This decision has been overturned by the Supreme Court, click here for our update.
Prior to 25 March 2011, there was no judicial decision in Ireland on whether the holder of a floating charge could validly improve its position in the order of priority of payments, vis-à-vis preferential creditors, in circumstances where its floating charge crystallises (i.e. converts into a fixed charge) prior to commencement of the winding up of a company.
On 25 March 2011, Ms Justice Finlay Geoghegan in the High Court delivered her decision in ‘In the Matter of J.D. Brian Limited (In Liquidation) and In the Matter of J.D. Brian Motors Limited (In Liquidation) and In the Matter of East Coast Car Parts Limited (In Liquidation) and In the Matter of the Companies Acts 1963 to 2009’ on an application by the liquidator for directions on this particular issue.
The main finding was that even where a floating charge has crystallised prior to the commencement of a winding up (whether crystallisation occurs as a matter of law or as a result of an express provision in the security document permitting crystallisation) the preferential creditors will have priority over floating charge holders (i.e. persons whose charges were originally created as floating charges) in relation to distributions from the proceeds of assets subject to the crystallised floating charge.
The Facts
The facts as outlined are that Bank of Ireland (the Bank) had security over the assets of the referenced companies (being members of the group of companies known as the Belgard Group). The security took the form of debentures, comprising fixed and floating charges over all of the assets of the companies. The operation of the fixed charges was not in issue and is not discussed here.
On 13 November 2009, a petition was presented for the winding up of the companies. On 7 December 2009, the winding up order was made and Tom Kavanagh was appointed as liquidator of the companies.
Prior to commencement of the winding up process (i.e. prior to the presentation of the winding up petition) the Bank had, on 28 October 2009, sought to crystallise its floating charges by service of notices on the companies. The notices stated that the floating charges had been converted into fixed charges. The notices were served pursuant to a clause in the debentures which permitted crystallisation of the floating charges into fixed charges, in circumstances where the Bank considered the assets to be in jeopardy.
As the Bank had taken steps to crystallise its floating charges over the relevant assets of the companies prior to the lodging of the winding up petitions, the liquidator sought directions from the court as to whether the Bank was entitled to priority over the preferential creditors in relation to distributions from the proceeds of assets subject to the crystallised floating charges.
The list of preferred creditors in question is set out in section 285(2) of the Companies Act 1963. The list contains a number of headings but can be reduced in essence to amounts due (i) in respect of local authority rates and assessed taxes due to the Revenue Commissioners (subject in both cases to an upper limit of 1 year’s worth) and (ii) to employees, including wages and salaries (subject to an upper limit of €3,174.35 for each claimant), sick and holiday pay, pensions and compensation for dismissal and damages for accidents at work (no limit).
Finlay Geoghegan J found that even where a floating charge is converted into a fixed charge prior to commencement of a winding up (whether crystallisation occurs as a matter of law (e.g. due to winding up / appointment of a receiver) or as a result of an express provision in the security document permitting crystallisation (e.g. on the service of a ‘crystallisation’ notice)), preferential creditors must still be paid in priority to the holder of the floating (now fixed) charge from the distribution of the proceeds of assets subject to the converted floating charge. As such, serving crystallisation notices in an attempt to improve priority will not achieve the desired result as against preferential creditors.
Finlay Geoghegan J’s reasoning was detailed as she was departing from long established English and Commonwealth authority, commencing with the English case In re Griffin Company Limited [1940]. In re Griffin Company Limited had concluded that the English equivalent of section 285 (section 264 of the UK Companies Act 1929 at the time) should be interpreted to the effect that if a floating charge had crystallised prior to the commencement of a winding up preferential creditors would have their priority displaced.
Finlay Geoghegan J grounded her reasoning on her obligation to give effect to the intention of the Oireachtas pursuant to its enactment of section 285. She stated that this was best achieved by construing the words of the section in their ordinary and natural sense. Finlay Geoghegan J concluded that it was not possible to discharge this obligation if she followed In re Griffin Company Limited.
Finlay Geoghegan J was also influenced by the fact that the English and the Australian legislatures have since enacted statutory definitions of ‘floating charge’ (in both cases to the effect that a floating charge shall be taken to mean a charge, which at the date of its creation, was a floating charge) to clarify matters surrounding the interpretation of the English and Australian equivalents of section 285 and to close the “unfortunate loophole” arising from deficiencies in the drafting of their equivalent provisions.
The judgment of Finlay Geoghegan J was that the proper meaning of section 285(7) is that the preferential debts rank in priority to the claims of floating charge holders (even where crystallised) in relation to the funds realised from the assets subject to the floating charge, irrespective of whether the floating charge crystallised prior to the commencement of winding up.
