SECURED CREDITORS AND FINANCE AGREEMENTS
This Part is divided into sections as follows:
Guidance on the avoidance (overturning) of charges is provided in Chapter 31.4B, Part 3.
The concept of a creditor holding security, being a secured creditor, is an important one in insolvency as a secured creditor retains rights against the property of the insolvent which are not available to an unsecured creditor [note 1] [note 2].
In particular, the secured creditor retains rights to take possession of, and sell, such property of the insolvent against which his/her debt is secured, with his/her responsibility to the insolvency estate being limited to a requirement to pay over any surplus funds to the liquidator/trustee for the benefit of the estate following the sale of the secured asset.
Security has been held to be defined in the following terms; ‘security is created where a person (‘the creditor’) to whom an obligation is owed by another (‘the debtor’) by statute or contract, in addition to the personal promise of the debtor to discharge the obligation, obtains rights exercisable against some property in which the debtor has an interest in order to enforce the discharge of the debtor’s obligations to the creditor’ [note 3].
A secured creditor, in relation to a company, means a creditor of the company who holds in respect of his/her debt a security over property of the company [note 4]. Security means, in relation to England and Wales, any mortgage charge, lien or other security [note 5].
The creation of a charge should be for the benefit of the company. If the monies advanced were for the benefit of another party, and the lender was aware of the purpose for which the moneys were to be used, the validity of the charge may be challenged [note 5a].
In bankruptcy, a debt is secured to the extent that the person to whom the debt is owed holds any security for the debt (whether a mortgage, charge, lien or other security) over any property of the person by whom the debt is owned [note 6].
In relation to an insolvent estate, a secured creditor can:
Where a creditor puts a value on his/her security and that security is subsequently realised, the net amount realised shall be substituted for the value previously placed on the security and the creditor will be entitled to prove for the adjusted balance [note 11] [note 12].
The official receiver, as liquidator or trustee, may give notice to a creditor whose debt is secured that he/she proposes, at the expiration of 28 days from the date of the notice, to redeem the security at the value put upon it in the creditor’s proof [note 15] [note 16]. In bankruptcy, the official receiver would require sanction to redeem security (see Chapter 29) [note 17].
It is unlikely that the official receiver would seek to use this power, and instead it is likely to more appropriate to seek the appointment of an insolvency practitioner to act as liquidator or trustee.
Where the liquidator or trustee serves notice of an intention to redeem the security, the creditor has 21 days (or such longer period as the liquidator or trustee may allow) to exercise his/her right to re-value the security. If the creditor re-values his/her security, the trustee may only redeem at the new value [note 18] [note 19].
The liquidator or trustee, if dissatisfied with the value which a secured creditor puts on his/her security (whether in his/her proof or by way of re-valuation) may require the property comprised in the security to be offered for sale [note 20] [note 21]. The exception to this is where, for company cases where the petition was presented on or after 6 April 2010, and all bankruptcies, the security has been re-valued and the re-valuation has been approved by the court [note 22] [note 23].
Where the petitioning creditor is a secured creditor and has, being the petitioner, put a value on his/her security, or has voted in respect of the unsecured value of the debt, he/she may re-value the security held only with the permission of the court [note 24] [note 25].
Where a secured creditor submits a proof of debt but fails to disclose a security held, he/she can be required to surrender the security for the benefit of the general body of creditors unless the court is satisfied that the omission was inadvertent or the result of an honest mistake [note 26] [note 27].
As a general rule, a charge created earlier would rank in priority over one created later. The exception to this would be that, in relation to a company, a fixed charge ranks over a floating charge (see paragraphs 40.115 to 40.116) even if created later [note 28] though, in reality, this rarely occurs in practice, as the floating chargeholder will generally require that the person giving the charge undertake not to further charge the assets.
The priority of the charges may be changed by a ‘deed of priority’ agreed between the borrower and the holders of the charges affected by the change in priority. The deed of priority would be effective even where it resulted in a floating charge taking priority to an earlier fixed charge [note 29].
Marshalling, or marshalling of securities, is the term to describe the equitable remedy available to secured creditors where they have security over the same assets of a debtor. Without going into detail, it describes the process of sharing the assets between the creditors.
Otherwise, the chargeholder may simply seek the repossession and sale of the charged property.
The proceeds of sale may be applied to the repayment of the capital sum and interest accrued prior to the date of the insolvency order. The creditor cannot include the post insolvency order interest in calculating the amount to be claimed in submitting a proof of debt [note 30].
Chapter 9 provides advice so far as regards the enforcement of charges against the property of the bankrupt.
Often, following repossession, there will be a shortfall in the monies required to repay the debt due under the charge.
