BANKING LAW 4000 words
The facts present that there are two lenders namely City Tower Bank and Principal Bank who have advanced funds in separate capacities to Fashionfairs for a variety of activities. Both banks have attained a minimum level of security for the loans provided in the event of a default by Fashionfairs. The key problem that has arisen is that Fashionfairs are now in a cash flow problem which has caused them to go into default on their responsibilities with Principal Bank, which in turn has created a substantial risk to City Tower Bank’s interest within Fashionfairs business. The question which this paper will address is whether City Tower Bank can do anything to prevent Principal Bank asserting its security arrangements with Fashionfairs. In essence the question revolves around which security will stand in law, whether the security attained by City Tower Bank or whether Principal Bank will be able to assert its rights over Fashionfair’s assets. This paper will firstly investigate the nature of the security held by City Tower Bank and to examine the capacity of City Tower Bank to protect its security over Fashionfair’s assets. Secondly the paper will focus on the agreement reached between Principal Bank and Fashionfairs especially focusing on the requirements of the loan and investigate which security arrangements will most likely prevail in law.
Security between City Tower Bank and Fashion Fairs:
The primary role security plays within law is that it provides the means which a creditor can ensure repayment of its loan in the event of the debtor’s inability to repay the loan. The commercial loan agreement between City Tower Bank and Fashionfairs contained a number of conditions to the availability of the loan consisting of representations, warranties and covenants made and given by Fashionfair in the event of default on the loan agreement. In particular, City Tower Bank has three clauses in their loan agreement which provide a level of security for the advanced loan. Firstly, a covenant that Fashionfair would not divest itself of any assets above £500,000, secondly a negative clause preventing Fashionfairs charging any other assets held by the company without first getting the consent of City Tower Bank. Thirdly, they have created a fixed charge against any book debts held by Fashionfairs. The covenant is designed to preserve the core earning element of Fashionfair’s business against which the bank has lent money. In determining a breach of a covenant the starting point will be the interpretation of the clause in the contract. The key issue in relation to the covenant is whether the activities between Fashionfair and Principal Bank will put them in breach of the covenant. As Fashionfairs has not directly divested itself directly of any assets above £500,000 the focus will be on the negative charge and the fixed charge relating to the book debts of Fashionfairs. The essential question will be whether City Tower Bank will be able to rely upon the negative pledge charge and the fixed charge to protect its interests against Principal Bank exercising their security rights over Fashionfairs business. This paper will now focus firstly on the negative pledge clause and secondly on the fixed charge to investigate what course of action City Tower Bank can now take in order to protect its interests from Principal Bank.
Negative Pledge Clause:
The negative pledge simply involves a promise by Fashionfair not to charge any of its assets without first attaining the permission of City Tower Bank. The facts present that whilst Fashionfair made Principal Bank aware of the existence of the loan facility with City Tower Bank they failed to investigate the terms and conditions on which the pre-existing loans were advanced. For City Tower Bank there are three core issues to consider; firstly the ambit of the negative clause, secondly the remedies it may seek against Fashionfair should they be found in breach of the clause and thirdly the remedies which it may seek against Principal Bank taking security from Fashionfairs in breach of the negative pledge clause. The ambit of the negative pledge clause appears to be framed sufficiently wide to prevent Fashionfair placing any further charges on any of their assets without first attaining the consent of City Tower Bank. The facts indicate that Fashionfairs have given security to Principal Bank without attaining the permission required which places Fashionfair in breach of their negative clause. Breach of a negative clause will give rise to the triggering of the default clause and an action in damages if City Tower Bank sustains any losses from the breach. It is argued by Cranston that a bank in the same position as City Tower Bank creates a unique problem in enforcing their security rights on Fashionfairs as the default remedy will usually be impractical and suing for damages will usually be costly and subject to delay. It does not appear practical for City Tower Bank to firstly jump to relying on the default clause because it is not sufficiently clear yet whether Fashionfair will be able to keep its commitments under the loan agreement. Cranston argues that the best course of action for breach of a negative pledge clause is either to apply for an injunction to stop the breach, or secondly to obtain specific performance of the ‘equivalent security’ negative pledge.
