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Fixed
Charges on Book Debts : The Brumark Case
The Privy Council recently delivered judgement
on a New Zealand case — re Brumark Investments; for all material purposes New
Zealand legislation is the same as England and Wales, and the case
is therefore persuasive but not binding here…….yet!
The case establishes that standard Clearing
Bank debentures with a fixed charge over book debts are floating charges,
as are book debt
charges, unless the Bank exercises real control over payments out of
the borrowers trading account. In practice Banks seldom exercise any
control — the company collects its debts, clears them through
the bank account and makes disbursements within agreed facilities.
Whilst the complex issues for Banks are debated
and resolved to protect their security positions; those accountants
and professional advisers
that give advice and support need to look closely at clients who
have ‘marginal banking facilities’, and where there is
a high Bank reliance on the debtor book, and maybe substantial preferential
debts.
If the Banks are unable to resolve the technical
aspects in the short term, then there is the possibility that a reduction
in facilities
may be imposed on a client — and because of the greater Bank
exposure created by the preferential creditors taking precedence
over the Banks historic prime security.
For example:
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XYZ Ltd
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| Bank Overdraft £200,000 |
Debtors £400,000 |
| Preferential Creditors £100,000 |
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1. Pre Brumark
Bank borrowing at these levels would not be unusual, given a fixed
charge over book debts with a 100% margin clause in their debenture
(everything else being equal).
2. Post Brumark (and if the judgement becomes
law)
Because the Bank now has a floating charge
over the book debts, the preferential debts have a first claim
in a receivership. The
Bank now in effect loses £100,000 of security cover, calculated
by deducting the prefs (£100k) from 50% of the debtors — and
could be looking to substantially reduce the bank facility, especially
if the business is a marginal case.
Where the Bank has taken additional security
by way of personal guarantee, the situation becomes more serious.
In the above example,
(1) if XYZ goes into receivership, the receiver collects, say,
50% of the debtors- the bank overdraft is cleared and no liability
falls on the guarantor. Post Brumark, (2) above, the situation
is different — the receiver collects 50% of the debtor book,
settles the preferential creditors and pays the Bank the balance — leaving
a shortfall of £100,000. The Bank looks to the guarantor to settle
the debt under the terms of the guarantee — unless there are
sufficient other assets available for the shortfall. Quite unlikely
in a marginal case!
The way forward.
Banks seem to be playing a watching game
at the present — they
seem to waiting for a test case, considering options and importantly
looking very carefully at the size and quality of debtor books
and the size of preferential creditors. In due course they may
need to take new security documents and establish new procedures — probably
quite complex, that give the Bank a substantial degree of actual
control and which clearly establish a fixed charge.
Clearly pre Brumark a guarantor had some protection because of
the fixed charge. For those clients where it may not be possible
to renegotiate and withdraw the guarantee, it might be appropriate
to consider factoring or other asset financing facilities. Factoring,
depending on the industry sector, can be very flexible and can
release up to 90% of the debtor book, often sufficient to repay
Bank borrowing, enabling a guarantee to be withdrawn.
Other solutions include the giving of a
chattel mortgage over assets not picked up by the debenture to
meet a Bank security shortfall
post Brumark, or to release a guarantee. Managing down the preferential
creditors is easier to suggest than attain — but clearly an
issue that needs tackling vigorously in the example we have given.
Its perhaps ironic that this case comes before us, following a substantial
Government consultation exercise and a White paper that considers
the abolition of Crown preferential status and the floating charge!
If you have any clients that are experiencing pressure on their Bank
facilities and might be affected by this case, or would like some
guidance on alternative sources of finance, speak to Jeremy Priestley
or Phil Revill on 0114 2755033.
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