Insolvency Update - March 2011
30 March 2011
Converted floating charge still ranks behind preferential creditors
This decision has since been overruled. See our update here.
In J.D. Brian Ltd (in liquidation) & Others the High Court held that, where a floating charge crystallised prior to the commencement of a winding-up, the preferential creditors still had priority pursuant to in section 285 of the Companies Act 1963 over the holder of what had become a fixed charge.
Bank of Ireland held several debentures constituting floating charges over the assets of a number of companies in the Belgard Group. The debentures contained a clause permitting the Bank to crystallise the floating charge by serving a notice. On 28 October 2009 the bank served such notices and two weeks later a petition was presented for the winding up of the companies and winding up orders were duly made.
The liquidator sought directions from the court and contended that the charges had crystallised consequent on the notices and that the effect of this was that preferential creditors had no entitlement to be paid in priority to the Bank. The Revenue Commissioners, as preferential creditors, contested this position.
The parties agreed that the court should treat the charge as having become a fixed charge following service of the notice so the issue was did the preferential creditors rank behind the now fixed charges.
The court held that it was not bound by the English and Commonwealth authorities cited to it and declined to follow them, preferring an Australian dissenting judgment and some criticism of the main English decision in subsequent English cases.
The court construed the language of section 285(7) from first principles and held that the phrase “holders of debentures under any floating charge” encompassed security of whatever nature, provided it was held “under or by reason of a floating charge created by the company”.
Therefore the Bank’s claim remained a claim as the holder of security under a floating charge. It did not matter that the charge had subsequently become fixed prior to the commencement of the winding up. The charge was a floating charge as created by the company and therefore the preferential creditors still took priority over the Bank.
Despite it not being necessary for the purposes of the judgment, the court also addressed the concept of automatic crystallisation with a focus on crystallisation by notice.
The court expressed the view that it was necessary to construe the debenture and any notice to see if together they truly had the effect of converting a floating charge to a fixed charge as distinct from the notice simply so stating.
In this regard, the court held that it would be important to look at whether or not the company was restricted by the combined terms of the debenture and notice (and not by examining what subsequently happened) from dealing with any of its assets.
This judgment means that a bank can’t get priority for itself over preferential creditors by serving a crystallisation notice just prior to the appointment of a receiver or liquidator.
While this is bad news for banks, it is difficult to disagree with the view that it is unlikely that the legislative intent, when giving preferential creditors preference over floating charge holders, was to permit that priority to be displaced by unilateral service of a notice. Indeed subsequent to the decisions in the UK and Australia, those countries both amended their statutes to ensure that this could not be done.
The decision also means that if a secured lender, for whatever reason, still elects to serve a crystallisation notice, the notice should include language restricting the use of the charged assets or else the purported conversion to a fixed charge may not be valid.
In this case a large proportion of the assets secured by the floating charge were motor vehicles. Lenders may consider more complex structures to provide effective security. For instance requiring such stock to be held by a subsidiary structured to have minimal exposure to tax and no employees and taking a charge over that subsidiary might have proven effective.
The decision is the first on the point in Ireland and may be appealed.
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