SPECTRUM CASE

Journal of International Banking & Financial Law/2007 Volume 22/Issue 2, February/Articles/Re Spectrum Plus, a year (and a bit) on -- what conclusions can now be drawn? - (2007) 2 JIBFL 67

Journal of International Banking and Financial Law

(2007) 2 JIBFL 67

1 February 2007

Re Spectrum Plus, a year (and a bit) on -- what conclusions can now be drawn?

Spotlight

Catherine Addy

was junior counsel to the Crown in RE Spectrum Plus. She is a barrister at Maitland Chambers, 7 Stone Buildings, Lincoln's Inn, London and specialises in insolvency and commercial chancery litigation. Catherine was appointed by the Attorney General as one of the Junior Counsel to the Crown in February 2003 and is currently a member of the 'B' Panel. Email: cjaddy@maitlandchambers.com
© Reed Elsevier (UK) Ltd 2007

The much awaited decision of the House of Lords in Re Spectrum Plus [2005] UKHL 41 was handed down in June 2005 and an immediate plethora of commentary followed. Since then over a year has elapsed and the excitement which the case invoked, both in anticipation of its determination and during the immediate aftermath, has seemingly all but evaporated. This article considers the conclusions, if any, that can be drawn from the case.

KEY POINTS

· Those operating at the coal face of financial lending have indicated that in practical terms much has remained unchanged.

· The creation of a 'blocked account' ultimately depends upon the genuine discretionary consent of the chargee to withdrawals.

· Sufficient restrictions should also be imposed in respect of the chargor's dealings with uncollected debts.

· It is likely that the next battleground will focus on the implications of the House of Lords' decision for charges on assets other than book debts.

Soon after the Re Spectrum Plus [2005] UKHL 41 decision was announced many proclaimed that the result had always been a foregone conclusion and the catastrophic economic implications of overruling Siebe Gorman (1979) 2 Lloyd's Rep 142 professed to be feared by the Bank (in support of its contention that, in the event of the House of Lords being otherwise against it, such case should be overruled only with prospective effect) seem never to have materialised.

SO, A YEAR AND A BIT ON, WHAT CONCLUSIONS CAN NOW BE DRAWN?

As at the time of writing this article, it seems that the only reported case in which Re Spectrum Plus has featured with any significance is Re Beam Tube Products Limited [2006] EWHC 486 (Ch) and even then that case merely involved a recitation and fairly straightforward application of the relevant principles; the facts of that case predominantly concerning the appropriate characterisation of a charge expressed to be fixed over the company's book debts and floating over the proceeds thereof once paid into a collection account.
Inevitably therefore all conclusions to be drawn, even a year and a bit on, must still be drawn from the contents of their Lordships' judgments in the case and from the debate which took place before the House in the course of those proceedings.

THE RESULT

As most readers will recall, Lord Hope of Craighead, Lord Scott of Foscote and Lord Walker of Gestingthorpe gave the substantive judgments on the question of characterisation of fixed and floating charges (the other four members of the panel expressly agreeing with them on this issue) and in most instances it is invariably sufficient to refer to the analysis set out in the judgment of Lord Scott.
The starting point continues to be the classical exposition by Romer LJ in Re Yorkshire Woolcombers' Association [1903] Ch 284 (at 295) that:

'... if a charge has the three characteristics that I am about to mention it is a floating charge. (1) If it is a charge on a class of assets of a company present and future; (2) if that class is one which, in the ordinary course of the business of the company, would be changing from time to time; and (3) if you find that by the charge it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class of assets I am dealing with.'


However, Lord Scott considered, as Lord Millett did before him in Re Brumark (Agnew v IRC) [2001] UKPC 28, that Romer LJ's first two characteristics, although typical of a floating charge, are not distinctive of it as they are not necessarily inconsistent with a fixed charge, rather it is the third characteristic which is the hallmark of a floating charge and that which distinguishes it from a fixed charge.
Indeed, he concluded that if a security has Romer LJ's third characteristic it cannot be a fixed charge whatever might be its other characteristics:
'the essential characteristic of a floating charge, the characteristic that distinguishes it from a fixed charge, is that the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event. In the meantime the chargor is left free to use the charged asset and to remove it from the security.'


Lord Scott further considered that such consideration depended upon the 'commercial nature and substance of the arrangement' and not upon a formalistic analysis of the bank clearing system, since to do otherwise was to perpetuate the New Bullas [1994] 1 BCLC 485 (CA) heresy that the categorisation of a charge over book debts could ignore the rights of a chargor over the proceeds of those debts.
Accordingly, the House of Lords concluded that, since the Bank placed no restrictions on Spectrum Plus' ability to draw upon the account into which the collected book debt proceeds were to be paid (provided of course that the company remained within its overdraft limit), the charge had to be characterised as a floating charge since, by paying such proceeds into the account, the company was thereby effectively able to withdraw them from the ambit of the charge without the consent of the bank chargee. In order for a charge over book debts to be characterised as a fixed charge, the account into which the proceeds are required to be paid has to be a 'blocked account'. Indeed, in Re Brumark Lord Millett seemingly went further than this expressing the view on behalf of the Privy Council (at para 48) that:
'their Lordships wish to make it clear that it is not enough to provide in the debenture that the account is a blocked account if it is not operated as one in fact'.


