Thorniley & Anor v HM Revenue & Customs & Anor

Section 176A of the Insolvency Act 1986 (which was inserted by s.252 of the Enterprise Act 2002) provides as follows:

“(1)

This section applies where a floating charge relates to property of a company—

(a)

which has gone into liquidation,

(b)

which is in administration,

(c)

of which there is a provisional liquidator, or

(d)

of which there is a receiver.

(2)

The liquidator, administrator or receiver—

(a)

shall make a prescribed part of the company's net property available for the satisfaction of unsecured debts, and

(b)

shall not distribute that part to the proprietor of a floating charge except in so far as it exceeds the amount required for the satisfaction of unsecured debts.

(3)

Subsection (2) shall not apply to a company if—

(a)

the company's net property is less than the prescribed minimum, and

(b)

the liquidator, administrator or receiver thinks that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits.

(4)

Subsection (2) shall also not apply to a company if or in so far as it is disapplied by—

(a)

a voluntary arrangement in respect of the company, or

(b)

a compromise or arrangement agreed under section 425 of the Companies Act (compromise with creditors and members).

(5)

Subsection (2) shall also not apply to a company if—

(a)

the liquidator, administrator or receiver applies to the court for an order under this subsection on the ground that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits, and

(b)

the court orders that subsection (2) shall not apply.

(6)

In subsections (2) and (3) a company's net property is the amount of its property which would, but for this section, be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company.

(7)

An order under subsection (2) prescribing part of a company's net property may, in particular, provide for its calculation—

(a)

as a percentage of the company's net property, or

(b)

as an aggregate of different percentages of different parts of the company's net property.

(8)

An order under this section—

(a)

must be made by statutory instrument, and

(b)

shall be subject to annulment pursuant to a resolution of either House of Parliament.

(9)

In this section—

“floating charge” means a charge which is a floating charge on its creation and which is created after the first order under subsection (2)(a) comes into force, and

“prescribed” means prescribed by order by the Secretary of State.

(10)

…..”

The question which I have to decide on this application for directions is whether the prescribed parts of the company’s net property (as defined in s.176A (6)) is available to satisfy any part of the debts due to a creditor which are secured by a floating charge in that creditor’s favour but cannot be paid out of the realisation of the net property due to a shortfall in the value of the security. In terms of the statute the question is whether “unsecured debts” in s.176A(2) include the unsecured balance of the debts due to the floating charge holder or other secured creditor.

Under s.176A(9) the provisions of the section apply only to floating charges created after 15 September 2003 which may explain why this issue has only recently arisen for decision.

The applicants are the administrators of two companies; Airbase Services (UK) Limited (“Services”) and Airbase Services International Limited (“International”) which were placed into administration on 28 April 2006. Services is a wholly owned subsidiary of International (which is a non-trading company) and (as its name suggests) it provides maintenance services in the UK to the commercial airline industry. Since their appointment the joint administrators have sold the valuable parts of the Services’ business for sums totalling about £1.14m. The residual assets comprised cash at the bank and some book debts.

The Second Respondent, Harris N.A. (“Harris”) holds fixed and floating charges over the assets of both companies. It is owed some £6.35m. In addition there are claims by unsecured creditors in the sum of about £1.7m of which some £621,000 (on current estimates) is owed to HM Revenue & Customs. The joint administrators have now completed any realisations that are achievable. The net recoveries from the sale of fixed charge assets amount to £243,000 and there is a further £1.312m net after expenses from floating charge realisations.

Applying the provisions of the Insolvency Act 1986 (Prescribed Part) Order 2003 (SI 2003/2097) (“the Order”) they have calculated the prescribed part to be £265,000 which leaves £1.047m available to meet the liabilities under the floating charge. On these figures there is a deficiency in Harris’ fixed charge security of some £6.107m and an unsecured shortfall under its security as a whole of £5.06m. The deficiency to unsecured creditors (including Harris in respect of the shortfall) is some £6.335m.

Given the level of realisations it will be apparent that there is a shortfall in Harris’ security of some £4.795m before deduction of the prescribed part. The parties have calculated that if Harris is entitled to participate in the prescribed part as an unsecured creditor for this sum, the dividend payable out of the unsecured part will be 4.08p in the £. This would result in Harris receiving about £195,636, HMRC about £25,336 and the other unsecured creditors about £44,145. If Harris is entitled to participate for the entirety of its shortfall (i.e. including the additional £265,000 attributable to the prescribed part) then the dividend figures are £198,352, £24,343 and £42,414 respectively.

