The decision of the Privy Council in Agent V Commissioner of Inland Revenue (affirming the judgment of the Court of Appeal of New Zealand in Re Brumark Investments Ltd) could have far reaching implications for directors who have given personal guarantees in respect of loans or overdrafts to banks.
The high street bank is generally the first port of call for the funding of small to medium sized businesses. To secure the obligations of the company under its banking facility the bank will take generally take fixed and floating charges over the assets of the company by way of a debenture. The assets to be charged will include the book debts of the company. In addition, the directors, who in many cases are the owners of the company, may also have to guarantee the facility. In some cases, these guarantees are supported by security, often the directors’ homes.
All is well until the business fails. Remember, businesses can fail for a myriad of reasons some of which are beyond the control of the directors. When a company fails the bank may look to appoint its own administrator or receiver who realises the assets. In the case of debtors, the receiver will collect payments for goods and services purchased from the company, generally prior to the insolvency. Other assets, such as stock, fixtures and fittings, will be sold by the receiver. The funds realised from the sale of assets and the proceeds of debts collected in will be used to discharge the company’s liabilities to its bank and creditors so far as is as possible.
Without going into great detail, unless the bank can show that the company’s book debts were paid into a blocked account and could not be used without the consent of the bank, the Brumark decision serves to prevent the bank from taking a priority over other creditors in respect of the proceeds of book debts. Unfortunately, however, the decision of the Privy Counsel is not binding in English law only persuasive, and many insolvency practitioners (IP’s) are holding debtor receipts rather than pass them back to the chargeholder whilst the position in English law is clarified. If the Brumark decision is binding in English law then the bank may have to look to recovery from the directors under their guarantees where there is a shortfall from realisations of assets charged under its debenture. This is worrying as many directors gave guarantees in the expectation that the bank would be able to recover its lending from the realisations of book debts in existence at the point the company failed.
How can directors protect themselves?
Assuming Brumark is good law (and most lawyers believe that it is) then it is clear that unless the bank has an element of day-to-day control over the proceeds of debtor payments, it will find it difficult to enforce its security. Directors should therefore review how their businesses are funded and obtain funding from a funder who is not reliant on its security over book debts. Releasing bank guarantees by transferring overdrafts to a factoring company is a clear solution as a factoring company is not a lender but a purchaser of book debts. In addition, there are also positive advantages for companies in that the factoring company will often advance up to 80% of the outstanding debtor book as opposed to the banks standard of 60%. In many cases, factoring companies can also recover a higher percentage of the outstanding debt in a recovery situation than insolvency practitioners, as they have dealt with the administration of the sales ledger on a daily basis and therefore have a better understanding of the customer base.