June 30, 2005
Form, substance and legal certainty
Posted by Caroline Bradley

Usually when I teach business associations I have a class full of formalists (or at least the most vocal students tend to be formalists). Last semester I had a class full of students who believed that the role of the courts was to do justice. Im not really sure why this was. I suspect that some of it had to do with recent corporate scandals. Perhaps some of it was a reaction to the public debate about whether judges should make law or not.

The UK’s House of Lords (to be replaced at some point by a Supreme Court) just decided to emphasise substance over form in a case with significant commercial implications.

For 25 years banks in the UK have believed that it was possible to create an effective fixed charge over a borrower’s book debts if the book debts were paid into an account the borrower had with the lending bank (based on a first instance decision in the Siebe Gorman case). Today the House of Lords overruled the Siebe Gorman decision in a case called National Westminster Bank v Spectrum. If the account into which the book debts are paid is a current account and the borrower can freely use the moneys in the account the charge is a floating charge rather than a fixed charge.

Lord Scott of Foscote says:

the essential characteristic of a floating charge, the characteristic that distinguishes it from a fixed charge, is that the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event.

If the charge were a fixed charge the bank would be entitled to be paid before preferential creditors (Customs & Excise, the Inland Revenue..). If the charge is a floating charge the preferential creditors are paid first. 

The bank tried to persuade the Law Lords that if they were going to overrule Siebe Gorman they should limit the impact of the decision by holding that it would only have prospective effects. In their judgments the Law Lords spill much ink over this question. They cite to cases from various jurisdictions where this question has been considered but ultimately conclude that the circumstances of this case are not so exceptional as to justify limiting the decision’s effects to the future. In particular in a case of statutory interpretation. Siebe Gorman was always wrong.

But what about the many banks that relied on Siebe Gorman in structuring their loans?   Lord Scott again: 

It was natural that banks and other lenders taking security from corporate borrowers should have modelled their security on the debenture form that had achieved success in Siebe Gorman. But they would not, or at least should not, have done so on the  footing that Slade J’s judgment had finally settled the law.

Banks lose.

The Bank of England has been so concerned about the possible negative impact of legal uncertainty that it has over the years set up a number of different bodies to address issues of legal risk. The most recent of these is the Financial Markets Law Committee which recently expressed some concerns about uncertainties in the Law Commission's work on security interests.

Note: The Enterprise Act 2002 removes the Crown preferences, although debts to employees are still preferential debts.

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