The potentially precedent-setting Spectrum Plus lawsuit - regarding the legal treatment of a charge over book debts - has taken a surprising turn.

The U.K. Court of Appeal overturned a recent High Court ruling that an unrestricted right to collect and make use of the proceeds of book debts is inconsistent with a fixed charge rate.

Nonetheless, the High Court said that once the case reached the highest-level court - that is, the House of Lords- it expects its decision will be upheld.

The Court of Appeal overturned the High Court decision - a commentary about which from Cadwalader, Wickersham & Taft was published in last week's ASR -based on two principal grounds. The court considered the specific facts of the Spectrum case, and the court was still bound by an earlier precedent.

"With regard to the earlier precedent, the Court of Appeal held that the Vice-Chancellor was wrong to hold that he should not follow the precedent established by the New Bullas case (an earlier decision of the Court of Appeal which has been widely criticized) based on the Privy Council's decision in the Brumark case (Agnew)," explained Jerry De Melo, a partner in the capital markets group of Cadwalader. "The law of precedent prevented the High Court and the Court of Appeal from reaching a conclusion that conflicted with New Bullas, as both courts are still bound by it. The Court of Appeal noted, however, that if and when the matter comes before the House of Lords (which it undoubtedly will), the Lords would hold that New Bullas was wrongly decided and that an unrestricted right to collect and make use of the proceeds of book debts is inconsistent with a fixed charge."

The Court of Appeal's ruling to overturn the decision based on this earlier case does not immediately affect the conclusions reached under the Spectrum case, as it does not institute a clear parameter on the issue of control on a more general level.

"The Court of Appeal decision provides no further guidance on the degree of control that would be sufficient to support characterization of a charge as a fixed charge (rather than a floating charge) in

circumstances where the proceeds

of the debt are not paid to the chargee bank," said De Melo. "Consequently, the law remains unclear, particularly with respect to the treatment of charges over book debts in the context of securitization transactions, where the relevant chargor is typically a special purpose vehicle (and not an operating company) and the proceeds of book debts are not paid into an account with the chargee bank."

But the decision does offer some guidance on the drafting of debentures, De Melo added. The characterization of a charge as a fixed charge is a pending question of law and will be decided by the courts, which will apparently consider the restrictions in a given debenture and how that impacts the chargor's rights. The Court of Appeal noted that the reasoning in the Brumark case does not preclude a court from giving weight to the intention of the parties in considering those restrictions, which may deem a particular charge as fixed. "Until such time as the courts or legislation may provide further guidance, parties should therefore seek to ensure that this intention is clearly reflected in their drafting," De Melo said.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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