England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Claim No.: 1246 of 2010 Leeds Combined Court Centre The Courthouse, 1, Oxford Row Leeds LS1 3BG
		11 November 2010

Judge Kaye QC:

Introduction

1. When a floating charge relates to property of a company which has gone into liquidation or administration (or other form of insolvency immaterial for present purposes), then, subject to exceptions which are also not material for the purposes of this case, the liquidator or administrator is required to "make a prescribed part of the company's property available for the satisfaction of unsecured debts": Insolvency Act 1986, section, 176A(2)(a).
2. The question for decision is whether the debts due to a former holder of a floating charge which, after the commencement of the liquidation of the company, releases its security, are "unsecured debts" within this provision. If they are unsecured debts, the former charge holder is entitled to share in the prescribed part; if they are not unsecured debts, it is not so entitled.

Narrative

3. The material facts are as follows.
4. PAL SC Realisations 2007 Limited ('the company') was formerly called Solcrest Limited and was one of the trading companies within the Autocruise group ('the group'). The business of the group, based in South Yorkshire, consisted of the manufacture of motor homes and the provision of aftercare services, such as the carrying out of works under warranty, accident repairs, and the operation of a parts centre.
5. In December 2006 the group was the subject of a management buyout. This was funded by finance from National Westminster Bank Plc ('NatWest'), the first and second respondents and a Mr Gordon Bentley. Among the securities which were executed by the company to enable the buyout to proceed were debentures executed by the company on 30 November 2006 (each debenture being subsequently duly registered at the companies' registry). These debentures each created a fixed and floating charge in common form over the assets of the company in favour of NatWest, Inflexion Private Equity Partners LLP (in the latter case as security trustee ("the Trustee") for the respondents), and Mr Bentley in order to secure all the obligations of the company to the lenders.
6. Also on 30 November 2006, a priority agreement was entered into by the funders of the buyout. The effect of this as between NatWest, the Trustee (i.e. the respondents) and Mr Bentley was that they ranked first, second and third respectively in relation to the debts owing to them and the securities for those debts.
7. On 5 October 2007 the group went into administration, and the applicants were appointed administrators by NatWest. A 'pre-pack' sale of the bulk of the group's assets was effected on the same day for about £5.35m.
8. Over the ensuing 12 months further assets were sold. Up to 4 October 2008 the total realisations from the group came to £5,780,896, of which £2,364,493 was attributable to sales of assets belonging to the company. Of the realisations from the company, the great bulk, £2,080,999, came from the sale of floating charge assets.
9. According to the administrators' statement of proposals, the sums due to secured creditors at the date of the appointment of the administrators were: NatWest, £7,521,000; the respondents, £6,071,000; Mr Bentley, £241,838. There has been some subsequent variation in the figures. All are agreed however that the changes do not alter the operation of the priority agreement on the rights of the lenders: the amount owing to NatWest (£7.5m) is such that nothing will be left for the respondents or Mr Bentley in their capacity of secured creditors.
10. The amount now due to unsecured creditors seems to be in some slight dispute (happily not for me to resolve). The liquidators' current estimate is that £2,344,893 is owed to unsecured creditors. None of this is preferential, and all that will be left for the unsecured creditors is the prescribed part, which is now estimated at £434,803. The amount owing to the respondents is, I am told by Mr Arnold who appeared on behalf of the respondents, now over £6.2m. The prescribed part has effectively been appropriated out of the floating charge assets that would otherwise have been paid to NatWest alone.
11. From the outset of the administration, it was the intention of the administrators that the prescribed part would be distributed through a creditors' voluntary liquidation. The company accordingly went into liquidation on 26 March 2009. It was readily and obviously apparent that if the Trustee (and the respondents) were to receive anything at all it could only be out of the prescribed part.
12. By a deed of release dated 29 June 2009, the Trustee, as security trustee for the respondents, released and surrendered its debenture executed on 30 November 2006 and all the assets thereby secured but not the debt which was thereby converted to a wholly unsecured claim.
13. Shortly after this deed of release was executed, solicitors for the respondents advanced, in correspondence with the applicants, the proposition that their clients were now entitled, as unsecured creditors, to share in the prescribed part. The applicants were unwilling to concede the claim, and these proceedings were issued on 28 May 2010 so that the matter could be resolved by the court.
14. If the respondents are entitled to share in the prescribed part they will, it was said, "swamp" the claims of the ordinary unsecured creditors. Mr Arden calculates that if the respondents are allowed to participate they and the other unsecured creditors will receive a dividend in the region of 4.5%, if not, the respondents will receive nothing and the other unsecured creditors will receive a dividend in the region of 16.4%. Put another way, suggests Mr Arden, if the respondents are permitted to participate they will take 72.8% of the prescribed part.