These figures are to be contrasted with the position which will obtain if Harris is not entitled to participate in the prescribed part for any portion of the shortfall on its security. The dividend for the unsecured creditors in this event will be some 15.56p in the £ which will result in HMRC receiving about £96,628 and the remaining unsecured creditors about £168,360. In that event, however, Harris would receive nothing in respect of its unsecured shortfall.

Prior to the changes made by the Enterprise Act the functions and powers of administrators were limited to the achievement of the statutory purposes set out in s.8(3) of the Insolvency Act and subject to that to pursuing an exit strategy via the approval of a company voluntary arrangement or (if necessary) the liquidation of the company. Although the administrator was routinely concerned in the disposal of the company’s assets and undertaking he was given no express power to make distributions to pre-administration unsecured creditors and the generally accepted view was that such a power could not ordinarily be implied as necessary or incidental to his functions as an administrator: see Re The Designer Room Limited [2004] EWHC 720. In practice a distribution could only be made by discharging the administration order under s.18 of the Act and by placing the company into liquidation.

Any distribution to creditors would therefore observe the established priorities. The holders of fixed charges would be entitled to recover the sums due to them from the sale of the secured assets and any prior sale by an administrator under the provisions contained in s.15 of the Insolvency Act did not displace the priority enjoyed by the secured creditors but merely transposed it to the proceeds of sale: see s.15(4).

The same applied to assets subject to a floating charge but in their case preferential creditors such as the Crown were given priority over the holder of the floating charge: see Insolvency Act s.175(2)(b).

One of the principal purposes of the Enterprise Act was to achieve what was described in the White Paper published in July 2001 (Cn 5234) as the streamlining of the administration procedure and the establishment of collective procedures designed to allow all creditors to participate whilst recognising their differing rights and status. To this end the right of secured creditors to appoint administrative receivers was curtailed and administration promoted as the appropriate means of regulating an insolvent company where there is some prospect of a rescue.

But the Enterprise Act also introduced a number of changes which operate in relation to companies whose businesses cannot be saved and whose assets are therefore realised to meet the claims of creditors as part of the administration. For present purposes two of these are of particular significance. The first is the creation in paragraph 65 of Schedule B1 of an express power for the administrator to make distributions to creditors. The power is subject to two restrictions. Paragraph 65(2) applies s.175 of the Insolvency Act to any such distribution so as to preserve the rights of preferential creditors and paragraph 65(3) prohibits any distribution under this paragraph to a creditor of the company who is neither secured nor preferential unless the Court gives permission. Such permission is unlikely to be given if any secured or preferential debts remain unpaid.

The second significant change is the reduction in the number of preferential creditors by the abolition of Crown preference. As the White Paper recognises, if taken alone the most immediate (and in many cases the sole) beneficiaries of this change will be the floating charge holders and this will be the position for all floating charges created before 15 September 2003. But beyond this transitional stage the intention behind the legislation was to benefit unsecured creditors.

Paragraph 2.19 of the White Paper states that the Government will achieve this “through a mechanism that ring-fences a proportion of the funds generated by the floating charge”. When the bill was introduced in the House of Lords the Minister (Lord McIntosh of Haringey) made a similar statement to the effect that the benefit of the abolition of Crown preference would go to unsecured creditors:

“….It is, after all, they who are at the end of the queue and for whom there is often nothing left after costs and secured creditors have been paid. It is estimated that an additional £70 million per year will become available to unsecured creditors as a result of the Crown giving up its preferential status. It is only right that unsecured creditors – including those in cases in which a floating charge has been given – receive the benefit of this money. This clause achieves that promise.

Therefore, in company insolvency cases where a floating charge has been given, this clause instructs the office holder to set aside – or “ring-fence” – a proportion of the money that he has available for the floating charge holder and to hold it for distribution to unsecured creditors.

..”

These statements of legislative intent are relied upon by HMRC on behalf of themselves and the other unsecured creditors as providing what they say is a clear indication that the provisions of s.176A should be read as excluding from participation in any distribution from the prescribed part secured creditors who have unsecured debts due to a shortfall in the value of their security. To allow them to prove for the unsecured portion of their debt would, they say, amount in effect to giving back what s.176A(2)(a) has taken away. In particular, the Crown (as a former preferential creditor) would find itself competing for a dividend in the administration or liquidation not only with other unsecured creditors but also with the holders of floating charges over whom it had previously enjoyed priority.

