Brumark anticipated - awaiting the decision of the Privy Council

United Kingdom

A recent appeal from the New Zealand Court of Appeal to the Privy Council in the case of Re Brumark(1) could have a series of legal consequences that will reverberate through the banking and leasing industries. The case has now been heard by the Privy Council (in April this year) but the decision has not, at the time of this paper, been handed down; it is expected to be delivered imminently. The issue in debate in Re Brumark is whether a security interest can be drafted in such a way as to create a fixed charge or security over a debt, with a floating charge over the cash proceeds of the debt. The English Court of Appeal has decided in Re New Bullas Trading(2) that it is possible to divide a debt from its proceeds and subject them to different types of security, as if the debt is the rainbow and the proceeds are the pot of gold at the end of the rainbow.

Book debts subject to fixed or floating charges?

The reason for the importance of the question whether it is possible for a debt to be subject to a fixed charge and its proceeds to a floating charge is the legal consequences that the different types of charge create. It is even possible that the decision in Re Brumark will be that it is not legally possible to create a fixed charge on present and future book debts at all. The principle that debts can be subject to a fixed charge has been recognised in English law since 1979 in the case of Siebe Gorman & Co Ltd v Barclays Bank Ltd(3), where it was held that the bank's debenture created an effective fixed charge over book debts both present and future so that the bank's rights to the book debts also attach to the proceeds when paid into an account with the bank. As a result, the bank had a right to restrict the company's right to deal with its cash once collected. It would have a significant effect on lending practices in the City if the Privy Council decide that it is not possible to create a fixed charge over future book debts or their proceeds at all.

To understand the importance of the distinction between fixed and floating charges entails an understanding of the legal effects of each. For example, most company borrowers from the clearing and other banks grant a debenture to the bank which creates fixed and floating charges over different classes of assets. The key distinction is that a company can deal with assets that are only subject to a floating charge whereas the fixed charge restricts the borrower from dealing freely with its assets without the banker's consent. This means that in the case of debtors, for example, the borrower must pay the proceeds of debts into its bank account with the bank and cannot sell, factor or charge the debts to someone else without consent. The charge is registered at Companies House so that a party dealing with the borrower will have notice of the fixed charge and be unable to take free of the bank's security interest if they deal with the company.

The other types of asset that are normally subject to a fixed charge include freehold and leasehold land, goodwill, shares in subsidiaries, intellectual property rights, rentals and fixed plant and equipment. Those assets usually represent the fixed assets of the company over which a bank will want first security that it can enforce easily in the case of a default without concern in the meantime about the assets becoming free from the charge or that a third party might acquire a priority right ahead of the bank. The fixed charge also attaches to these categories of assets as they are acquired in the future by the borrower. There are other types of assets that are not amenable to a fixed charge because they are constantly changing so that is not practical nor realistic for the bank to give its consent every time the company needs to deal with them; the most obvious example is a company's stock which is fluctuating daily and can only be the subject of a floating charge.

The consequences of a charge being fixed or floating are important in understanding the reason for the concern over the Brumark decision. The most important consequence is that certain preferential debts are payable out of assets that are subject to a floating charge ahead of the bank's debt, thereby diluting the bank's potential recovery in an insolvency. These priority debts include certain debts of a company to its employees that remain unpaid on an insolvency and certain unpaid taxes, including unpaid VAT which could be substantial on an insolvency. There are also statutory provisions which can be used to invalidate a floating charge taken within twelve months prior to a liquidation. Importantly, fixed charges also take priority over floating charges over the same assets, so that the holder of the fixed charge will have first recourse to the assets. These issues are not only of importance on an insolvency but also when the bank makes its original lending decision. Lending is calculated in most cases as a percentage of the value of the underlying assets that are to be subject to the security. That percentage is always lower in respect of assets that cannot be subject to a fixed charge. As a result, if the fixed charge on book debts is found to be an unenforceable security interest the effect would be that the lending ratio would drop for a company's book debts with the result that less finance may be available to corporate borrowers on this model.

Characteristics of a floating charge

All secured creditors would prefer to have a fixed charge where legally possible. The characteristics of a floating charge are that the company has a licence to deal with floating charge assets without the bank's consent. The classic definition of a floating charge is that it has three characteristics, as follows:

  • If it is a charge over a class of assets both present and future;

  • If the class of assets is one which, in the ordinary course of business of the company, would be changing from time to time; and

  • If you find that by the charge it is contemplated that, until some future step is taken by the person interested in the charge, the company may carry on in its business in the ordinary way as far as concerns the particular class of assets being dealt with.

