The Supreme Court has failed to agree on the nature of a charge that had no underlying debt attached and on the scope of the equitable doctrine of marshalling of securities.
The charge arose after an investigation by the Serious Organised Crime Agency (SOCA). SOCA attempted to seize certain properties under the Proceeds of Crime Act 2002; this culminated in an agreement under which a second charge was created in favour of SOCA with a ‘Secured Amount’ of £1.24m in settlement of SOCA’s claim to confiscate the property. However, despite the definition of Secured Amount, there was no express creation or acknowledgment of indebtedness in the settlement agreement. The holder of the first charge enforced its security, even though it also held a first charge over another property.
The Supreme Court were unanimous in deciding that marshalling did not apply to the particular charge, as a matter of construction of the particular, unusual documents. However, they differed on whether it was available as a matter of principle..
For further details of the struggles of the Supreme Court to apply the principles of marshalling, see the inset box: Marshalling. But this should not obscure the more important point: the Supreme Court were faced with what looked like a charge with no underlying debt. Was this a contradiction in terms? If not, how did it work?
The majority of the Supreme Court appeared to find that there was some sort of charge but did not squarely address the contradictory nature of a charge without a debt.
Reasoning of the individual judges
Lord Neuberger, with whom Lord Reed agreed, held that there was no underlying debt, except that the charge was accompanied by a contingent obligation to pay a sum out of the net proceeds of sale of the property. This is rather like a limited recourse provision in a securitisation. While this avoids the problem of a charge with no debt, it is hard to see how Lord Neuberger arrived at this interpretation from the documents, particularly as he is quite clear that the settlement agreement did not create or acknowledge any indebtedness.
Lord Sumption held that there was no underlying personal liability and the sole effect of the transaction was to confer a contingent interest in the charged asset, not as the means to recovery of a liability, but as a primary benefit. This construction avoids the contradiction of a charge without a debt, seeing the interest as a separate distinct type of proprietary interest, perhaps arising from a constructive trust. However, his short judgment does not go into further detail – particularly as to how this construction is consistent with the terms of the agreement.
Lord Harnwath referred to the problem of a charge without a debt being a ‘contradiction in terms’ without coming to any clear expression as to its juridical basis, although he was clear that the charge in this case fell into that category. He felt that such charges would be very rare and should be considered in their particular factual contexts.
Lord Hughes considered the situation where the chargor underwrote the debt of another by putting up security but did not enter into a personal guarantee, so that there was an underlying debt but not one necessarily owed by the chargor. In this way, it relates to situations common in international financings, for instance where there is a security trustee or group of companies giving security. His reasoning is relatively undeveloped, but seems to imply that there must always be some ‘liability’ from the chargor to the chargee, although he does not suggest what that might be.
The Supreme Court’s reasoning is varied and undeveloped. Only Lord Sumption gave an interpretation of the underlying agreement that is consistent with the orthodox interpretation of a charge, by finding that the interest created was not a charge at all. It may be that the other judgments should be confined to the particular facts of the case, although they include some interesting discussion as to the nature of charges and their use in finance transactions.
Marshalling works as follows. Take a single debtor D and two creditors C1 and C2. C1 has a first mortage over property A and property B. C2 has a second mortgage over property A. If C1 enforces its security over property B and C2 enforces its security over property A, both may recover their debts. However, if C1 chooses to enforce its security over property A and the recovery is insufficient to provide for both debts, C2 may be left as an unsecured creditor. In this situation, equity steps in and allows C2 to take advantage of the security over property B: this is the process known as marshalling. The basis for this -- so far as the Supreme Court could agree -- is that it is unconscionable for C1 to be able to disadvantage C2 by its choice, in circumstances where it should not make any difference to D.
In this case, the majority in the Supreme Court held that as there was no underlying debt, once the charge over property A had been enforced, there was nothing to which the principle of marshalling could be applied. The minority held that the principle was intended to achieve justice between creditors, not between creditor and debtor, and so marshalling was applicable.