What Liquidation Does For Secured Creditors, And What It Does For You

Date01 September 2008
DOIhttp://doi.org/10.1111/j.1468-2230.2008.00712.x
Published date01 September 2008
What Liquidation Does For Secured Creditors,
And What It Does ForYou
Rizwaan Jameel Mokal
n
This article analyses the liquidation process, challenging the much repeated proposition that
secured claimants‘stand outside’l iquidation. It is argued that this proposition (i) is a productof a
misunderstanding of the dual duality i n the nature of liquidation proceedings,in that, in princi-
ple, they serve both public and private functions, and they further the interests of both secured
and unsecured creditors; (ii) overlooks how secured creditors bene¢t from liquidation, and also
how unsecured creditors have a real interest in the properadmi nistration of their debtor’s encum-
bered assets; (iii) mistakes the secured creditor’s choice in usually being able to gain immunity
from the liquidation process, for a compulsion to stand exiled from this process; (iv) is incorrect as
a matter of history and practice; and (v) is rendered unsustainable by the statutory text. It con-
cludes that secured creditors have never ‘stood outside’l iquidation, that liquidation is an impor-
tant tool for the protection of their interests, and thatit is right to require £oating charge holders
to pay their fair share of liquidation expenses.
INTRODUCTION
How may the secured creditors of an insolvent company vindicate their claims?
What are the proper functions of the statutory corporate liquidation regime?
What is the status of the insolvent company’s estate at the intersection of the laws
governing property and insolvency? And how far-reaching may be the unin-
tended damage caused bya decision of the highest court, even though Parliament
has intervened to reverse its actual e¡ect?
In Buchler vTa l b o t (Leyland Daf),
1
the House of Lords set out to answer the
apparently obscure question of the correct priority as between themselves of, on
the one hand, the expenses properly incurred by the liquidator of an insolvent
company (liquidation expenses), and on the other, debt claims against the com-
pany secured by a £oating charge (£oating charge claims).The statutory context
was section 175 of the Insolvency Act 1986 (the Act). This provides that the
company’s statutory preferential debts should be paid in priority to all other
debts’, and should rank behind liquidation expenses. If ‘the assets’ are insu⁄cient
to meet them, preferential claims should abate in equal proportions. And ‘so far
n
Professor of Legal Theory, University College, London; Academic Member, 3- 4 South Square
Chambers. Much in this paper owes to Alison Clarke, Look Chan Ho, and Sandy Shandro, to all of
whom I acknowledge my gratitude. Many thanks are also due to Paul Davies, Ian Fletcher, Sandra
Frisby, Joshua Getzler, Louise Gullifer, Andrew Keay, Stuart Lakin, Gerard McCormack, Jonathan
Rogers, James Shirley, RobertStevens, DominicVenton,JayWestbrook,and three anonymous referees
for invaluable comments, suggestions, and discussion. The views expressed and mistakes made are
mine alone.
1 [2004] UKHL 9. All self-standing references in square bracketsbelow are references to the para-
graphs of their Lordships’speeches in this judgment.
r2008 The Author.Journal Compilation r2008 The Modern Law Review Limited.
Published by BlackwellPublishing, 9600 Garsington Road,Oxford OX4 2DQ,UK and 350 Main Street, Malden, MA 02148, USA
(2008) 71 (5) 69 9^733
as the assets of the company available for payment of general creditors’
are insu⁄cient to meet them, preferential claims should have priority over a
£oating charge claim with respect to ‘any property comprised in or subject to
that charge’.
For thirty-four years, ending with LeylandDaf, section 175 had been authorita-
tively interpreted according to the Court of Appeal’s judgment in Re Barleycorn
Enterprises Ltd (the Barleycorn approach).
2
The Barleycorn approach had been based
on three arguments (amongst others).There was, ¢rst, the principle of transitivity:
the statute appeared to rank X (liquidation expenses) ahead of Y (preferential
claims), and to placeY before Z (£oating charge claims). It should necessarily fol-
low that X ranked ahead of Z. Secondly, the statute said that preferential debts
would begin to abate upon the exhaustion of ‘the assets’. Given that preferential
debts had priority over £oating charge claims as well as unsecured ones, they
could not abate at all unless bothu necumberedassets and assets subject to a £oating
charge had been exhausted. It must follow that the statutory term ‘the assets’ is a
generic reference to both the ‘ass ets. . . available for payment of general creditors’
and also‘any propertycomprised in or subject to’ the £oatingcharge.Thirdly, the
statute unambiguously intended to place liquidation expenses ahead of preferen-
tial claims. But this intention could be easily frustrated unless liquidation
expenses also had priority over £oating charge claims. If they did not, then the
debtor and one of its creditors could overturn the statutory priorities as between
liquidation expe nses and preferential claims t hrough the simple exp edient of
creating a £oating charge over all of the company’s property. Any interpretation
that allowed parties through private contracting thus to u ndermine clea r legisla-
tive intent was regarded as unacceptable.
The crucial decision for their Lordships in Leyland Daf,then,waswhether
assets subject to a £oating charge are assets of the company’ for the purposes of
section 175 of the Act.They decided that they are not.
Both the conclusio n and the reasoning supporting i t were the subject of exte n-
sive discussion and criticism.
3
The central objection was that there is nothing in
property law that places, at any point during the existence of the encumbrance,
the bene¢cial ownership of £oating charge assets (or indeed, of any encumbered
property) in the secured claimant. The chargee certainly obtains a bene¢cial pro-
prietary interest in the collateral, but the collateral itself remains ‘property of the
[chargor] company’.
