only deposit proceeds but cannot make withdrawals unless the lender has given ‘active concurrence’;
• That ‘active concurrence’ is required for each and every withdrawal;
• The proceeds collected must be ‘preserved’ and held in trust ‘for the benefit of the financier’s security’.

The negative implications of the ruling in Spectrum Plus, in respect to its fixed charge structure, may be divided into two types:

1 Conceptual implications that conflict with other laws

• Spectrum Plus removes the fundamental right of freedom of contract. The lender and the company, both commercially minded, have no say in how their charge documents are to be structured to suit their own needs and purposes.
• If the tests in Spectrum Plus were to apply (ie, the requirements of ‘blocked account’, ‘active concurrence’, ‘control and consent’), the potential side effect is that the lender may be construed as an ‘officer’ of the company as per s 9 of the Corporations Act 2001 (Cth), which means that the lender may potentially be caught under chapter 2D.1 of the Corporations Act 2001 (Cth) which provides the duties of directors and officers. The word ‘officer’ is defined broadly in s 9 to include a person:

(i) who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporations; or

(ii) who has the capacity to affect significantly the corporation’s financial standing...

Arguably, the lender may be construed as playing a management role in the company similar to that played by a director and officer of the company, ie, deciding on how the company should use the collected proceeds, demanding that the company seeks ‘consent’ when making each and every withdrawal on the account, and taking a significant interest in the company’s financial standing during the term of the charge.

• If Spectrum Plus is applied, the bargaining power will be shifted towards the lender. The company will be unduly oppressed and crippled potentially if the lender were to assert its strict legal rights under the terms of the fixed charge to withhold consent and prevent any withdrawals made on the blocked account.
• It is arguable that the ruling in Spectrum Plus gives rise to a platform of corporate discrimination. This concept may be unheard of in the commercial world as business people are presumed to know how to protect themselves against commercial forces and pressures and how to apply the law to their advantage. One thing that is out of their control, however, is the corporate discrimination imposed by law. Spectrum Plus appears to be actively discouraging companies from taking out loans and creating charges if they do not own any valuable operating fixed assets, as illustrated in the above example.^[60] There is an increasing number of companies with very little or no valuable fixed assets for use as security and to this end, Spectrum Plus is alienating a section of the potential chargor companies that have only book debts and proceeds as their major assets.

2 Other commercial implications

Under the Spectrum Plus’ ruling, both the lender and the company will be faced with the substantial and yet unnecessary increase in the administrative load. The lender will be required to deal with the continuous requests for consent when the company wishes to make withdrawals on the blocked account. By the same token, the company’s freedom to deal with the book debts and use the collected proceeds in the ordinary cause of its business will be severely restricted when consents are required for each and every withdrawal made. The added administrative burdens on the parties and the conceptual unworkability of the current law can now only be resolved through legislative interventions.

Vi How can the law be changed?

There are four possible ways that the law in this area could be reformed.

A Freedom of contract

One should be reminded that parties dealing at the commercial level are well aware of their rights to freedom of contract, that is, freedom to negotiate on terms with equal bargaining strength concerned to maximise their individual positions and to protect against any possible consequences that may arise. This is a fundamental right of the parties dated back as early as the 18th century.^[61] It is a right commonly recognised in Australia and throughout other common law jurisdictions.

In the context of creating charges, the same principle should apply. In the interest of promoting consistency in contract law, lenders and companies should be given the same right as all other business people. The interest created from a charge, whether fixed or floating, is derived from a loan agreement. It should be more appropriate for the parties concerned to decide whether they wish to create a fixed charge or a floating charge as they are the only people who know what is workable for them at the time. When book debts and proceeds are used as security, which may be the only type of assets available in a company, the lender cannot possibly be given the right to insist on a fixed charge. Similarly, it would not be reasonable for the company to offer only a floating charge. The simple facts are, the company needs circulating assets to trade and the lender needs certainty in the security. It should not be left to the standard categorisation process that if the assets are book debts that they can only be subject to a floating charge. The parties’ respective interests and intention at the time of creating a charge must be taken into account, as intention is an element in entering into a loan agreement.

