It is very common for banks to take charges over contracts, a for example over a lease on a property. Other types of contract over which security is frequently taken include intellectual property rights, example the copyright in music will often by vested in a company under a contract with the artist.
It is not unusual for many types of contract to contain a prohibition on assignment. This is normally intended to prevent transfer of the contract or the asset to which the contract relates. There has however been a long running debate whether a prohibition on assignment in a contract prevents charging. Obviously the other party to the contract could give consent to assign but this might take some time and there is always the risk that the other party would require some consideration or concession before giving consent.
The critical question is therefore whether a charge over a contract is effective where there is a prohibition on assignment.
Existing case law is very confused and, somewhat surprisingly, quite limited. It has been further confused by the recent case of Don King Productions Inc. v Frank Warren (1999) which allowed a purported transfer of a non assignable contract by way of a trust mechanism.
An assignment involves a transfer of title. Whether a charge involves a transfer of title is a highly contentious issue. There are two House of Lords decisions which contradict each other. In Swiss Bank v Lloyds Bank (1982) Lord Wilberforce decided that a fixed charge created an equitable assignment but in BCCI (No. 8) (1997) (the case that over ruled Charge Card Services) Lord Hoffman stated "a charge is a security interest without any transfer of title or possession".
If Lord Hoffman is correct then a charge over a non assignable contract will be effective. That is, however, only half the answer. Whilst the charge may be effective and the granting of it will not give the other party to the contract any right to terminate due to breach it would be very difficult to enforce the charge over the contract. Any attempt to sell the benefit of the contract (either by a receiver of the chargee) inevitably breaches the restriction on assignment built into the contract.
If there are difficulties with enforcement why would a bank want to take a charge over a non assignable contract? In some circumstances it is cheaper and easier to take security immediately and then get consent to any transfer due to enforcement for example in an MBO where financial assistance is being given at acquisition as taking security subsequently would necessity going through the financial assistance white wash procedure again. Also if significant assets are held under non assignable contracts if security is not taken over those contracts it may be that the Bank does not have a floating charge over substantially all the assets of a borrower and is therefore unable to appoint an administrative receiver.
For these reasons unless a contract contains a prohibition against charging it is recommended that banks take charges over non-assignable contracts and get consent later.
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.
For further information please contact Gwen Griffiths, Banking, Hammond Suddards.