The Relevant Law

15. Section 176A Insolvency Act 1986 was introduced by s 252 Enterprise Act 2002 with effect from 15 September 2003 (see Insolvency Act 1986 (Prescribed Part) Order 2003 (SI 2003 No. 2097)). It provides so far as relevant for present purposes as follows:

"(1) [Application of section] This section applies where a floating charge relates to property of a company—

(a) which has gone into liquidation,

(b) which is in administration,

(c) of which there is a provisional liquidator, or

(d) of which there is a receiver.

(2) [Prescribed part for unsecured debts] The liquidator, administrator or receiver—

(a) shall make a prescribed part of the company's net property available for the satisfaction of unsecured debts, and

(b) shall not distribute that part to the proprietor of a floating charge except in so far as it exceeds the amount required for the satisfaction of unsecured debts.

(3) [Non-application of s.176A(2)] Subsection (2) shall not apply to a company if—

(a) the company's net property is less than the prescribed minimum, and

(b) the liquidator, administrator or receiver thinks that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits.

(4) ….

(5) [Non-application by court order] Subsection (2) shall also not apply to a company if—

(a) the liquidator, administrator or receiver applies to the court for an order under this subsection on the ground that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits, and

(b) the court orders that subsection (2) shall not apply.

(6) [Net property in s.176A(2),(3)] In subsections (2) and (3) a company's net property is the amount of its property which would, but for this section, be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company.

(7) ….

(8) ....

(9) ["Floating charge", "prescribed"] In this section—

(a) "floating charge" means a charge which is a floating charge on its creation and which is created after the first order under subsection (2)(a) comes into force, and

(b) "prescribed" means prescribed by order by the Secretary of State."

16. There have been two previous relevant reported decisions on the effect of s 176A. The first (chronologically speaking) was a decision of HH Judge Purle QC sitting as a High Court Judge in the Birmingham District Registry in Re Permacell Finesse Ltd (in liquidation) [2008] BCC 208. The second was a decision of Patten J as he then was in Re Airbase Services (UK) Ltd [2008] 1 WLR 1516. Both decided that a floating charge holder could not share as an unsecured creditor for any shortfall in the value of its security in the prescribed part save to the extent of any surplus after discharge of the unsecured debts in full. The precise basis of these two decisions was, in my judgment, rightly summarised by Mr Peter Arden QC, counsel for the liquidators, as follows:

A floating charge holder was barred from participating in the distribution of the prescribed part for the shortfall in its security because it was a proprietor of a floating charge for the purposes of s 176A(2)(b) (Permacell)

Neither a fixed charge holder nor a floating charge holder was entitled to participate in any such distribution because its debts were not "unsecured debts" for the purposes of s 176A(2)(a) (Airbase).

17. As noted above, in Airbase Patten J held that a fixed charge holder was also excluded from participating in the prescribed part in respect of any shortfall in the value of his security. His Lordship pointed out that s 176A places the emphasis on the identity of the creditor rather than the nature of his debt (para. 23). Section 176A was intended, he concluded, to exclude secured creditors as defined by s 248 of the 1986 Act from participating in any distribution of the prescribed part. Both fixed and floating charge holders were thereby excluded.
18. Two other provisions are also relevant for the purposes of this judgment.

Thus s 248(1) Insolvency Act 1986 provides so far as relevant

"(a) "secured creditor", in relation to a company, means a creditor of the company who holds in respect of his debt a security over property of the company, and "unsecured creditor" is to be read accordingly".