The floating charge does exactly what you would expect, it 'floats' over a class of assets until the secured creditor enforces it, which occurs when it crystallises over the assets and becomes fixed. A floating charge will crystallize if the secured creditor serves a notice crystallizing the charge, or appoints a receiver under the charge, or the company ceases to trade, in which event the charge crystallises as a matter of law.

On the basis of this definition of a floating charge it is easier to see why a class of assets that is changing might only be capable of being subject to a floating charge. The important principle in the Siebe Gorman case(4) that was relied upon to characterize the charge as fixed was that the debenture required the company to pay the proceeds of the debts into an account with the bank and, the court found, the bank had control over the proceeds as a result. It has been assumed, since Siebe Gorman, that it is possible to create an effective fixed charge on debtors if the secured creditor is the borrowers' clearing bank that actually receives the proceeds over which the bank has control.

  • Position of venture capitalists

The position has always been different where the lender who is given security is not a clearing bank and so does not receive the debt proceeds. In those cases, such as with venture capitalists that also provide finance, such as 3i, a technique has developed whereby the lender designates an account at the company's clearing bank to which the funds should be paid. The security would then provide that the debts would be subject to a fixed charge, but the proceeds were then released from the fixed charge and became subject only to a floating charge. This formula recognizes the reality that the non-clearing bank lender has no control over the proceeds. However, it relies upon the distinction between debt and proceeds being legally effective.


Re New Bullas(5): 'can separate debt from proceeds'

In the case of Re New Bullas Trading Ltd the Court of Appeal has held that it is conceptually possible to separate a debt from its proceeds so that an uncollected debt could be subject to a fixed charge with the cash proceeds subject to a floating charge only. The slightly artificial reasoning used to justify the position that a charge over debts can be fixed despite no control over the proceeds was that both the chargor and the chargee had agreed in the debenture that the fixed charge ceased, rather than the chargor having the ability to deal with the proceeds at is own discretion.

The New Bullas case has been criticized subsequently because it appears to have changed the long established principle that requires an element of control on the part of the security holder over the proceeds for there to be an effective fixed charge. The ability of the borrower to collect book debts for its own account without the bank retaining control over the proceeds has been the reason for characterizing the charge on debts as floating (for example in Re Brightlife Ltd(6)), but that is, in effect, what happened in Re New Bullas. In a later case, Re New Bullas was criticized in its analysis that the proceeds of a debt were divisible from the debt itself. In Royal Trust Bank v National Westminster Bank plc(7) in the Court of Appeal, Lord Justice Millett decided that, in his view, a book debt and its proceeds were indivisible.

When book debts are floating charges

Almost the directly opposite conclusion was reached in the case of Re Brightlife Ltd(8), where in a very strong judgment Hoffmann J held that where the company was free to collect its own book debts and pay them into its bank account, the liberty to deal with the proceeds once they are in the account because they are then outside the charge on book debts meant that they were at the disposal of the company and therefore the charge was a floating charge. A New Zealand case called Supercool Refridgeration and Air Conditioning(in receivership and liquidation ) v Hoverd Industries Ltd(9) came to the same conclusion where the charge was described as fixed; it obliged the company to pay the debt proceeds into the company's account with BNZ, restricted assignment elsewhere and provided for a specific assignment in favour of the bank if called upon to do so. The fact that the company was again able to use the proceeds without restriction once they are paid into the account meant that the court decided that the charge was floating, not fixed.

Siebe Gorman(10)

It should however be noted that the decision in Siebe Gorman itself was made on the basis that the judge was persuaded that the proceeds of the book debts could not be used in the ordinary course by withdrawal from the account at the bank, whereas in practice this is exactly what actually happens. To guard against the risk that a liquidator or preferential creditors might argue that the restriction on using the monies is not operated in practice, in rescue situations at least one bank takes the precaution of creating two accounts with a right of set off between them. The book debt proceeds are paid into one collections account from which the company cannot draw and the other account is a debit account on which all the advances are made, so there can never be any argument that the borrower has the right to use the proceeds.

Re Brumark(11)

First instance

The decision at first instance in Re Brumark was that the debenture was effective to create a fixed charge over uncollected book debts and a floating charge on the proceeds. The debenture was drafted using the same wording as in Re New Bullas. The effectiveness of the fixed charge was being challenged by the Revenue who would otherwise have priority if the charge on book debts was held to be floating as the only assets available were the uncollected book debts. The judge at first instance rejected the reasoning of Millett LJ in the Royal Trust case that it is impossible to separate out the debt from the proceeds of its realization. He was of the view that the security over the debts was not dependant on the level of control over the proceeds. Again this is exactly opposite to the line of cases that emphasise the need for control over the fixed charge asset. LJ Millett's view that the control over the proceeds is an essential element of a fixed charge derives from the starting point in this debate, namely Siebe Gorman, thereby raising the possibility in this appeal of that case coming under scrutiny and potentially being overturned.

