More equal than others?
Two English cases appear to settle the question of which creditors are entitled to share under the new "prescribed part" provisions
Section 176A Insolvency Act 1986 (inserted by Enterprise Act 2002) affects distributions out of administrations, liquidations or receiverships where the debtor company granted a floating charge on or after 15 September 2003. In a move seen as a quid pro quo for the Crown giving up its preference, a “prescribed part” of the company’s net property is to be made available “for the satisfaction of unsecured debts”. Bys 176A(2)(b), a distribution from the prescribed part is not to be made to a chargeholder except so far as that part exceeds the amount required to satisfy unsecured debts.
From the outset there was debate as to whether a floating charge creditor whose claim was not satisfied in full from the charge could rank in respect of the balance along with the other unsecured creditors – on the basis that, the security having been exhausted, the unsatisfied balance was an “unsecured debt”. The contrary argument, based on the prohibition in s 176A(2)(b), was that in this context “unsecured debts” did not include this unsecured portion as otherwise the section was nonsensical.
We now have two (English) decisions on directions sought by administrators/ liquidators which address this point.
In Permacell Finesse Ltd  EWHC 3233 (Ch), the floating chargeholder wanted to participate as an unsecured creditor for its shortfall of £918,850. The prescribed part was approximately £379,000 and other unsecured creditor claims amounted to over £3m. The judge decided that s 176A created an exception to the general pari passu rule. The clinching argument was that subs (2)(b) contained an exception which could never apply if a floating chargeholder were able to participate in the prescribed part.
The second case (also reported as Thorniley v HMRC) was AirBase Services (UK) Ltd and AirBase International Services Ltd  EWHC 124 (Ch). Unsecured creditors amounted to £1.7m, of which £620,000 was due to HMRC, the prescribed part was £265,000 and the deficiency to the chargeholder (in respect of both fixed and floating charges) £4,795,000. If the chargeholder participated in the prescribed part for this shortfall it would receive £196,000, HMRC £25,000, and the other unsecured creditors about £44,000 between them. If the chargeholder did not participate, HMRC would receive £97,000 and other creditors £168,000.
The first three submissions for the secured creditor were considered uncontroversial: (1) under s 176A the prescribed part was made available to satisfy unsecured debts; (2) the shortfall on the fixed and floating charges was such a debt; (3) nothing in s 176A or its legislative history expressly excluded the shortfall as an unsecured debt.
However the judge observed that the question depended on how “unsecured debts” was construed in the context of the section as a whole. He preferred the argument that “unsecured debts” could mean only the debts due to unsecured creditors as defined in s 248, where “secured creditor” means a creditor who holds a security over property of the company, and “‘unsecured creditor’ is to be read accordingly”. On this argument, s 176A(3) makes clear that a distribution under subs (2) is a distribution to creditors other than the chargeholder, “and this emphasis on the identity of the creditor rather than the nature of his debt can be seen in other parts of the legislation and the rules”.
The judge found the “most compelling argument for limiting the prescribed part to unsecured creditors as such” in s 176A itself. If the floating chargeholder was allowed to participate, s 176A(2) (b) would be meaningless because the whole amount due to the chargeholder would already have been paid out of the prescribed part. It followed that chargeholders were excluded from participation in respect of their unsecured claims. He said: “The pari passu rule although fundamental is not immutable and… its application has necessarily to be restricted if s 176A is to have its desired economic effect.”
As regards the fixed chargeholder the judge said it was clear that “no distinction is drawn in s 176A between the ‘unsecured debts’ of a floating chargeholder and those of a fixed chargeholder. If those words in
s 176A(2)(a) apply to exclude the unsecured portion of the debts of an otherwise secured creditor they must apply to both categories of secured creditor alike”. Therefore fixed chargeholders could not benefit from prescribed part assets unless and until all unsecured creditors had been paid. The contrary view would in most cases prevent unsecured creditors from receiving anything significant in the administration or liquidation, and the judge acknowledged that this had not been the intention in creating the prescribed part.
It is helpful that both judges separately came to the same conclusion by the same route. It is understood the decisions are not likely to be appealed. In the absence of further legislative change, it is likely that they will settle the question whether a secured creditor can participate in the prescribed part.
Alistair Burrow, Head of Recovery, Tods Murray LLPL