Rule 13.12(1) Insolvency Rules 1986 defines "Debt" in relation to the winding up of a company as "any of the following-

(a) any debt or liability to which the company is subject

(i) in the case of a winding up which was not immediately preceded by an administration, at the date on which the company went into liquidation;

(ii) in the case of a winding up which was immediately preceded by an administration, at the date on which the company entered administration.

(b) any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date; and

(c) any interest provable as mentioned in Rule 4.93(1)".

The Rival Contentions

19. Although the application was issued by the liquidators seeking directions from the court under s 112 Insolvency Act 1986 it is the respondents who have advanced the case that they are entitled to share in the prescribed part. The Trustee was not joined to the proceedings but no one has taken any point about that beyond Mr Arnold pointing out that his clients, the respondents, were never under any circumstances in fact the floating charge holder but were the beneficiaries of one, namely the Trustee. For the purposes of the present proceedings the acts and events of and affecting the Trustee are to be treated as those of the respondents. It is convenient therefore to deal first with the submissions of the respondents.
20. Mr Arnold does not seek to challenge the decisions in Permacell and Airbase but submits as follows:

Those cases (Permacell and Airbase) are entirely different from the present: Those cases concerned the question of whether the secured creditor could, in respect of its unsecured shortfall, share in the prescribed part in circumstances where the secured creditor had, in each case, already received amounts by way of distribution under their security upon which they continued to rely.

By contrast, this case concerned not a shortfall at all but a situation where the secured creditor (the Trustee and the respondents)

Had received nothing in respect of their security,

Had surrendered and released the entirety of their security (albeit worthless),

Had by so surrendering, converted their status to that of unsecured creditor.

No other decided case directly assists but there is nothing in the wording of s 176A or policy to exclude the respondents from sharing in the prescribed part in these circumstances.

21. Mr Arden QC for the liquidators has helpfully argued the case comprehensively for the unsecured creditors. He submits that

in order to determine whether or not the respondents are entitled to share in the prescribed part the court must ask itself a subsidiary question: what is the relevant time for determining the answer to that question? Is it

The time when the floating charge assets were realised and the fund placed aside under s 176A(2)?

The time when the company went into administration (which has for the sake of shorthand been referred to as the liquidation cut-off date): see rule 13.12 Insolvency Rules 1986 (as amended)?

The time when the funds came to be distributed?

If the first or second time was correct, then the respondents were not entitled to share in the prescribed part. If the third, then Mr Arden conceded that they were.

In determining the correct time it is legitimate, argues Mr Arden, to have regard to the legislative purpose or policy of s 176A which is to set aside a fund for a defined class of creditors, namely unsecured creditors, the latter not including a debt secured in whole or in part by a floating charge. As HH Judge Purle QC put it in Permacell "The prohibition on distributing the prescribed part to a floating charge holder is in my judgment absolute." (para. 22). Patten J thought in Airbase that this prohibition also applied to a fixed charge holder. To enable a charge holder (fixed or floating) to release its security and then claim the prescribed part would defeat the legislative purpose of excluding such creditors from the prescribed part. Thus the correct time to pose the question must be at the liquidation cut-off date (see above) or the time when the assets are appropriated to meet the claims of unsecured creditors. If the later (distribution) time is taken the legislative policy is defeated.

That the earlier time is correct is also consistent with the general rule applicable in the application of the statutory scheme on insolvency, namely that debts or liabilities provable in the liquidation are determined as at the date of the commencement of the winding up subject only to a few recognised exceptions such as contingent debts or debts ceasing to exist after commencement of the liquidation

Discussion

22. Mr Arnold's first point is an important one. Permacell and Airbase were both concerned with a shortfall. In both cases the charge holder hung on to their security. That is not this case.
23. Mr Arnold has also helpfully reminded me of the legal history leading to the enactment of s 176A.
24. As long ago as the celebrated case of Salomon v Salomon & Co [1897] AC 22 Lord Macnaghten had voiced concern on behalf of unsecured creditors when he said (at p. 53):

"I have long thought, and believe some of your Lordships also think, that the ordinary trade creditors of a trading company ought to have a preferential claim on the assets in liquidation in respect of debts incurred within a certain limited time before the winding up."

