Banks win greater protection in company liquidations

Mary Carolan

Banks have secured greater protection for loans to companies in a landmark Supreme Court ruling.

The court's unanimous judgment means Bank of Ireland gets priority over preferential creditors, including the Revenue, which is owed €600,000, in the liquidation of companies in the Belgard Motors Group. As the bank is owed €16.2 million, no other creditor will get paid.

The Supreme Court said amending legislation is needed to reverse what it said were the “undoubtedly unsatisfactory” effects of its judgment clarifying the law relating to priority of creditors in liquidations.

At issue was whether a "crystallisation" notice served by the bank was sufficient to convert the bank's floating charge to a fixed charge. The High Court had ruled previously that it did not.

A floating charge, which applies generally to movable assets, ranks below preferential creditors in the event of a liquidation. The holder of a fixed charge, secured normally on property or other "fixed" assets, is deemed to be a secured creditor and gets paid ahead of preferential creditors.

Overturning the High Court, the Supreme Court ruled that a notice in writing from the lender to the company, ahead of the beginning of any wind-up process, crystallising the debt does convert the floating charge to a fixed charge and makes the lender a secured creditor.

The court's decision was based on the wording of provisions of the old Companies Act. Those particular provisions remain unchanged in the new Companies Act, which came into effect last month.

Ms Justice Mary Laffoy, sitting with Mr Justice Frank Clarke and Mr Justice Peter Charleton, said the outcome means an "unsatisfactory state of affairs" because debenture holders – a bank or other lender who issues a loan secured on company assets and registers it with Companies Office – can "effectively leap frog" over the priority debts of preferential creditors such as the Revenue by crystallising their floating charge..

Ms Justice Laffoy said this could be rectified by amending legislation but she regretted that a drafting “defect” was perpetuated in the new Companies Act, the largest piece of legislation ever enacted here.

It appeared that Act needs to be amended to reverse the outcome of the court’s decision, which “gives rise to a number of concerns”, including the possibility a form of “false crystallisation” might be contrived in other cases, she said. She was also concerned the Companies Act does not require the registration of conversion of a floating charge to a fixed charge.

There was no suggestion of any lack of genuineness in the crystallisation process in this case, the judge stressed.

The case arose from liquidation of three companies in the Belgard Motors group – J.D. Brian Ltd, trading as East Coast Print and Publicity; J.D. Brian Motors Ltd, trading as Belgard Motors and East Coast Car Parts Ltd.

The companies petitioned for winding up at the High Court in December 2009 and Tom Kavanagh was appointed liquidator. He sought directions under the Companies Act concerning debentures each company had entered into with Bank of Ireland under which each charged, in favour of the bank, all their property and assets. A clause in each debenture referred to a “floating security”.

Ms Justice Laffoy said a specific clause in each debenture, clause 10, was at the core of the legal issues. It provided the bank may, prior to a winding up, serve a written notice on the company converting the floating charge into “a first fixed charge”. The clause said a notice under clause 10 may be served only if, in the sole judgment of the bank, the bank considers the assets and rights at issue “are in any way in jeopardy”.

While a new definition of floating charge was introduced in the UK in the 1980s and New South Wales in 1971, there is no definition of floating charge in the Irish Companies Act 1963 or in the new Companies Act 2014, she noted.

The judge noted the High Court had construed Section 285 (&) of the Companies Act 1963, dealing with priority of creditors in a winding up, as meaning the preferential debts rank in priorty to the claim of the bank as debenture holder to the funds realised from assets subject to the floating charge, irrespective whether the floating charge cystallsed before commencement of the winding up. The High Court also ruled the serving of the cystallisation notice by the bank did not convert the property subject to the floating charge into a first fixed charge over such property.

The liquidator, supported by the bank, appealed to the Supreme Court. The Revenue opposed the appeal.

Ms Justice Laffoy ruled the service by the bank of the crystallisation notice did convert the floating charge in the debentures into a fixed charge, with the effect no floating charge existed at the tiem of the winding up.

The only possible effect of the service of the notice under Clause 10 was to convert the floating charge into a first fixed charge, she said. Service of the notice also meant the company would cease to be entitled to use the relevant property in carrying on its business without the bank’s consent.

The High Court had wrongly construed Section 285, she ruled. That could not be read as entitling preferential creditors to priority for the priority debts specfied in the Section over the claims of a debenture holder whose charge has crystallised into a fixed charge before the commencement of a winding up.