The chargeholder would, in this circumstance, become an unsecured creditor for the amount of the shortfall (see paragraph 40.4).
A mortgagee or other secured chargeholder may request the bankrupt to sign a document acknowledging the level of debt, shortfall or similar. Such a document is generally known as a deed of acknowledgement. This might be in connection with an arrears repayment plan or a re-mortgage (see paragraph 31.3.35).
If the bankrupt completes such a deed, a new debt might be created on which recovery action might be based at any time within the limitation limit. It is not for the official receiver to influence the bankrupt about how to proceed in this matter. The bankrupt should simply be advised to seek independent legal advice.
Whilst a post bankruptcy debt can be created by rescheduling and deed, the underlying debt it is still a bankruptcy debt.
The official receiver should check that monies secured by a charge against the insolvent’s property were received by the insolvent before or at the time the charge was created. If not, the transaction may be a preference (see Chapter 31.4A, Part 2).
A mortgage is the conveyance, assignment or demise of any land or estate in it as security for the repayment of money borrowed. The owner of the land (mortgagor) signs a deed (mortgage) that gives the lender (mortgagee) an interest in the property. The term mortgage (from the French ‘death pledge’) is applied to the transaction itself, the deeds and the rights of the mortgagee.
Mortgages are governed by statute [note 31], and the terms will be set out in the deed.
This may be because of a defect in the paperwork or because the borrower lacked capacity to properly grant the mortgage to the borrower (where he/she was only a joint owner, for example).
If registered, an equitable mortgage can take priority as usual (see paragraph 40.116).
See paragraph 40.135 regarding equitable charges.
Any contract for a disposition in land, which would include a mortgage or a charge, is not valid unless it is writing, incorporates all the terms agreed by the parties and is signed by all the parties [note 33].
Where the charged property comprises unregistered land and the mortgage is capable of registration, then it should be registered at the Land Charges Registry [note 34] in order to bind purchasers.
Where the property comprises registered land the charge should be registered with the Land Registry; again this is to bind purchasers.
It is not necessary for a charging order obtained against a company to be registered with the Registrar of Companies [note 35].
Guidance on the practicalities of the registration of charges obtained by the official receiver against the property of a bankrupt is in paragraph 31.3.269.
Where a charge was created before 6 April 2013, the company must send details of the charge to the Registrar of Companies [note 36]. Where the charge was created on or after 6 April 2013, the Registrar must register the charge where it is filed within the period allowed [note 37], but there is no requirement to effect registration. Failure to register the charge will however render it void against a liquidator, administrator or creditor of the company [note 38].
Providing the secured creditor is content, there is nothing to prevent the bankrupt or joint-owner continuing to reside in the charged property.
Where payments continue to be made to the secured creditor, the creditor would, in these circumstances, and subject to the terms of the mortgage arrangement, use these sums in the first instance to discharge the continuing accrual of interest under the mortgage. The creditor is otherwise unable to pursue the bankrupt for interest falling due after the order date (see paragraph 40.157).
Where a creditor obtains a judgment it may be followed up by a charging order in execution of the judgment (see paragraph 9.124).
A charging order may be made either absolutely or subject to conditions as to notifying the debtor or as to the time when the charge is to become enforceable, or as to other matters. The court by which a charging order was made may at any time, on the application of the debtor or of any person interested in any property to which the order relates, make an order discharging or varying the charging order [Note 38a].
A charging order may be granted by the court over any interest held by the debtor beneficially in property, certain securities, funds in court or under any trust. The court making the order may provide for the charge to extend to any interest or dividend payable to the debtor in respect of the asset [Note 38b].
The legislation [note 39] provides that a company has unrestricted capacity to borrow unless that power is restricted in the objects of the company in its memorandum of association (see Chapter 75, Part 5).
Similarly, unless restricted by the objects, the directors have power to give security for the company’s borrowings on such terms as they see fit [note 40].
Technically, borrowing or the giving of a charge in contravention of the objects of the company is void at common law [note 41], though the decision of the directors is binding on the company where the creditor acted in good faith [note 42] [note 43] [note 44].
Chapter 31.4B, Part 3 gives advice on the avoidance of charges in liquidation, and Chapter 31.4B, Part 4 gives advice on civil recoveries against directors where they have breached their fiduciary duties (such as when borrowing outside the scope of the company’s objects).
The right of a creditor to recover his/her capital sum and interest from definite and ascertainable assets is termed a fixed charge.
A fixed charge fastens from the moment of its creation to the particular property in question (machinery or buildings, for example), and gives the holder of the charge an immediate security over that property so that the debtor may not sell or otherwise deal with the charged property without the consent of the chargeholder.