25. The Cork Report on Insolvency Law and Practice: Report of the Review Committee (Cmnd 8558, 1982) recognised that insolvency results in all too many cases in the distribution of the proceeds among the preferential and secured creditors with little or nothing to unsecured creditors. The Committee recommended a 10% fund (i.e. 10% of the net proceeds of the assets of the company subject to a floating charge) should be available for division amongst unsecured creditors (see paras. 1485-1489 and Chapter 36). The Committee however recognised that both fixed and floating charge holders could participate in any 10% fund provided they first realised, surrendered or valued their security (in the case of fixed charge holders – the participation being in respect of any balance) or first surrendered their security in toto (in the case of floating charge holders) (see paras. 1543-1544).
26. While these points are important in an historical context as illustrating the tension between the claims of secured and unsecured creditors Mr Arnold rightly points out that these proposals (like others) found acceptance neither in the Insolvency Act 1985 enacted following the review of the Cork Committee nor in the consolidating 1986 Insolvency Act. Moreover s 176A contains no express provision as to what is to happen in the case – as here – where a floating charge holder surrenders his security. The Insolvency Act 1986 indeed preserved the preference given to Crown debts over the holder of a floating charge: see s 175(2)(b).
27. Instead, the Enterprise Act 2002 abolished the preference accorded to Crown debts and in return created a fund out of the floating charge holder's security to which unsecured creditors alone could have recourse in return for the advantage offered to the floating charge holder by the abolition of the preferential status of Crown debt which would otherwise have ranked ahead of the floating charge (see Permacell at paras. 14-19; Airbase at paras. 9-19).
28. Thus the position now reached (with the helpful and illuminating assistance of Permacell and Airbase and subject to any decision by a higher court) is that the preference accorded to Crown debts is now abolished but fixed and, more importantly, floating charge holders are excluded from participating under s 176A in any distribution of the prescribed part in respect of any shortfall save to the extent that unsecured creditors are paid in full.
29. But what, asks Mr Arnold in effect, if they are no longer floating charge holders when the prescribed part comes to be distributed? What if, as here, they have in the meantime surrendered and released their security such as it is and if anything for the benefit of the general body of creditors? Then, he argues, they are no longer to be identified as secured creditors at all and no longer have any secured debt but are entirely unsecured.
30. Mr Arnold points to the classic statement as to the position of the secured creditor, and the choices open to him, in the judgment of Lord Jessel MR in Moor v Italian Bank (1879) 10 Ch D 681, at 690:

"In bankruptcy, if a secured creditor wants to prove, he must do one of three things: he may give up his security altogether and prove for the full amount, or he may get his security valued and prove for the difference, or he may sell and realize his security and then prove for the difference. If, without doing either of the latter two things, he proves for the full amount, as he cannot prove for the full amount and receive a dividend except on the theory of giving up the security, he shews by that an intention to give up his security; and, if he so proves and receives a dividend or votes, he shews pretty conclusively that he has finally elected to give up his security and take his dividend; in other words, having two funds to resort to, the bankrupt's general estate, so as to get a dividend on the whole amount of his debt, or his security, he elects to take the bankrupt's estate, and in that way gives up his security. It is not forfeiture, it is election; but, the petitioning creditor gets nothing unless he proves."

31. This principle has survived to the modern law: thus Rule 2.83(2) (administration), Rule 4.88(2) (winding up), and Rule 6.109(2) of the Insolvency Rules 1986 are all in the same or similar form. Rule 4.88(2) provides:

"If a secured creditor voluntarily surrenders his security for the general benefit of creditors, he may prove for his whole debt, as if it were unsecured."

