A FIXED OR FLOATING CHARGE ??
THE SPECTRUM CASE ( UK House of Lords August 2005)
A Company’s Book Debts maybe a valuable asset to have available as security. It is not surprising therefore that Spectrum availed of such to secure a loan from Nat West Bank.
The significant question however, is how this Charge is treated. It can either be a fixed or a floating charge. The former has priority over preferential creditors (Revenue, Customs and Excise and Employees) hence Nat West Bank’s concern as to its classification.
It is accepted practice that Bank’s will take a fixed charge over Company book debts on condition that the proceeds of those debts are paid into a designated Bank Account. What happens next is the central issue in the NatWest –v- Spectrum case. Can NatWest Bank allow Spectrum to withdraw and make use of these book debts, without the status of the fixed charge being affected? In essence, this permission/authority effectively gives Sprectum working capital. Where lies the fixed charge you may ask?
This permission/authority has now been upset by the House of Lords. The net effect of this is that the preferential creditors leap frog the apparent fixed charged holders. This is bad news for Lending Institutions. There is now the likelihood that “Banks will be stricter when drawing up the terms of the loans and this could have a serious effect on small Firms liquidity” says Gerard Loughnane, President of the A.C.C.A.
The impact on the SMEs is that this potential source of working capital may no longer be available and therefore could tip small Firms over the edge.
Furthermore, the Lords declined Nat West’s invitation to apply their Judgement prospectively only. This decision will therefore apply to all past and future cases where a Bank has purported to take a fixed charge over book debts but failed to exercise “control” over the proceeds.
The following practical points may be gleaned from this Judgement:
Lending Institutions perspective:
1. What happens in practice may prevail over the substance of the Loan Offer hence the need for greater stringency in the future.
2. All lending against book debts is to be monitored against the application of this judgment by the Irish Courts.
3. The financing of certain types of transactions will need to be re-assessed.
Company – Borrower’s Perspective:
1. Don’t rely on the security as working capital.
2. Look for other forms of finance.
3. It keeps your debt equity/levels down and forces you to become fully aware of the Company’s finances.
General Note:
The impact of this Ruling is persuasive in Irish Courts and not authorative. Do not underestimate how persuasive it may become bearing in mind the parallels taken by the Courts in both Jurisdictions on this topic!