The recent case of Re J T Frith Ltd  EWHC 196 (Ch) shows:
- how secured lenders may surrender their security in order to participate in the prescribed part available for unsecured creditors on insolvency; and
- how intercreditor deeds may be worded to allow senior secured creditors to participate in the prescribed part, despite retaining their security.
Section 176A(2)(b) of the Insolvency Act 1986 sets aside a prescribed part (or ringfenced fund) of an insolvent company’s assets for unsecured creditors. That prescribed part (which depends on the amount of the company’s assets which are realised, subject to a maximum of £600,000) takes priority over floating charge holders.
Rule 4.88(2) of the Insolvency Rules 1986 provides that if a secured creditor voluntarily surrenders its security, it may prove for its whole debt as an unsecured creditor.
Where a creditor has not surrendered its security, that secured creditor is not entitled to share in the prescribed part, even in respect of a shortfall in the value of its security (Re Permacell Finesse Ltd  EWHC 3233 (Ch) and Re Airbase (UK) Ltd  EWHC 124 (Ch)). However, if it surrenders the whole of its security, it may both prove for its debt and participate in the prescribed part, as if it were an unsecured creditor (Re PAL SC Realisations 2007 Ltd  EWHC 2850 (Ch)).
JT Frith Limited (the “Company”) had granted a guarantee and debenture in favour of a number of creditors (the “Junior Creditors”). It also granted a debenture in favour of Bank of Scotland (the “Senior Creditor”) which, under the terms of an Intercreditor Deed, took priority over the Junior Creditors. The Intercreditor Deed provided that on an insolvency of the Company, the Junior Creditors could prove for their debts but were obliged to turn over any distributions they received to the Senior Creditor until the Senior Creditor had been paid in full.
The Company went into administration and then liquidation. Its net assets had been distributed in part payment of the Senior Creditor’s debt, leaving only the prescribed part remaining to be distributed.
The Junior Creditors were told by the liquidator that they were not entitled to participate in the prescribed part since they were secured creditors. They applied to the Court on the grounds that they had released their security and were therefore unsecured.
The Judge held that the Junior Creditors could surrender their security simply by omitting to mention the security in their proofs of debt and they could therefore participate in the prescribed part. He also held that the liquidator could not argue that the Junior Creditors could not participate in the prescribed part on the grounds that they were required under the terms of the Intercreditor Deed to turn over that prescribed part to the Senior Creditor, who was still a secured creditor. Although the Senior Creditor was not entitled to participate directly in the prescribed part, the turnover provision was simply a matter of contract between the creditors and did not offend against policy or contravene s.176A(2) IA 1986.
This case is interesting for two reasons. First, it confirms that for a secured creditor to participate directly in the prescribed part, it must surrender its security entirely. However, that surrender may be achieved either by a formal Deed of Release or automatically by the omission of any mention of the security in the proof of debt.
Second, a senior secured creditor may still participate indirectly in the prescribed part without surrendering its security if a subordinated creditor is under a contractual obligation to turn over any unsecured distributions it receives to the senior creditor.