It may be sufficient for City Tower Bank to apply for an injunction to stop Principal Bank exercising any further rights over Fashionfair’s assets but if they have already exercised their rights over the shares it is unlikely an injunction alone would be the most effective form of action to protect City Tower Bank’s interests. In the exceptional case where it appears that there is an urgent and imminent risk in preserving the assets of Fashionfair, City Tower Bank may apply to the courts for a freezing order preventing Principal Bank taking any further action to acquire Fashionfair’s assets. Whilst this action would be extreme in that freezing the assets of a business may further exacerbate Fahsionfair’s ability to recover and maintain its loan commitments, it can be considered an action necessary if the bank views no future capacity in Fashionfair’s business being able to meet their loan responsibilities.
There are three possibilities for City Tower Bank restraining Principal Bank from exercising its rights over Fashionfair’s assets which were subjected to a negative pledge clause in priority to Principal Bank. Firstly the rule in De Mattos v Gibson allows the possibility for Principal Bank to be restrained by an injunction from exercising rights under their loan agreement with Fashionfairs. The net effect of getting an injunction under the DeMattos principle would be to place Principal Bank’s interest second in line to the interests of City Tower Bank. However in order for City Tower Bank to succeed they would need to show that Principal Bank had actual knowledge of the existence of the negative pledge clause. The dicta of Lord Browne-Wilkinson in Westdeutsche Landesbank v Islington tends to suggest that an injunction would not be granted against a third party purchaser who acquired the assets under scrutiny in good faith without having notice of the first party’s rights. The important factors the courts would take into account in deciding whether to grant an injunction would be whether Principal Bank’s deliberate failure in attaining the terms and conditions of the pre-existing loan arrangements between City Tower Bank and Fashionfair was a deliberate attempt to avoid the knowledge of the negative pledge clause. In order for City Tower Bank to succeed in getting the injunction they would have to show that Principal Bank’s intention in failing to investigate the terms and conditions of the pre-existing loan arrangements was a deliberate attempt to defeat any potential negative pledge clause.
A second possibility for City Tower to take action against Principal Bank would be to sue for an interference with their contractual relations with Fashionfair under their original loan agreement. In essence this would be a claim in the tort of interfering with contractual relations between Fashionfair and City Tower Bank by Principal Bank exercising their security rights. For this action to succeed, City Tower Bank would need to prove:
(a)Knowledge of the Negative Pledge.
City Tower Bank would need to show clear knowledge on the part of Principal Bank of the existence of the negative pledge clause in the agreement between City Tower Bank and Fashionfair. As the facts suggest that they clearly do not have specific knowledge of the negative pledge it may prevent City Tower Bank from successfully establishing the tort of interfering with contractual relations. The courts have showed a reluctance to allow such actions where specific knowledge did not exist even though negative pledge clauses are a standard form clause in most if not all commercial loan agreements. Similarly to the injunction above, they would need to show a deliberate avoidance of knowledge on the part of Principal Bank by failing to request the terms and conditions of Fashionfairs pre-existing loan arrangemetns which intended to defeat the negative clause. It would be within a courts general discretion whether to find the existence of such knowledge.
(b) Intention to defeat the Negative Pledge.
If City Tower Bank were able to prove that Principal Bank were aware of the existence of the negative pledge then the necessary intention element would be sufficiently established by the action of Principal Bank advancing the credit regardless of the pre-existing pledge.
Causation will be the most difficult hurdle for City Tower Bank to establish, in that Principal Bank may argue that it was the borrower, Fashionfair, which breached the negative pledge by failing to attain the correct consent and secondly seeking further credit outside of their loan agreement with City Tower Bank. It will be for City Tower Bank to advance an argument that the credit advanced by Principal Bank induced the borrower into taking the loan.
