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New Zealand

Charges over book debts finally fixed

In February of this year the High Court of New Zealand decided that a charge over book debts is capable of being a fixed charge (Re Brumark Investments Ltd (in rec) v Commissioner of Inland Revenue).

The significance of this decision is that, in a liquidation or receivership, the holder of a fixed charge over book debts (often a bank) gets priority over certain preferential claims (mainly of the Inland Revenue Department and employees). If a charge over book debts was only a floating charge at its inception, these preferential creditors' would have priority over the claim of the floating charge holder.

Brumark involved the competing claims of a bank (the holder of a charge over book debts) and the employees of Brumark and the IRD (each a preferential claimant). The only assets of Brumark available for distribution were its book debts.

In the UK authorities cited in the case, there were two conflicting positions on the status of a charge over book debts. One line of cases viewed book debts and their proceeds (the money received when the debts are paid) to be indivisible, so that whether the charge was fixed or floating depended on the control the chargee had over the proceeds of the book debts. The alternative view was that the chargor and chargee themselves could determine the status of the charge by drawing a distinction in the debenture between the book debts, the proceeds and the nature of charge to which they are each subject. In light of this conflicting case law, the Court adopted a back-to-basics approach.

As a starting point, the Court found that it is the legal substance of the rights and obligations under a charge that govern its status, and not whether it is labelled as fixed or floating. The Court then stated the essential characteristic of a fixed, as opposed to floating, charge to be the absence of a power of disposition to others. The Court held that the power of disposition is different from the power of conversion. The ability to convert the charged asset into a form no longer subject to the charge, and to dispose of the asset resulting from the conversion does not prevent there being a fixed charge over it. This is particularly relevant in relation to book debts, which are constantly realized and converted into proceeds that are disposed of without reference to the charge holder.

The Court distinguished book debts and their proceeds as different types of property. The Court found no inherent inconsistency in having a fixed charge over a book debt that extinguishes when the debt is realized, meaning that it is possible to have a fixed charge over book debts, and a floating charge over the proceeds (without the need to specifically refer to the conversion of book debts to proceeds). The power to dispose of the proceeds of book debts without reference to a charge holder, does not mean that the book debts themselves cannot be subject to a fixed charge.

The Court stressed that the distinction between book debts and their proceeds is a commercial distinction and not just semantic. Book debts can be valuable assets of a company in their own right, and it is not correct to say that a charge over book debts only assumes significance when the proceeds are collected.

As Brumark had no power under the bank's charge to dispose of its book debts, the Court found the charge to be a fixed charge. This gave the bank priority over both Brumark's employees and the IRD.

Ironically, after the long wait for clarity on the status of a charge over book debts, the Brumark decision may soon become largely irrelevant in New Zealand. The Personal Properties Securities Bill, if enacted in its current form, will end the need to distinguish between floating and fixed charges for the purposes of determining the priority of preferential claimants, and may result in the floating charge becoming of little consequence under New Zealand law.

James Aitken/James Durham

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