Fixed and Floating Charges – Landmark Articles publications full...Fixed and Floating Charges – Landmark Articles Editor-in-Chief Mark Fennessy, Orrick, Herrington & Sutcliffe

International Corporate Rescue – Special Issue

1 An‘UnsatisfactoryAreaoftheLaw’–FixedandFloatingChargesYetAgainSarah Worthington

11 FixedandFloatingChargesoverBookDebts–theImplicationsoftheHouseofLords’DecisioninRe Spectrum Plus Limited[2005]UKHL41,PartICatherine Addy

16 FixedandFloatingChargesoverBookDebts–theImplicationsoftheHouseofLords’DecisioninRe Spectrum Plus Limited[2005]UKHL41,PartIICatherine Addy

Fixed and Floating Charges – Landmark Articles

Editor-in-Chief Mark Fennessy, Orrick, Herrington & Sutcliffe (Europe) LLP, London

Publisher Sasha Radoja, Herbert Smith, London

Editorial BoardJohn Armour, Oxford University, OxfordStephen Ball, Bryan Cove, LondonSamantha Bewick, KPMG, LondonGeoff Carton-Kelly, Baker Tilly, LondonSandie Corbett, Walkers, British Virgin IslandsStephen Cork, Smith & Williamson, LondonDavid Dhanoo, Qatar Financial Centre Regulatory Authority, QatarHon. Robert D. Drain, United States Bankruptcy Court, Southern District of New York Nigel Feetham, Hassans, GibraltarStephen Harris, Ernst & Young, LondonChristopher Jarvinen, Hahn & Hessen LLP, New YorkJoachim Koolmann, J.P. Morgan, London Matthew Kersey, Russell McVeagh, AucklandBen Larkin, Berwin Leighton Paisner, LondonAlain Le Berre, Huron Consulting Group, LondonGuy Locke, Walkers, Cayman IslandsLee Manning, Deloitte, LondonDavid Marks Q.C., 3-4 South Square, LondonIan McDonald, Mayer Brown International LLP, London Riz Mokal, 3-4 South Square, LondonLyndon Norley, Greenberg Traurig Maher LLP, LondonRodrigo Olivares-Caminal, United Nations Conference for Trade and Development, Geneva Susan Prevezer Q.C., Quinn Emanuel Urquhart Oliver & Hedges LLP, LondonSandy Purcell, Houlihan Lokey Howard & Zukin, LondonPeter Saville, Zolfo Cooper, LondonDaniel Schwarzmann, PricewaterhouseCoopers, LondonSandy Shandro, 3-4 South Square, London Richard Snowden Q.C., Erskine Chambers, LondonDr Shinjiro Takagi, Nomura, Japan Lloyd Tamlyn, 3-4 South Square, LondonStephen Taylor, Alix Partners, LondonWilliam Trower Q.C., 3-4 South Square, LondonRobert van Galen, NautaDutilh, AmsterdamMiguel Virgós, Uría & Menéndez, MadridDr Haizheng Zhang, Beijing Foreign Studies University, Beijing

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Economists’ OutlookEditors: Simon Davies, The Blackstone Group, LondonMahesh Uttamchandani, The World Bank, Washington, DC

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1

ARTICLE

An ‘Unsatisfactory Area of the Law’ ^ Fixed and Floating ChargesYet Again

SarahWorthington, Professor of Law, London School of Economics, London,UK

News of the Court of Appeal’s unanimous decision on¢xed and £oating charges in the test case, NationalWestminster Bank plc v Spectrum Plus Ltd & Ors,1 isnow a little stale, but incredulity over the resultpersists. Few lawyers had correctly predicted the out-come. If Lord Phillips MR is right,2 a bank’s charge willbe ¢xed so long as the proceeds obtained by the debtorfrom any sale of the charged assets are paid into thedebtor’s account with the lending bank. How theaccount is then operated is immaterial. In particular,the debtor is free to use the account in the ordinarycourse of its business, subject only to any contractualrestrictions the bank cares to impose. Put like this, thedecision is astonishing. All the post-insolvency advan-tages of ¢xed security can be obtained without any ofthe pre-insolvency disadvantages: the debtor can sellthe charged assets in the ordinary course of itsbusiness, pay the proceeds to the bank, and then usethe account at will; if the debtor defaults, the bank canrealize its ¢xed security over the charged assets with-out a thought for statutory £oating charge invalidityprovisions,3 or for the claims of preferred or generalunsecured creditors.4 For banks, the Court of Appealdecision suggests the £oating charge has all butdisappeared. If a bank wants a £oating charge,5

perhaps for control rather than for ¢nancial security,it will need to take some rather odd steps to ensurethat its security falls outside this new expanded classof ¢xed charges. This note respectfully suggests thatthe Court of Appeal decision is unsupportable, and

that the case well merits the forthcoming appeal to theHouse of Lords.6

Facts

The debenture in Spectrum secured a relatively insig-ni¢cant overdraft of GBP 250,000. Crucially, it speci-¢ed that the security was by way of speci¢c chargeover all present and future book debts and other debts,and that the chargor was prohibited from charging orassigning the debts, and was required to pay theproceeds of collection into an account with thelending bank. The debenture did not specify anyrestrictions on the chargor’s operation of that ac-count.7 The issue was whether this charge was ¢xedor £oating.

Decision at first instance

At ¢rst instance, Sir Andrew Morritt V-C decided thecharge was £oating.8 He held, ¢rst, as a matter of law,that if a chargor is entitled to use proceeds in thenormal course of business unless and until thechargee intervenes, then the charge will necessarilybe £oating notwithstanding other restrictions on thedealing with the book debts. This followed the PrivyCouncil’s approach in Agnew v Commissioner of InlandRevenue9 (better-known simply asBrumark). Secondly,he held that the e¡ect in law of the actual terms of thedebenture was this. This second step e¡ectively over-

Notes

1 [2004] EWCA Civ 670 (CA), 26 May 2004 (Lord Phillips MR, Jonathan Parker LJ, Jacob LJ) (‘Spectrum’).

2 Lord Phillips MR gave the only reasoned decision. Jonathan Parker and Jacob LLJ simply concurred.

3 InsolvencyAct 1986 s 245 and Schedule B1 para 70.

4 InsolvencyAct 1986 ss 40 and 175(2)(b), and, more recently, s 176A.

5 All charges created as such, regardless of subsequent crystallization: InsolvencyAct 1986 s 251.

6 Some sense of the scale of the problem emerges from the realization that there are apparently over 500 post-Brumark insolvencydistributions frozen, awaiting determination of this test case. The outcome may indicate that distributions e¡ected earlier in the debatewere incorrectly made.

7 [12] (all unattributed paragraph numbers in this comment are references to the judgment in Spectrum [2004] EWCA Civ 670 (CA)).

8 15 Jan 2004, [2004] 2 WLR 783.

9 [2001] UKPC 28, [2001] 2 AC 710 (PC) (‘Agnew’).

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ruled the 25-year-old decision of Slade J in SiebeGorman & Co Ltd v Barclays Bank Ltd,10 where a clausein essentially the same terms had been upheld as a¢xed charge.

The Court of Appeal’s three-step analysis

The Court of Appeal disagreed. Lord Phillips MR gavethe only reasoned judgment; Lord Justices JonathanParker and Jacob simply agreed. The argument wasdelivered in three steps. First, the Court of Appeal heldthat it was not entitled to follow the Privy Councildecision in Brumark. That decision was in directcon£ict with an earlier Court of Appeal decision, ReNew Bullas Trading Ltd,11 and the rules of judicialprecedent required the Court of Appeal to follow NewBullas.12 This latter case held that it was possible tohave a ¢xed charge over book debts regardless of whatmight then happen to the proceeds. In particular, acharge over book debts could be ¢xed even though thechargor was at liberty to collect and use the proceedsin the ordinary course of its business. However, allparties conceded that this rule of precedent coulddeliver only an ‘ephemeral’ victory,13 in that an appealto the House of Lords would inevitably overrule NewBullas and would insist that freedom to collect thebook debts and use the proceeds in the normal courseof business, unless and until the chargee intervenes, isthe hallmark of a £oating charge over book debts. Thismust be right, and that legal principle seems unlikelyto be re-visited with real vigour in any futureappeal.14

The next crucial step, then, was to determinewhether the chargor here did have this type of free-dom to deal with the proceeds of the book debts. TheCourt of Appeal held it did not. The implication is that,even following Brumark, the charge would safely beclassi¢ed as ¢xed, just as in Siebe Gorman. Withrespect, this conclusion seems impossible to defend.This is the critical part of the Court of Appeal’sjudgment, and must be the focus of the House of Lordsappeal. Before considering the relevant issues, the

third and ¢nal step in the court’s reasoning should benoted.

In concluding his judgment, Lord Phillips MR madea startling observation. He indicated, obiter, that sincebanks had relied on the decision in Siebe Gorman forover 25 years, he would be inclined to hold that thisform of words had, by customary usage, acquired themeaning and e¡ect that Slade J had attributed to iteven if Slade J’s construction of the debenture hadbeen erroneous.15 This conclusion might be justi¢edwhen the issue of construction relates solely to therights and obligations of the contracting parties. Theessence of the ¢xed/£oating charge distinction, how-ever, is that it a¡ects third parties (preferred andgeneral unsecured creditors). Statutory prescriptiongives these parties particular rights to the securedassets if the agreement between the contractingparties is, at law, a £oating charge. No amount of self-interested desire or customary usage by debtors andsecured creditors can expropriate these statutoryrights from the unsecured creditors if, at law, thecharge is £oating.

Defining the characteristics of fixed and floatingcharges

Characterization of charges is a matter of law, and thisbrings us back to the second step in Lord Phillips MR’sjudgment. As Lord Phillips MR rightly surmised, ‘thecritical issue of principle [is] whether the restrictionsimposed ... on the use that the chargor canmake of theproceeds of the book debts charged are su⁄cient inlaw to create a ¢xed charge on those debts.’16

The easy cases are at the extreme ends of thespectrum. If the debenture denies the chargor anyfreedom to dispose of the charged assets, and insteadrequires them to stand permanently as security for thedischarge of the obligations owed to the chargee, thenthe charge is ¢xed. On the other hand, if the debenturegives the chargor complete freedom to dispose of thecharged assets unless and until the chargee inter-venes, and only then requires them to be made

Notes

10 [1979] 2 Lloyd’s Reps 142 (‘Siebe Gorman’).

11 [1994] 1 BCLC 485 (CA) (‘New Bullas’).

12 [58]-[59].

13 [7].

14 See the comments at [7], [59] and [86].

15 [97].

16 [86].

SarahWorthington

176International Corporate Rescue, Volume 1, Issue 4

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available to the chargee in priority to the othercreditors, then the charge is £oating.17 It is theintermediate cases that cause di⁄culty, and, unfortu-nately, most debentures fall into the intermediaterange. These are the debentures that impose somerestrictions on the manner in which a chargor maydispose of the charged assets, but not a total embargo.Spectrum is just such a case. Is this type of charge ¢xedor £oating?

