The Supreme Court has held that a floating charge, crystallised by notice, prior to the commencement of a winding up, ranks ahead of preferential creditors. However, the Court expressed the view that the relevant legislation needs to be amended to reverse the "undoubtedly unsatisfactory outcome".

Background

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 High 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 High Court decision1

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 relevant part of the legislation2 provided that the preferential debts:

"...have priority over the claims of holders of debentures under any floating charge created by the company, and be paid accordingly out of any property comprised in or subject to that charge."

Similar wording had been the subject of previous court decisions in England and other common law jurisdictions which found that provisions in identical terms only applied where there remained property subject to a floating charge (i.e. one which had not crystallised) when the winding up commenced.3 Banks exploited this by using various devices, including the service of notices, to convert floating charges into fixed charges just prior to a winding up, thereby getting priority over preferential creditors.

However, the High Court noted that it was not bound by the English and other 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 relevant section of the Companies Act 1963 from first principles and held that the phrase "holders of debentures under any floating charge" encompassed security of whatever nature, provided it originated "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.

The Supreme Court

The liquidator appealed to the Supreme Court which unanimously4 reversed the decision of the High Court.

It is now clear that where the holder of a floating charge serves a notice of crystallisation and the Company is subsequently wound up:

  1. as a matter of law, on service of the notice, the rights of the chargee become the same as if the charge was originally a fixed charge and the debtor company can no longer deal with the charged assets, except subject to the charge; and
  2. the preferential creditors will rank behind the charge holder.

Comment

This judgment means that the practice of serving crystallisation notices just prior to the appointment of a liquidator and, by close analogy, a receiver in order to gain priority over preferential creditors is effective. Successful execution of this tactic can often save secured creditors very significant sums, usually at the expense of the State.

The service of such a notice will paralyze the debtor company, except to the extent that the chargee consents to the company dealing with the charged assets. Accordingly, decisions to serve such notices should be carefully considered and followed through with appropriate enforcement.

Moreover, existing liquidations and receiverships, where a floating charge had crystallised prior to appointment but the preferential creditors have not yet been paid should be considered on a case by case basis.

The Court also noted that the relevant sections in the Companies Act 2014 had been transposed from the old Act, without amendment, and the same position will apply under that Act.

The Court expressed disquiet with its own decision. Ms Justice Laffoy stating:

"Unfortunately it does appear that the replacement of s. 285(7) [of the Companies Act 1963], s. 621 of the [Companies] Act of 2014, requires to be amended to reverse the undoubtedly unsatisfactory outcome of this decision..." [emphasis added]

Given the current readiness of the State to legislate against the interests of secured lenders, and the fact that the judgment creates an avoidable cost to the State, amending legislation may be enacted promptly.

Footnotes

1 See our note of 30 March 2011 for more detail in relation to the High Court decision.

2 Section 285(7)(b) of the Companies Act 1963.

3 The position in England had been reversed in the Insolvency Act 1986

4 Judgment of Laffoy J., Clarke J. and Charleton J. concurring.

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