If Spectrum Plus were to apply, which technically means that if a charge were to operate as fixed on book debts and proceeds and the company is unable to use those proceeds until the charge is released or until the lender gives consent, then what is the benefit for the company to borrow money at one end and seeing its proceeds frozen at the other end?

B Split charge may be possible

In Shepherd v Federal Commissioner of Taxation [1965] HCA 70; (1965) 113 CLR 385, (1966) ALR 969, Kitto J of the High Court drew a distinction between the tree and the fruit when examining an equitable assignment of royalties derived from the manufacture and sale of castors. In that case, Kitto J noted that the tree was the manufacture of castors which was the presently existing right and the fruit was the royalties arising in the future which was the mere expectancy. In that example, when one party assigns a presently existing right to a future property to another party for valuable consideration, an equitable assignment is created, ie, the assignee is having a presently existing right to a mere expectancy which may or may not become real. There is a legally binding contract to receive mere expectancies and the law of equity would assist to perfect an imperfect assignment, for example by way of specific performance, if necessary.^[62] Kitto J noted that the future property is merely an expectancy because the manufacturer could prevent royalties accruing by choosing not to manufacture castors. The manufacturer, however, cannot unilaterally end the contractual arrangement which requires him to pay royalties if he chooses to manufacture.

The above concept – the tree and the fruit - applies to equitable assignments where valuable consideration is provided. The same concept also applies to a declaration of trust of future property, and again, for valuable consideration.^[63] Overall, the concept appears to work where future property is involved.

A similar thinking may be adopted to support the view that the uncollected book debts and the collected proceeds are two separate items or two separate security interests. The uncollected present book debts represent the tree while the future book debts and the future proceeds represent the fruit. A split charge could be created over the two security interests under one contractual arrangement, just as in the example of an equitable assignment in Shepherd v Federal Commissioner of Taxation. Essentially, it is possible to create a fixed charge over the uncollected book debts and a floating charge over the collected proceeds as seen in New Bullas and Whitton. That thinking could also be extended to apply to a multiple split charge arrangement as canvassed in the next heading below.

C Extending the concept in New Bullas and still complying with the ruling in Spectrum Plus

If the tree and the fruit analogy could be accepted as a way for creating a split charge as discussed earlier, then arguably one could create a further split in the proceeds component. Understandably, the business of the company is dependent on cash flow, and thus it would not be reasonable for the chargee lender to block the account entirely nor would it be reasonable for the chargor company to use up all of the collected proceeds.

The further split would provide some flexibility for the company to deal with the book debts and proceeds in the ordinary cause of its business and in turn would provide the lender with a high degree of certainty in the security. In the double split arrangement, it would be possible for the two parties to comply with the ‘control/consent’ and the ‘blocked account’ tests expected in Spectrum Plus. In the event of insolvency, the preferential creditors can still have their fair share of the statutory priority claims in the floating charge component – this is assuming that the company has not completely wiped out its circulating assets.

The concept can be illustrated by way of examples. In securing a loan to a company, the following combinations could be structured and accepted by the lender:

(1) Create a fixed charge over the company’s present and future book debts to the extent that the chargor company is not permitted to enter into a factoring or discounting arrangement with a third party other than converting them into proceeds, which will then be subject to a floating charge as seen in New Bullas and Whitton.



(2) Create a fixed charge over the company’s present and future book debts to the extent that the chargor company is not permitted to enter into a factoring or discounting arrangement with a third party other than converting them into proceeds. A portion of the collected proceeds may be subject to a fixed charge by requiring the company to deposit into a specified blocked account to be used towards paying off the loan amount, while the remaining portion may be subject to a floating charge. Essentially, there will be a fixed charge over the book debts and a quasi-fixed and floating charge over the proceeds.



(3) Create a floating charge over the company’s present and future book debts, essentially allowing factoring, discounting and the like. A portion of the collected proceeds may then be deposited into a blocked account and be subject to a fixed charge while the remaining portion may be subject to a floating charge.

Other combinations are also possible and the rules in Spectrum Plus can still be followed provided there is a floating charge component which would allow the company to use its book debts and/or proceeds freely. The portion that will be fixed may be represented by percentage or by some other mathematical equations to ensure that the lender will have some degree of security in the charged assets and the company will have some degree of freedom in using the circulating assets. The arrangements would enable the lender to exercise strict control over the company’s circulating assets without being construed as interfering into the company’s day to day business.

