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judge decides that holders of a floating charge cannot participate in the prescribed part for their shortfall

4 January 2008

There has been much academic debate over whether or not banks and other holders of a floating charge can receive any payment from the prescribed part in respect of any shortfall under the floating charge.

The statutory framework

Section 176A of the Insolvency Act 1986 (which applies to charges created on or after 15 September 2003 which were floating charges on their creation) was inserted by the Enterprise Act 2002 and came into force on 15 September 2003.

Subsection (2) of section 176A provides as follows:

"(2) the Liquidator, Administrator or Receiver -

(a) shall make a prescribed part of the companys net property available for the satisfaction of unsecured debts, and

(b) shall not distribute that part to the proprietor of a floating charge expect in so far as it exceeds the amount required for the satisfaction of unsecured debts"

The "prescribed part" is ascertained by reference to the Insolvency Act 1986 (Prescribed Part) Order 2003 and is subject to a maximum of £600,000 calculated as a percentage of the net realisations of the companys property which is subject to the floating charge.

Section 176A was one of the major innovations made by the Enterprise Act 2002 and was seen by some as a quid pro quo for the abolition of the Crowns preferential status as preferential creditor.

Re: Permacell Finesse Limited ("Permacell")

Permacell entered administration on 18 May 2006. As at the date of its administration, Permacell owed Synseal, a private debenture holder, £2,307,000. During the course of the administration, all of Permacells assets were realised. Out of those realisations £1,188,150 was distributed to Synseal, leaving a shortfall of £918,850 under its floating charge. The prescribed part was set aside in the sum of approximately £379,000. Unsecured creditors (not including Synseal in respect of its shortfall) totalled approximately £3,104,000.

The question which came before the Court was whether Synseal could participate, in the prescribed part, as an unsecured creditor, in respect of its shortfall of £918,850.

The arguments

The answer, on the face of Section 176A(2)(b), seems clear enough. Synseal was the proprietor of a floating charge and would therefore not be able to participate in a distribution to unsecured creditors until unsecured debts are satisfied. However, ordinarily, a secured creditor can prove for any shortfall and therefore ought to be in no different position to the other unsecured creditors. This is also supported by the importance attached by law to the policy of pari passu distribution amongst creditors of the same class, including unsecured creditors. This is often described as the "Statutory Scheme".

The Courts ruling

Although the principle of pari passu distribution is recognised by case law at the highest level, His Honour Judge Purle QC, sitting as a Judge of the High Court in Birmingham, held that in his judgment, the present case did not fall to be determined by reference to the generalities of the statutory scheme but was to be determined by reference to the specific provisions of section 176A. In his view, section 176A operated as a departure from the general rule that secured creditors rank ahead of unsecured creditors. He held that the policy behind the changes to the legislation was to create a fund out of the floating chargeholders security to which unsecured creditors could have recourse in return for the advantage given to floating chargeholders by the abolition of the preferential status of the Crown.

The Judge therefore doubted that a floating chargeholder, compelled to accept the setting aside of the prescribed part for the benefit of others, could then be allowed to claw some of it back which would, in many cases, swamp the claims of unsecured creditors. Furthermore, the Judge observed that if the floating chargeholders own shortfall was itself to rank as an unsecured debt the exception in section 176A(2)(b) which prohibits a distribution of the prescribed part to the proprietor of a floating charge except in so far as it exceeds the amount required for the satisfaction of unsecured debts could never, in the case of an insolvent company, apply. This was a strong indication that the expression "unsecured debts" in section 176A did not include any shortfall under the floating charge.

Accordingly the Judge held that the prohibition on distributing the prescribed part to a floating chargeholder was absolute.

Commentary

This decision will undoubtedly come as a blow to banks and other proprietors of floating charges. His Honour Judge Purle QC adopted a literal interpretation to give effect to what he believed to be the intention of Parliament, which was that - having allowed floating chargeholders the benefit gained from the abolition of the Crown preference - the prescribed part should not be diluted by secured creditors having a second bite at the cherry.

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The content on this page is provided for the purposes of general interest and information. It contains only brief summaries of aspects of the subject matter and does not provide comprehensive statements of the law. It does not constitute legal advice and does not provide a substitute for it.

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