On 4 March 2004, the landmark judgment in Leyland Daf overturned 35 years of law. In so doing, the House of Lords handed a significant victory to floating charge-holders, such as Leyland Daf debenture holder Stichting Ofasec. At the same time, the decision sounds an important note of warning for liquidators. Freshfields Bruckhaus Deringer acted for Stichting Ofasec throughout the proceedings.
Since the case of Barleycorn in 1970, liquidation costs and expenses have been payable out of floating charge assets ahead of the floating charge-holder (naturally, only to the extent that there were insufficient assets in the liquidation itself). The House of Lords held that the Barleycorn decision is wrong: liquidation costs and expenses are not recoverable out of floating charge assets – at least not until the secured debt has been paid in full.
The facts of the case are relatively simple. In March 1992, Leyland Daf Limited granted a mortgage debenture to Stichting Ofasec, a Dutch foundation, to secure money lent to the Leyland Daf group.
The debenture created fixed and floating charges over the assets of Leyland Daf Limited. In early 1993, following the collapse of the Leyland Daf group, Stichting Ofasec appointed administrative receivers under the mortgage debenture. The administrative receivers proceeded to realise the assets comprised in the mortgage debenture.
On 24 July 1996, some three years after the appointment of the administrative receivers, Leyland Daf Limited went into creditors’ voluntary winding-up. As at the date of the House of Lords hearing, the administrative receivers held, from realisations and interest, approximately £72m. The liquidators had realised an amount of approximately £1.5m, but had incurred estimated liquidation costs and expenses of approximately £10m (including corporation tax). The liquidators sought a declaration that their costs and expenses were payable out of the floating charge assets that the receivers were holding, in priority to the debenture holder. The Lords refused (overturning the Court of Appeal).
The Lords’ reasoning was that it was a question of property, not of priorities – the key point being that there are two distinct funds which belong to different parties:
(i) proceeds of the assets subject to a floating charge, which belong to the charge-holder (to the extent of the secured debt) and are administered by the receiver; and
(ii) proceeds of the ‘free’ unsecured assets, which belong to the company and are administered by the liquidator in the winding up – they would include any surplus from the proceeds of the floating charge assets.
Each fund bears its own costs and expenses – ie the liquidator cannot
dip into the floating charge fund simply because there are insufficient assets in the liquidation to pay its costs and expenses. Furthermore, each fund has its own separate order of priorities.
Lord Hoffman stated: “The expenses of the administrative receivership are borne by the debenture-holder’s fund. The expenses of winding up are borne by the company’s fund. The debenture-holder has no interest in the winding-up and the unsecured creditors have no interest in the administrative receivership.”
As the debenture-holder is entitled to the proceeds of realising the secured assets, it is right that it should pay for the costs of their realisation. The debenture-holder’s security should not, however, be subject to the general costs of the winding-up.
There are a number of separate points that the Lords’ decision does not deal with. These include: the possible consequences of the decision on administration; the differences between the funds available to meet expenses in a liquidation and in an administration; and the calculation of net property under Section 176A of the Insolvency Act 1986.
Administration was simply not relevant to the facts of the case.
In a situation where no receiver has been appointed, there are no uncharged assets, but there is a shortfall to the debenture holder, then a liquidator may only be entitled to fees and expenses for its work (if any) that relates to the preservation and realisation of the charged assets.
In relation to the fees and expenses incurred in identifying, agreeing and paying preferential claims, the position is less clear.
Lord Nicholls indicated that these fees and expenses are payable from floating charge assets – in the same way as the actual preferential claim. However, Lords Hoffman and Millett were more circumspect, preferring only to mention that the costs associated with protecting and realising the secured assets should be payable out of those secured assets.
The preferred view must be that the costs associated with identifying, agreeing and paying the preferential creditors are payable out of the floating charge assets; it is difficult to see how a liquidator is obliged to pay preferential claims but not be properly reimbursed for the cost and expenses relating to the same.
A prudent liquidator will agree with the debenture-holder the scope of the work to be undertaken in relation to the protection and realisation of the secured property and identifying, agreeing and paying preferential claims and the rates to be charged. Fees and expenses relating to general liquidation matters can only be taken from the floating charge assets to the extent that the debenture-holder agrees.
Prior to the Lords’ decision, a liquidator may have incurred fees and expenses on the (now mistaken) belief that it would be entitled to be paid those fees and expenses out of the floating charge realisations.
The liquidator may find it difficult to recover those fees and expenses unless: it has already been paid them (and can successfully rely on the defence of a change of position in any restitutionary action); and/or it has reached an agreement with the receiver/debenture-holder.
Judge Rimer at first instance, and all three judges in the Court of Appeal, decided in favour of the liquidators and against the debenture-holder. On the basis of these judgments (and, of course, the judgment in Barleycorn itself), liquidators may have incurred expenses believing that these costs and expenses would be met out of the floating charge realisations and may even have been paid their costs and expenses ahead of the debenture-holder. Given this, disputes seem sure to arise and it is unlikely that we have heard the last of the conflicts regarding the payment of expenses where there is a concurrent liquidation and receivership.
The decision was unanimous and, unusually, pro the floating charge-holder. Following the weakening of the position of secured creditors by Brumark, the Enterprise Act and most recently Spectrum, no doubt Leyland Daf will be welcomed by the banks. On the other hand, liquidators will have to consider very carefully the extent of the assets in a liquidation before they start incurring fees and expenses. For all parties, this is an important change in the law.
Anne Sharp is a senior associate in the restructuring and insolvency group at Freshfields Bruckhaus Deringer