DEVELOPMENTS IN THE PRIORITY OF PAYMENTS IN A LIQUIDATION
When a company is wound up by reason of insolvency the various creditors of that company will often become embroiled in a fight for the limited assets and funds available for distribution to undischarged creditors of that company. The system of priority for ranking those creditors is set out in various pieces of legislation. In simple terms, the costs and expenses of the liquidator of the company will be paid first. Following that, the law provides for a number of preferential creditors which enjoy priority over unsecured creditors. Examples of preferential creditors include employees whose wages have not been fully paid and the Revenue Commissioners.
Section 285(7) of the Companies Act, 1936 (as amended) (“the Act”) provides that preferential debts shall “have priority over the claims of holders of debentures under any floating charge created by the company, and be paid accordingly out of any property comprised in or subject to that charge”. A floating charge is a form of security taken by lenders which is not attached to any specific asset or assets of the borrower. Rather, the security hovers over the assets of the borrower and does not attach itself to any specific asset until specified events occur. When those events occur the floating charge is said to “crystallise” and attach to specific assets in favour of the lender. Floating charges have been an extremely popular form of security in this country particularly where a fixed charge is already in place in relation to the principal asset or assets of the borrower and further secured finance is required.
A recent decision of Judge Finlay Geoghegan in the High Court in the Belgard Motors Case (In Re JD Brian Limited (In Liquidation) and related companies) has cast doubt over the value of a floating charge to the lender. In that case the Judge held that the priority afforded by section 285 (7) of the Act subsists even where the floating charge crystallises prior to the commencement of the liquidation of the borrowing company. In other words there was no way the bank, in whose favour the floating charge security was granted, could rank ahead of the preferential creditors for priority of payment from the limited funds available in the liquidation of the company despite having taken steps to secure its position and crystallise the charge prior to the appointment of a liquidator to the borrowing company.
Furthermore, in a later supplementary judgment, Judge Finlay Geoghegan found that the floating charge in question could not be considered to have converted to a fixed charge despite the bank having taken the steps it believed necessary to do so on foot of the terms of the debenture document which detailed the nature of the security. The debenture in question provided that the bank could serve on the borrower notice of conversion of the floating charge to a fixed charge over the stock in trade, cash at bank and book debts of the company where the bank considered those assets to be in jeopardy. However, despite service of the notice of conversion by the bank, Judge Finlay Geoghegan found that the borrowing company was still at liberty to deal freely with those assets following service of the notice of conversion. As such, conversion to a fixed charge did not take place as it is central characteristic of a fixed charge that the borrowing company should be restricted in dealing with the assets, the subject of the fixed charge, without the absent the consent of the lender.
These decisions will be of considerable concern to floating charge holders around the country, primarily the banks. Judge Finlay Geoghegan took the step of departing from judicial precedent established in England, which precedent is of persuasive authority only here. The decisions are the subject of an appeal to the Supreme Court and the outcome of that appeal will be watched closely.
Matthew Austin