4
The practical implications of the judgment that £oating
charge assets would no longer be available to service winding-up expenses were
2[1970]Ch465.
3 See R. Mokal,‘Liquidation Expenses and Floating Charges ^ The SeparateFu nds Fallacy’[2004]
LMCLQ 387 (reprinted at (2005) 21IL&P 46); H. Rajak,‘Liquidation Expenses Versus a Claim
Secured bya Floating Charge’ (2005) 18Insolvency Intelligence 97; G.McCormack,‘Lords Ho¡-
mann and Millett and the Shaping of Credit and Insolvency Law’ [2005] LMCLQ491,496^499;
L. C.Ho,‘Reversing Buchler vTal b o t : The Doctrinal Dimension’(200 6)21 BJIBFL 10 4; L. C. Ho,
‘The Debenture Holder’s Liability in Unjust Enrichment After Sp ectrum’i nJ. Getzler and J.Payne
(eds),Com pany Charges: Spectrum and Beyond(Oxford: OUP, 2006) 173 at175^179; and D.Venton,
‘The Rightful Ranking of Liquidation Expenses^A Statutory Perspective’ (2006) 22 IL&P 205.
4 The detailed argument is to be found in R. Mokal,‘LiquidationExpense s and Floating Charges^
The Separate Funds Fallacy’ [2004]LMCLQ 387.
What Liquidation Does
700 r2008 The Author. Journal Compilation r2008 The Modern Law ReviewLimited.
(2008) 71(5) 699^733
also highlighted, particularly by legal and accountancy practitioners.
5
In view of
these objections and after exhaustive consultation,
6
the Government announced
that it would seek the legislative reversal of Leyland Daf.
7
This was brought about
by section1282 of the Companies Act 2006.
8
In a paper written some months before the Government’s decision to seek statu-
tory reversal but published some considerable time after the announcement of that
decision, John Armour and Adrian Walters ( A&W) have sought to support the Ley-
land Daf judgment.
9
They concede (though this might not be readily apparent on a
cursory reading of their paper)
10
the principle underlying the central objection to
their Lordships’reasoning, that neither the creation nor the crystallisation of a £oat-
ing charge in itself removes bene¢cial ownership of encumbered property (the col-
lateral) to the chargee.
11
They claim, however, that this objection is simply beside the
point, since their Lordships must be understood as having held thatthe chargee gains
bene¢cial ownership of the collateral by virtue not of property but of insolvency law,
and in particular, byvirtue of the law governing corporate liquidation.When a char-
gee ‘enforces’ his security subsequently to the commencement of the winding-up ^
and, it seems, even beforee nforcement,
12
and, arguably, even in the absence of it,
13
so
long as the debtor is being wound up ^ the collateral is regarded as having been
bene¢cially vested in the chargee from the time at which winding-up began,
because, according to A&W, that is what liquidationlaw dictates.
So what might there be in the law of corporate liquidation which brings about
this result?A&Wsuggest avariety of candidates. Perhapsthe most fundamentalof
these is the propositionthat secured creditors are ‘not . . . entitled to participate in
the collective [liquidation] proceedings’.
14
This allegedly follows from the very
purposes of theliquidation regime, and alsobecause the references in the statutory
text to‘the assets/property of the company’ cover only free but not encumbered
assets. A&W conclude that this (among other factors) supports their Lordships
judgment that the reference in section 175 of the Act to‘the company’s assets’ does
not include £oating charge assets.
This paper undertakes a fresh analysis of the liquidation process. By way of
essential background, the second section introduces and critiques the central ele-
5 For an overview, see L. Peasland,‘Company LawReform Bill: Views from the Profession Com-
piled by the ABRP General Technical Committee’ (2006) 22 IL&P 88.
6 See eg the account of a seminar held on the subjectby the Insolvency Service on17 February 2005
at http://www.insolvency.gov.uk/insolvencyprofessionandlegislation/policychange/LeylandDAF
seminar.doc (last visited 21 January 2008); and ‘Insolvency Service Consults on Reversal of
LeylandDaf ’ in Company Law Reform Bill’ (2006) 27 CompanyLawyer 119.
7 The reasoned statement by S. Leinster,the Head of Policy at the Insolvency Service, is essential
reading for anyone interested in the o⁄cial policy on this area; see ‘InsolvencySer vice Response
to FMLC Papero n Clause 868 of the Company Law ReformBil l ^ The Statutory Reversal of
Re Leyland DAF’ reproducedat (2006) 22 IL&P 43.
8 Inserting a new section 176ZA in the InsolvencyAct 1986(IA).
9 J. Armourand A. Walters, ‘FundingLiquidation: A Functional View’ (2006) 122 LQR3 03(AW).
10 Perhaps because of the discussion in AW, ibid, 302^303 (i ncluding n 44); their arguments on this
issue are addressed in R. J. Mokal, ‘At the Intersection of Property and Insolvency:The Insolvent
Company’s Encumbered Assets’ (2008) 20 SingaporeAcademyof Law Journal 495.
11 AW, ibid,301 (particularly text to nn 30^31),305 and 309 (the two ¢nal paragraphs).
12 ibid, 309.
13 ibid,3 09.
14 ibid,307.
Rizwaan Jameel Mokal
701
r2008 The Author.Journal Compilation r2008 The Modern Law Review Limited.
(2008) 71(5) 699^733

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