32. Whilst these provisions were not sufficient in themselves to persuade Patten J in Airbase that the prescribed part was available for the unsecured part of a secured creditor's claim (para. 22) he was there dealing with a situation where the floating charge holder remained a floating charge holder. His identity as such had not changed. Here it has.
33. Mr Arnold pointed out that the rationale behind the addition of the words "as if it were unsecured" in the Rules was not immediately apparent. Mr Arden submitted that they were "deeming" words. It seems to me that the addition of these words is merely to emphasise the change in identity of the creditor. He is no longer to be treated as a secured creditor but as unsecured; his debt is no longer a secured debt, but one which is unsecured. This chimes precisely with the point being made by Patten J in Airbase. The nature of the debt was no longer to be treated as secured but as unsecured; accordingly the identity of the creditor must be altered also to that of an unsecured creditor as defined by s 248.
34. I now turn to s 176A. Interesting though the historical background is to s 176A it is preferable, in my judgment, to approach matters at least at the outset by looking at the words of the statute.
35. Section 176A(2) tells the office-holder both what he must and what he must not do with the prescribed part. He must make it "available for the satisfaction of unsecured debts". There is no definition of "unsecured debts". I do not intend to repeat the careful analysis of the interpretation of this phrase in the Airbase which I respectfully adopt as far as it goes. I repeat: Patten J held that this term was in the context of s 176A apt to exclude all secured creditors.
36. But in my judgment this construction (as that in Permacell) that fixed and floating charge holders were excluded from participation in the prescribed part was in the context of a continuing security. In both cases the claiming floating charge holder continued to hold a floating charge from which benefit had been derived in the form of value or realisations. It was only the shortfall that was claimed. That was the context in which the phrase "unsecured debts" fell to be construed. Here the floating charge holder had nothing, has surrendered its security and is entitled on that basis to prove "as if it were unsecured" at least for the purposes of Rule 4.88(2).
37. I accept Mr Arden's point, as generally made, that the scheme contemplated by the Insolvency Act is that debts and assets should be ascertained at the commencement of the insolvent administration, liquidation or here administration (i.e. what has been referred to as the liquidation cut-off date), and that creditors who prove their debts are entitled to share (so far as they are unsecured) rateably in the assets pot pari passu (see for example Rules 12.3 and 13.12 and Re T & N Ltd [2006] 1 WLR 1728 at para. 113 per David Richards J). Nevertheless, bearing in mind Mr Arden's points about the timing of the subsidiary question referred to above but leaving aside s 176A for the moment, Rule 4.88(2) by its very terms is contemplating an event that could occur after the commencement of the winding up or after, as Mr Arden called it, "the liquidation cut-off date". The contemplated event is the surrender of the charge holder's security. After that event he is treated no longer as a secured creditor but one who is unsecured.
38. In Wight v Eckhardt Marine GmbH [2004] 1 AC 147 PC Lord Hoffmann at paras. 28-33 indicated that there was nothing contrary to principle with the court having regard to the subsequent extinguishment of a creditor's debt after the commencement of the liquidation just as the court looks at events after that date to see if a contingent debt had matured to a full debt under Rule 13.12. As Lord Hoffmann put it:

"32 These cases on the use of hindsight to value debts which were contingent at the date of the winding up order show that the scene does not freeze at the date of the winding up order. Adjustments are made to give effect to the underlying principle of pari passu distribution between creditors. Hindsight is used because it is not considered fair to a creditor to value a contingent debt at what it might have been worth at the date of the winding up order when one now knows that prescience would have shown it to be worth more. The same must be true of a contingent debt which prescience would have shown to be worth less.

33 It therefore seems to their Lordships that the principle of pari passu distribution according to the values of debts at the date of winding up does not necessarily lead to the conclusion that someone who was a creditor at that date must be allowed to participate in the distribution even when he is no longer a creditor at all. There is nothing unfair, or contrary to principle, in a rule which requires that anyone who claims to participate in a distribution should have the status of a creditor at the time when he makes that claim. It would be strange if the court can have regard to subsequent events in valuing a creditor's contingent claim at much less than it would have been thought to be worth at the date of the order but not to the fact that someone has ceased to be a creditor at all."