Every charge must inevitably be one type or theother. Lord Phillips MR’s attraction for an intermedi-ate third category is conceptually impossible.18 The¢xed/£oating charge distinction is not one that speci-¢es the relative rights of chargor and chargee (here athird category might be apt); it is one that de¢nes therights of non-contracting third parties to have accessto the asset pool. Either these third parties have accessor they do not: only those two possibilities exist.

It follows that these di⁄cult intermediate casesrequire a correspondingly more sophisticated assess-ment of what distinguishes ¢xed and £oating charges.The issue is critical. Very few charges are drafted toleave the chargor with no power at all to deal with thecharged assets, nor, equally, with complete freedom todeal. Most fall at some intermediate point on thecontinuum, and di⁄cult characterization decisionshave to be made. This must be done on a principled,defensible, and commercially certain basis. It is di⁄-cult to tease out of the Court of Appeal’s decision theprecise basis for its particular conclusions. LordPhillips MR’s judgment can be interpreted in at leasttwo ways, although both appear £awed.

A false step in characterization?

First, Lord Phillips MR may have based characteriza-tion on his preferred view of the doctrinal dividing line

between ¢xed and £oating charges. He seems muchattracted by the idea that a £oating charge is one thatpermits the chargor unrestricted freedom to deal withthe charged assets.19 He quotes Lord Halsbury inIllingworth v Houldsworth:20 ‘... the whole purport ofthis instrument is to enable the [debtor] ... to carry on[its] business exactly as if this deed had not beenexecuted at all. That is what we mean by a £oatingsecurity [my emphasis].’ Brumark, too, seems to besubjected to this interpretation: ‘[ignoring the NewBullas precedent, the decision in Brumark] wouldsurely lead this court to the conclusion that an unrest-ricted freedom on the part of a chargor to use theproceeds of book debts charged necessarily meansthat the charge cannot properly be described as a ¢xedcharge [my emphasis].’21 Starting from this perspec-tive, a charge is either ‘£oating’ or ‘not-£oating’, and itis £oating only if the chargor has unrestricted freedomto deal.22

From this perspective, Lord Phillips MR can readilyconclude that the debenture in Spectrum, whichrestricts charging or assigning the book debts, andinsists that all proceeds be paid into an account withthe lending bank, gives the chargor insu⁄cient free-dom for the charge to be £oating. It is, therefore, ¢xed.The degree of control that the bank might choose toexert over the bank account is irrelevant, except toreinforce the ¢nding that the chargor is not left free tocarry on its business exactly as if the debenture hadnever been agreed.

Evidence that this is Lord Phillips MR’s de¢nitionalstarting point comes from his repeated suggestionsthat these di⁄cult cases do not really ¢t the categoryof £oating charges ‘proper’, and that there should be aspecial third category to accommodate this class ofsecurity.23 Failing that, his touchstone remains that£oating charges must leave chargors free to conduct

Notes17 Indeed, this overstates the degree of freedom assumed this end of the spectrum. Precedent indicates that the assumed freedom associated

with a £oating charge is con¢ned to the right to deal with the charged assets in the ordinary course of business. To reinforce this, a £oatingcharge will crytallize automatically once the chargor is unable to carry on its business in this way, even though no term in the debenture soprovides: ReWoodro¡es (Musical Instruments) Ltd [1986] Ch 366 (CA), 377-8 (Nourse LJ); Re Brightlife [1987] Ch 200, 212-215 (Ho¡mann J).As charged assets are dissipated, it is assumed that any newly acquired assets matching the same descriptionwill be subjected automaticallyto the same charge.

18 See especially [24]

19 See especially [20], [24], [34], [52], [54] choice of the words ‘unrestricted right of the chargor’.

20 [1904] AC 355, 357, cited by Lord Phillips MR at [20].

21 [86]. Also see [54], and contrast it with the more appropriate description in [55] which recognizes that Lord Millett’s approach in Brumark isthat a charge is £oating if the chargor remains free to use the charged assets to run its business. It follows without question that if the chargorhas an unrestricted right to collect the book debts and use the proceeds, then the charge is £oating.

22 See especially [20], [24],

23 See the text to n. 18, above.

An‘Unsatisfactory Area of the Law’ ^ Fixed and Floating ChargesYet Again

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their business without restriction. He ¢nds furthersupport for this in several cases where minor restric-tions imposed on the chargor were deemed su⁄cientto render the charge ¢xed, even though the chargorremained free to collect and use any proceeds derivedfrom the charged assets.24

The better alternative ^ an orthodox definitionof the fixed charge

If this is the rationale, then Lord Phillips MR’s conclu-sions follow, but, with respect, the initial premise isunsound and cannot be supported. Fixed charges havelong been recognized as security devices, but theirexistence was always conditional on an obligation onthe chargor to preserve the secured asset for thebene¢t of the chargee. Until £oating charges were¢nally recognized, the absence of this requirementmeant that there was no true security. In the UnitedStates, this remained the case: £oating charges werenot recognized by the courts because the absence of arequirement to preserve the charged asset for thebene¢t of the security holder was seen as inconsistentwith the security holder having a proprietary interestin the assets rather than a simple contractual claim topriority (and one that would not work in the face of aninsolvency regime that demanded pari passu distribu-tion). English courts’ recognition of the £oatingcharge, and then the legislature’s later intervention togive unsecured creditors rights over the £oatingcharge assets, needs to be read in the light of thishistory. This suggests that any de¢nition should startat the ¢xed charge end of the continuum. In otherwords, a charge is either ‘¢xed’ or ‘not-¢xed’; if it is not¢xed, then it is £oating. A charge is ¢xed if, and only if,it imposes restrictions on the activities of the chargorthat are su⁄cient to ensure that the charged assets arepreserved for the bene¢t of the security holder. If thecharge does not do this, then it is £oating, with all thestatutory consequences that entails. The issue inSpectrum is whether the debenture restrictionsachieve this end.

Parts of Lord Phillips MR’s judgment can be seen asaddressing this very issue.25 This is the secondpossible interpretation of his judgment. It sees himstarting from a defensible de¢nitional standpoint, andthen concluding that the terms of the debenture aresu⁄cient to ensure that the charged assets (the bookdebts) are preserved for the bene¢t of the chargee. Ifthis is his task, then his conclusion seems impossibleto defend. There are only two ways to ensure that thebook debts are preserved for the bene¢t of the chargee.The chargee may either prohibit all dealings by thechargor (clearly not done here), or mayallow dealings,but only on account of the chargee, so that anysubstitute assets are, in turn, either handed overabsolutely to the chargee, or are preserved for thebene¢t of the chargee’s security.26 What must nothappen is that the chargor be allowed to remove thecharged assets from the ambit of the security withoutgiving the chargee either the absolute or the securitybene¢t of the substitute.

Control and benefit tests ^ asking the rightquestion

At various points in his judgment, Lord Phillips MRappears to advance di¡erent reasons for ¢nding thatthe chargee has the necessary control of the bookdebts and their proceeds to ensure that the charge is¢xed according to the second, and arguably proper,approach outlined above. None is convincing. First,there is a persistent, if subliminal, suggestion thatprohibitions on charging or assigning the book debtswill su⁄ce to meet this test, even though the chargoris allowed to collect the debts and use the proceeds atwill.27 This is clearly £awed. The assertion eitherassumes the false ¢rst test of the ¢xed/£oating chargedistinction noted earlier (ie any restriction on thechargor’s activity will render the charge ¢xed), or itinsists, contrary to the reality, that the second test ismet even though the chargor retains the right, albeitrestricted, to use the charged assets at will. LordMillett, in Brumark, described this second suppositionas ‘contrary to both principle and authority’.28 It is

Notes

24 See the long discussion at [35]-[43], analysing In re Atlantic Computer Systems Plc [1992] Ch 505, ReAtlantic Medical Ltd [1992] BCC 653, ReNew Bullas Trading Ltd [1994] 1 BCLC 485, Royal Trust Bank v NationalWestminster Bank [1996] 2 BCLC 682. All these cases have been thesubject of signi¢cant criticism. See especially R Goode, ‘Charges Over Book Debts: A Missed Opportunity’ (1994) 110 LQR 592; A Berg,‘Charges Over Book Debts: A Reply’ [1995] JBL 433; SWorthington, ‘Fixed Charges Over Book Debts and Other Receivables’ (1997) 113 LQR562. These cases are in direct con£ict with Brumark, discussed by Lord Phillips MR at [46]-[50], and also with Re Brightlife Ltd [187] 1 Ch200, discussed by Lord Phillips MR at [22]-[24], [41], and more recent cases discussed at [44].

25 See especially [95]: ‘The [chargor] Company never had any control of these proceeds.’

26 In Brumark at [20], [38] and [48], Lord Millett suggests that Slade J in Siebe Gorman had interpreted the debenture in that case in thisrestricted way to support his ¢nding that the charge was ¢xed, although Lord Millett also appears to suggest that, on the facts, thisinterpretation is open to doubt.

27 See the tenor of [51]-[56], even before determining as a matter of law that the Court of Appeal must follow New Bullas rather than Brumark.

28 Brumark at [36].

SarahWorthington




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impossible to disagree. Lord Phillips MR cites LordMillett’s analysis in full.29 Put brie£y, this partialrestriction undoubtedly allows withdrawal of the debtand its proceeds from the ambit of the security at thewill of the chargor. On this basis, the charge should be£oating.

Secondly, Lord Phillips MR seems at times tosuggest that the bank has control over (ie has thebene¢t of) any proceeds because the chargor must paythem into an account with the bank, and the bank isthen entitled to impose restrictions at will on thechargor’s use of the account.30 Slade J in Siebe Gormanmay have adopted the same reasoning.31 This, too, isplainly insu⁄cient to render the charge ¢xed withinthis second, and arguably proper, de¢nition of a ¢xedcharge. This provision does not give the bank thebene¢t of the proceeds (either absolutely or as anenhancement to its security); it merely gives the bankthe right to demand, at will, that it be given this bene¢tat some time in the future. Until such intervention, thechargor remains free to dissipate the proceeds at will.Translating this into the language of security, thebank has a present £oating charge over the bookdebts, with the right, in the future and at will, toconvert or crystallize this into a ¢xed security. On thefacts of Spectrum, this right had not been exercised.Even if it had, however, this would not have assistedthe bank. The statutory carve-outs for preferred andgeneral unsecured creditors apply to any chargewhich, as created, is a £oating charge.32

Thirdly, Lord Phillips MR goes even further thanthis, and asserts that the bank has the necessarybene¢t of the proceeds simply because the chargormust pay them into an account at the chargee bank.33

In a remarkable paragraph, he says:34

I do not consider it satisfactory that the limitedrestraint that Slade J held arose under the deben-

ture should be the critical factor in determiningwhether the charge should be categorized as a ¢xedor £oating charge. It seems to me that it is at leastarguable that a debenture which prohibits a char-gor from disposing of book debts before they arecollected and requires him to pay them, bene¢-cially, to the chargee as and when they arecollected properly falls within the de¢nition of a¢xed charge, regardless of the extent of his contrac-tual right to draw out sums equivalent to theamounts paid in. Strictly speaking, the chargor isneither entitled to dispose of the book debts beforethey fall due for payment, nor to dispose of theproceeds. What he does enjoy are contractualrights to payments ... from the bank. .... It is notsatisfactory that the categorization of a chargecreated by a debenture should turn upon theprecise details of a bank’s relationship with itscustomer.

