How can creditors participate in the prescribed part?

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An administrator, liquidator or receiver must make a “prescribed part” of the company’s net property available for the satisfaction of unsecured debts. The amount of the prescribed part will depend upon the amount of the company’s assets that are realised but is subject to a maximum of £600,000. The prescribed part must not be distributed to the proprietor of a floating charge unless the claims of unsecured creditors have been satisfied and there is a surplus.

The courts have established that a creditor, having made a secured recovery, cannot share in the prescribed part in respect of its unsecured shortfall [1] and that a secured creditor can share in the prescribed part if it releases its security and proves as an unsecured creditor [2].

The recent High Court decision of Re JT Frith Ltd [3] has shown how senior secured creditors may be able to participate in the prescribed part while at the same time retaining their security.

In this case, an intercreditor deed provided – as is common – that the junior creditors were entitled to prove for their debts in the insolvency of the borrower but must turn over any distributions they received to the senior creditor until the senior creditor had been repaid in full. The borrower went into administration and subsequently liquidation. Its assets had been distributed in part repayment of the senior creditor’s debt, leaving only the prescribed part available for distribution. The liquidator refused to allow the junior creditors to participate in the prescribed part on the basis that they were secured creditors. The junior creditors applied to the court on the basis that they had released their security and were therefore able to participate in the prescribed part as unsecured creditors.

The judge held that the junior creditors could surrender their security simply by omitting to mention the security in their proofs of debt and they could therefore participate in the prescribed part. The requirement to turn over the prescribed part to the senior creditors did not prevent them from participating in the prescribed part. The judge considered that this did not offend the policy objectives behind the prescribed part.

The case confirms that the surrender by a secured creditor of its security, enabling it to participate in the prescribed part, may be effected by the omission of any mention of the security in the proof of debt.

Of more interest though to senior creditors is that by including a contractual provision obliging the subordinated creditors to prove as an unsecured creditor and to turn over unsecured distributions they receive, they may at the same time retain their own security and the ability to participate in the prescribed part.

[1] Thornily v Revenue and Customs Commissioners [2008] EWHC 124 (Ch)
[2] Kelly v Inflexion Fund 2 Ltd [2010] EWHC 2850 (Ch)
[3] [2012] EWHC 196 (Ch)