Lords decision ‘affects buyout financing’

A ruling last month by the House of Lords, the UK’s highest appeal court, may make it harder to borrow money against the security of a typical British company. Law firm SJ Berwin believes the decision could affect the financing of leveraged buyouts and general working capital facilities.

Senior banks active in UK deals may choose between fixed and floating charge security, but have a very strong preference for fixed charges. A floating charge is less valuable because it ranks behind a range of costs and expenses incurred during administration, as well as certain claims of employees and unsecured creditors.

It is difficult to get fixed charges over certain types of asset, however. “Put simply, the bank has to exercise control rights over the security,” SJ Berwin said. “That means that fixed assets, like real property, are readily amenable to fixed charges, but assets that are traded in the course of the company’s business are not: it would be impractical to have to seek consent from the bank every time the asset is bought or sold.”

There has long been a question mark over the conditions under which fixed charges can be granted over a company’s trade debts. Senior banks seeking access to these valuable assets have argued that, if the company has to pay the proceeds of the debts into a designated bank account once they are collected, then they have control over those proceeds.

The House of Lords has now said that that is not enough. In order for a charge over book debts to count as a fixed charge, the lender must have contractual rights stopping withdrawals without the lender’s consent. In other words, the account must be blocked, which is likely to be impractical for most lending banks.

This decision is likely to increase factoring or discounting of receivables, as these transactions are unaffected by the court decision.

“Larger banks have discounting arms. They are likely in future to offer financing with a discounting element, even for transactions where the strength of the borrower’s covenant is not in doubt,” SJ Berwin said.