With respect, this loses sight of the question thatneeds to be answered. It also seems inconsistent withprinciple and common sense. Indeed, the ¢nal sen-tence goes so far as to suggest that it is inappropriate‘that the categorization of a charge created by adebenture should turn upon the precise details of a[chargee’s] relationship with its [chargor].’ It is verydi⁄cult to see what else categorization can be basedupon. This is the relationship that must be assessed todetermine whether the security is of one type oranother.35

At issue is whether the charge over the book debts is¢xed or £oating. According to the orthodox de¢nition,the charge is ¢xed if the chargor is required to preservethe charged assets (the book debts), or their permittedsubstitutes, for the bene¢t of the chargee (eitherabsolutely, or as part of the pool of charged assetsstanding as security for the chargor’s obligation).

Notes

29 [48].

30 See his discussion of Siebe Gorman at [76]-[77] and [82]-[83].

31 See Siebe Gorman pp 158-9 (cited by Lord Phillips MR at [72]), where Slade J concedes that the charge in that case would certainly be £oatingif, prior to crystallization or enforcement of the security, the bank had no rights to prevent the chargor from dealing with the proceeds of thebook debts at a time when the account was in credit. He decided that this was not the position in the case before him, however. His reasoningis di⁄cult to distil, but it seems that this is because either (i) ‘the bank had the right, if it chose, to assert its lien’ on the proceeds (p 159, myemphasis); or (ii) the parties intended the charge to be ¢xed, and nothing in the debenture, including the absence of prohibitions on certainforms of dealings, was su⁄cient to negative the existence of a speci¢c charge. The ¢rst alternative is that discussed in the accompanying textto this footnote, although it is in fact exceedingly di⁄cult to decide which term in the debenture might give the bank this right to intervene. Itappears that Slade J decided that the charge was ¢xed because the parties said it was, and that therefore the bank would have the right tointervene and block the account even though it was in credit (Siebe Gorman p 159). Also see Lord Phillips MR at [83], [85], [87], [93]. Thesecond alternative seems patently £awed, in that it places too much reliance on the parties’ intention and their own labelling, and notenough on the actual rights given to chargor and chargee, and, in any event, it seems to adopt the inappropriate distinction between ¢xedand £oating charges discussed earlier, where most charges are ¢xed rather than £oating, because the chargor is usually subject to somerestriction on use of the charged assets.

32 InsolvencyAct 1986 s 251.

33 [87]. Also see especially [88]-[91] and [94]-[95].

34 [94].

35 Brumark at [48]. This is true whether the secured assets are tangible or intangible: see, eg, Re Cosslett (Contractors) Ltd [1998] Ch 495 (CA).





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Otherwise the charge is £oating. In particular, it is£oating if the chargor is free to remove the chargedassets, and their substitutes, from the scope of thesecurity, and use them for its own bene¢t in the courseof its business (at least until the charge crystallizes orthe chargee intervenes to enforce the £oating secur-ity). The security in Spectrum seems to fall very clearlyon the £oating side of this line.Why was Lord PhillipsMR so sure that it did not, so long as the proceeds hadto be paid to the chargee bank?

The relevance of payment to the chargee bank

It is uncontroversial that a charge over book debts is£oating if the chargor can collect the book debts, paythe cash proceeds into a bank account with some bankother than the chargee, and then draw on the bankaccount at will.36 Why should the result be anydi¡erent simply because the charge requires thechargor to pay the proceeds into an account with thechargee bank? The test remains the same: the chargeis ¢xed only if the asset or its permitted substitute isnecessarily preserved for the bene¢t of the chargee’ssecurity. A transaction where the chargee itself makesthe substitution, accepting one form of property anddelivering another, which the chargor is then free todispose of at will, does little more to preserve thechargee’s security than if the substitution is made bya stranger.

Consider inventory, and some trivial sums of moneyfor ease of explanation. Assume A has a charge overB’s goods to secure a debt of GBP 100. This charge isunquestionably £oating if B can sell the goods to C anduse the proceeds at will. B might, for example, sellsome of the goods to C for GBP 25 and then use theproceeds at will. It makes no sense to suggest that thecharge will be ¢xed, not £oating, simply because Bmayonly sell the goods to A, but when A then pays GBP 25for the parcel, B is free to use the cash at will. Thisundoubtedly restricts B’s freedom to deal with thecharged assets,37 but this is not enough to make thecharge ¢xed. To ensure that the charge is ¢xed, therestriction must preserve A’s protection against therisk of B’s default in repaying the loan. This restrictiondoes not do that. It allows B to remove the chargedassets from the ambit of the security, and to use thesubstitute at will. The result is that value of A’ssecurity interest in the goods is reduced with nocountervailing bene¢t by way of security over the

substitute asset (the GBP 25), or outright assignmentof the substitute asset in part payment of the out-standing debt (so that although the value of thesecurity is reduced, so too is the value of the out-standing obligation). In short, a requirement that thechargor may dispose of charged assets only by way ofsale to the chargee, will not make the charge ¢xed ifthe chargor is then allowed to dispose of the proceedsat will.

Precisely the same reasoning applies with intangi-bles, and with substitutions further down the chain ofdealings. In particular, if a chargor is permitted todispose of the charged assets (whether book debts orinventory) to anyone, but must then pay the cashproceeds (the ¢rst substitute asset) into an accountwith the chargee bank, yet is then left free to deal withthis second substitute asset at will (ie the chose inaction constituted by the contract between chargorand chargee governing the bank account), then thesame process of reasoning suggests that this chargetoo is £oating. The chargee has simply insisted that itbe party to the transaction which e¡ects the secondsubstitution. Notwithstanding this, the end result isthat the chargee’s security is reduced (book debts havebeen removed); no substitute asset stands as replace-ment security; and the chargee’s exposure to thechargor’s potential default has not been reduced bymandatory repayment of part of the outstanding debt.Accordingly, this charge, too, must be £oating.38

As Lord Millett puts it:39 ‘Taking the relevant assetsto be the uncollected book debts, the [chargor]company was left in control of the process by whichthe charged assets were extinguished and replaced bydi¡erent assets which were not the subject of a ¢xedcharge and were at the free disposal of the company.That is inconsistent with the nature of a ¢xed charge.’

Notwithstanding this, Lord Phillips MR pursuedvarious leads that enabled him to reach the contraryconclusion. His analysis is not, for the most part,explicit. This makes it very di⁄cult to respond to whatmight have been the persuasive arguments. Even so,and with respect, any possible reasoning to a ‘¢xedcharge’ conclusion seems to be £awed.What were thepitfalls?

Notes

36 Siebe Gorman, Brumark and Spectrum are at one on this.

37 This is commercially unrealistic, admittedly, but serves a pedagogic purpose: see below.

38 The only way to reach the contrary conclusion is to revert to the £awed de¢nition of ¢xed and £oating charges discussed earlier, whichsuggests that any restriction on the chargor’s dealings with the charged assets is su⁄cient to render the charge ¢xed rather than £oating.This seems unsupportable as a matter of history and commercial sense.

39 Brumark at [49], cited by Lord Phillips MR at [50]. Also see Spectrum [48]-[49].

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A proprietary diversion ^ the bank’s interest inthe cash proceeds

The ¢rst pitfall seems to arise from the uncontroversialproposition that ‘[m]oney, when paid into a bank,ceases altogether to be the money of the principal ...it is then the banker’s money ... to do with is as hepleases’,40 although there is inevitably a correspond-ing contractual obligation to repay the principal atleast an equivalent sum.

The signi¢cance of this familiar proposition to LordPhillips MR’s reasoning is unclear. It certainly allowedhim to ¢nd that, although collection of the book debtswas allowed, the chargee bank then acquired absoluteownership and control of the cash proceeds. Surely,however, this did not then lead him to suppose that,with such complete control over the proceeds, thecharge could safely be characterized as ¢xed. Such aconclusion would take the literal words of Brumarkand apply them without understanding their context.The Privy Council opinion in Brumark shows that ifthe chargor, not the chargee, has control of thesubstitute for the book debts (ie their proceeds), thenit has control of the book debts, and so the charge overthe book debts is £oating. It misconceives the logic,however, to suggest that if the chargee has control ofthe proceeds, even though the chargor has control oftheir substitute (ie the chose in action ^ the bankaccount), then the charge is ¢xed. This was explainedin detail in the previous section.

Alternatively, Lord Phillips MR may have thoughtthere was some signi¢cance in the fact that thechargor’s substitute for the proceeds was a chose inaction, the bene¢t of which was to some extentgoverned by the contractual arrangements with thechargee bank. He says, ‘Insofar as the customer isentitled to call upon the bank to pay over the amountof the proceeds received, the right will be contractual,not proprietary [my emphasis].’41 The signi¢cance ofthese ¢nal words is unclear.42 But somehow, withoutexplanation, perhaps because these substitute rightswere ‘not proprietary’, they became irrelevant incharacterizing the charge. The error in this is clear.The issue being pursued is whether the charged asset,or any permitted substitutes, whatever their value, arerequired to be preserved for the bene¢t of the chargee’ssecurity. If they are, then the charge is ¢xed; if they arenot, then the charge is £oating. In Spectrum there is no

requirement that adequately protects the chargee inthis way.

The relevance of overdrafts

The second pitfall is more subtle. Lord Phillips MRmade much of the fact that the account with thechargee bank was always overdrawn, with no sugges-tion that this would ever be otherwise. For this reasonhe insisted that:

it is wholly arti¢cial to ask the question, would the[chargor] Company be entitled to draw freely on itsaccount if in credit? .... In the result payment ofbook debts into the account were received bene¢-cially by the Bank by way of partial repayment ofthe indebtedness of the Company to the Bank. TheCompany never had any control of these proceeds.It was bound to permit them to be used to reduce itsindebtedness. Admittedly it then had, until with-drawn, the contractual right to borrow from theBank up to the overdraft limit, but as a matter ofstrict analysis that did not mean that the charge onthe book debts remained £oating.43

This analysis does not adequately address the coreissue. It is essential to determine whether the cashproceeds derived from the book debts, or their sub-stitutes, must stand for the bene¢t of the chargee(either by reducing the chargor’s outstanding debt, asis suggested by Lord Phillips MR here, or by augment-ing the security that protects that obligation), orwhether they, or their substitutes, are left at the freedisposal of the chargor. In an account with an over-draft limit, the position is unquestionably the latter,not the former. This is true even when the account isoverdrawn, despite the implications in Lord PhillipsMR’s judgment.