D Removing the distinction between fixed and floating charges

An alternative solution would be to remove the distinction between fixed and floating charges, but this would require a major reform not only to the law in this area but also in areas affecting the priority rights of the preferential creditors. This appears to be the case in New Zealand through its Personal Property Securities Act 1999 (NZ) which came into effect as law on 1 May 2002. That Act, amongst other things, has essentially abolished the distinction between fixed and floating charges, making the decision in Brumark redundant. One of the consequences of the enactment is that the preferential creditors can no longer rely on the charges for priority payments in so far as floating charges are involved.^[64]

The writer is not saying that the New Zealand model should be adopted in the entirety, but is suggesting that some consideration should be given to that Act in reforming the law in Australia. For the purpose of this article, only key points from the Act are highlighted.

The Personal Property Securities Act 1999 (the ‘PPSA’) applies to all security interests on all kinds of personal property other than land. It is intended to consolidate the securities of all personal properties under one centralised registration system, irrespective of the type of securities being created. Much emphasis is placed on terms such as ‘security interest’, ‘security agreement’, and ‘personal property’.^[65] Section 17(1) of the PPSA defines ‘security interest’ to mean:

(a) … an interest in personal property created or provided for by a transaction that, in substance, secures payment or performance of an obligation, without regard to:

(i) the form of the transaction; and

(ii) the identity of the person who has title to the collateral; and

(b) … includes an interest created or provided for by a transfer of an account receivable …

Section 17(3) eliminates the distinction between fixed and floating charges by providing a long list of interests that fall into the ‘security interest’ category:

… to avoid doubt, this Act applies to a fixed charge, floating charge, chattel mortgage, conditional sale agreement,…, hire purchase agreement, pledge, security trust deed, trust receipt, consignment, lease, an assignment, or a flawed asset arrangement, that secures payment or performance of an obligation.

Section 40 clarifies the point further by saying that a security interest attaches to personal property when “value is given by the secured party; and the debtor has rights in the personal property”.

The term ‘personal property’ is not defined in the Act, is being used loosely and is referred to very frequently throughout the legislation. In the context of security interest on personal property, the term “personal property” could mean fixed assets such as plant and machinery and circulating assets such as book debts and the collected proceeds.

It should be noted that ‘a flawed asset arrangement’, as stated in s 17(3) of the PPSA, could constitute the creation of a security interest, provided valuable consideration is given towards that arrangement by the secured party. It is not clear from the Explanatory Memorandum to the Bill as to why that phrase is used. Section 17 has not yet been challenged in the New Zealand courts. One possible explanation is the recognition of the fact that, in reality, there may be some minor technical problems in the asset arrangement and so such things should be excused. For example, as seen in all of the cases above, when circulating assets are used to secure a loan, the lender wants full protection from the security arrangement while the company wants freedom to use the circulating assets. The PPSA is designed to overcome this problem by ‘accepting’ certain technical flaws and defects and allowing some flexibility in the security arrangement.

Now that the distinction between fixed and floating charges has been removed from the New Zealand legislation, the priority claims of the preferential creditors are now blurred. One commentator expresses the view that the New Zealand Act provides ‘preferential creditors [some] priority over some security interests in accounts receivables’^[66] but is uncertain as to the extent of that priority.^[67] The priority rules are found in s 30 of the Receiverships Act 1993 (NZ) and s 312 and Schedule 7 of the Companies Act 1993 (NZ). These Acts make no mention of the different types of charges, which overall make the entire regime difficult to follow. The PPSA was introduced on 1 May 2002, but the provisions relating to the rights of the preferential creditors remain substantially unchanged. There are no reported cases as yet on matters relating to securities on book debts under the PPSA.

Historically, the distinction between fixed and floating charges was seen necessary as a way of governing the relative position of the lender and the company. Their rights and liabilities were determined largely by the type of charge being created. These common law rules still exist to some extent, but over time the rules have changed through legislative interventions so as to allow the interests of the preferential creditors to be ranked ahead of the floating charge holder’s interests. Removing the distinction between fixed and floating charges may be the way to go about solving these vexing problems concerning securities and charges over book debts, but it is important to bear in mind that a balancing act is required so as not to remove the existing legislative rights of the preferential creditors. To do so would only cause unrest.