If City Tower Bank can satisfy the above conditions for an action in the tort of interfering with contractual relations they will be entitled to recover damages which are suffered as a result of Principal Bank exercising their rights over Fashionfair’s security.
A final possible action that City Tower Bank can take against Principal Bank is to argue that their interest is a security interest from the outset which takes priority over all interests created after its negative pledge. However, it should be noted that this argument would be likely to fail in that a negative pledge cannot create an immediate security interest in that they are not registered under section 395 of the Companies Act 1985.
Additionally, City Tower Bank may apply to the courts for the discretionary remedy of specific performance against Fashionfairs for their negative pledge clause to be enforced against other assets of the company. Whether the bank would seek specific performance would depend upon the level of equity remaining within Fashionfair’s business.
It is evident that City Tower Bank has a number of options available in seeking to protect its interests in Fashionfair’s assets through an assertion of its rights under the negative pledge clause. Ultimately what course of action the bank will take will depend upon a thorough assessment of Fashionfair’s current state of affairs, in that the bank will need to assess whether the business has a current capacity or a future capacity to meet their loan responsibilities by continuing their operations. The actions of Fashionfair accepting a new line of credit advanced by Principal Bank is in clear breach of the negative pledge which would entitle the bank to invoke the default clause and escalate the repayment rate with interest and charges. However, in this instance it is unclear how financially unstable Fashionfair’s business is, and it may be more prudent to try and get injunctive relief which will stop Principal Bank exercising its rights over Fashionfair’s assets.
Whether City Tower Bank would be successful in getting an injunction will depend upon whether the courts would be willing to accept that Principal Bank deliberately did not investigate the terms and conditions of the loan agreement between Fashionfair and City Tower Bank because they were intentionally trying to defeat the negative pledge. Therefore, from a legal perspective the best course of action for City Tower Bank is to firstly investigate the extend of Fashionfair’s financial state of affairs which will allow the bank to determine whether or not it should immediately seek to exercise its rights upon the security.
Fixed Charge over Fashionfairs Book Debts:
It is evident from the facts that City Tower Bank has a third clause in the loan agreement whereby it seeks to place a fixed charge over the all of Fashionfair’s book and other debts, revenues and monetary claims both currently and in to the future as security for their loan liability. It is clear by the language used in the clause that the bank is seeking to establish a fixed charge as security in an attempt to create a priority over every other creditor in the event of the insolvency of Fashionfairs but further analysis will be required to determine whether the charge is fixed or floating. The distinction between fixed and floating charges will be particularly relevant for City Tower Bank in that if it is considered a fixed charge the bank will take priority over Principal Bank’s claim on Fashionfair’s accounts. However, if it is considered a floating charge the bank may not rank in priority to Principal Bank’s claim. The bank’s charge over receivables is a mere right to be paid out of the proceeds of all the money from the operation of the business. In such situations the bank will not acquire a right to pursue any individual debtors but rather the bank’s legal right to the money is from the charger and in this case Fashionfair for an assignment. It is important to note that this type of security may require registration in accordance with section 860 and 861 of the Companies Act 2006 (CA). It is clearly stated within section 860(7)(f) of the CA 2006 that a charge on book debts of a company must be registered. However, it is unclear from the facts whether City Tower Bank has in fact registered their interest over the book debts of Fashionfair, if they failed to register this interest the clause would be void at law in relation to the book debts. It is important to note that the clause also attempts to create a charge over all monies and revenues held by Fashionfair both current and into the future. It is unclear whether the courts are willing to classify money in a bank account as being a book debt. However, it was held in Northern Bank v Ross there may be no need to register an interest in deposits held within a bank account. Therefore, there is potential that if the bank did not register the book debt it may still have a right to any money belonging to Fashionfair held on deposit in bank accounts.