Take a practical example, closely mirroring Spec-trum. Assume A has a charge over B’s book debts tosecure an overdraft of GBP 1,000. Assume also that Bis allowed to collect the proceeds but required to paythem into the overdraft account at A’s bank. Considerthe position where the account is GBP 400 overdrawnwhen B receives GBP 100 in proceeds and depositsthis sum in the account. Before the collection ofproceeds, A has advanced GBP 400 and is contrac-tually obliged to advance a further GBP 600, with thistotal GBP 1,000 loan secured by a charge over thebook debts.When B collects GBP 100 in proceeds, and

Notes

40 Foley v Hill (1848) 2 HLC 28, 36, cited by Lord Phillips MR at [88].

41 [89].

42 Lord Phillips MRmay simply have been pursing the problem of how Slade J had managed to ¢nd that the chargee bank in Siebe Gorman couldassert a lien on the proceeds if it so decided. It seems more likely, however, that they were material to Lord Phillips MR’s later ¢nding, cited infull earlier: see the text at n. 34 above.

43 [95]. Also see his comments at [68], in relation to Siebe Gorman.





8

pays it into the account, the pool of charged assetssecuring B’s obligation is reduced. B’s current debt toAis also temporarily reduced from GBP 400 to GBP300.44 But, importantly, B is now entitled towithdrawGBP 700 from the overdraft account, not the GBP 600it was entitled to withdraw before the proceeds weredeposited.45 Clearly, the GBP 100 proceeds paid intothe overdraft account with A are being applied for B’sbene¢t, not A’s.This is the crucial feature, not whetherthe advances to B (the initial GBP 400 or anysubsequent withdrawals) are ‘B’s funds’ (ie somehowB’s proceeds)46 or are, instead, fresh advances by thebank of the bank’s own money. The latter is in fact thecase,47 but this is immaterial to the issue in dispute.What is important is that the substitute assets ^ thecash proceeds and, later, the corresponding chose inaction ^ serve to augment B’s position, not A’s.

This characteristic means that the charge over thebook debts is £oating: the book debts can be removedfrom the ambit of the security and used for the bene¢tof B; there is no requirement that they, or theirsubstitutes, be segregated and preserved for the bene¢tof A. The reasoning is no di¡erent if the account is incredit. Indeed, this is as it should be. The chargeshould be either ¢xed or £oating as created, at itsinception. The nature of the charge should not changeas the loan account moves into and out of credit.

Potential tracing confusions?

How did this muddled thinking begin? Some of theblame might be laid at the door of tracing rules andconsequential proprietary remedies. There is admit-tedly no explicit reference to these issues in LordPhillips MR’s judgment, but some of his preoccupationwith distinctions between proprietary and contractualclaims seems to come from here.

The tracing rules can be relevant in security agree-ments, but only if the chargor breaches the terms of thecharge agreement. If the charge is ¢xed, according tothe orthodox de¢nition discussed earlier, but thechargor nevertheless disposes of the charged assetsnotwithstanding the prohibition on such dealing, thechargee will expect some remedy. The rule is that thechargee can follow its proprietary interest in thecharged assets into the hands of anyone who is not abona ¢de purchaser for value (although it is perhaps

unlikely to ¢nd that the transferee is such a party), orcan trace the charged assets into their substitutes inthe hands of the defaulting chargor. This possibilityinevitably raises the question of whether the un-authorized disposal has generated a traceable substi-tute in the chargor’s hands. Traditionally, payment ofthe charged assets, or its traceable cash substitute,into an overdrawn bank account marks the end of thetracing trail.48 The chargor is then considered to haveno traceable asset representing the substitute for theinitial charged asset, and the chargee is therefore leftwithout any substitute proprietary security for theoutstanding obligation owed by the defaulting char-gor. This analysis is fundamentally di¡erent from thatapplied when determining the initial characterizationissue ^ i.e. is the charge ¢xed or £oating. In the formercase the issue is whether there is property that willstand as the traceable substitute for the charged asset.In the latter case the issue is whether the chargor canmake use of the original asset, and its substitutes, forits own bene¢t, regardless of whether this use producesa proprietary end-product.

Taking security ^ ensuring the charge is fixed

From all of this, it follows that there are a limitednumber of ways to ensure that a charge over bookdebts is ¢xed. The ¢rst is to prevent all dealings withthe book debts so that they are preserved for thebene¢t of the chargee’s security. This is commerciallyunattractive if the restriction has to include a ban oncollection. Restrictions on other dealings are lessproblematical, and can be seen as the fair price forthe commercial advantages of credit. The secondmethod is to prevent all dealings other than collection,and to require the collected proceeds to be paid to thechargee in reduction of the chargor’s outstandingdebt. In this way, both the value of the security andthe value of the outstanding obligation are reduced intandem, and the security is e¡ectively redeemed as theobligation is reduced. The third method is again toprevent all dealings other than collection, and torequire the collected proceeds to be paid into a bankaccount with the chargee bank. This account mustthen be blocked. The purpose of this is not to expro-priate the chargor’s contractual chose in action, as inthe previous case.49 This chose in action is a valuable

Notes

44 As Lord Phillips MR found.

45 Williams & Glyn’s Bank Ltd v Barnes [1981] Com LR 205.

46 See the next section on tracing confusions.

47 See the InsolvencyAct 1986 s 127 cases, eg,Re Gray’s Inn Construction Ltd [1980] 1 WLR 711 (CA);Hollicourt(Contracts) Ltd v Bank of Ireland[2001] Ch 555 (CA).

48 Bishopsgate Investment Management Ltd v Homan [1995] Ch 211 (CA), although ‘backwards tracing’ certainly has its adherents.

49 The analysis applies equally whether the chargor has a credit balance or an overdraft: see the previous section.

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asset and continues to belong to the chargor. Blockingthe accountmerely ensures that this substitute asset isnot at the free disposal of the chargor, to be dissipatedat will, but is instead preserved for the bene¢t of thechargee’s security. The preceding analysis, based onthe orthodox de¢nition of a ¢xed charge, suggests thatthis blocking requirement will be interpretedstrictly.50 The ¢nal method is, yet again, to preventall dealings other than collection, and to permit thecollected proceeds to be paid into a bank account witha third party bank. The chargee must then take a ¢xedcharge over this account, or enter into a controlagreement with the third party bank to ensure thatthe account is blocked. These controls are necessaryfor the same reasons that control is required over theaccount with the chargee bank.

Incidental issues

Clearly the choice is limited, and each option isundoubtedly commercially unattractive. This onlyserves to highlight why ¢xed charges over book debts,inventory and other circulating assets will rarely arisein practice. The analysis raises three important in-cidental issues. First, it cannot be emphasized toostrongly that the characterization of charges is amatter of law. The agreement between the partiesmust be construed to determine the rights and obliga-tions that have been agreed between the chargor andthe chargee. If, and only if, these rights and obliga-

tions are su⁄cient to ensure that the charged assetsare preserved for the bene¢t of the chargee, then thecharge is ¢xed. Otherwise it is £oating. In particular, acharge is £oating if the chargor can remove thecharged assets from the ambit of the security and usethem, or their permitted substitutes, for its ownbene¢t, rather than preserving them for the bene¢t ofthe chargee.51 In making this assessment, it is irrele-vant that the parties intended their agreement to becharacterized di¡erently;52 or that the permissionsgiven to the chargor to take particular bene¢ts areonly those agreed in the contract;53 or, conversely,that the written agreement prohibits disposal by thechargor if in reality the parties operate di¡erently;54 orthat the chargee allows the chargor to deal, butsubject to termination of this permission at will bythe chargee;55 or, ¢nally, that the chargee’s economicposition is not in fact madematerially worse,56 or eventhat it is not made worse at all, because the facts aresuch that as charged assets are removed by thechargor, new assets of the same description areacquired and subjected to the same security, sopreserving the chargee’s position.57

Conclusions

Spectrum is a di⁄cult case.58 It is also an importantcase, and one likely to generate much debate anddisagreement. The personal property security legisla-tion currently mooted by the Law Commission59 will

Notes

50 In particular, as argued here, it is not met by an ability to control the account in the future (as in Siebe Gorman), nor, probably, by blockedaccounts subject to an advance agreed facility or sweeper agreement.

51 Brumark, passim.

52 Spectrum [33]; Brumark [32]. Contrast Siebe Gorman and New Bullas.

53 Brumark [34], roundly criticizing the contrary ¢nding in New Bullas, pp 491-3, cited by Lord Phillips MR at [39].

54 Brumark [48], cited by Lord Phillips MR at [79].

55 As in Siebe Gorman, but criticized above at text to n. 30.

56 See Lord Phillips MR at [51], suggesting that it is possible to distinguish long-term and short-term debts on the basis that collection of theformer, normally paid by instalments, does not remove the [bulk of] the charged asset from the ambit of the security, and so might beconsidered as readily meeting the requirement of a ¢xed charge, even though similar provisions permitting collection of short-term debtswould be characterized as £oating charges. This assertion is reminiscent of the decisions in Atlantic Computers and Atlantic Medical, andre£ects similar errors in legal analysis (see n. 24 above). It is irrelevant that the value of the pool of charged assets in fact remains relativelyconstant despite the chargor’s dealing for its own bene¢t. If the chargor can engage in such dealing, then the charge is £oating.Characterization depends upon the rights to deal with each item of the charged assets, as granted by the parties’ agreement, so that thecharge can be characterized ‘as created’, not by virtue of some process of taking accounts during the course of the operation of the security.Take a practical example: a ¢xed charge over machinery (such as computers) will permit the chargor to use the machines for its own bene¢t,collecting rents and using these rents at will, so long as the machines themselves are preserved for the bene¢t of the chargee. If the charge isover the rental stream, however, then the charge is necessarily £oating if the chargor is permitted to collect the rents and use the proceeds forits own bene¢t rather than preserving these substitute assets for the bene¢t of the chargee.

57 Both ¢xed and £oating charges can be drafted to attach to future assets: see Holroyd v Marshall (1862) 10 HL Cas 191 (¢xed charges), andalmost every authority on £oating charges. The security in both cases may be enhanced, but this says nothing at all of the propercharacterization of the charge. That depends solely uponwhether charged assets can be removed from the ambit of the security at the will ofthe chargor: see Brumark and its precedents.

58 Lord Phillips MR’s judgment runs to 30 pages, and contains strings of long quotations from the relevant authorities, often with little toexplain the particular emphasis to be given to them.

59 Law Commission Consultation Paper No. 164 (2002) on the registration of security interests.





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remove the particular problem, but only to replace itby another. The real issue is not what parties canagree about security, but how parliament then inter-venes to make special rules for the insolvency dis-tribution of the proceeds of sale of secured assets. Atthe moment the test relies on a distinction between¢xed and £oating charges. Any new regime willundoubtedly want to maintain some form of manda-tory sharing with preferred and unsecured creditors,and will have to develop a new test.