Vii Conclusion

As discussed above, the writer is not convinced that the House of Lords’ decision in Spectrum Plus has assisted in clarifying the law in respect to the taking of securities over the company’s book debts and proceeds. The writer’s view is that the House of Lords has only complicated the matter further when it places much emphasis, in respect to a ‘fixed’ charge, on the strict requirements of ‘blocked account’ that must be seen to be ‘operated as one in fact’, ‘control’ and ‘consent’ in the form of ‘active concurrence’ – anything short of those requirements would fall into the floating charge category. As discussed in the case study, such ruling is unworkable in practice. One must remember that book debts and proceeds are the company’s life line.

The writer has suggested several other alternatives. Arguably it is possible to use the idea in New Bullas and Whitton to create a split charge or even a double split charge. That is, a fixed charge over the present and future book debts coupled with a fixed charge over a portion of the proceeds collected and a floating charge over the remaining portion of the proceeds. Simultaneously, the strict rules in Spectrum Plus could still be fulfilled, provided there is careful drafting of the component on proceeds, giving the company some flexibility in the use of the proceeds. Another alternative would be to remove the distinction between fixed and floating charges as seen in the New Zealand’s PPSA.

It is best to see the law in this area to be resolved by legislation than by the High Court. This is because there are considerable overlaps with other areas, for example, the statutory rules on preferential creditors’ rights to priority payments may need to be addressed when enacting laws with respect to charges over book debts. A reform in one area requires a reform in other areas.

^[∗] BSc LLB (Mon) Grad Dip Ed (Melb) LLM (Mon). Lecturer, School of Law, Deakin University. Barrister and Solicitor of the Supreme Court of Victoria and High Court of Australia.

^[1] See, for example, R Lowe and S Beale, ‘The Spectrum decision: bad news for banks’ (2005) Journal of International Banking Law and Regulation 482; D Capper, ‘Fixed charges over book debts’ (2004) Modern Law Review 1007; S Worthington, ‘Fixed charges over book debts and other receivables’ (1997) 113 Law Quarterly Review 562; D Brown, ‘Charges over book debts: Can lenders have their cake and eat it in pieces?’ (2000) 8 Insolvency Law Journal 50.

^[2] See, for example, the New Zealand’s Personal Property Securities Act 1999 which came into force on 1 May 2002; A Berg, ‘Charges over book debts’ (2004) Modern Law Review 1007; Naren and Rubenstein, ‘Separation of book debts and their proceeds’ (1994) Commercial Law Journal 225.

^[3] Examples of preferential creditors are employees and taxation office and other government authorities – these are provided for in the Corporations Act 2001 (Cth) under ss 433, 556, 561 and Income Tax Assessment Act 1939 (Cth) under s 215.

^[4] The decision was handed down on 30 June 2005 by seven judges.

^[5] See, s 9 of the Corporations Act 2001 (Cth) where the term ‘charge’ is defined to mean ‘a charge created in any way and includes a mortgage…’

^[6] J. O'Donovan, Company Receivers and Managers (3^rd ed, 1997) para 5.20 citing Tudor Heights Ltd v United Dominions [1977] 1 NZLR 532.

^[7] Romer LJ's description has received wide acceptance over the years, for example, by Millett LJ of the Privy Council in Agnew v Commissioner of Inland Revenue [2001] UKPC 28; [2001] 2 AC 710 (also known as Brumark), by Hoffman LJ of the House of Lords in Smith (Administrator of Cosslett (Contractors) Ltd v Bridgend County Borough Council [2001] UKHL 58; [2002] 1 AC 336 at 352, by Tompkins J in Supercool Refrigeration and Air Conditioning v Hoverd Industries Ltd [1994] 3 NZLR 300.

^[8] Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lyoyd’s Rep 142 (‘Siebe Gorman’).

^[9] Ibid clause 5(c) of the debenture.

^[10] Subsequent discussion provides examples of cases.

^[11] Re Keenan Bros Ltd [1985] IR 401.

