 Book debts as security for overdrafts – Brumark updated
Since the Brumark ruling in 2001 there has been much uncertainty about how the proceeds of a failed company’s book debts would be treated in cases where those book debts were held as security by a bank under a debenture.
Here we cover the latest developments on this issue and consider the possible future of the traditional bank overdraft.
Background
Before 2001, the bank as a secured creditor always claimed the proceeds of book debts in such cases. This is because debentures gave the banks a fixed charge over a borrower’s book debts, and therefore priority over any preferential (for example PAYE, VAT and employee wages) or unsecured creditors. As such, overdraft borrowing was the most widely used type of working capital finance available.
The legal position – the Brumark and Spectrum cases
However, in 2001 what became known as the Brumark case threw this practice into some doubt. Basically, the ruling here (made in the House of Lords on a case referred by the New Zealand Court of Appeal) was that a lender could not claim a fixed charge over book debts if the borrower was free to use the proceeds of those book debts as they wished.
This was certainly the case with bank overdrafts, where usually the only restriction on a borrower was to maintain a minimum overall value of book debts in relation to their overdraft facility.
Invoice discounting and factoring facilities, however, did pass the test since they do place restrictions on the proceeds of a borrower’s book debts.
(Note: there is a separate news article, which explains in more detail how invoice discounting and factoring facilities work, and the benefits and pitfalls of each).
The Brumark ruling caused much confusion and concern since, although the judgement was made in the House of Lords, it was not binding in the UK.
Eventually, a case to test the ruling was brought in the UK courts. Nat West bank vs Spectrum Plus Ltd in July 2005 upheld the Brumark ruling: book debts couldn’t be categorised as fixed charge security for bank overdrafts and would be treated as floating charge assets only. Preferential creditors would therefore get first bite of the cherry ahead of the banks. Case closed!
So what change does the future now hold?
Well, not much probably.
The writing has been on the wall for the banks since 2001 and they have had ample time to consider how to respond. In ‘appropriate cases’, borrowers’ facilities will already have been cut back, or extra security taken, or will have been switched into the banks’ invoice discounting or factoring products.
Conveniently, the Government helped the position by abolishing Crown preference under the 2002 Enterprise Act, where the preferential status of the Revenue & Customs was removed with effect from September 2003, leaving only employee wages and holiday pay to rank ahead of lenders for the proceeds of floating charge assets.
Overdrafts: dead or alive?
Overdrafts most certainly have not gone the way of the dinosaurs, and in the right circumstances, remain an important part of the funding available to small and medium sized businesses.
Whilst banks now approach them with a greater degree of caution than before, borrowers should not consider them off limits, and should certainly not be forced down the route of invoice discounting or factoring against their wishes.
However, anyone who has given a guarantee to the bank in support of a business overdraft where book debts have always been thought to be the primary security, must now realise they themselves are likely to be, in all probability, the primary security for the bank.
If in doubt, IBC are available to discuss any appropriate cases and offer advice on the most suitable funding options available.
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