For now, however, the ¢xed and £oating chargecharacterization is essential to the process. This hasbeen the case for decades, so it is astonishing that theprocedure remains so controversial. On the viewpresented here, the Spectrum appeal has failed todeliver defensible answers. It remains the case, as LordPhillips MR so accurately notes, that this ‘is anunsatisfactory area of the law.’60

Notes

60 [99].

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ARTICLE

Fixed and Floating Charges over Book Debts ^ the Implications ofthe House of Lords’ Decision in Re Spectrum Plus Limited [2005]UKHL 41, Part I

Catherine Addy, Barrister at Maitland Chambers, London,UK and Junior Counsel for the Crownin Re Spectrum Plus

Introduction

This article examines the history behind and thereasoning and implications of the House of Lords’recent decision in Re Spectrum Plus Limited [2005]UKHL 41 concerning the grant of ¢xed and £oatingcharges over a company’s book debts. The materialfacts in Re Spectrum Plus are set out in the CaseSummary written by the author in Issue 4 of Volume2 of this publication and this more in-depth analysisshould be read in conjunction with that earlier article.

The importance of creating a fixed charge

S175 of the Insolvency Act 1986 (‘the Act’) providesthat in so far as the assets of the company available forpayment of general creditors are insu⁄cient to meetthe claims of the preferential creditors, those creditorshave priority over the claims of any £oating chargeholder in respect of any property comprised in orsubject to that charge. By virtue of the Enterprise Act2002 (‘EA 2002’), most creditors who were prefer-ential lost their status as such in respect of liquida-tions commencing on or after 15 September 2003(including HM Revenue and Customs (‘HMRC’))although debts due to employees within Category 5of Schedule 6 to the Act remain preferential andaccordingly the Secretary of State for Trade andIndustry retains a potential interest as a preferentialcreditor by way of subrogation.

In addition, s252 EA 2002 inserted a new s176Ainto the Act which provides that, with e¡ect from 15September 2003,1 a ‘prescribed part’2 of the netproperty of a company which has gone into liquida-tion, administration or receivership shall ordinarily bemade available for the satisfaction of unsecured debts

in preference to the claims of £oating charge holdersto those assets; the net property being de¢ned as theamount of the company’s property which, but fors176A, would be made available for the satisfactionof £oating charge holders’ claims. (S251 of the Actprovides that a ‘£oating charge’ means ‘a chargewhich, as created, was a £oating charge’.)

Accordingly, a chargee will ordinarily prefer andtherefore seek the grant of a ¢xed charge rather than a£oating charge over the book debts of a debtorcompany.

When Spectrum Plus Limited went into creditors’voluntary liquidation the assets available for paymentof its general creditors were insu⁄cient to pay itspreferential creditors and accordingly, if the chargewhich it granted to NatWest was, as created, a £oatingcharge then the preferential creditors, HMRC (then theInland Revenue and Customs & Excise) and theSecretary of State for Trade and Industry, would bepaid out of the realised book debts in priority to theBank’s claim.

The law prior to the bank’s application in ReSpectrum Plus

The starting point was and is the classic de¢nitionexpounded by Romer LJ in In reYorkshireWoolcombers’Association Ltd [1903] Ch 284:

... I certainly think that if a charge has the threecharacteristics that I am about to mention it is a£oating charge. (1) If it is a charge on a class ofassets of a company present and future; (2) if thatclass is one which, in the ordinary course of thebusiness of the company, would be changing fromtime to time; and (3) if you ¢nd that by the charge it

Notes

1 And applying only to those £oating charges created after such date; see section 176A(9).

2 The ‘prescribed part’ has been ¢xed by SI 2003/2097 as follows:Where the net property is less than GBP 10 000, 50% of that property andwhere the net property is at least GBP 10 000, 50 % of the ¢rst GBP 10 000 plus 20% of the property which exceeds GBP 10 000 up to amaximum prescribed part of GBP 600 000.

306


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is contemplated that, until some future step is takenby or on behalf of those interested in the charge, thecompany may carry on its business in the ordinaryway as far as concerns the particular class of assetsI am dealing with.3

That test was approved without limitation by theHouse of Lords, in short ex tempore Judgments, subnom Illlingworth v Houldsworth [1904] AC 355. LordMacNaghten, considering that there was ‘not muchdi⁄culty in de¢ning what a £oating charge is incontrast to what is called a speci¢c charge’.

Subsequently, the now infamous decision of Slade Jin Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2Lloyds Rep 142 established clearly for the ¢rst timethat conceptually at least a company could create avalid ¢xed charge over future book debts. In that case,R H McDonald Ltd (‘RHM’) had delivered certainforeign bills to its bankers, Barclays Bank, for collec-tion which were held by the Judge to constitute ‘bookdebts’. RHM had then executed a deed of assignmentin respect of those bills to Siebe Gorman and thereforethe ¢rst issue was whether the bills were subject to a¢xed or £oating charge in favour of the Bank at thetime of their purported assignment to Siebe Gorman.The proceeds of the bills were required to be paid intothe company’s account with the chargee bank and itwas argued that it must have been contemplated thatthe company would then be free immediately to drawout all those monies for the ordinary purposes of itsbusiness. Slade J accepted that if the company had hadthe unrestricted right to draw on the proceeds of thedebts so long as the account remained in credit hewould have characterised the charge as a £oating onehowever, he held that the company did not have sucha right. It was his conclusion in this last respect whichwas in error.

He reached such conclusion by determining ¢rstthat it was conceptually possible to create a ¢xedcharge over future book debts and by then deter-mining that because the parties had agreed that therewas to be a ¢xed charge over the book debts it mustnecessarily follow that there was a speci¢c chargeover the proceeds. From this he then reasoned:

This conclusion that the charge is a speci¢c chargeinvolves the further conclusion that, during thecontinuance of the security, the bank would havethe right, if it chose, to assert its lien under thecharge on the proceeds of the book debts, even at a

time when the particular account into which theywere paid was temporarily in credit. However, I seenothing surprising in this conclusion, bearing inmind that the charge a¡orded continuing securityto the bank not only in respect of any indebtednesson that particular account but also in respect of anyother indebtedness of [RHM] to the bank. Thebank’s lien would, after all, continue only duringthe subsistence of the debenture, which the debtorwould at all times have the right to redeem.

However, as a matter of general banking law, abanker does not have a lien over any credit balancesfor payment of debit balances on other accounts orother liabilities owed by the customer to the bank; ithas only a right of set-o¡. Absent express contractualwords to the contrary, a banker cannot refuse tohonour a cheque drawn on a current account merelybecause there are other liabilities owing to the bankunless and until he has given notice terminating therelevant facility.4

Thereafter, in Re Keenan Bros Limited [1986] BCLC242, the Irish Supreme Court considered a chargeover book debts in broadly Siebe Gorman terms savethat that company was required to pay all book debtrealisations into a special designated account with thechargee bank from which the company was expresslyprohibited from making drawings without the bank’sprior consent. The charge was held to constitute a¢xed charge expressly in view of this restriction.

Subsequently, in Supercool Refrigeration and AirConditioning v Hoverd Industries [1994] 3 NZLR 300,the New Zealand High Court, faced with a debenturein broadly Siebe Gorman terms, held that the absence ofany restriction on how the company might use thebook debt realisations once they had been credited toits account with the chargee bank was fatal to thecharacterisation of the security as a ¢xed charge. Inholding the charge under consideration to be a £oat-ing one, Tomkins J distinguished between SiebeGorman and Re Keenan expressly preferring the latter.

Next came Re New BullasTrading in which the Courtof Appeal notoriously reversed the ¢rst instancedecision of Knox J and held that an instrumentpurporting to grant a ¢xed charge over the relevantcompany’s uncollected book debts and a £oatingcharge over their proceeds created a valid ¢xed chargeover the company’s uncollected book debts.5

A New Bullas style charge then came to be con-sidered by the New Zealand courts and subsequently

Notes

3 At 295.

4 Halesowen Presswork and Assemblies Ltd vWestminster Bank Ltd [1971] 1 QB 1 at 46 approved by the House of Lords in NationalWestminsterBank Ltd v Halesowen Presswork and Assemblies Ltd [1972] AC 785; and Joachimson v Swiss Bank Corpn [1921] 3 KB 110.

5 [1993] BCLC 1389 (Knox J) [1994] 1 BCLC 485 (CA).

Fixed and Floating Charges over Book Debts ^ the House of Lords’Decision in Re Spectrum Plus Limited, Part I




13

by the Privy Council in Agnew v Commissioners ofInland Revenue (sub nom. Re Brumark) [2001] UKPC28. The New Zealand Court of Appeal6 considered thatBrumark’s freedom to collect and deal with theproceeds of its book debts prior to the appointment ofthe Receivers rendered the charge incapable of being a¢xed security over the book debts and reversed the¢rst instance decision of Fisher J which had relieddirectly upon Re New Bullas. Accordingly, the issuebefore the Privy Council was whether or not thecompany’s right to collect the debts and deal withtheir proceeds free from the security meant that thecharge on the uncollected debts, though described inthe debenture as ¢xed, should nevertheless be char-acterised as a £oating charge until it crystallised bythe appointment of the receivers. Lord Millett, deliver-ing the Judgment of the Board considered theapproach of the Court of Appeal in Re New Bullas tohave been ‘fundamentally mistaken’.

Since Lord Millett’s reasoning in Agnew has nowbeen approved and applied by the House of Lords in ReSpectrum Plus it merits careful consideration. As heexplained, determining whether a particular charge is¢xed or £oating involves a two-stage process:7

At the ¢rst stage [the court] must construe theinstrument of charge and seek to gather the inten-tions of the parties from the language they haveused. But the object at this stage of the process isnot to discover whether the parties intended tocreate a ¢xed or a £oating charge. It is to ascertainthe nature of the rights and obligations which theparties intended to grant each other in respect ofthe charged assets. Once these have been ascer-tained, the court can then embark on the secondstage of the process, which is one of characterisa-tion. This is a matter of law. It does not dependupon the intention of the parties. If their intention,properly gathered from the language of the instru-ment, is to grant the company rights in respect ofthe charged assets which are inconsistent with thenature of a ¢xed charge, then the charge cannot bea ¢xed charge however they may have chosen todescribe it. ... in construing a debenture to seewhether it creates a ¢xed or £oating charge, theonly intention which is relevant is the intentionthat the company should be free to deal with thecharged assets and withdraw them from the secur-ity without the consent of the holder of the charge;

or to put the question another way, whether thecharged assets were intended to be under thecontrol of the company or of the charge holder.