THE FACTUAL OPERATION OF THE 'BLOCKED ACCOUNT'

The above comment of Lord Millett on behalf of the Privy Council in Re Brumark sparked much debate in the course of the Spectrum Plus litigation but regrettably received no further clarification from the House of Lords.
Nevertheless, the parties in Spectrum Plus were essentially in agreement that it ought not to be read as requiring a post-contractual analysis of conduct for the purposes of construing the relevant charge. Indeed, to habitually do so would be contrary to established case law on interpretation of contracts; the meaning and construction of a contract cannot be reconsidered by reference to events subsequent to its creation; see for example James Miller and Partners Limited v Whitworth Estates (Manchester) Ltd [1970] AC 583.
This point is somewhat exemplified by the judgment in Re Beam Tube Products in which Blackburn J concluded that the parties' subsequent attempt to operate a blocked account (in the mistaken assumption that that was what the security documentation required or otherwise) could not assist the chargees in their attempts to have the charge construed in a way which would be characterised as fixed; rather the lenders had to rely upon the objective contractual rights conferred by the Debenture as at the time of execution. The Debenture stipulated that the company chargor was to have free use of the proceeds once they were paid into the collection account, the fact that the collection account was operated in such a way that it did not, could not put the Debenture holder in any better position than it would have been in if the terms of the Debenture had been duly observed.
However, stated restrictions which would otherwise suffice for the charge to be characterised as fixed, will not be given appropriate consideration if they amount to mere window dressing and/or were otherwise never intended to be observed and it is of course permissible to examine the subsequent conduct of contracting parties in order to determine whether or not any parts of an agreement between them are in fact a sham.
Conversely, if the reverse of the position in Re Beam Tube Products were to occur, such that, although there was a genuine intention to operate the requisite blocked account at the time that the charge was created, general permission to draw on the account is then subsequently given to the chargor, it remains to be seen whether this would operate to convert the charge from a fixed to a floating security. However, the insolvency legislation of course defines a floating charge as meaning 'a charge which, as created, was a floating charge'.
Lord Millett's wording would therefore seem to pertain only to those cases involving allegations of window dressing or sham transactions; whilst it may be difficult to prove the existence of a contemporaneous intention not to operate a blocked account as one in fact, or alternatively the absence of any intention to operate such an account, either may very easily be inferred from the subsequent conduct of the parties to the charge.

FIXED CHARGE OVER BOOK DEBTS IN THE FUTURE

In terms of conclusions, it is of course clear that a charge such as the one used by the Bank in Spectrum Plus will not create an effective fixed charge but where does that leave the position in relation to the creation of fixed charges over book debts in the future?
Lord Hope expressly considered that there are only three limited ways in which a fixed charge over book debts could be created:

(i) preventing all dealings with the book debts other than their collection and requiring those collected proceeds to be paid to the chargee in reduction of the chargor's outstanding debt (although Lord Hope himself recognised that this is unlikely to prove acceptable to any trading company desiring working capital);

(ii) preventing all dealings with the debts other than their collection and requiring the collected proceeds to be paid into an account with the chargee bank which 'must then be blocked so as to preserve the proceeds for the benefit of the chargee's security'; and

(iii) preventing all dealings with the debts other than their collection and requiring the collected proceeds to be paid into a separate account with a third party bank over which the chargee takes a first fixed charge so as to preserve the sums paid in for the benefit of its security.

Many more sophisticated transactions are of course entered into and whether the restrictions imposed in the course of those arrangements will suffice to create the necessary 'blocked account' will, in my view, ultimately depend upon whether any withdrawals by the chargor from the relevant fund can be made only pursuant to the genuine discretionary consent of the chargee exercised on a transaction by transaction basis; anything less will expose the arrangement to the risk of being characterised as a floating security.

CAN ANY OTHER CONCLUSIONS BE DRAWN FROM THE HOUSE OF LORDS' DECISION?

