Background to Re Permacell

The liquidators asked the court whether the floating charge holder could share in the prescribed part as an unsecured creditor to make up its shortfall under its floating charge. The prescribed part was introduced by the Enterprise Act 2002 and is set out in section 176A of the Insolvency Act 1986 (the Act). It is a portion of the floating charge realisations used to pay unsecured debts, rather than to pay the floating charge debt. The prescribed part is (a) 50 per cent of the first £10,000 of net floating charge realisations plus (b) 20 per cent thereafter, subject to an aggregate maximum prescribed part of £600,000.

Section 176A(2) provides that the liquidator, administrator or receiver shall set aside the prescribed part and ‘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’. At first sight, this appeared to answer the liquidators’ question – the prescribed part was for the unsecured debts, not the floating charge holder.

However, ordinarily a secured creditor (after fully realising its security) can prove for any shortfall in the liquidation. Some people said that the secured creditor’s shortfall ought to be regarded as an unsecured claim and it ought to share, alongside the ordinary unsecured creditors, in the prescribed part. It was also suggested that the policy of pari passu distribution among creditors of the same class supported this conclusion.

The decision

Purle QC (sitting as a judge in the High Court in Birmingham) held that the floating charge holder is not entitled to participate in the prescribed part as an unsecured creditor to make up its shortfall under its floating charge.

While accepting the importance of the pari passu principle, Purle QC noted that the principle’s source was statutory and it did not operate as a ‘free-standing principle against which specific statutory provisions fall to be construed’. The present case should be decided by referring to the specific provisions of section 176A, which operate as a departure from the general rule that secured creditors rank ahead of unsecured creditors.

The judge referred to the underlying reasons for the introduction of section 176A: to create a fund out of the floating charge holder’s property for distribution among the unsecured creditors. He said that it would defeat the object of setting aside the prescribed part if the charge holder could participate by claiming as an unsecured creditor – its claim would, in many cases, likely swamp the other unsecured claims. Purle QC stated that this would in effect deprive the unsecured creditors of a substantial part of their already-capped benefit.

In addition, section 176A(2)(b) states that the relevant office holder shall not distribute the prescribed part to the proprietor of a floating charge ‘except in so far as it exceeds the amount required for the satisfaction of unsecured debts’. Purle QC stated that if the floating charge holder’s own shortfall was included as an unsecured debt for these purposes, the exception could never apply in the case of an insolvent company. In his view, this was a strong indicator that the ‘unsecured debts’ were not to include a floating charge holder’s shortfall.

Accordingly, Purle QC decided that, on his view of section 176A(2)(b), the floating charge holder is not entitled to participate in the prescribed part as an unsecured creditor to make up its shortfall under its floating charge.

Comment

This decision is unlikely to come as a shock for most people. The idea of a share of floating charge realisations’ being taken from the floating charge holder and paid to unsecured creditors was put forward in 1982 in the Cork Report’s 10 per cent Fund. The report proposed that the 10 per cent Fund would be for ‘ordinary unsecured creditors’ and the debenture holder should not participate in it. The prescribed part regime differs from the Cork Report’s proposal, but it may be that this influenced the judge (although the judgment does not indicate this).

Unsecured creditors will clearly welcome the decision because it benefits them. Likewise, insolvency office holders will be grateful for the clarification it provides. Clearly, it is less pleasing news for floating charge creditors and the decision in Re Permacell will apply to all liquidations that commenced after 15 September 2003 (when section 176A came into force).

The floating charge holder’s inability to share in the prescribed part will further encourage creditors to seek fixed charges where the prescribed part does not apply. However, the importance of the prescribed part should not be overstated. As noted above, the prescribed part fund cannot exceed £600,000 and to reach that sum there needs to be £3m of floating charge realisations. That said, it should be noted that it is £600,000 per company. Therefore, in a group situation, the amount taken from the floating charge holder’s realisations could be several times £600,000.

On the topic of deductions from the floating charge realisations, it should be remembered that, from 6 April 2008, liquidation expenses will become payable out of floating charge realisations. This follows the coming into force of section 176ZA to the Act, which was introduced by the Companies Act 2006. As has been widely reported, this partially reverses the House of Lords decision in Leyland DAF. However, draft rules (to be introduced at the same time) restrict the application of this new section. Litigation expenses – liquidation expenses and costs properly chargeable or incurred relating to the preparation and conduct of any legal proceedings – are not to be paid out of floating charge property unless the relevant floating charge holder or preferential creditor consent has been obtained. The liquidator may also seek court approval of litigation expenses in certain circumstances – for example, where the litigation expenses relate to legal proceedings against the floating charge holder.

The reversal of Leyland DAF by section 176ZA will not affect liquidations that are ongoing on 6 April 2008 because the legislative changes are prospective only. However, the reversal will apply to all floating charges where the liquidation commences after 6 April 2008, even if the charge was entered into when the parties thought that Leyland DAF would apply. Again, something that is not welcome news for the floating charge holder.