Automatic Crystallisation
The case also addresses the different circumstances in which crystallisation of floating charges can occur. Finlay Geoghegan J noted that there is some confusion around terminology, in particular in relation to ‘automatic crystallisation. To clarify the situation, Finlay Geoghegan J sets out what she believes to be the correct classification of crystallisation scenarios:
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‘implicit crystallisation’ (which may also be referred to as ‘automatic crystallisation’) - events of the traditional kind from the prior case law being: (a) a business cessation event; and (b) appointment of a receiver / taking possession as mortgagee. It is generally acknowledged that these events are so well established that they exist in law. That said they are generally also re-iterated in the security document; and
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‘express crystallisation’ - explicitly agreed crystallisation events which are set out in the security document as a matter of contract. These generally require some specified intervention by the charge holder e.g. the service of a ‘crystallisation’ notice where the charge holder believes the assets the subject of the charge to be in jeopardy.
The decision goes on to consider whether express crystallisation clauses are permitted in law. Finlay Geoghegan J found that express crystallisation clauses are permitted.
She went on, however, to note that although a security document may include a clause which purports to be an express crystallisation clause, this does not mean that the clause will achieve its intended effect. In this regard, the charge holder should be aware that it is necessary to construe the terms of the security document and any notice on their true meaning to see if they truly have the effect of converting a floating charge into a fixed charge. Some guidance is provided as to how this can be achieved – a crystallisation notice should include language restricting the use of the assets the subject of the floating charge.
Floating Charge – any benefit?
The decision now begs the question for lenders as to whether there is any benefit in taking floating charges. In practice, there are still substantial benefits to be derived from taking a floating charge. In brief, floating charge holders will still (i) rank in priority to unsecured creditors and (ii) enjoy the rights and remedies of enforcement available to security holders, albeit ranking after preferential creditors in the order of priority of payments.
For instance, in relation to the enforcement rights and remedies these are generally much the same for floating charge holders as for fixed charge holders and the main legislation regulating enforcement does not make any distinction between fixed and floating security. In this regard, a floating charge holder can generally take control of a company's assets the subject of its charge and sell them, either as mortgagee or through a receiver. The charge holder can then apply the proceeds against amounts owed. This represents a significant benefit over unsecured creditors who rank pari passu with each other and who generally have to sue to prove their debt.
Against this there is always the concern that the judgment will be seen as a set back by lenders which in turn will impact on the availability of credit, especially as in reality many trading businesses do not have an asset base over which it is appropriate to take fixed security (e.g. stock in trade and book debts). In this context it is worth bearing in mind that Finlay Geoghegan J regards her decision as upholding the intention of the legislature in its enactment of section 285 and by extension the public policy underpinning the section. In this regard, she quotes with some approval the pronouncements of Hoffman J i.e. in In Re Brightlife Limited [1987] and In Re Permanent Houses (Holdings) Limited [1988]. To better understand the public policy context of floating charges and the role that the floating charge concept plays in relation to economic activity in general (and the availability of credit in particular), it is worth quoting Hoffman J in In Re Brightlife Limited as follows:
“The floating charge was invented by Victorian lawyers to enable manufacturing and trading companies to raise loan capital over debentures. It could offer the security of a charge over the whole of the company's undertaking without inhibiting its ability to trade".
On a practical level, the quantum of the preferred amounts will obviously differ from company to company. In circumstances where lenders are relying on floating security they may now be more concerned with actively monitoring the levels of potentially preferred amounts in their borrowers. This can be done by analysing regular financial information to be provided to lenders by borrowers and lenders can seek to include covenant suites in their loan and security documentation in respect of the regular delivery of such financial information. In addition, covenants requiring borrowers to remain compliant in relation to payments due in respect of potentially preferred amounts can also be included.
In the case at hand, 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 number of employees and taking a charge over that subsidiary might prove effective.
Conclusion
There is a danger that if this decision stands it will erode the usefulness of the floating charge, as so eloquently exemplified by Hoffman J above. Against this there are some commentators and practitioners who may regard the decision as simply confirming what is in fact the position in any case e.g. see Courtney’s comments in ‘The Law of Private Companies’ (2nd Ed.) at page 1584. Either way, it is likely that the decision will be appealed to the Supreme Court.
In the event that the Supreme Court confirms Finlay Geoghegan J’s decision then the matter will be beyond doubt. If the Supreme Court does not agree then there may very well be legislative intervention to provide clarity on the matter (although this is not currently proposed under the current company law reform and consolidation process).
While the outcome of the decision may be unwelcome for secured lenders, it does at least provide clarity on a question which had not yet benefitted from specific Irish judicial analysis.
