The recent English case Arlington Infrastructure Ltd (in administration) and another v Woolrych and others demonstrates the importance of a secured creditor obtaining any consent necessary under the terms of intercreditor arrangements before taking enforcement action.
The facts of the case
At different times, senior and junior creditors lent money to Arlington Infrastructure Limited (AIL). The junior creditors (who lent to the company first) took fixed and floating security from AIL and its subsidiaries. The senior creditors later took floating security only from AIL. In each case the creditors' security was expressed to become enforceable if there was an event of default under the relevant loan agreement, including in the case of non-payment. The senior and junior creditors entered into a Deed of Priority (DoP) which provided as follows:
“Except with the prior written consent of the Senior Creditors, the Junior Creditors shall not: …
9.1.4 take any step to enforce any Junior Security Interest, whether by appointing a Receiver, exercising its power of sale or otherwise; or
9.1.5 present, or join in, an application for an administration order or a petition for a winding-up order to be made in relation to [AIL] or initiate, or support or take, any step with a view to any voluntary arrangement or assignment for the benefit of creditors or similar proceeding involving [AIL] or issue a notice of intention to appoint an administrator or appoint an administrator of [AIL].”
In August 2020, as the holders of a qualifying floating charge (QFCH), the senior creditors appointed administrators over AIL, using the out of court procedure set out in paragraph 14 Schedule B1 of the Insolvency Act 1986 (IA86). In September 2020, the junior creditors, who were also QFCHs, appointed administrators over the subsidiaries, again using the out of court procedure. However, the junior creditors did not obtain the consent of the senior creditors prior to that appointment. The appointment was challenged by AIL (in administration) and one of the senior creditors (the Applicants).
The main points before the court were as follows:
- Was the appointment of an administrator by a QFCH using the out of court route "enforcement" of security, falling within clause 9.1.4 of the DoP?
- Paragraph 16 Schedule B1 IA86 requires that the qualifying floating charge be enforceable at the time the out of court appointment is made by a QFCH. It was accepted that there had been a non-payment event of default under the junior creditor loan agreement so on the face of it the junior creditor security was enforceable. However, did the lack of senior creditor consent mean that in fact the security was not enforceable, and therefore the junior creditors had no right despite being a QFCH to appoint administrators using the out of court route? In other words, what was the meaning of "enforceable" when used in paragraph 16 Schedule B1 IA86?
- If the security was not enforceable when the junior creditors made the appointment, did that make the appointment invalid, or was there simply a procedural defect which could be cured by the court?
Is the appointment of an administrator by a QFCH using the out of court route enforcement of security?
The junior creditors argued first that administration is not an enforcement procedure. It is a process that can be started not only by a QFCH but also by the company or the directors, and the aim of the process was either to rescue the company, to produce a better return for creditors than would be achieved in liquidation or to make a distribution to one or more secured or preferential creditors. The administrator, once appointed, owed his duties to all creditors. They argued that these were not the hallmarks of an enforcement process. Secondly, the DoP referred separately to enforcement of security (clause 9.1.4) and the appointment of an administrator (clause 9.1.5) so it was clear from the DoP that administration should not be treated as enforcement of security.
The court disagreed. In SAW (SW) 2010 Ltd v Wilson1 (SAW), Briggs LJ had said that "the power to appoint administrators is in my judgment itself a means of enforcement". The court concurred. In its view, an out of court appointment of an administrator under paragraph 14 Schedule B1 IA86 amounted to enforcement of a floating charge.
The meaning of "enforceable" under paragraph 16 Schedule B1 IA86
The Applicants argued that the assessment of whether security had become enforceable required consideration of all of the circumstances, including the terms of the security document, any other collateral contract or agreement whether between the parties to the security or otherwise, any promissory estoppal and any statutory provision. Both sides and the court cited SAW and in particular this statement from Briggs LJ:
"the requirement in paragraph 16 of Schedule B1 that the floating charge relied upon for the appointment of administrators “be enforceable” is concerned with the question whether the chargee has a right to enforce, rather than with the question whether there are free assets to which the chargee can have recourse for the purposes of enforcement. A floating charge is in my judgment enforceable if any condition precedent to enforcement has been satisfied (such as an event of default) and there remains a debt for which the floating charge stands as security.”
The Applicants' view was that there were two conditions precedent to the floating charge becoming enforceable: the first was that it must have become enforceable in accordance with the terms of the security; the second was that senior creditor consent to enforcement must have been given. The first condition precedent had been satisfied but not the first.
The junior creditors argued firstly that the assessment should be carried out by solely looking at the terms of the security; and secondly that if the appointment of administrators over the subsidiaries constituted enforcement of security, the failure to obtain senior creditor consent was a breach of contract only, and that accordingly it did not affect the enforceability of the security against the subsidiaries, not least because the subsidiaries were not party to the DoP.
The court agreed with the Applicants. The question of whether a floating charge was enforceable had to be assessed objectively, with consideration given to all of the circumstances including the terms of the security, any collateral contract whether between the chargor and chargee or otherwise, any promissory estoppal and any statutory provision. The DoP was part of the surrounding circumstances and had to be taken into account. Clause 9.1.5 referred to the appointment of an administrator over AIL only, not the subsidiaries, and so there was no issue with construing clause 9.1.4 as covering administration of the subsidiaries. As clause 9.1.4 prevented the junior creditors from enforcing their security without senior creditor consent, and as the appointment of an administrator constituted enforcement of security, it followed that the junior creditors required senior creditor consent before making the appointment. According to the court, by entering into the DoP, the junior creditors "…willingly chose to fetter their ability to enforce their security". The question was not whether there was a breach of contract between the senior and the junior creditors, but instead whether, for the purposes of paragraph 16 Schedule B1 IA86, the security was enforceable. The lack of senior creditor consent meant that there was a condition precedent to enforceability which remained unsatisfied. Accordingly, the court decided that the junior creditor security was not enforceable for the purposes of paragraph 16 Schedule B1 IA86 when the appointment was made.
Invalid appointment or curable defect?
The court considered a number of cases concerning the effect of a failure to comply with the provisions under Schedule B1 IA86 when appointing administrators using the out of court procedure, including the recent case of Re Tokenhouse VB Ltd2,Gregory v ARG Mansfield3, Re Euromaster4 and Re Care People Limited5. The junior creditors argued that Parliament could not have intended breach of paragraph 16 Schedule B1 IA86 to result in automatic invalidity in circumstances where the companies over which the appointment was made were clearly insolvent, some of the senior creditors were connected with the subsidiaries and had a vested interest as potential purchaser of the subsidiaries' shares, and the appointment was made to protect the appointer's security. In a brief conclusion, the court stated that it did not agree with these arguments. This was not a case where there had been a failure of procedure. The lack of senior creditor consent was a fundamental defect and it was clear that even if senior creditor consent were now sought, it would not be obtained. In those circumstances the appointment was a nullity and could not be cured.
Why is this decision important?
Although the case specifically considered the term "enforceable" in the context of paragraph 16 Schedule B1 IA86, the court's reasoning would seem wide enough to apply more generally. On that basis, the decision supports contractual agreements made between creditors in connection with a financing where one party agrees not to enforce security without the consent of another party. These types of arrangement are common in many types of complex financings, including leveraged loans, real estate finance and project and infrastructure deals. If a court will reject enforcement action if such a required consent has not been obtained, rather than treat the matter simply as a breach of contract, this gives additional teeth to that contractual agreement. Depending on the circumstances, wrongly taking such action could potentially also result in a significant claim for damages.
Arlington Infrastructure Ltd (in administration) and another v Woolrych and others ( EWHC 3123 (Ch))