Brumark and the banks

For many years, banks have used debentures as a means of acquiring fixed charge security over book debts, mostly in connection with overdraft facilities.

Since 1979, case law had established that a fixed charge on book debts was possible, as long as the debts and their proceeds were under the control of the charge holder.

In the case of a bank, such a charge was felt to be quite in order, since the proceeds of book debts had to be paid into an account held with the bank, thereby giving the bank control over them. To reinforce this, bank debentures were worded in such a way that companies could deal with their book debts without restriction, allowing funds to flow freely through their bank accounts.

However, the Brumark ruling has cast doubt on the validity of such fixed charges.

The Brumark ruling

The New Zealand Court of Appeal referred the case, Re Brumark Investments Ltd, to the House of Lords in June 2001 (the law in this area is based on English law).

The House of Lords decided that a true fixed charge must give the charge holder absolute control of the proceeds of any book debts. From a bank's perspective, it may no longer be sufficient simply to have the proceeds routed through the customer's account, since this does not constitute absolute control. Under the Brumark judgement, the account into which proceeds are paid must actually be blocked, i.e. the customer must have no automatic access to the funds. This would cause problems with overdraft limits in particular - especially when the bank account was in credit.

Until a similar case comes before the English courts, the law here will not be changed. When it does, although the decision in the Brumark case will not be binding, it will at least be seen as "persuasive".

The implications

The implications for the banks could be significant. In a liquidation, all "pre-Brumark" fixed charges on book debts could be demoted to floating charges: the proceeds of book debts would then be used to pay the costs of the liquidation first, and then any preferential creditors. Banks could lose money as a result.

Banks will now be reviewing their security arrangements and companies, especially those experiencing difficulties, may find themselves under pressure to provide extra security, or else switch to the bank's factoring and invoice discounting products.

Such products are not affected by the Brumark ruling, since the factor or discounter has complete control over the proceeds of book debts, which are paid direct to them or to an account under their complete control. Although Brumark hasn't caused a stampede, there are already signs that some banks are "encouraging" companies down this route.

Whatever happens, companies should be wary if they find themselves in this position. Factoring and invoice discounting products can be a minefield (see the separate article on this site) and we would certainly recommend exploring the market before making any firm decisions in this regard.

Companies who are asked to give extra security instead should also remember that there are many ways to negotiate an improved position for themselves. If you have any doubts, get in touch with us and we will be happy to help.