It is also important to note the legal problems associated with banks seeking to create security from future revenues and book debts of a company in loan agreements. The first question will be whether such a charge is registerable under section 860 of the CA 2006 and whether such a charge would create priority for City Tower Bank over Principal Bank in the event of Fashionfair’s insolvency. It is normally considered that charges over book debts will be a floating charge because the holder of the account will be able to use the account as they require with a floating charge over the account by the bank. It is common that banks attempt to dress up their commercial lending clauses as fixed charges in an attempt to create a priority over existing creditors in the event of insolvency. Even though the clause is stated as a fixed charge, it will not necessarily follow that the charge will be classified as fixed in law. It has been doubted in the House of Lords in Re Spectrum Plus Ltd whether a clause can create a fixed charge over property in an account when the borrower can use that property in any way it chooses. Prior to Re Spectrum the courts allowed a line of case law which provided two charges from this type of charge, one which was fixed on uncollected book debts and secondly one that was floating over the proceeds once collected and paid into an account. The approach was changed in Agnew v IRC (“The Brumark”) where the Privy Council held that the correct way to analyse book debts was to focus on the rights and obligations which the parties granted each other in the loan agreement and then to categorise them after a true identification of the party’s intention. The acid test set out by Lord Millett in Agnew is whether the assets were under the free control of the borrower or whether they were under the restricted control of the bank. It is likely that in the case of Fashionfairs, that as they had full control over the property in the accounts, the charge on the book debts and bank accounts will be considered a floating charge. Therefore in the event of insolvency the priority over the book debts and bank accounts cannot be guaranteed in City Tower Bank’s favour.
It may be possible for City Tower Bank to further argue that the charged created a multiple mix of charges creating separate securities. In particular the bank may argue that the clause allowed for two charges to exist, one over the uncollected debts which is fixed and one which is floating over the collected debts. However, in light of Agnew it is likely that this argument may fail in that court will examine the genuine intention of the parties from a construction of the loan agreement. The facts do not indicate a differential treatment by Fashionfairs over those debts that were collected and uncollected and would tend to suggest that the charge would most likely be considered a floating charge which would only be crystallised at the time at which the bank would choose to exercise its rights over the security.
In summary City Tower Bank may be able to rely upon its charge against the book debts and monies of Fashionfairs which will be primarily contingent upon whether the charge is registered in accordance with the CA 2006. If the bank has registered the charge then the focus will be on whether the charge can be categorised as being fixed or floating. It is likely on the basis of Agnew that the charge in City Tower Bank’s loan agreement will be considered a floating charge because it is evident from the facts that Fashionfairs was able to use the property in the accounts freely and without restriction from the bank. City Tower Bank may try and advance an argument that their clause created multiple charges and the uncollected debts were secured in the form of a fixed debt and secondly the actual collected debts were secured by a floating charge over the account used to keep the money. However, as Agnew has changed the approach of the bank it is very likely that the courts would firstly focus on what the genuine intentions of the parties were and then examine Fashionfairs freedom in dealing with the book debts.
It is highly likely that in this case the book debts will be considered a floating charge and that any other charged created by the clause would also be considered a floating charge which would only be crystallised upon the bank’s decision to exercise their rights over the security. As City Tower Bank did not exercise their rights over the book debts until after Principal Bank’s exercised their rights over the bank accounts, the courts may consider that Principal Bank’s rights take priority over City Tower Bank. The priority may be given to Principal Bank because they have identified the property for seizing prior to City Tower Bank’s decision to exercise their rights and before their charge became crystallised in property.
It is clear that City Tower Bank faces two problems of ensuring its priority over Principal Bank in relation to Fashionfairs assets. Firstly, Principal Bank is attempting to exercise its rights over shares to the value of £1.5 million given by Fahsionfairs after the loan agreement with City Tower Bank. The primary avenue which City Tower Bank has to protect its right over those shares is through the negative pledge which did not allow Fashionfairs to pledge any security on its assets without the bank’s prior approval. It is unquestionable that the actions of Fashionfairs would entitle City Tower Bank to invoke the default clause and demand repayment of its loan with interest and accelerate the payments. However, one important factor the bank will have to consider is whether this would actually be in the best interests of the bank. If Fashionfairs are in financial difficulty the bank’s security may be worthless and foreclosing the agreement may not result in any actual money for the bank. The better option may be to act upon its rights to injunctive relief to stop Principal Bank attaining the assets and to carry out a thorough investigation of Fashionfairs business operation.