There is, I think, little doubt that in many cases (of which this is one) the benefits to unsecured creditors of the prescribed part will be considerably reduced if the floating charge holder is entitled to participate. Its claims are likely to be substantial and if the company’s business and associated assets are of limited value the unsecured portion of its claim is likely to make it one of the largest unsecured creditors. That said, there is only limited guidance to be obtained from the White Paper and the Ministerial statement on the issue which I have to decide. There is no doubt that a secured creditor is entitled to prove as an unsecured creditor for any part of the debt not covered by the value of the security and in relation to that part of its claim a secured creditor (to use Lord McIntosh’s words) stands at the end of the queue in the same way as any other unsecured creditor.

The proposals set out in the White Paper proceed at a fairly high level of generality and do not in terms address the issue I am concerned with. One can contrast this with the Cork Report (Cmnd 8558, 1982) in which the question of the degree of priority to be given to the holder of a floating charge is discussed in considerable detail. The Cork Committee proposed that 10% of the net assets secured by the floating charge should be made available for distribution among what are described as the ordinary unsecured creditors and that the debenture holder should not himself participate with the unsecured creditors in that fund unless he first abandoned his security in toto. However, in relation to creditors whose debts are secured by a fixed charge the Committee recommended that they should be entitled to participate to the extent of the unsecured balance.

As Mr Arnold pointed out, these proposals were not taken up by the legislature and there is no indication in the White Paper or elsewhere as to whether they had any and if so, what influence upon the changes introduced by the Enterprise Act. What is at least clear is that no distinction is drawn in s.176A between the “unsecured debts” of a floating charge holder and those of a fixed charge holder. If those words in s.176A(2)(a) apply to exclude the unsecured portion of the debts of an otherwise secured creditor they must apply to both categories of secured creditor alike. The position of the two classes of secured creditor will only differ if “unsecured debts” include the unsecured debts of all types of creditor (both secured and unsecured) but the floating charge holder is excluded from participating in the prescribed part as a result of the provisions of s.176A(2)(b).

I prefer to approach the construction of s.176A (2) through the language and provisions of the relevant legislation. The White Paper and the other now historical documents such as the Cork Report are only helpful in setting out the background debate from which the legislation has emerged. The argument of Mr Arnold on behalf of Harris can, I think, be summarised in the following propositions:

The first three propositions are uncontroversial. But the question whether an otherwise secured creditor falls within s.176(2)(a) in respect of any unsecured part of his debt depends on how one construes “unsecured debts” in the context of s.176A(2) as a whole. This is not as such a defined term and I accept that if taken in isolation it could include the unsecured portion of the debts due to a secured creditor. Mr Arnold referred me to various of the Insolvency Rules governing the quantification of claims by creditors. Rule 2.83 enables a “secured creditor” to prove for the balance of his debt, after deducting the amount realised or to prove for the whole debt “as if it were unsecured” if he first surrenders his security. Rule 2.102(2) deals with a case where a re-valuation of security by the secured creditor results in a reduction of his “unsecured claim”. This language (although not identical) is said to indicate that “unsecured debts” in s.176A(2) must have been intended to include the unsecured portion of a secured creditor’s claim.

It seems to me that these provisions (taken by themselves) are inconclusive. Although they contemplate a secured creditor being able to prove in an administration or liquidation for the unsecured part of his claim, that does not answer the question whether the prescribed part is available for that purpose unless one assumes that the “unsecured debts” referred to in s.176A(2) are entirely general in meaning. The contrary argument is that “unsecured debts” mean only the debts due to unsecured creditors as defined in s.248 of the Insolvency Act. Section 248 provides that:

“In this Group of Parts, except in so far as the context otherwise requires—

(a)

“secured creditor”, in relation to a company, means a creditor of the company who holds in respect of his debt a security over property of the company, and “unsecured creditor” is to be read accordingly; and

(b)“security” means—

(i)

in relation to England and Wales, any mortgage, charge, lien or other security, and

(ii)

in relation to Scotland, any security (whether heritable or moveable), any floating charge and any right of lien or preference and any right of retention (other than a right of compensation or set off).”

If one goes back to s.176A it is apparent from s.176A(3) that a distribution of the prescribed part under s.176(2) is contemplated to be a distribution to “unsecured creditors” who on the application of s.248 would not include the holders of a floating charge or fixed security and this emphasis on the identity of the creditor rather than the nature of his debt can be seen in other parts of the legislation and the rules. One example of this is in fact rule 2.83 but perhaps more relevant is rule 2.95 which requires the administrator to give notice of any proposed distribution to creditors and provides in sub-rule (2)(c) that the notice shall:

“ where the administrator proposes to make a distribution to unsecured creditors, state the value of the prescribed part, except where the court has made an order under section 176A(5).”

