Insolvent borrowers: is there a trust?

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An issue that commonly comes before the courts in insolvency situations is whether a lender, that has advanced money to the now insolvent borrower, has retained a ‘security interest’ in the monies advanced, so that the monies are held in a trust for the benefit of the lender (termed a Quistclose trust). This would mean, therefore, that the monies held in the trust are not available for distribution in the insolvency proceedings as part of the insolvent borrower’s estate. This in turn involves a consideration of the detailed provisions of the loan agreement. A recent case has emphasised the importance of getting the drafting right.

In Gabriel v Little [1] the lender had advanced money to a property developer. The relevant provision of the facility letter in issue defined the term “Loan” as “The sum of £200,000 which will be made available as a contribution to the costs of development of the Property, such sum to be advanced on the Drawdown Date”. The stipulated purpose of the Loan was “To assist with the costs of development of the Property”.

The particular claim in this case was for dishonest assistance in breach of trust by the borrower but to succeed on this claim, the claimant needed to show that there was indeed a trust.

The Court upheld the High Court finding that neither the terms of the facility letter nor any of the surrounding circumstances implied the establishment of a Quistclose trust. The “mere fact” that the facility letter stated that the purpose of the loan was “to assist with the costs of development of the property” did not impose an obligation of trust on the borrower as to the application of the loan monies nor did the fact that the borrower was a special purpose vehicle established specifically to develop the property.

The case demonstrates that, while using words such as “sole” or “exclusive” in the purpose clause of a facility agreement will not be determinative of whether or not a Quistclose trust is established, the lender will find it easier to show the existence of such a trust, where the words are used. Without them the task of proving the existence of a trust will be very difficult.

[1] [2012] EWHC 1193 (Ch)