In Capital + Merchant Finance Limited (in receivership) v Vision Securities Limited (in receivership) our Wellington commercial litigation team was successful in the Court of Appeal on a defendant's summary judgment application involving the interpretation of a subordination clause in a Security Trust Deed (Deed).

Capital + Merchant Finance Limited (in receivership) (CMF) and Vision Securities Limited (in receivership) (Vision) advanced substantial sums of money to a property developer, Education Holdings Limited (Education).  CMF held security for those advances on trust for Vision and itself.  The Deed governed the agreement between the lenders and provided that the debt owed to CMF by Education was subordinated to that owed to Vision.  Therefore, any payment "in respect of" any subordinated indebtedness was to be held on trust by CMF for Vision until its senior indebtedness was paid in full.  The Deed also provided that any assignment of the subordinated indebtedness was prohibited without the consent of Vision.

A mortgagee sale left Vision with a shortfall and CMF with nothing.  CMF assigned its subordinated indebtedness to a third party, Honk.  Vision made demand for the sale proceeds of the assignment under the subordination clause in the Deed.  Vision argued that CMF had to apply the proceeds of sale in reduction of the amount owed by Education to Vision being the senior indebtedness.

The Court of Appeal did not agree.  The Court held that if the assignment proceeds were caught by the subordination clause a commercial absurdity would result.  CMF would be left with neither debt, nor sale proceeds, while Education, having done nothing, would receive the benefit of the application of the sale proceeds in reduction of the debt owed by it to Vision.  Education would receive a windfall.  The true intention of the clause was to ensure CMF was unable to retain the benefit of any payment made to it by or on behalf of Education for the purpose of reducing the subordinated indebtedness.  CMF was required to account to Vision in order to preserve Vision's rights to prior payment of the senior indebtedness.  The capital payment to CMF did not reduce the subordinated indebtedness and, as such, Vision's right to priority was preserved.

The proceeding was therefore struck out.

See Court decision here.