The danger of precedents -- the importance of imposing sufficient restrictions on chargors' dealings with the relevant assets

There is in fact a danger that an erroneous conclusion might be drawn from either Re Spectrum Plus or indeed Re Brumark in considering the effectiveness of the wording of existing or intended future charges. Such conclusion is the often presumed effectiveness of the wording of the charge considered by the Irish Supreme Court in Re Keenan Bros [1986] BCLC 242; one might easily be forgiven for forming the view, based on a cold reading of the judgments in Re Spectrum Plus, that the form of that particular charge will necessarily operate to create an effective fixed charge in the future. However, for the reasons explained below, a copycat Re Keenan transaction might nevertheless fail to survive a challenge to its averred fixed charge status.
What is not apparent from reading their Lordships' judgments in Spectrum Plus is the fact that the Crown additionally took issue with whether or not the restrictions imposed by the Debenture on the relevant company's dealings with the uncollected book debts were sufficient for the charge in question to be otherwise characterised as a fixed charge. Since the Crown necessarily succeeded in Re Spectrum Plus simply in the absence of the proceeds being required to be paid into a blocked account, which was created as such, their Lordships did not need to address the further issue of whether sufficient restrictions were imposed upon the uncollected book debts for the charge to be otherwise characterised as fixed.
The Debenture used by the Bank expressly restricted the company from selling, factoring, discounting or otherwise charging or assigning the uncollected book debts however, there were no other express restrictions on what the company might do with them, save for the requirement to pay the proceeds of any debts which it might collect into the relevant account. By way of example, there were no restrictions preventing the company from granting further time for payment, accepting lesser sums by way of compromise, electing not to collect or even formally releasing any debt, or accepting discharge of the debt by means of consideration being provided to the company in other than monetary form.
The Crown therefore argued that, if the Company was free to undertake any of the foregoing for its own benefit without being required to seek the consent of the bank on each respective occasion, the chargee had insufficient control over the uncollected book debts for the charge to be properly characterised as a fixed charge; the company could remove a debt from the ambit of the security without the consent of the bank, for example, by simply choosing to accept services in lieu of payment from the debtor.
In Re Spectrum Plus the Crown accordingly expressly reserved its position upon whether the charge under consideration in Re Keenan Bros should be regarded as creating an effective fixed charge. Accordingly, it is important for those intending to create fixed charges in the future (or for those considering the correct characterisation of existing ones) that they address not just the method of creating the infamous blocked account but also ensure that sufficient restrictions are imposed in respect of the chargor's dealings with the uncollected debts. Indeed, in this regard it is of note that in each of the three fixed charges identified by Lord Hope he prescribes that 'all dealings with the book debts other than their collection ...' must be prevented [emphasis added].

The implications of the House of Lords' decision

To date, the practical effect of Re Spectrum Plus upon the commercial forum appears, perhaps surprisingly, to have been relatively modest; many operating at the coal face of financial lending and transactional drafting indicate that, whilst there has been some increase in the use of invoice discounting/factoring arrangements, much has remained unchanged, with lenders simply accepting the consequences of their securities having only floating status. Neither does there appear yet to have been the banks' predicted raft of attempts to unravel previous liquidation distributions and/or erroneous discharges of directors' guarantees and charges over their homes.
Meanwhile, time will tell what other conclusions may be drawn. The author's own prediction is that the next likely battleground will be the effect of the analysis in Re Spectrum Plus upon the characterisation of fixed and floating charges over assets other than book debts and the determination of what restrictions are necessary in respect of any particular asset for the chargee to be considered to have the necessary control.
In the author's opinion there is a real likelihood that the facts in Re Atlantic Computer Systems Plc [1992] Ch 505 would be decided differently in the light of the judgments of the House of Lords in Re Spectrum Plus. Post Spectrum Plus, the analysis which ought, in the author's view, to be undertaken is to first identify precisely the asset which is intended to be charged and second to consider whether that particular asset has been 'permanently appropriated' to the chargee.
Accordingly, the author's current view is that if the relevant asset can be sensibly separated from its income stream (such that there can truthfully be said to be commercial value in the ultimate reversion as well as in the rental income), it ought to be possible to create a fixed charge over the former without necessarily imposing any restriction on the chargor's use of the latter. By contrast, in Re Atlantic Computer Systems Plc what appeared to be under consideration was really a charge upon the relevant income stream under which the company was allowed free use of the proceeds as and when it collected them. Accordingly, by collection, the company was able to remove the relevant assets from the ambit of the charge without the chargee's consent and the charge ought therefore in the author's view to have been considered to be floating rather than fixed.
In this regard the analysis of the Court of Appeal delivered by Nicholls LJ in Re Atlantic Computer Systems Plc (at 534F-H) would seem to be at odds with that since adopted by the House of Lords in Spectrum Plus, in which Lord Nicholls of course also sat.
However, given that it took over 25 years for the issues in Siebe Gorman to reach the House of Lords, it may take some time for consequential issues regarding the correct characterisation of fixed and floating charges over other assets to reach such necessary heights. In addition, given the intervening abolition of the preferential status of debts owed to HM Revenue & Customs it may be that the impetus to challenge such averred fixed charges is significantly depleted, although the prospective statutory overruling of Re Leyland Daf (Buchler v Talbot) [2004] UKHL 9 brought about by the enactment of the Companies Act 2006 may nevertheless provide some incentive for further litigation in this field.


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