UK: Enforcing Security – When Can A Secured Creditor Incur Liability?

Last Updated: 7 August 2018
Article by Adam Pierce and Emma Zymanczyk

In Davey v. Money & Anor [2018] EWHC 766 (Ch) the owner of a company in administration alleged that the company's main asset, a commercial property, had been sold at an undervalue by the administrators, and argued that the secured creditor (Dunbar) that had appointed the administrators was liable as well as the administrators themselves. The court held that neither the administrators nor Dunbar was liable. But it did not discount the possibility that a secured creditor could incur liability for the actions of an administrator it had appointed, if it had sought to influence the administrator's actions. In this article, we explain the court's findings on this point in Davey, and summarise the extent to which a secured creditor can potentially incur liability when enforcing its security by other methods.

Sales by an administrator

Administrator acting as creditor's agent?

In Davey, the claimant attempted to fix Dunbar with liability for the administrators' alleged breaches of duty by arguing that the administrators were acting as Dunbar's agents. Dunbar argued that the administrators could not possibly be acting as its agents, because it is hard-wired into the Insolvency Act 1986 (the 1986 Act) that an administrator acts as agent of the company. The court concluded that this statutory agency does not automatically apply when an administrator sells assets subject to fixed security. The 1986 Act gives the administrator no powers to do so without the consent of the fixed charge holder or a court order. So an agency relationship could arise between lender and administrator in these circumstances, but it would require "something going beyond the legitimate involvement that a secured creditor could expect to have". An administrator can consult with a creditor, but it should not follow its directions unquestioningly.

Liability in tort

The claimant also argued that Dunbar was liable to it in tort for causing the various alleged breaches of duty by the administrators. The court held that an appointing creditor (or other third party):

  • cannot be liable in tort for causing administrators to breach their fiduciary duties to the company, as the law does not recognise such a tort;
  • can be liable if shown to have dishonestly assisted a breach of fiduciary duty by administrators (although this was not alleged in this case); and
  • can be liable if shown to have procured a breach of statutory duty (including duties under the 1986 Act) but only if it had both knowledge of, and a clear intention to bring about, the breach.

How do these liability risks compare with those a secured creditor might face when enforcing security by other methods?

Secured creditor exercising its power of sale

If a secured creditor enforces its security by exercising its power of sale, its duties to the owner and any other parties with an interest in the proceeds include:

  • Obtaining the best price reasonably obtainable.
  • Acting with reasonable skill and care.
  • Acting in good faith.

To avoid risk that an interested party claims a breach of one of these duties, secured creditors are usually reluctant to exercise a power of sale themselves. A secured creditor will usually only seriously consider this option if a third party has lower ranking security over the same asset and refuses to consent to a sale. By exercising its statutory power of sale, a first ranking security holder can "overreach" (or sell clear of) the interests of subsequent charge holders under powers set out in section 104, Law of Property Act 1925. Otherwise, a secured creditor will usually prefer to appoint a receiver to sell a secured asset.

Sale by a receiver

When selling a secured asset, a receiver has similar duties to those of a secured creditor exercising its power of sale (summarised above). The appointing creditor should not usually be liable for any breach by the receiver of those duties: security documents invariably provide that any receiver appointed by the creditor will act as agent of the security provider.

However, if the secured creditor "directs or interferes with" the receiver's activities, the courts are more likely to find that the receiver was in fact acting as agent of the creditor, making the creditor potentially liable for its breaches of duty. "Interfere" would not include discussions and consultation. But if a creditor insists that the receiver appoints an inexperienced agent, who in turn negligently obtains a below market price, the creditor risks incurring liability to the owner and other stakeholders.

Conclusion

The risk that a secured creditor will be found liable for the defaults of an administrator remains very low; lower than the equivalent risk when a receiver has been appointed over secured assets; and of course much lower than when a secured creditor exercises a power of sale itself. However, Davey is likely to encourage administrators and secured creditors to be more cautious in their communications.

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