Unlike a mortgage (see paragraph 40.122), a charge does not give the chargeholder a proprietary interest in, or possession of, the property.
A floating charge is defined in the Act as a charge which, as created, was a floating charge [note 45].
It has been further defined in case law [note 46] as follows:
‘A floating charge is ambulatory [movable] and shifting in its nature, hovering over and, so to speak, floating with the property which it is intended to affect until some event occurs, or some act is done, which causes it to settle and fasten on the subject of the charge within its reach and grasp [also known as crystallisation (see paragraph 40.132)].’
Deciding whether a charge is a fixed charge or a floating charge is a matter of establishing the intentions of the parties in creating the charge and also characterising the charge by reference to law [note 47] (see paragraph 40.130). Even though the parties consider the charge to be of one variety that does not prevent the court from declaring it otherwise [note 48] taking into account the substance not the form of the charge [note 49].
Certain events cause a floating charge to become a fixed charge, meaning that the company can no longer sell the charged property without the consent of the chargeholder. This is known as crystallisation of the charge. Those events are:
In addition to the automatic crystallisation of a floating charge (see paragraph 40.132), the parties may also agree contractually that a floating charge, created by a debenture, may be crystallised into a fixed charge by intervention of the debenture holder [note 55]. Generally, this intervention will be by way of the appointment of a receiver out of court, by may be by service of a notice.
An equitable charge arises where a chargee is entitled to look to an asset or class of assets to discharge a liability [note 56].
It differs from an equitable mortgage (see paragraph 40.123) in that there is no agreement to create a charge or mortgage and the property may only be sold by order of the court.
If registered, an equitable charge can take priority as usual (see paragraph 40.116).
A charging order is defined as a court order giving a judgment creditor security over specified assets of the debtor (usually freehold or leasehold property [note 57].
The order may be made absolutely or subject to conditions such as to notifying the debtor or the date it comes into effect [note 58] and any person interested in the property may apply for an order discharging or varying the charging order [note 59].
Subject to limitation (see paragraph 40.11) [note 61], a solicitor may apply to court for a charging order in respect of costs in relation to a matter for which he/she was acting in bringing proceedings.
Guidance on the effect of such an order against the property of a bankrupt can be found in paragraph 9.119.
A debenture is a written acknowledgement of a debt by a company, usually under seal [note 62], containing provisions as to the payment of interest and repayment of principal (the original loan sum). A debenture does not necessarily provide for security in the form of a charge over the company’s assets, but debentures are usually secured by a floating charge (see paragraph 40.130) or a fixed and floating charge.
A company can create more than one debenture, in which case, unless specified otherwise, they would rank in order of priority according to the dates on which they were created.
A lien is a right to retain possession of another’s property pending the discharge of the indebtedness. A creditor with a lien would generally be treated as a secured creditor in insolvency proceedings [note 63] [note 64].
A pledge is the term to describe the item given to a pawnbroker in return for a loan. If the loan is not repaid within a certain time period, the pawnbroker has the right to sell the goods.
If an insolvent has goods in pawn the guidance in paragraphs 31.0.47a to 31.0.47h should be followed.
A security bill of sale is a bill given to secure payment of monies. Generally it is given over personal assets/chattels.
The legislation provides that an applicable bill of sale must be registered within seven clear days of its making [note 67], and must be renewed at least once every five years [note 68]. The method of registering the bill of sale is to send, to the High Court, the original bill of sale, together with a witness statement attested in front of a solicitor stating that the effect of the bill of sale has been explained to the person granting the assignment [note 69].
Failure to register the bill of sale properly will mean that it is ineffective against a trustee in bankruptcy [note 70]. This would mean that the debt would be considered to be unsecured and the goods purportedly covered by the bill would be free to be realised by the official receiver, as appropriate.
Where there is doubt as to whether a bill of sale is properly registered the official receiver may conduct a search of the register by issuing a letter to the High Court of Justice Enforcement Section. The letter should give details of the persons who may have been party to the assignment, and also such details as are known of the assignment itself (such as the date and the property concerned). The request should be accompanied by a payment of £40 made payable to “HMCS” and should be sent to:
Judgments and Orders Section
Royal Courts of Justice
Tel no: 020 7947 6221
This office will provide a certificate showing details of the registration (if any) and for a further fee of £5 will provide an office copy of the documents provided in support of the application of registration.
A finance agreement where the lender retains ownership or repossession rights over the vehicle until a specific date or when certain conditions (such as the amount of repayment made) have been met is usually known as a ‘conditional sale agreement’ or ‘hire-purchase agreement’.