Secondly, it is evident that Principal Bank is attempting to exercise rights over Fashionfair’s accounts which may have money in them. The charge created by the bank will most likely be considered a floating charge and Principal Bank’s ability to exercise their rights over the accounts may be given priority. Although the charging clause is couched as being in fixed terms it is likely that as City Tower Bank did not crystallise their charge until after Principal Bank had asserted a right to the money. Ultimately it will be within the courts to decide but it is possible for City Tower Bank to attain injunctive relief against the shares being transferred but it is less certain whether the will be able to succeed on the money in the bank accounts and book debts.
Agnew v IRC (“The Brumark”)  2 AC 710.
- Campbell, ‘The LMA Recommendation Form of Primary Documents’  JIBFL 53.
Companies Act 1985.
- Cranston, Principles of Banking Law, (Oxford University Press, Oxford 2002).
De Mattos v Gibson (1858) 45 ER 108.
- Devonshire, ‘Freezing Orders, Disappearing Assets and the Problem of Enjoining Non-Parties’ (2002) 188 LQR 124.
- Ellinger, E. Lomnicka and R. Hooley, Ellinger’s Modern Banking Law, (Oxford University Press, 2009).
- Ferran, Company Law and Corporate Finance, (Oxford University Press, Oxford 1999).
- Goff and G. Jones, The Law of Restitution, (Sweet and Maxwell, London 1998).
- Hudson, The Law of Finance, (Sweet and Maxwell, London 2009).
Mainstream Properties Ltd v Young  EWCA Civ 861.
Northern Bank v Ross BCC 883.
Re BCCI (No 8)  AC 214..
Re Spectrum Plus Ltd  UKHL 41.
- Salinger, Factoring Law and Practice, (Sweet and Maxwell, London 1999).
Siebe Gorman & Co Ltd v Barclays Bank  2 Lloyd’s Rep 142.
- Stone, ‘Negative Pledges and the Tort of Interference with Contractual Relations’  8 JIBL 310.
Tailby v Official Receiver (1888) 13 App Cas 523.
Westdeutsche Landesbank v Islington  AC 669.
 E. Ferran, Company Law and Corporate Finance, (Oxford University Press, Oxford 1999) at p. 471-472.
 M. Campbell, ‘The LMA Recommendation Form of Primary Documents’  JIBFL 53 at p. 55.
 R. Cranston, Principles of Banking Law, (Oxford University Press, Oxford 2002) at p.314.
 Cranston (n3) at p. 317.
 Ibid, at p. 317-318.
 P. Devonshire, ‘Freezing Orders, Disappearing Assets and the Problem of Enjoining Non-Parties’ (2002) 188 LQR 124 at p. 142-144.
 (1858) 45 ER 108.
  AC 669.
 Mainstream Properties Ltd v Young  EWCA Civ 861.
 J. Stone, ‘Negative Pledges and the Tort of Interference with Contractual Relations’  8 JIBL 310.
 A. Hudson, The Law of Finance, (Sweet and Maxwell, London 2009) at p. 465-466.
 R. Goff and G. Jones, The Law of Restitution, (Sweet and Maxwell, London 1998) at p. 689-693.
 Tailby v Official Receiver (1888) 13 App Cas 523.
 F. Salinger, Factoring Law and Practice, (Sweet and Maxwell, London 1999) at p. 3- 4.
 E. Ellinger, E. Lomnicka and R. Hooley, Ellinger’s Modern Banking Law, (Oxford University Press, 2009) at p.810 -815.
 Re BCCI (No 8)  AC 214.
  BCC 883.
 Ellinger et al (n15) at p. 578.
  UKHL 41.
 Siebe Gorman & Co Ltd v Barclays Bank  2 Lloyd’s Rep 142.
  2 AC 710.