Lord Millett then explained that the critical ques-tion was whether or not the company was free tocollect the uncollected book debts for its own bene¢t8

and accordingly, the ‘debt’ could not sensibly beseparated from its ‘proceeds’:

While a debt and its proceeds are two separateassets, however, the latter are merely the traceableproceeds of the former and represent its entirevalue. A debt is a receivable; it is merely a right toreceive payment from the debtor. Such a rightcannot be enjoyed in specie; its value can beexploited only by exercising the right or by assign-ing it for value to a third party. An assignment orcharge of a receivable which does not carry with itthe right to receipt has no value. It is worthless as asecurity. Any attempt in the present context toseparate the ownership of the debts from theownership of their proceeds (even if conceptuallypossible) makes no commercial sense.9

Further, at paragraph 48:

To constitute a charge on book debts a ¢xed charge,it is su⁄cient to prohibit the company from realis-ing the debts itself, whether by assignment orcollection. If the company seeks permission to doso in respect of a particular debt, the charge holdercan refuse permission or grant permission onterms, and can thus direct the application of theproceeds. But it is not necessary to go this far. Astheir Lordships have already noted, it is not incon-sistent with the ¢xed nature of a charge on bookdebts for the holder of the charge to appoint thecompany its agent to collect the debts for itsaccount and on its behalf. The Siebe Gorman case[ref] and In re Keenan Bros Ltd [ref] merely intro-duced an alternative mechanism for appropriatingthe proceeds to the security.[10] The proceeds of thedebts collected by the company were no longer tobe trust moneys but they were required to be paidinto a blocked account with the chargeholder. Thecommercial e¡ect was the same: the proceeds werenot at the company’s disposal. Such an arrange-ment is inconsistent with the charge being a£oating charge, since the debts are not available to

Notes

6 [2000] 1 NZLR 223.

7 At paragraph 32.

8 Paragraph 45.

9 Paragraph 46.

10 Although earlier in his Judgment Lord Millett had stated that such situation ‘was thought to obtain in the Siebe Gorman case [ref] and didobtain in In re Keenan Bros Ltd’; at paragraph 38 [emphasis added].

Catherine Addy




14

the company as a source of its cash £ow. But theirLordships would wish to make it clear that it is notenough to provide in the debenture that the account is ablocked account if it is not operated as one in fact.[emphasis added]

NewBullaswas accordingly overruled as a matter ofNew Zealand law but remained an unfortunate blotupon the English legal landscape, albeit one whichmost academics and practitioners regarded as likely tobe transitory. The likely meaning and/or e¡ect of thelast sentence in the extract from Lord Millett’s Judg-ment, emphasised above, will be returned to later inthis article.

Re Spectrum Plus

As part of its new banking arrangements, SpectrumPlus granted NatWest a Debenture which purported tocreate a speci¢c charge over the book debts of theCompany in terms which were materially indistin-guishable from that considered in Siebe Gorman. TheBank initially advanced GBP 200 000 to the Com-pany, debiting its new current account accordingly,and thereafter during the Company’s trading historythe overdraft facility varied from time to time but wasnever in credit. The proceeds of the book debts werecollected by the Company and paid into the currentaccount and the Company drew on that account asand when it needed to in the ordinary course of itsbusiness.

Inevitably the Bank asserted that the charge was a¢xed one and its submissions were principally foundedupon equitable tracing rules: It was pointed out by theBank that Slade J’s analysis in Siebe Gorman had beendirected at an account when in credit whereas inSpectrum Plus the parties had envisaged that theaccount would almost certainly always be overdrawnand the relationship between the parties had to beconstrued and characterised at the time the relevantcharge was created. Accordingly, so the Bank sub-mitted, since the book debt proceeds could not for-mally be traced into the payments made out of thebank account, the further drawings on the overdraft,whilst technically enabled by the payment in of theproceeds of the Company’s book debts, should notproperly be regarded as the use by the Company ofthose realisations. On the contrary, since the accountwas always overdrawn, each subsequent withdrawal

was a lending of new monies by the Bank and not arecycling of the book debts.

In contrast, the Crown’s position was that itmattered not whether the relevant account was incredit or in debit (provided that it was within acontractually agreed overdraft limit); what matteredwas the Company’s freedom to draw on the sameunless and until the current account/overdraft facilitywas withdrawn or otherwise terminated by the Bank.The Crown accepted that the present orthodox view inrelation to tracing assets is that if a company holds abook debt on trust for a third party, the payment of theproceeds of that book debt into an overdrawn accountand the immediate purchase of an asset of equivalentvalue by the Company with the use of monies drawnon that account will not enable the bene¢cial owner ofthe book debt to trace into that asset. However, it wassubmitted that this was to ignore the commercialreality of the situation and Lord Millett in Agnew, sothe Crown submitted, had made it clear that whencharacterising charges as ¢xed or £oating the issuewas di¡erent: ‘The question is not whether the com-pany is free to collect the uncollected book debts, butwhether it is free to do so for its own bene¢t’. Inparagraph 23 of his Judgment he put the question inthe following terms:

If the chargor is free to deal with the charged assetsand so withdraw them from the ambit of the chargewithout the consent of the chargee, then the chargeis a £oating charge. But the test can equally well beexpressed from the chargee’s point of view. If thecharged assets are not under its control so that itcan prevent their dissipation without its consent,then the charge cannot be a ¢xed charge.

In the absence of any express contractual restric-tions, the Bank necessarily came under an immediatecontractual obligation to permit the Company to drawan equivalent sum for the Company to use in theordinary course of its business, assuming of coursethat such drawings were within the authorised over-draft facility limit, and could not terminate thatcurrent account facility except upon notice.11Accord-ingly, the Crown submitted that unless and until theoverdraft facility was expressly terminated by theBank, the Company could at will remove the bookdebts from the ambit of the charge and use theproceeds (or at least their value) for its own ratherthan the Bank’s bene¢t, without the prior consent ofthe Bank.

Notes

11 See Joachimson v Swiss Bank Corpn [1921] 3 KB 110 andWilliams and Glyn’s Bank Ltd v Barnes [1981] Com L R 205.





15

Although New Bullas was formally binding uponthe Vice Chancellor and upon the Court of Appeal, ithad been so discredited that the Bank did not found itssubmissions on that precedent since any victory onsuch grounds would almost certainly have beenephemeral. Nevertheless it was with some surprisethat the Vice Chancellor departed from it at ¢rstinstance, holding that the charge over Spectrum Plus’book debts was only a £oating security.12

By contrast, Lord Phillips of Maltravers MR, givingthe Judgment of the Court of Appeal, accepted thatwhilst the reasoning in New Bullas could no longer besupported, it had not been open to the Vice Chancellorand indeed it was not open to the Court of Appeal to¢nd that the charge in question was anything otherthan a ¢xed charge. However, Lord Phillips proceededto consider the matter further stating that he would inany event otherwise allow the appeal on 2 alternativegrounds.

First he considered that the Company’s obligation topay the proceeds of the book debts into a currentaccount which was at any time (as a matter ofcontractual assumption) likely to be overdrawn oper-ated as a repayment pro tanto of the Company’s debtto the bank such that the Company chargee could notin fact use the proceeds of the book debts for itsongoing business. His reasoning in reaching thisconclusion was along the following lines: ApplyingFoley vHill (1848) 2 HL Cas 2813, upon payment of theproceeds into the bank account title to those (physical)proceeds passes absolutely to the bank; the obligationswhich the bank then comes under to permit with-drawals of funds from the account are merely con-tractual and confer no proprietary rights in thoseproceeds to the Company; when a bank honours acheque drawn on an overdrawn account, the bank isin fact advancing monies to the customer ^ Coutts &Co v Stock [2000] 1 WLR 906, 910; upon payment ofproceeds into an overdrawn bank account, thoseproceeds operate to discharge in part the debt owedto the bank and are thus appropriated to the chargee;and it was ‘not satisfactory that the categorisation of acharge created by a debenture should turn upon theprecise details of a bank’s [contractual] relationshipwith its customer’14. If this analysis was correct, itnecessarily threw into doubt much of the previous lawand was in direct con£ict with the reasoning inAgnew

which had emphasised the importance of consideringthe commercial reality of the situation.

Second he held that, even if Slade J had beenerroneous in his construction of the material terms,he ‘would have been inclined to hold that the form ofdebenture in question had, by customary usage,acquired the meaning and e¡ect that he had attrib-uted to it’15. With respect to Lord Phillips, it is notentirely clear what he meant by his statement that therelevant wording had by customary usage acquired themeaning and e¡ect attributed to it by Slade J: It is onething to suggest that the meaning and e¡ect of thewords was such as to actually impose the relevantrestriction upon the Company’s use of the bankaccount (of which there was no evidence before theCourt) but another to suggest that by custom andusage such contractual arrangement had acquiredthe status of a ¢xed rather than a £oating chargethereby a¡ecting the interests of independent thirdparties.

The Crown’s arguments were, ¢nally, ¢rmlyendorsed by the House of Lords [2005] UKHL 41;[2005] 3 WLR 58.

The House of Lords’ decision oncharacterisation

Lords Nicholls, Steyn, and Brown and Baroness Haleall expressly agreed with the Judgments of Lords Scott,Hope andWalker on the issue of characterisation.

Lord Scott ¢rst con¢rmed his agreement with LordMillett’s comment in Agnew that Romer LJ’s ¢rst twocharacteristics, although typical of a £oating chargeare not distinctive of it as they are not necessarilyinconsistent with a ¢xed charge, rather it is the thirdcharacteristic which is the hallmark of a £oatingcharge and distinguishes it from a ¢xed charge.16

He then disposed of New Bullas, by adopting LordMillett’s reasoning in Agnew. In particular he notedthat

If a book debt were to be charged as security butwith an accompanying provision that any moneyreceived from the debtor in payment of the debtwould belong to the chargor, the so-called ‘charge’,whether expressed to be a ¢xed charge or a £oatingcharge, would not be a security at all ... And if the

Notes

12 In side-steppingNew Bullas, the Vice Chancellor appears to have adopted the argument put forward by the Crown that New Bullaswas itselfinconsistent with the House of Lords’ own decision in Illingworth v Houldsworth (as further elucidated by their Lordships in theAgnew case)and could thus be ignored since he was bound by the latter: This issue was dealt with in some brevity in paragraph 34 of his Judgment,perhaps re£ecting the degree of enthusiasm with which the submissions had been put forward.

13 Per Lord Cottenham LC, ‘Money, when paid into a bank, ceases altogether to be the money of the principal’.

14 Paragraph 94

15 Paragraph 97.

16 At paragraph 107.

Catherine Addy




16

charge were to be expressed to be a ¢xed charge asrespects the receivable debt but a £oating charge asrespects the money received from the debtor therewould be an internal contradiction in the formula-tion of the charge. Since the essential value of abook debt as a security lies in the money that can beobtained from the debtor in payment it seems to methat Lord Millett was right in concluding that sucha security should be categorised as a £oatingsecurity.

