Introduction The case originated in New Zealand and was decided by a ruling of the Privy Council (effectively the House of Lords) dated 5 June 2001. The question at issue was whether a charge over book debts was a fixed or floating charge. If the latter, debtor proceeds would be payable first to preferential creditors under the provisions of section 40 (2) Insolvency Act 1986. Effect Essentially the Council ruled that where a charge has been operated in such a way that the borrower has been allowed an unfettered right to draw on the proceeds of the book debts without the specific consent of the chargeholder, this did not constitute sufficient control to qualify as a fixed charge over those debtors. Overnight this meant that there was a strong possibility (given that the House of Lords sits as the ultimate appeal court) that banks and other lenders did not necessarily have first bite over debtor books. This clearly has implications for lenders, borrowers and guarantors. As a result, the Crown Departments issued a statement that if an insolvency practitioner made a distribution of book debt proceeds subject to a purported fixed charge, or proposed to do so, the Crown Departments reserved the right to challenge it. They also revised their policy of repaying pre-insolvency VAT credits to companies subject to insolvency proceedings unless the control test could be passed (in practice effectively only by invoice discounters or factorers). The Crown Departments also confirmed they would not seek to challenge distributions made prior to 5 June 2001. The future As the wording of debentures and elements of control vary, a test case is unlikely to provide a clear-cut answer applicable in all circumstances. Any decision of an insolvency practitioner that is not agreed by both the debenture holder and preferential creditors is therefore likely to give rise to litigation. Insolvency practitioners in relevant cases have therefore adopted the following procedure: Seek the view of the debenture holder as to whether their charge is fixed or floating If they believe it is floating, the office holder may distribute first to preferential creditors If they believe it is fixed, they will be asked to provide the basis for their view This will be notified to the preferential creditors, seeking their views If the preferential creditors disagree, there is nothing the office holder can do other than apply to court for directions. Conclusion In practice, the problem only becomes an issue if there are insufficient funds to discharge both the debenture holder and preferential creditors. An office-holder will otherwise wait until they have realized sufficient assets to discharge both simultaneously. It is not yet clear how debenture holders will treat any guarantees that may be called as a result of this decision. Stephen Goderski 22 July 2002 Back