^[12] Ibid clause 6 of the debenture.

^[13] See, Romer LJ’s famous statement in Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284, 295.

^[14] Re New Bullas Trading Ltd [1994] 1 BCLC 485.

^[15] Agnew v Commissioner of Inland Revenue [2001] UKPC 28; [2001] 2 AC 710 (also known as ‘Re Brumark’).

^[16] Re Brumark Investments Limited (1999) NZTC 15, 467.

^[17] See, for example, L Widdup, ‘The Aftermath of New Bullas and Beyond Brumark Investments’ (2000) 11 Journal of Banking and Finance Law and Practice 247; A Berg, ‘Charges over book debts: A reply’ (1995) Journal of Business Law 433; McLauchlan, ‘Fixed charges over book debts – New Bullas in New Zealand’ (1999) 115 Law Quarterly Review 365; McLauchlan, ‘New Bullas in New Zealand: Round two’ (2000) 116 Law Quarterly Review 211.

^[18] In characterising fixed and floating charges, the Privy Council at page 719 cited a famous judgment of Romer LJ in Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284, 295, which is discussed in the earlier part of this article.

^[19] National Westminster Bank plc v Spectrum Plus Limited and Others [2005] UKHL 41 (‘Spectrum Plus’).

^[20] The Crown creditors were comprised of Customs & Excise, the Inland Revenue, and the Secretary of State for Trade and Industry.

^[21] It was important for the Crown creditors to argue that the charge was a floating charge on the basis that s 175 of the Insolvency Act 1986 (UK) provides the Crown creditors a right to have their debts paid out of the proceeds of the book debts in preference and in priority to all the other secured creditors such as the bank in the present case. The sum owed to the Crown was relatively small, but as pointed out by Lord Scott at page 16, this was a test case. The position is similar in Australia under s 561 of the Corporations Act 2001 (Cth).

^[22] Re Spectrum Plus Ltd [2004] EWHC 9; [2004] 1 BCLC 335 (High Court in UK).

^[23] In Re New Bullas [1994] BCC 36, which was decided in 1994, the Court of Appeal approached the matter differently from that in Siebe Gorman and decided that there was a fixed charge over the uncollected book debts, but once the proceeds were collected from those book debts the proceeds would then be subject to a floating charge. In effect, the Court of Appeal took a hybrid approach, saying that the book debts were continuously subject to both a fixed and a floating charge. This case will be discussed further in the article.

^[24] Morritt VC relied on the Privy Council’s decision (ie, the New Zealand’s Court of Appeal’s decision) in Re Brumark, above n 15. This case is discussed earlier in the text of this article.

^[25] National Westminster Bank plc v Spectrum Plus Ltd [2004] Ch 337 (Court of Appeal in UK).

^[26] Spectrum Plus, above n 19.

^[27] Spectrum Plus, above n 19, 29.

^[28] Spectrum Plus, above n 19, 29.

^[29] Spectrum Plus, above n 19, 30.

^[30] Spectrum Plus, above n 19, 30.

^[31] Spectrum Plus, above n 19, 19.

^[32] Scott LJ in Spectrum Plus, above n 19 at 21 cited the definition of a floating charge from the judgment of Romer LJ in the Court of Appeal in Re Yorkshire Woolcombers Association Ltd, above n 13. See Part II of this article for the three essential characteristics of a floating charge.

^[33] In support of this point, Scott LJ together with Walker LJ in Spectrum Plus, above n 19 at 30, referred to authority in Street v Mountford [1985] UKHL 4; [1985] AC 809.

^[34] Spectrum Plus, above n 19, (per Nicholl LJ at 5 and 8 and per Hope LJ at 15).

^[35] Spectrum Plus, above n 19, Nicholls LJ at 9 and Walker LJ at 34.

^[36] Spectrum Plus, above n 19, Nicholls LJ at 9 and Hope LJ at 13.

^[37] Spectrum Plus, above n 19, Nicholls LJ at 9 and Scott LJ at 27. It was noted by Scott LJ at 16 in that case that ‘several hundred liquidations are being held up pending the resolution of [this] issue’. Under s 175 of the Insolvency Act 1985 (UK), the preferential creditors such as the Crown creditors had preference or priority of payments over the chargee under a floating charge. This is also similar in Australia – see ss 433, 556 and 561 of the Corporations Act 2001 (Cth).