Section 176A does not of course itself confer any power of distribution on an administrator or liquidator. Its purpose is to set aside a portion of the company’s assets secured by the floating charge for the satisfaction of unsecured debts and to do so by restricting the right of the floating charge holder to have recourse to those assets to satisfy the debts due under the floating charge: see s.176A(2)(b) and (6). As mentioned earlier, the power of distribution (in the case of an administrator) is contained in paragraph 65 of Schedule B1 to the Insolvency Act. Any distribution would have to be consistent with the administrators’ statement of proposals approved at a creditors’ meeting and it is, I think, significant that paragraph 52(1)(b) of Schedule B1 (which deals with the obligation to send out copies of the statement of proposals to creditors) removes that obligation in cases where the administrator thinks:

“(b)

that the company has insufficient property to enable a distribution to be made to unsecured creditors other than by virtue of section 176A(2)(a)”

This is a further indication that any distribution of the prescribed part is to exclude secured creditors as defined in s.248.

Ultimately however, the most compelling argument for limiting the prescribed part to unsecured creditors as such and for excluding secured creditors even in respect of the unsecured portions of their debts can be found in the provisions of s.176A itself. The phrase “unsecured debts” must obviously have the same meaning in both s.176A(2)(a) and (b). Section 176A(2)(b) deals with the case where the prescribed part of the company’s net property as defined in s.176A(6) exceeds the amount required to discharge the unsecured debts in full and therefore leaves a surplus. In such cases the embargo on distributing the prescribed part to the floating charge holder is removed and the surplus reverts to its original purpose of being available to satisfy the claims of the holders of floating charges: see s.176A(6).

On Mr Arnold’s construction of “unsecured debts” the provisions of s.176(2)(b) are inoperable because by definition the prescribed part will have discharged the entirety of the “unsecured debts” due to the floating charge holder in accordance with s.176A(2)(a). For s.176A(2)(b) to have any possible application “unsecured debts” cannot include the unsecured debts of any type of secured creditor as defined.

On this basis, the floating charge holder and the fixed charge holder are excluded from participating simply because of the provisions of s.176A(2)(a) and not by virtue of the express restriction on distributions to a floating charge holder contained in s.176A(2)(b). As already explained, that embargo is directed to the right of the floating charge holder to recover its debts from its security which is recognised by s.176A(6) and the operation of the general law. But even if I were to have taken a different view of s.176A(2)(a) it is difficult to see how on any view of s.176A(2)(b) the floating charge holder could participate. It follows that on my construction of the statute the prescribed part is held for the benefit of unsecured creditors alone and both floating charge holders and fixed charge holders are excluded in respect of their unsecured claims.

Although there is no reference to the position of fixed charge holders in the White Paper, this view of s.176A is in my view consistent with the reality of the position as it existed prior to the enactment of the Enterprise Act. The holders of fixed charges had and continue to have unfettered access to their security but in respect of the assets subject to a floating charge, they rank behind the claims of the preferential creditors and floating charge holders and have no greater rights or expectations than any other unsecured creditors. They are, however, secured creditors and their exclusion from the prescribed part for the benefit of unsecured creditors will in most cases be as important as the exclusion of floating charge holders if the ordinary unsecured creditors are to obtain any significant advantage from the provisions of s.176A. In most of these cases the extraction of the prescribed part will be necessary if the unsecured creditors are to receive anything significant in the administration or liquidation. On the basis that the abolition of Crown preference was intended to enure for the benefit of unsecured creditors the exclusion of fixed charge holders in parallel with floating charge holders cannot be said to be inconsistent with the stated purpose of the legislation.

In the face of these provisions the pari passu rule is necessarily modified so as to differentiate between unsecured creditors with no form of security and the unsecured claims of secured creditors. The pari passu rule although fundamental is not immutable and it seems to me that in this case its application has necessarily to be restricted if s.176A is to have its desired economic effect.

I propose therefore to make a declaration that the Second Respondent is not entitled to participate in the prescribed part in respect of any claim based on any shortfall in its security.

Following the hearing of this application and the preparation of this judgment I was provided with a copy of an unreported decision dated 30 November 2007 of HHJ Purle QC (sitting as a High Court Judge) in the case of Re Permacell Finesse Limited (in liquidation). Unbeknown to the parties at the time of the hearing before me the Judge had already reached the same conclusion about s.176A(2) for reasons which are not dissimilar to my own. I have received further submissions about that decision but since it accords with my own views, I do not propose to add anything further to this judgment.

I am grateful to Counsel on both sides for their submissions.