39. Patten J too in Airbase thought that "The pari passu rule although fundamental is not immutable" (para. 29). Thus just as pari passu distribution is not an entirely fixed or immutable rule, so there are other circumstances, not necessarily confined to contingent debts or debts no longer existing, where the liquidator may have to have regard to events occurring after the "cut-off date".
40. I therefore see nothing in s 176A(2)(a) which is intended to exclude the floating charge holder who is no longer a floating charge holder in the special circumstances I have mentioned (total surrender of his security) from claiming a share in the prescribed part for the satisfaction of his (now) unsecured debts.
41. As to s 176A(2)(b) this prevents the liquidator distributing to "the proprietor of a floating charge" (except where there is a surplus after all unsecured debts have been satisfied in accordance with (a)). Setting aside the fact that the respondents in this case never were nor have been proprietors of a floating charge as distinct from their trustee, in my judgment the same consistent approach must be adopted as under (a). Thus if the charge holder has surrendered his entire security under or in accordance with Rule 4.88(2) and if, in consequence he is entitled to prove as if his debt were unsecured, for my part I do not see why he should not be treated for the purposes of s 176A as no longer being a charge holder at the time he makes his claim. This interpretation does not conflict, it seems to me, with s 176A(6) that net property is to exclude "holders of debentures" or "holders of any floating charge". The charge holder who has surrendered his entire security is no longer a "holder" of a debenture or charge and no longer "holds" (the word used in s 248) "in respect of his debt a security…".
42. I pointed out to Mr Arnold and to Mr Arden that one possible matter stood in the way of this interpretation, namely the definition in s 176A(9) of "floating charge" as "a charge which is a floating charge on its creation …" [my emphasis]. The purpose of the subsection is designed to apply only to those floating charges (as defined) created after the section came into force, 15 September 2003, but the question arises does the definition, particularly the words "is … on its creation" mean that one can never have regard to events after the creation of the charge so that in s 176A(2)(b) it means that the liquidator may not distribute to the proprietor of a floating charge which is a floating charge on its creation? The definition in s 176A(9) applies "In this section" and was therefore for some reason presumably intended to exclude the definition of floating charge in s 251 of the 1986 Act that "floating charge" means "a charge which, as created, was a floating charge" [my emphasis]. I cannot for myself see that there is any material distinction between the change of tense from "was" in s 251 to "is" in s 176A. Both definition provisions seem to me to be concerned with identifying the animal in question, namely a floating charge which was such when it was created whatever it may now have become, e.g. through crystallisation.
43. Accordingly I do not consider that it was necessarily intended to exclude the participation in the prescribed part of a floating charge holder who has surrendered his entire security. If it were, I would have thought that clearer words were needed.
44. It follows from the foregoing that if it were necessary to answer Mr Arden's timing question I would answer it by saying the relevant time to determine the matter was when the claim against the prescribed part was made. Thus I conclude that there is nothing in s 176A to exclude a floating charge holder who has surrendered his entire security from participating in the prescribed part.
45. Is there anything in the application of legislative policy or the legislative scheme under the Insolvency Act 1986 to compel a different view?
46. In my judgment there is not; if anything quite the opposite. As Mr Arnold pointed out, once the security has been surrendered that means the former secured (now unsecured) creditor is entitled to share in the general distribution of assets in accordance with the pari passu principle of equal and rateable distribution of the insolvent company's unsecured assets amongst unsecured creditors. He has surrendered his security and the assets (if any) comprised in that security. He is not seeking to keep the benefit and then recover the shortfall as best he can by sharing in the prescribed part as in Permacell and Airbase. He has become a totally unsecured creditor entitled to be treated as such and ranking as such at the end of the queue with other unsecured creditors.
47. There is no temporal limitation on the secured creditor's right to make his election under Rule 4.88(2) subject only to the insolvent administration being incomplete and to the further fact that a creditor who surrenders his security must surrender it in toto. That means if he is not to be regarded as in fact attempting to recover his shortfall only he must surrender the assets, proceeds and anything else recovered by virtue of his being a secured creditor under his security for the general benefit of creditors.
48. As to the apparent legislative policy of the entire insolvency scheme and s 176A in particular in my judgment this interpretation is entirely consistent. As I have said before the floating charge holder who surrenders his security is not having his cake and eating it. He cannot both surrender his entire security and keep the benefit of it. He must elect. If he elects to become an unsecured creditor I do not see why he should not be treated as such both to the extent of proving his debt under Rule 4.88(2) and participating under s 176A.

Conclusion

49. Accordingly I conclude that in my judgment the respondents in this case (if necessary through the Trustee) are entitled in the circumstances to share in the prescribed part. The answer therefore to the question posed at the outset of this judgment is that the debts due to the respondents are to be treated as an unsecured debt for the purposes of s 176A(2) of the Insolvency Act 1986.