Having dealt with issues of principle he thenproceeded to deal with the question of the character-isation of the charge over the book debts of SpectrumPlus. In considering whether or not there were su⁄-cient restrictions placed upon the Company’s ability touse the proceeds of the book debts he addressed thefairly novel point which had been raised by LordPhillips and which was inevitably pressed upon theHouse of Lords by Counsel for the Bank. Lord Scott’sanswer was in the following terms:

Your Lordships should not, in my opinion, acceptthis argument. It seeks to perpetuate what I regardas the New Bullas heresy, namely, that the categor-isation of a charge over book debts can ignore therights of the chargor over the money received inpayment of those debts. The expression ‘£oatingcharge’ has never been a term of art but is anexpression invented by equity lawyers and judgesto describe the nature of a particular type ofsecurity arrangement between lenders andborrowers. The categorisation depends upon thecommercial nature and substance of the arrange-ment, not upon a formalistic analysis of how thebank clearing system works. If part of the arrange-ment is that the chargor is free to collect the bookdebts but must pay the collected money into aspeci¢ed bank account, the categorisation mustdepend, in my opinion, on what, if any, restrictionsthere are on the use the chargor can make of thecredit to the account that re£ects each paymentin.17

Since the Bank placed no restrictions on SpectrumPlus’s ability to draw upon the account (provided thatthe same remained within its overdraft limit), heconcluded the charge must necessarily be charac-terised as a £oating charge:

The overdraft facility was there to be drawn on bySpectrum at will. In the operation of the accountthere was never a suggestion that Spectrum needed

to obtain the bank’s consent before writing acheque. The bank could, by notice, have terminatedthe overdraft facility, required immediate repay-ment of the indebtedness and turned the accountinto a blocked account. Pending such a notice,however, Spectrum was free to draw on theaccount. Its right to do so was inconsistent withthe charge being a ¢xed charge and the label placedon the charge by the debenture cannot, in myopinion, be prayed in aid to detract from thatright.18

The future implications of Re Spectrum Plus

How can ¢xed charges over book debts be created postRe Spectrum Plus? Lord Hope expressly consideredthree limited ways in which a ¢xed charge over bookdebts could be created (as least so far as the law ofEngland andWales is concerned)19:

(i) Preventing all dealings with the book debts otherthan their collection and requiring the proceedsto be paid to the chargee in reduction of thechargor’s outstanding debt ^ however, as hehimself recognised, this is unlikely to prove ac-ceptable to a company wishing to carry onbusiness normally, maintaining its cash £ow andworking capital.

(ii) Preventing all dealings with the debts other thantheir collection and requiring the collected pro-ceeds to be paid into an account with the chargeebank. ‘That account must then be blocked so as topreserve the proceeds for the bene¢t of thechargee’s security’.

(iii) Preventing all dealings with the debts other thantheir collection and requiring the collected pro-ceeds to be paid into a separate account with athird party bank over which the chargee thentakes a ¢rst ¢xed charge to preserve the sums paidinto it for the bene¢t if its security.

The writer is of the view that there are 2 key issuesarising from the substantive decision in Re SpectrumPlus, for the future characterisation of charges, being(i) control and (ii) commercial realism.‘Control’, mean-ing permanent control, by the chargee over the assetswhich are the subject of the relevant charge and‘commercial realism’ in assessing whether or not suchcontrol exists. In particular, in view of the terms of theJudgments of Lords Scott and Hope, as noted above,the writer is presently of the view that unless a charge

Notes

17 Paragraph 116.

18 Paragraph 119.

19 At paragraph 54.





17

requires the proceeds of the book debts to be paid intoa designated account and expressly prohibits thechargor from drawing on such account without thechargee’s prior and genuine discretionary consent ona transaction by transaction basis, that chargewill notconstitute a ¢xed charge over the relevant book debts.In this regard, the terms of the recent ‘Statement onbehalf of HM Revenue & Customs and the DTI InsolvencyService (The Crown Departments)’,20 issued expressly inthe light of the House of Lords’ Judgment in ReSpectrum Plus are of note.

Lord Millett’s comments regarding theoperation of the blocked account

The Crown Departments’ Statement makes clear thatthey ‘consider that charges which formally appear tomeet the criteria for a ¢xed charge as they appear inthe debenture but fail to do so are, in reality, £oatingcharges’. This is perhaps a reference to Lord Millett’scomment in Agnew noted above that, ‘their Lordshipswish to make it clear that it is not enough to provide inthe debenture that the account is a blocked account ifit is not operated as one in fact’ but exactly what thePrivy Council meant by this is not entirely clear. Itpresumably should not be read as requiring a postcontractual analysis of the parties’ conduct for thepurpose of construing the charge. Indeed, to habi-tually do so would £y in the face of established law onthe issue of contractual interpretation; see e.g. JamesMiller and Partners Ltd v Whitworth Estates (Man-chester) Ltd [1970] AC 583. However, it is also wellestablished that, ‘although the subsequent actings ofthe party may not be prayed in aid for the purposes ofconstruing the agreement they may be looked at forthe purposes of determining whether or not parts ofthe agreements are a sham in the sense that they wereintended merely as ‘dressing up’ and not as provisionsto which any e¡ect would be given’.21

Accordingly, if the common intention of the partiesis that a stated restriction is simply designed to givethe appearance of creating a blocked account when itis understood by all concerned that it will not beoperated as one in fact the apparent creation of a ¢xedcharge will nevertheless be impeachable as a shamtransaction. Such an intention will often be incapableof direct proof, but perfectly capable of being inferred,for example, by an habitual drawing by the companyfrom a purportedly blocked account without obtain-ing prior consent, or from a purely formal process ofthe seeking and giving of consent unaccompanied byany genuine exercise of discretion by the chargee.

Query whether, if when the debenture is executedthe genuine intention of the parties is to create ablocked account but the chargor is subsequently andindependently given general permission to draw onthe account by the chargee, the debenture never-theless created a ¢xed charge for the purposes of theInsolvency Act 1986 as the Act de¢nes a £oatingcharge as ‘a charge which, as created, was a £oatingcharge’.

Other necessary restrictions

It is also worth noting that in Re Spectrum Plus Limitedthe Crown had additionally taken issue with whetheror not the restrictions imposed by the Debenture uponthe Company’s dealings with the uncollected bookdebts were su⁄cient for the charge to be otherwisecharacterised as a ¢xed charge. The Debenture ex-pressly restricted the chargor from selling, factoring,discounting, or otherwise charging or assigning thebook debts but, there were no other express restric-tions on what the Company was permitted to do withthe book debts (other than to require the proceeds ofany debts which might be collected to be paid into theCompany’s account with the bank). For example, therewere no express restrictions on the Company prevent-ing it from: (i) granting further time for payment; (ii)accepting a lesser sum by way of compromise; (iii)deciding not to collect the debt; (iv) abandoning orreleasing the debt; (v) agreeing with any creditor thatthe book debt should be set o¡ against a debt owed bythe Company; or (vi) agreeing to accept property orservices in lieu of money payment.

The Crown argued that if the Company was free toundertake the above activities for its own bene¢t andin the ordinary course of its business without seekingthe prior consent of the Bank on a case by case basis,the Company did not have su⁄cient control over therelevant book debts for the charge to be correctlycharacterised as a ¢xed charge in any event. Underthe terms of the Debenture, the Bank was entitled torequire the Company to assign the relevant debts to it,thereby terminating the Company’s liberty to under-take such activities; however the freedom of a chargorto deal with charged assets pending the future inter-vention by a chargee is of course a classic hallmark ofa £oating charge. In this regard, it is signi¢cant thatLord Hope, in each of his proposed examples of ¢xedcharges over book debts, refers to such chargespreventing all dealings with the book debts other thantheir collection and payment into designatedaccounts.

Notes

20 Available from5http://www.hmrc.gov.uk/news/spectrum.htm4.

21 AG Securities Ltd vVaughan [1900] 1 AC 417.

Catherine Addy




18

Prospective overruling

The second part of this Article follows in the nextedition of this publication and will explore the implica-tions of the House of Lords’ decision in Re SpectrumPlus on the issue of ‘prospective overruling’.




19

CASE REVIEW SECTION

Fixed and Floating Charges over Book Debts ^ the Implications ofthe House of Lords’ Decision in Re Spectrum Plus Limited [2005]UKHL 41, Part II

Catherine Addy, Barrister at Maitland Chambers, London,UK and Junior Counsel for the Crownin Re Spectrum Plus

Introduction

Part I of this article, which appeared in issue [insertno.] of this publication, examined the history behindand the reasoning and implications of the House ofLords’ recent decision in Re Spectrum Plus Limited[2005] UKHL 41 in relation to the characterisation of¢xed and £oating charges over book debts. This secondpart of the article, which should be read in conjunc-tion with the ¢rst, explores the implications of theHouse of Lords’ decision in Re Spectrum Plus on theissue of ‘prospective overruling’.

Prospective overruling

As noted in the Case Summary which appeared inIssue 4 of this publication earlier this year, ReSpectrum Plus is the ¢rst occasion in English legalhistory on which their Lordships have collectivelyexpressly considered that they would have the powerto engage in prospective overruling of previous deci-sions in an appropriate case.1 Lord Nicholls of Birken-head gave the leading Judgment on this issue,ultimately expressing the view that the House ofLords, in the exercise of its judicial function wouldnot be trespassing outside its proper functions under

the constitution if it decided in a particular case todepart from the normal principle of retrospectivityand engage in prospective overruling. Although therewas some dissent regarding whether or not it would bepermissible to exercise such a power in relation toquestions of statutory interpretation,2 all of the Lord-ships expressly agreed with Lord Nicholls that theHouse would, in an appropriate case, be permitted toengage in prospective overruling.

However, Lord Nicholls considered that the situa-tion inRe Spectrum Plus (25 years’ asserted reliance bybanks and guarantors on the ¢rst instance decision ofSlade J in Siebe Gorman3) was ‘miles away’ from theexceptional category of cases in which prospectiveoverruling might be appropriate. So when is suchpower likely to be exercised? Not unsurprisingly, noguidance was given by their Lordships as to whensuch a ‘wholly exceptional case’ might be consideredto have arisen.

The only other common law jurisdictions whichhave to date engaged in prospective overruling arethe United States and India.4 Since India has onlyreally engaged in prospective overruling in constitu-tional lawmatters, useful guidance is more likely to beobtained from US jurisprudence. Prospective Over-ruling has been part of the US judicial armoury since

49

Notes

1 Although individual law lords have on previous occasions expressed a possible willingness to engage in prospective overruling, the writer isunaware of any previous decision in which a majority of the House of Lords has expressly reached the conclusion that it would have such apower in appropriate circumstances and indeed, the argument before their Lordships in Re Spectrum Plus Ltd by the Crown Appellants, theRespondent Bank and the Advocates to the Court all proceeded on this basis.

2 See for example the Judgments of Lords Scott and Lord Steyn.

3 Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyds Rep 142.