^[38] As this issue is only subsidiary, it will not be discussed further in this article.

^[39] Spectrum Plus, above n 19, 11.

^[40] Spectrum Plus, above n 19, 11 where Hope LJ adopted the four suggestions of Professor Sarah Worthington in S Worthington, ‘Fixed charges over book debts and other receivables’ (1997) 113 Law Quarterly Review 562.

^[41] Spectrum Plus, above n 19, 19.

^[42] Spectrum Plus, above n 19, 30 [140] and 34 [160].

^[43] These were the words of Millett LJ in Re Brumark, above n 15 at 730 [48], which were echoed in Walker LJ in Spectrum Plus, above n 19 at 30 [140] and 34 [160].

^[44] [1983] VicRp 111; (1983) 2 VR 517.

^[45] Ibid 521.

^[46] Ibid 521.

^[47] Whitton v ACN 003 266 886 Pty Ltd (Controller Appointed) In Liq (1996) 42 NSWLR 123 (‘Whitton’).

^[48] Ibid 143.

^[49] Whitton, above n 48, 143, citing from New Bullas, above n 14, 3208-3209.

^[50] Tailby v Official Receiver (1888) 13 App Cas 523 gives recognition to a floating charge over book debts as an equitable charge.

^[51] Yorkshire, above n 13.

^[52] See the statement of Walker LJ in Spectrum Plus, above n 19 at 30 and 34, which echoed the statement of Millett LJ in Re Brumark, above n 15 at 730.

^[53] Spectrum Plus, above n 19, 11 (per Hope LJ).

^[54] The names of these remaining judges in Spectrum Plus are Nicholls LJ, Steyn LJ, Hale LJ, and Brown LJ.

^[55] See the case of Re Yorkshire Woolcombers Association Ltd [1903], above n 13.

^[56] In this modern society, leasing and hire-purchase arrangements have become increasingly popular because of the tax deduction benefits and the need to update technologies regularly.

^[57] Examples of preferential creditors are employees and the taxation office if there is any tax liability. Discussion of the postponement of interests and priority payments are found in Part III of this article.

^[58] Further discussion on this point is found in Part III of this article.

^[59] In reality, the company tends to fall into insolvency when the company is falling short of book debts and is unable to put back whatever monies that have been withdrawn from the account.

^[60] The smaller companies that do not own any valuable operating fixed assets to be used as security, but only have floating assets such as book debts, proceeds and the like, will be most affected by the ruling in Spectrum Plus.

^[61] See J W Carter and D J Harland, Contract Law in Australia (4^th ed, 2002) 7-18.

^[62] See, for example, Holroyd v Marshall [1861-1873] All ER Rep 414 at 418 where Lord Westbury LC stated that equity would compel performance of the assignor’s promise to assign, assuming that the contract was ‘one of that class of which a court of equity would decree the specific performance’. Further in Tailby v Officer Receiver [1888] 13 App Cas 523, Lord Macnaughton expressed the view that ‘it was well settled that an assignment of future property for value operates in equity by way of agreement, binding the conscience of the assignor, and so binding the property from the moment when the contract becomes capable of being performed…’

^[63] See, J D Heydon and P L Loughlan, Cases and Materials on Equity and Trusts (5^th ed, 1997) 129-134, 170.

^[64] Prior to 1 May 2002, the interests of the preferential creditors were ranked ahead of the floating charge holders. The position in New Zealand was similar then to that in Australia. Examples of the preferential creditors who are generally recognised in the legislation as such are the taxation office, other government authorities, employees’ wages, holiday pays, superannuation pays, and accumulated long service leave.

^[65] The Personal Property Securities Act 1999 (NZ) avoids terms such as ‘charges’, ‘debenture’, and ‘book debt’, the purpose of which is to avoid confusion with the old law.

^[66] M Gedye, ‘New Zealand’s Personal Property Securities Act’ (2004) 15 Journal of Banking and Finance Law and Practice 20, 37.

^[67] M Gedye, above n 68, 38.