In Re JT Frith Limited [2012] EWHC 196 (Ch):

  • the terms of an intercreditor agreement; and
  • some unwitting help from the junior creditors,

enabled a senior secured lender to benefit indirectly from the prescribed part on the insolvency of its debtor.

Existing law at a glance

The Enterprise Act 2002 introduced the prescribed part under a new section 176A(2) of the Insolvency Act 1986. It reserves part of the floating charge recoveries for unsecured creditors.

Since then, the courts have held that:

  • a creditor, having made a secured recovery, cannot share in the prescribed part on account of its unsecured shortfall (In Re Airbase (UK) Ltd [2008] EWHC 124 (Ch)); but
  • a secured creditor can share in the prescribed part if it releases its security and proves as an unsecured creditor in the insolvency of the debtor (In Re PAL SC Realisations 2007 Ltd [2010] EWHC 2850 (Ch)).

Facts of Re Frith

The applicants were junior secured creditors of a company in liquidation. The court considered whether they had effectively surrendered their security interest and so were able to share in the prescribed part.

One applicant had already filed a proof of debt stating that he held no security. The court concluded that this in itself turned the applicant's claim into an unsecured one.

A security trustee held the applicants' security for a wider group of junior creditors. The security trustee had not released its security, but the applicants had signed a deed of release giving up their rights to the security. The court said this was also effective to make their claims unsecured.

The junior creditors were also party to an intercreditor agreement with a senior secured lender, Bank of Scotland. The sting in the tail for the applicants was that this agreement required them to turn over all recoveries to the senior lender, until the latter had been repaid in full. The court held that this contractual term was effective: it did not offend the policy objectives behind the prescribed part.

Points for creditors to consider

Can senior creditors force junior creditors to file unsecured claims?

Intercreditor agreements commonly require the junior creditor to prove in the debtor's insolvency and to turn over any proceeds it receives to the senior creditor (until the latter has been fully repaid). Re Frith shows that these turnover proceeds may be greater if the junior creditor gives up its security. The junior creditors in Re Frith appear to have gone down this route voluntarily, unaware that their efforts would benefit the senior creditor rather than themselves. In future, junior creditors are unlikely to make this mistake. So where, as in Re Frith, senior and junior creditors hold separate security, a senior creditor may want a right to require the junior creditor to prove as an unsecured creditor in some situations. If so, the turnover arrangements in the intercreditor agreement should expressly deal with this.

Can junior creditors give up their security where they share it with the senior creditors?

In Re Frith, the junior creditor applicants successfully re-characterised their claims as unsecured, even though the security trustee holding their security had not released it. So could a junior creditor do the same, either voluntarily or to fulfil a contractual obligation, where a security trustee holds a single set of security for both senior and junior creditors? In principle, a junior creditor in that situation should be able to file a proof of debt as an unsecured creditor, or otherwise expressly give up its rights to the security, as in Re Frith. But it is possible a court would not be as comfortable treating a previously secured junior creditor as unsecured where:

  • other beneficiaries of the same security (i.e. the senior creditors) have made a secured recovery; or
  • the same entity also holds some or all of the senior debt.

However, it seems likely this case will only encourage secured creditors to look for ways of sharing in the prescribed part when their security does not give them a full recovery.