Marshalling – an opportunity for junior creditors

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The law

Marshalling is a equitable remedy for achieving fairness between two or more secured creditors of the same debtor. Where the first creditor enforces its security against assets over which both hold security but not against assets over which it alone holds security, the second creditor may be entitled to use the assets over which the former has security. Alternatively, the doctrine may require the former creditor to satisfy itself out of the asset over which the latter has no security.

The first case

In the first case [1], the Serious Organised Crime Agency (SOCA) brought proceedings to seize properties owned by Mr and Mrs Szepietowski on the basis that they were the proceeds of crime (the SOCA Proceedings). Some of the properties, including the family home, were registered in the name of Mrs Szepietowski and the Royal Bank of Scotland had a charge against them (and other properties) for a debt of £3.225m (the RBS Charge). The SOCA Proceedings settled on terms that included a deeming provision that the Szepietowskis’ home was not a “recoverable property” and pursuant to which Mrs Szepietowski granted a charge to SOCA over other properties (the SOCA Charge). The SOCA Charge contained various provisions, including a statement that Mrs Szepietowski did not personally owe any money to SOCA, and it was registered as a second charge over properties (excluding the marital home) that were already subject to the RBS Charge. The intention behind the settlement arrangement was that there would be sufficient proceeds of sale of the other properties to satisfy both the RBS Charge and the SOCA charge. However, proceeds were ultimately less than expected, leaving SOCA with only a nominal sum once the RBS Charge had been satisfied.

SOCA therefore brought an action to invoke the remedy of marshalling in respect of the Szepietowskis’ home. Mrs Szepietowski argued, in defence to that claim, that SOCA could not rely on marshalling because there was no underlying debt owed by her to SOCA.

The case reached the Supreme Court, which found that the doctrine did not apply in this case for two reasons. First, that marshalling cannot apply in circumstances where there is no underlying debt owed; and secondly that the doctrine of marshalling was precluded owing to the particular language of the settlement documentation and the nature of the SOCA charge.

Importantly though, the Supreme Court recognised that the remedy has a role to play in the modern commercial world and set out a clear test for marshalling: the correct approach to ask is whether, in the perception of an objective reasonable bystander at the date of the grant of the second mortgage, taking into account:

  1. the terms of the second mortgage;
  2. any contract or other arrangement which gave rise to it;
  3. what passed between the parties prior to its execution;
  4. all the admissible surrounding facts, it is reasonable to conclude that the second mortgagee was nonetheless not intended to be able to marshal.

The second case

In this case [2], Zirfin had borrowed money from Barclays Bank, secured by a charge over a property (Number 31). Barclays also made loans to companies affiliated to Zirfin (the Affiliates) which were secured by charges over the Affiliates’ own properties. In addition, Barclays took a guarantee from Zirfin in respect of the Affiliates’ obligations; that guarantee was also secured on Number 31.

Zirfin was also indebted to Highbury Pension Fund Management Company (Highbury), in whose favour it had granted second and third charges over Number 31.

When Zirfin and the Affiliates defaulted, Barclays enforced its security over Number 31, and took from the proceeds not only the amount of Zirfin’s direct indebtedness, but also its obligations as guarantor of the Affiliates. If Barclays had looked to the Affiliates’ own assets as security, there would have been enough surplus from the sale of Number 31 to satisfy Zirfin’s obligations to Highbury. On the face of it Highbury was left as an unsecured creditor of Zirfin. Highbury could not stand in Barclays’ shoes in relation to other security given by Zirfin to Barclays, as there was none.

The issue was whether a second ranking creditor of a guarantor was entitled to marshal securities granted to the first ranking creditor by the primary debtor – in this case, the Affiliates.

The High Court ruled that Highbury was entitled to share in the security constituted by the Affiliates’ charges, although only to the extent of any surplus remaining after amounts secured by those charges had been fully paid to Barclays. This was the case even though the Affiliates were not a common debtor of both Barclays and Highbury. However, the Zirfin guarantee to Barclays contained a (fairly standard) clause that Zirfin could not be subrogated to the rights of the Bank under the Affiliates’ loans until all sums due by the Affiliates to Barclays had been repaid in full. This meant the benefit of the remedy was qualified as Highbury could only participate in the proceeds of realisation of the Affiliates’ properties after Barclays had been repaid in full.

On Highbury’s appeal, the Court of Appeal took issue with the High Court’s interpretation of the clause in the guarantee, finding that it did not expressly apply or restrict Highbury’s right to require Barclays to marshal its securities. Accordingly, Highbury could begin the process of exercising its right to marshal immediately without waiting for Barclays to enforce its remaining security over the Affiliates’ properties.

Points to consider

The doctrine of marshalling has led a sheltered life for decades with the key authorities predating Waterloo. With two cases from higher courts in a matter of months, both endorsing the doctrine, we are likely to see more attempts by second mortgagees to use the remedy. Both cases are important in their own right. Szepietowski sets out the approach the courts will take when considering whether to apply the doctrine. And Highbury dispenses with the idea that the doctrine could only apply to marshal security given to two creditors by the same debtor. Now, it is clear, where there would otherwise be no return for subordinated secured creditors (by virtue of a senior secured creditor being entitled to, and exhausting, realisations) there may be an opportunity for subordinated secured creditors to be paid out of asset realisations made in another group company.

[1] Szepietowski v National Crime Agency (formerly the Serious Organised Crime Agency) [2013] UKSC 65
[2] Highbury Pension Fund Management Company v Zirfin Investments Management Ltd [2013] EWCA Civ 1283