Marshalling cases are rare these days. Therefore, it is notable that two separate cases were heard in the appeal courts in 2013: Szepietowski v. The National Crime Agency (formerly the Serious Organised Crime Agency) and Highbury Pension Fund Management Company and another v. Zirfin Investments Management Ltd and othersCharlotte Drake explains why marshalling might affect a secured creditor's position, and the significance of these recent cases.

What is marshalling?

Marshalling is an equitable principle which aims to prevent one secured creditor arbitrarily depriving another secured creditor of his only security. Traditionally it applies where the same debtor owes debts to two secured creditors.

It is easiest to show how marshalling works with an example:

  • B has borrowed money from L1. L1's debt is secured against two properties owned by B – Shady Pines and Grassy Knoll.
  • B has also borrowed money from L2. L2's debt is secured by a second ranking charge against Shady Pines. L2 has no security over Grassy Knoll.
  • L1 decides to enforce its security against Shady Pines and is paid out in full. There is no value left in Shady Pines to pay off the debt owed to L2.
  • Marshalling will not enable L2 to interfere with L1's right to resort to whichever security it chooses. However, it could enable L2 to look to Grassy Knoll to repay its debt, even though it does not have security over Grassy Knoll. In effect it would enable L2 to be subrogated to L1's rights against Grassy Knoll.

How relevant is marshalling to secured creditors?

  • Junior creditors: Marshalling is usually of most relevance to junior secured creditors. In the example above, marshalling could put L2 in a better position than it would have been in if L1 had had less extensive other security. Junior secured creditors should be aware of the circumstances in which they might be able to exercise a right to marshal to improve their recoveries. Both recent cases are relevant to this question.
  • Senior creditors: Marshalling is often less relevant to a senior secured creditor. In the example above, L2's right to marshal did not affect how or when L1 enforced its security, or its priority position. L2 made use of marshalling once L1 had been paid off. However, the Highbury case illustrates that in some circumstances, the junior security holder may have a right to use marshalling before the senior debt is fully satisfied. The circumstances in which it might be able to do so are likely to be rare. However, a senior creditor may wish to address this potential loss of control, by expressly restricting the junior creditor from exercising any right to marshal until the senior debt is fully satisfied. This could be included in a priority deed or other intercreditor agreement. The Supreme Court's objective reasonable bystander test in the Szepietowski case also supports addressing the issue of marshalling up front in an intercreditor agreement.

A new objective reasonable bystander test

In the Szepietowski case the Supreme Court unanimously approved a new "objective reasonable bystander" test. It seems clear you would only apply this new test if the other ingredients for marshalling existed at the relevant time.

Lord Neuberger said that "the correct approach is to ask whether, in the perception of an objective reasonable bystander at the date of the grant of the second mortgage, taking into account, in very summary terms, (i) the terms of the second mortgage, (ii) any contract or other arrangement which gave rise to it, (iii) what passed between the parties prior to its execution, and (iv) all the admissible surrounding facts, it is reasonable to conclude that the second mortgagee was not intended to be able to marshal on the occurrence of the facts which would otherwise potentially give rise to the right to marshal."

The Supreme Court's approval of this test seems only to underline the advisability of addressing the issue of marshalling expressly in an intercreditor agreement entered into at the time of the second ranking security. What better way is there to inform the objective reasonable bystander as to whether the second chargee was intended to be able to marshal?

Do you always need a common debtor?

The case of Highbury Pension Fund Management Company and another v. Zirfin Investments Management Ltd and others came before the Court of Appeal in late 2013.

Before the High Court's decision on the case (earlier in 2013) it had been accepted that, for marshalling to apply, the two affected creditors needed to be recovering money from a common debtor. However, based on the facts the High Court decided it was possible to justify an exception to the "common debtor rule".

Barclays and Highbury had both advanced money to Zirfin and each had taken security over a property owned by Zirfin in Brompton Square. Barclays had also lent money to companies associated with Zirfin (the Affiliates), secured by charges over properties owned by the Affiliates. Zirfin had guaranteed the Barclays loan to its Affiliates and this guarantee was also secured by the charge over the Brompton Square property.

Following defaults by Zirfin and the Affiliates, Barclays appointed receivers to sell the Brompton Square property. The sale proceeds paid off sums which Zirfin owed Barclays and the surplus was applied in respect of Zirfin's obligations under the guarantee (but did not pay them in full). Barclays opted not to enforce its security over the properties owned by the Affiliates. If it had, there would have been enough surplus from the sale of the Brompton Square property to satisfy Zirfin's debt to Highbury.

It had been settled in the High Court that Highbury could use the doctrine of marshalling to look to Barclays' security over the Affiliates' properties, even though Zirfin (the common debtor) did not own them.

However, as is common, the Zirfin guarantee contained a clause precluding Zirfin from exercising any subrogation rights until Barclays had been paid in full. The High Court decided that because Highbury had been claiming "through" Zirfin, Highbury could not exercise its rights over the charged properties until Zirfin could exercise its rights under the guarantee. So, Barclays had to be paid off in full first.

It was this which formed the subject of the appeal. The Court of Appeal disagreed with the High Court. It held that the clause in the Zirfin guarantee did not postpone Highbury's marshalling rights until Barclays had been paid in full. Highbury was exercising marshalling rights that had accrued to it independently from Zirfin's rights under its guarantee. Therefore, the marshalling remedy should be treated separately. The Court of Appeal judges concluded that Highbury had an immediate right to use marshalling to enforce Barclays' security over the Affiliates' properties.

Law stated as at 22 April 2014.