Brumark case, Factors and Invoice Discounters, Insolvency Practitioners UK

Brumark - Fixed or Floating Charge?

Bad News For UK Clearing Banks?

Background

On 5 June 2001 the Privy Counsel gave judgement on appeal from the New Zealand Court of Appeals decision in re Brumark Investments Limited.

The case was brought by the receivers of Brumark Investments Limited who were seeking formal interpretation of a clause in a debenture granted by the company to the Westpac Banking Corporation. This clause purported to provide Westpac with a fixed charge over the company's book debts arising from the normal course of business and over the proceeds of such book debts.

It is recognised that UK Clearing Banks have relied upon a fixed charge over book debts created by their own debentures in instances of a client company's insolvency. This has until the Brumark ruling resulted in Insolvency Practitioners paying over receipts from book debts to the Clearing Bank in priority to other creditors.

The Brumark ruling brings into question the validity of a fixed charge over the book debts of an insolvent company. These are most commonly held by the clearing banks.

The ruling relies upon long standing authority that if a debtor (the client company) is free to deal with an asset as it sees fit and without recourse to the approval of the chargeholder, the asset cannot be subject to a fixed charge. The fact that a debtor is free to collect monies due from its book debts and dispose of those monies as it sees fit is inconsistent with the nature of a fixed charge.

What does this mean?

Historically, Insolvency Practitioners distributed book debt realisations to bankers pursuant to the fixed charge contained within the bank's debenture. The Brumark ruling contends that such realisations are in fact, only floating charge assets and are therefore not payable to the chargeholder under its fixed charge. Instead realisations of this nature represent floating charge assets and are therefore subject in the first instance to the remuneration and out of pocket expenses of the appointed Insolvency Practitioner and thereafter to the preferential creditors i.e. the government departments in respect of PAYE/NIC and VAT and employee claims in respect of arrears of wages to a maximum of £800 per employee and holiday pay.

The Government Position

Insolvency Practitioners have been left in no doubt by the government departments that where a distribution of book debt proceeds is made subject to a purported fixed charge, the departments concerned reserve the right to challenge that distribution.

Practical Implications

Despite the fact that Brumark remains a New Zealand Privy Counsel ruling and is yet to become law in England and Wales, the Privy Counsel is nonetheless comprised of the highest Law Lords in the UK. It is currently therefore assumed that it is only a matter of time before it also becomes the law of our land. Indeed recent literature received from the Insolvency Practitioners Association indicates that the House of Lords will affirm the Brumark ruling when a suitable case is brought before it.

The banks position is therefore materially affected resulting in all costs of the insolvency proceedings and repayment in full to preferential creditors being made before it may expect to receive a distribution under its floating charge. In these circumstances the banks will see a significant reduction in the level of their security and consequently the level of funds received from insolvency proceedings.

The effect of Brumark will have a significant knock on effect to those parties, particularly Directors, who have provided additional security to banks in the form of either personal guarantees or charges over their properties, which will now be called upon where historically the banks would have received some level of repayment under their fixed charge. The persuasive nature of Brumark means the vast majority of Insolvency Practitioners throughout the UK are currently holding funds realised from insolvent companies book debts, until such time as the law has been clarified.

The Effect on Factors and Invoice Discounters

Factors and Invoice discounters take an assignment of their client's book debts thereby assuming legal title to the debt and it's proceeds. Additionally, collections are received into blocked accounts. The terms of Brumark therefore do not affect the security held by Factors and Invoice Discounters. As a consequence of this in practical terms where possible the clearing banks have taken steps to transfer many of their clients from more recognised forms of funding such as business development loans and overdraft facilities to their factoring and invoice discounting arms.

Reproduced with permission of Harrisons Business recovery and insolvency specialists.