Court of Appeal (NZ)

The conclusion of the New Zealand Court of Appeal was that as a general principle if the borrower remains free to deal with the charged book debts, the charge cannot be a fixed charge. It involves determining whether or not the charged book debts are under the control of the chargee. The court did not accept that there is any distinction between dealing in the uncollected debts by, for example, disposal to third parties and dealing with collection. The court held that the book debt charge was floating and disagreed with the reasoning that book debts and their proceeds were divisible. The Court referred to the long established authorities and in particular Re Brightlife(12). The analysis of that case was that the debenture contained a fixed charge over debtors present and future and a floating charge over all other property and assets. As the company was free to collect its book debts the security over the debts would be extinguished once collected and turned into cash, so the proceeds would become other assets that became subject to the floating charge. There was little to distinguish then between this case and the position in Re Brightlife where the whole charge was floating. The Brumark facts are distinguishable in one respect, in that in Re New Bullas there was an express release of the fixed charge once the money was paid into the account. The judge there thought that this was a deliberate drafting point that showed a clear agreement that should be given effect to so that the floating charge then arising on the cash occurred because both parties intended it rather than the company having unilateral control over the process. The New Zealand Court of Appeal rejected this agreement principle as having no effect on the previous authorities where the fundamental principle has been described as whether the charged book debts are under the control of the chargee.

Privy Council

If the ultimate outcome of the Privy Council decision in Re Brumark is that the Siebe Gorman decision is overruled so that there cannot in law be an effective fixed charge on book debts, the debenture security that all clearing banks employ will be significantly reduced in value. The most obvious next step for secured creditors will be to offer a factoring facility to their borrowers, by which the debts are bought outright by the lender for a percentage of their value. This will, however, complicate the security process and make it more expensive. It would bring the UK experience more into line with US asset finance techniques where the control over the assets sold by a company is often achieved by way of an outright sale of the assets charged and the resulting book debt.

There will be other less foreseen consequences. The rights of preferential creditors to take priority over the realizations made in an insolvency from floating charge assets is presently the subject of some scrutiny in the ongoing review of rescue and reconstruction procedures by the DTI. Those creditors that are preferential are so mainly for historical reasons. They include deductions for PAYE and national insurance contributions not made in the twelve months before receivership or liquidation, VAT unpaid in the previous six months, contributions not made to occupational pension schemes and other unpaid remuneration. The scheme of the list of preferential payments is to ensure that the Crown is paid because even when the employees are unpaid on an insolvency the State picks up at least part of the bill under the Redundancy Fund and this is a mechanism for recouping that liability. This is regarded as a public policy reason for including the different categories of preferential rights, so that the continuing debate as to fixed or floating is usually a fight between the preferential creditors and the chargee banks. That tension could be removed by limiting the categories of preferential creditors or, alternatively, restricting the categories of asset that are amenable to being caught by a fixed charge. The DTI have put out a consultation paper that contemplates the possibility of abolishing certain types of preferential debts and this would certainly make the position of the banks easier. The collection mechanism for the government of their preferential claims in a receivership is that the receiver is under a statutory duty contained in the Insolvency Act 1986 s 40 to pay preferential creditors out of floating charge realizations coming into his hands during the receivership. The limitation or abolition of this class of creditors will also make a receiver's job easier.

This is a complex legal area but in many ways the decisions are driven by economic arguments and the relative strengths of the providers of credit to a business. The Crown is in effect providing credit by deferring the payment of VAT for example for a period of 30 days beyond the time that it is incurred, hence the protection as a preferential debt. The banks are the largest providers of credit, along with trade creditors and the balance between the stakeholders is a delicate one because if there is a tinkering with the rights of one of them the relative strengths of the others come into play. The decision of the Privy Council in Re Brumark will no doubt be carefully thought out but could have severe commercial consequences.

For further information, please contact Stephen Foster by e-mail at or by telephone on +44 (0)20 7367 2812.


(1) Re Brumark Investment Ltd, Commissioner of Inland Revenue v Agnew [2000] I BCLC 353, NZ CA

(2) Re New Bullas Trading [1994] 1 BCLC 485

(3) Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyd's Law Reports 142

(4) See note 3, above

(5) See note 2, above

(6) See note 8, below

(7) Royal Trust Bank v National Westminster Bank plc [1996] 2 BCLC 682

(8) Re Brightlife Ltd [1986] BCLC 418

(9) Supercool Refridgeration and Air Conditioning(in receivership and liquidation ) v Hoverd Industries Ltd [1995] 3 NZLR 577

(10) See note 3, above

(11) See note 1, above

(12) See note 8, above