UK: Floating Chargeholders Triumph Over Liquidators

Last Updated: 14 January 2005
Article by John Longdon

The House of Lords overruled the High Court and the Court of Appeal in the recent case of Re Leyland Daf Ltd (sub nom Buchler v Talbot). In doing so, the House of Lords ruled that liquidators’ expenses were not to be paid out of property subject to a floating charge which had crystallised and held that Re Barleycorn Enterprises Ltd (1970) ("Barleycorn") had been wrongly decided in the Court of Appeal.

Leyland Daf Limited ("Leyland Daf ") granted a mortgage debenture in favour of a Dutch entity Stichting Ofasec ("Ofasec") in March 1992. This was to secure money lent to the group of companies headed by DAF NV, of which Leyland Daf was a member. The mortgage debenture contained fixed and floating charges over Leyland Daf ’s assets. The following year, DAF NV group found itself in financial difficulty and Ofasec, in exercise of its powers under the mortgage debenture, appointed receivers to Leyland Daf, crystallising its floating charge into a fixed charge. The receivers realised the assets subject to the security, paying preferential creditors, as well as making interim payments to Ofasec. In 1996, Leyland Daf entered creditors’ voluntary liquidation with a shortfall of funds to pay the full amount of liquidation costs and expenses. The question for the House of Lords was whether these should be paid out of realisations made by the receivers from the assets in priority to amounts owed to the chargeholder, Ofasec. Lord Millett, Lord Nicholls and Lord Hoffman gave concurring speeches, with which Lord Rodger and Lord Walker agreed.

As readers will be aware, on insolvency creditors of a company are paid out in the following order of priority: holders of fixed charges rank first, followed by the so-called "preferential creditors", then floating chargeholders and finally unsecured creditors. However, this was not always the case: when the category of preferential debts was created by statute in the late nineteenth century, they were a category of unsecured debts which ranked behind the claims of floating chargeholders. It soon became apparent that the law needed to change, as there would often be no surplus to pay preferential creditors after payment was made to floating chargeholders. Section 2 of the Preferential Payments in Bankruptcy (Amendment) Act 1897 (the "1897 Act") addressed this issue, providing as follows:

"In the winding up of any company ………. the debts mentioned in section one of the Preferential Payments in Bankruptcy Act, 1888, shall, so far as the assets of the company available for payment of general creditors may be insufficient to meet them, have priority over the claims of holders of debentures or debenture stock under any floating charge created by such company, and shall be paid accordingly out of any property comprised in or subject to such charge."

Where a company was not being wound up and a debenture holder appointed a receiver or took possession of property subject to a floating charge, section 3 of the 1897 Act provided that "the debts mentioned in section one of the said Preferential Payments Act shall be paid forthwith out of any assets coming to the hands of the receiver, or other person taking possession as aforesaid, in priority to any claim for principal or interest in respect of such debentures". Section 2 of the 1897 Act referred to preferential debts only. There was nothing to suggest that liquidation expenses should be discharged from assets subject to a debenture and nor were there any grounds for implying that this had been Parliament’s intention. Whilst the statutes mentioned above had since been amended and replaced – so that the relevant provisions were currently to be found in sections 40 and 175 of the Insolvency Act 1986 – their meaning had not changed.

Lord Nicholls made a distinction between a company’s charged assets and its noncharged assets in the context of distributing a company’s assets to creditors. He held that in the distribution of non-charged assets of the company, liquidation expenses ranked ahead of the preferential debts. However, the charged assets belonged to the debenture holders to the extent of the amounts secured. Whilst the charged assets might be eroded to the extent of the claims of preferential creditors,

"…. According a like priority in respect of liquidation expenses would represent a potentially major additional incursion into the proprietary interests of debenture holders."

Lord Nicholls’ distinction between distribution of a company’s charged and non-charged assets was further developed in the speeches of Lord Hoffmann and Lord Millett. Lord Hoffmann held that there were two separate funds from which the different categories of creditor would be paid. The charged assets would be realised and funds paid to the debenture holder, subject to the company’s equity of redemption. This was the so-called "debenture holder’s fund". The non-charged assets – the so-called "company’s fund" – would be held in trust for unsecured creditors. Each fund would bear its own costs so that the expenses of administrative receivership would be paid out of the debenture holder’s fund and the expenses of the winding up would be paid out of the company’s fund. Neither fund would bear the costs of administering the other,

"… And in particular the assets comprised in the floating charge are not required to bear the costs and expenses of the winding up as well as those of the receivership." Lord Millett set out the two distinct funds and order of priority of payments as follows:

"1. Assets subject to a floating charge….

(i) the costs of preserving and realising the assets;

(ii) the receiver’s remuneration and the proper costs and expenses of the receivership;

(iii) the debts which are preferential in the receivership;

(iv) the principal and interest secured by the floating charge;

(v) the company.

2. The company’s free assets….

(i) the costs of preserving and realising the assets;

(ii) the liquidator’s remuneration and the proper costs and expenses of the winding up;

(iii) the debts which are preferential in the winding up;

(iv) the charge holder to the extent that the preferential debts have been paid out of assets subject to the floating charge;

(v) the general body of creditors."

In Barleycorn, the Court of Appeal had held that the costs of winding up a company were payable from property subject to a floating charge which had crystallised, in priority to the floating chargeholder. However, this was wrong, due to a misreading of the word "assets" to include not only a company’s free assets but also those subject to a floating charge. The decision: "ignores the proprietary interest of the debenture holder in the debenture holder’s fund and treats it and the company’s fund as a single massed fund in which there is a single order of priorities."

In holding that the Barleycorn decision was wrong, the House of Lords has clarified the position for all of a company’s creditors, but this is of course particularly good news for floating chargeholders.

Re Leyland Daf Limited (Sub nom Buchler v Talbot) [2004] 2 WLR 582

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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