Subject to any express clause in the agreement, the rights of the insolvent under the agreement (such as the right to acquire ownership – see paragraph 40.145) will pass to the official receiver as liquidator or trustee.
Where there is doubt, the official receiver should peruse the terms of the agreement to confirm the extent to which the finance company retains ownership rights.
The key difference between a conditional sale agreement and a hire purchase agreement is that under a hire-purchase agreement the hirer acquires an option to purchase the goods after complying with the terms of the agreement (to make 24 monthly payments, for example), whereas under a conditional sale agreement there is no such condition: property passes only on the payment of all instalments.
In practice an agreement where the finance company retains an interest in the property (see paragraph 40.143) will usually contain a clause giving the finance company the right to terminate the agreement in certain circumstances, such as default on repayment or the making of an insolvency order against the borrower.
Where the finance company exercises such a right in relation to an agreement that relates to property of an insolvent, the potential benefit to the official receiver as liquidator or trustee will be restricted to the rights of the insolvent on termination of the agreement. The key right that the insolvent would hold in this regard is that the vehicle may not be repossessed without a court order if more than two thirds of the total price of the vehicle has been paid [note 71].
In deciding whether to consent to such an order, the official receiver should consider the value of the property to the estate were it to be sold (taking into account the need to settle the finance and any arrears).
Where the official receiver is dealing with property subject to a finance agreement, he/she should send the standard letter [note 72] to establish the type of agreement (that is, whether it is a simple credit agreement or a conditional sale-type agreement – see paragraph 40.144) and the amount required to settle the agreement.
The official receiver as liquidator or trustee may pay the amount required to complete the agreement and obtain title to the asset [note 73] if it is beneficial to do so, subject to any consolidation clause (see paragraph 40.147). In many cases there is no benefit in taking such action as the amount outstanding on a finance agreement, taking into account interest and charges, is in excess of the value of the item, taking into account depreciation. In bankruptcy, sanction would be required to make a payment to secure property which is subject to a conditional sale-type or hire-purchase agreement (see paragraph 29.42).
Where the finance is a simple credit agreement, the official receiver may deal with the property as an asset in the proceedings.
The standard agreements of most finance companies contain consolidation clauses which require the hirer to treat all agreements with the company as one for completion purposes. In this case the official receiver will not be able to complete one agreement (see paragraph 40.146) without completing them all.
The early termination of a finance agreement as a result of insolvency may give rise to the finance company making a claim for damages for breach of contract. In such a case the official receiver will have to decide whether the claim relates to genuine liquidated damages (which should be admitted) or a penalty (which should not) [note 74].
Where the finance agreement is expressed to terminate on insolvency it should be remembered that the insolvency is not a breach of contract (unless specifically provided for) but simply an event on which the parties agree that the agreement should end. No question of damages therefore arises, although the agreement may provide for a contractual payment as compensation for early termination. This payment may be reduced or off-set by a discount for early settlement.
The payment of instalments by a person other than the party to the agreement does not result in the transfer of any rights (such as a right to take ownership of the property) to that third-party [note 75].
Any such payments should be treated as a loan and the person that made them may claim in the proceedings as an unsecured creditor.
A ‘logbook loan’ is a type of loan that is granted generally to individuals in severe financial difficulty where other sources of borrowing are not available. Typically, the loan will have a very high APR (rates of up to 500% are not unknown) and, with punitive charges for missing payments, etc., the amount required to be repaid is often well in excess of the original loan. The loan is secured on the borrower’s vehicle through a bill of sale (see paragraph 40.141) transferring ownership of the vehicle to the lender.
Where the official receiver encounters a logbook loan, or similar, he/she should check that the bill of sale on which the transfer is registered with the court (following the guidance in paragraph 40.142). If it is not, the lender will have no security over the vehicle and it may be dealt with normally. If the bill of sale is registered, the official receiver should treat the vehicle as one with hire purchase (see paragraph 40.143).
Depending on the nature of the arrangement entered into by the bankrupt, or the manner in which the account was managed by the lender, the official receiver should also consider whether the agreement might be challenged as an extortionate credit transaction (see Chapter 31.4B, Part 6).
It has been held that a landlord’s right of re-entry is not a form of security [note 76].
A retention of title clause, also referred to as a ‘reservation of title’ or ‘Romalpa’ clause, is a form of security used by a supplier of goods to afford protection against the possibility of the buyer default or insolvency. Where a valid retention of title clause exists the supplier may retain title to the goods until payment is received, and this will be valid against any subsequently appointed liquidator or trustee.
Full guidance on retention of title clauses can be found in Chapter 63.