4 The High Court of Australia has emphatically rejected the existence of any such power on the part of the judiciary; see Ha v New SouthWales[1996-7] 189 CLR 465. It has on occasion been asserted that the Irish Supreme Court engaged in prospective overruling in Murphy andMurphy v AG [1982] IR 241; however the writer is of the view that this is to misunderstand the Judgment of Henchy J, with whom themajority of the other members of the Court agreed on this issue. That case concerned the constitutionality of tax legislation whose e¡ect wasto discriminate between married and unmarried couples living together such that the former had a lower tax free allowance. Henchy J heldthat married couples ought properly to have been required to pay less tax but that ‘in the events that have happened and for the reasonsgiven in this judgment, no taxpayers other than the plainti¡s would have the standing necessary to maintain a claim that the State shouldreimburse them’. However this was simply because, on his analysis of the law, the taxpayer’s action had to be framed either as a common-lawaction in quasi-contract for money had and received or as an equitable claim for restitution and that, in the events which had inevitably


20

the mid 19th century and was most famously en-capsulated by the Supreme Court in Great NorthernRailway Co v Sunburst Oil and Re¢ning Co (1932) 287US 358. In that case, the Supreme Court consideredthe argument that adherence to a precedent for theinterpretation of a local statute in the past, whencoupled with the declaration of an intention to departfrom it in the future, constituted a denial of dueprocess. (The appeal was against a decision of theSupreme Court of Montana which had refused to giveits own determination retroactive e¡ect.) Justice Car-dozo delivered the Judgment of the Court in thefollowing terms:

‘We think the federal constitution has no voiceupon the subject. A state in de¢ning the limits ofadherence to precedent maymake a choice for itselfbetween the principle of forward operation and thatof relation backward. It may say that decisions of itshighest court, though later overruled, are law nonethe less for intermediate transactions. Indeed thereare cases intimating, too broadly [ref.], that it mustgive them that e¡ect; but never has doubt beenexpressed that it may so treat them if it pleases,whenever injustice or hardship will thereby beaverted [refs.] On the other hand, it may hold tothe ancient dogma that the law declared by itscourts had a Platonic or ideal existence before theact of declaration, in which event the discrediteddeclaration will be viewed as if it had never been,and the reconsidered declaration as law from thebeginning. [refs.] The alternative is the samewhether the subject of the new decision is commonlaw [ref.] or statute [refs.].’

This was later followed by the US Supreme Court inrelation to federal law matters in Chevron Oil Co vHuson (1971) 404 US 618, which was regarded inthe US as the leading decision on the circumstances inwhich the power would be exercised. In that case theUS Supreme Court helpfully summarised the positionin the following terms:

‘In our cases dealing with the nonretroactivityquestion, we have generally considered three sepa-rate factors. First, the decision to be applied non-retroactively must establish a new principle of law,either by overruling clear past precedent on whichlitigants may have relied, see, e.g. Hanover Shoe vUnited ShoeMachinery Corp., or by deciding an issue

of ¢rst impression whose resolution was not clearlyforeshadowed, see, e.g. Allen v State Board of Elec-tions. Second, it has been stressed that ‘we must ...weigh the merits and demerits in each case bylooking to the prior history of the rule in questionits purpose and e¡ect, and whether retrospectiveoperation will further or retard its operation’.Linkletter v Walker. Finally, we have weighted theinequity imposed by retroactive application, for‘[w]here a decision of this Court could producesubstantial inequitable results if applied retro-actively, there is ample basis in our cases foravoiding the ‘injustice or hardship’ by a holding ofnonretroactivity’. Cipriano v City of Hourma.’5

However, as noted by Lord Nicholls, despite theirpreviously enthusiastic embrace of the doctrine, theUS Courts have since retreated and the Supreme Court(at least for the present time) has abandoned prospec-tive overruling when directly reviewing criminalcases and abandoned selective prospective overrulingin civil cases. Whether the US Supreme Court hasabandoned pure prospective overruling in civil casespresently remains unresolved.6 In the circumstances,whilst some guidance might be gleaned from previousUS cases, care will need to be taken in assessingwhether or not they remain good law. The writerwould presently recommend reading the Judgment ofthe Court of Appeals of the Eleventh Circuit in Glaznerv Glazner (2003) 347 F 3d 1212 for a clear andcomprehensive summary of the current US juris-prudence on this subject.

EU jurisprudence is also likely to be helpful and it isof interest that the doctrine appears to have been ¢rstadopted by the European Court of Justice at theinvitation of the UK in Defrenne v SABENA (Case 43/75)7. In that case a female air hostess, who had beenpaid less than her male counterparts, was dismissedwhen she reached the age of 40 pursuant to a term ofher contract of employment applicable only to femaleemployees. The ECJ ruled that the then Article 119(equal treatment) had been directly e¡ective in the UKsince 1973. However, in view of the UK’s representa-tions of the serious possible economic consequences ofthe decision, the ECJ ruled that their judgment wouldhave prospective e¡ect only, save in relation to thecase before it and as regards those workers who hadalready brought legal proceedings or made equivalentclaims under national law as at that date.

50

Noteshappened (being the mixing and application of funds by the state), he considered that unless individual taxpayers had previously challengedthe constitutionality of the relevant deductions, the e¡ect of the application of the doctrine of laches and/or a ‘change of position’ defence bythe State was such that those taxpayers could not successfully recover their payments in any event; it was not, as has been suggested bysome, any exercise in prospective overruling.

5 404 US 97 at 106 [references omitted].

6 See for example the authorities referred to by Lord Nicholls in paragraph 19 of his Judgment.

7 [1976] ECR 471.

Catherine Addy

International Corporate Rescue, Volume 3, Issue 1# 2006 Kluwer Law International


21

More recently in Rider (Bida) v Ealing London Bor-ough Council [2005] 2 WLR 1078 the ECJ explained:

‘The court has taken that step [of prospective over-ruling] only in quite speci¢c circumstances, wherethere was a risk of serious economic repercussionsowing in particular to the large number of legalrelationships entered into in good faith on the basisof rules considered to be validly in force and whereit appeared that both individuals and nationalauthorities had been led into adopting practiceswhich did not comply with community legislationby reason of objective, signi¢cant uncertaintyregarding the implications of community provi-sions, to which the conduct of other member statesor the commission may even have contributed ...’8

In Re Spectrum Plus Lord Nicholls also highlightedthe di⁄culties in choosing between pure or selectiveprospective overruling and, if the latter, in determin-ing such selection. By way of example, in Re SpectrumPlus a wide variety of commencement dates couldhave been justi¢ed: the various dates of publishedcriticism of Siebe Gorman; the date the Privy Councilhanded down its decision in Agnew; the publicationdate of the Crown Departments’ Statement; the date ofthe ¢rst instance or House of Lords’ Judgment in theinstant case. Alternatively Siebe Gorman could havebeen overturned with prospective e¡ect from the dateof the House of Lords’ Judgment but whilst making anexception for the parties to that litigation and perhapsto any other proceedings which had already beencommenced. The potential injustices are obvious.

What is however clear is that any party whoenvisages inviting the House of Lords to engage inprospective overruling in the future must ensure thatit presents cogent evidence of the relevant relianceand injustice which would be su¡ered by the ordinarye¡ects of overruling without temporal restriction andthat it has given careful thought to the most appro-priate form of temporal limitation.

Finally, is prospective overruling ever likely to beapplied to a question of statutory interpretation?Whilst Lord Nicholls has no present issues with thispossibility, both Lords Scott and Steyn made cleartheir position that that they would regard such anexercise as outwith their proper judicial function.

The writer’s own present view is that their Lord-ships would be likely to be trespassing outside thefunctions properly to be discharged by the judiciaryunder this country’s constitution if they engaged inprospective overruling in relation to a matter ofstatutory interpretation: Arden LJ has also said extra-judicially that there are ‘probably cases where it canbe said with certainty that the concept of prospectiveoverruling should not be used, as where the decisionturns purely on the construction of a statute’9. Thisresults from the doctrine of parliamentary sover-eignty: Parliament cannot be taken to have meantone thing for one period of time and another for asubsequent period of time; it would be for Parliamentto decide whether any remedy should be provided forthose who had previously misunderstood its intentionand not for the courts to e¡ectively mis/dis-apply thestatute for a court-prescribed period of time.10 Theonly exception to this would be those rare instanceswhere the meaning of a particular word or expressioncould legitimately be said to have changed over timeand since an Act of Parliament is ‘always speaking’ itsmeaning can be said to have actually changed; see byway of example the construction of the Rent Actlegislation in Fitzpatrick v Sterling Association Ltd[2001] 1 AC 27.11

In this regard it is of note that Lords Scott and Hopewere expressly persuaded by the Crown’s argumentthat since the statutory regime for the postponementof £oating charges to preferential debts was institutedby Parliament (speci¢cally for the bene¢t of classes ofpersons distinct from the parties to the charges inissue), it was not open to the courts in exercise of theirjudicial power to deprive the preferential creditors ofthe rights given to them by statute: The retrospectiveoverruling of Siebe Gorman gave e¡ect to the will ofParliament, whereas a merely prospective overrulingwould not have done, otherwise than in the future.12

Indeed, Lord Nicholls also regarded this e¡ect as afactor weighing against prospective overruling in thepresent case.13 Since the area of insolvency law is onewhich is necessarily dominated by statutory provi-sion, the strength of this argument is likely to be ofparticular interest or signi¢cance to insolvency law-yers and practitioners alike if the desirability ofobtaining a prospective overruling should arise againin the future.

51 International Corporate Rescue, Volume 3, Issue 1# 2006 Kluwer Law International

Notes

8 Paragraph 69 at p.1112 of the report.

9 [2004] 120 LQR 7 at 11. See also Nicol [1976] MLR 542 at 555^6.

10 Ibid.

11 Where it was accepted that the expression ‘member of a tenant’s family’ should, in view of the changed social climate, now be considered toinclude a long-term homosexual partner.

12 Paragraph 74 and paragraphs 126--127.

13 Paragraph 43.

Fixed and Floating Charges over Book Debts ^ the House of Lords’Decision in Re Spectrum Plus Limited, Part II


22

By way of postscript, readers should also be warnedthat, when it came to considering the possibility ofengaging in prospective overruling, their Lordshipswere seemingly united in their view that reliance bylawyers, insolvency practitioners, banks and/or othercommercial institutions upon the terms of a Judgmentgiven at ¢rst instance (even by a Judge as eminentlywell-respected as Slade J) would be most unlikely toprovide su⁄cient foundation to justify the exercise ofsuch power. In particular, Lord Hope considered thatas a ¢rst instance decision is always open to correction

by an appellate court those who relied upon it must betaken to have been aware of this14 and in the words ofLord Nicholls: ‘No doubt over the years the clearingbanks, including the respondent bank, have to someextent relied upon the Siebe Gorman decision [ref.]when formulating and using their standard forms ofcharges on book debts. The Siebe Gorman case was a¢rst instance decision. It cannot have been regardedas de¢nitively settling the law in this ¢eld.’15 Theterms of these comments are likely to raise muchwider concerns for many readers!

52

Notes

14 Paragraph 64.

15 Paragraph 43.

Catherine Addy

International Corporate Rescue, Volume 3, Issue 1# 2006 Kluwer Law International

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