In Highbury Pension Fund Management Company v Zirfin Investments Ltd (Highbury) the High Court has extended the doctrine of marshalling. Office holders dealing with group insolvencies will need to take account of this important new development.
The aim of the equitable doctrine of marshalling is to achieve fairness between secured creditors.
Let’s look at an example. Bank (B) is the first ranking secured creditor of a debtor (D). B has security over all of D’s assets. Another creditor (C) has a second charge over D’s head office building, but has no further security. D goes into administration. If the administrator sells the head office first, and repays B (as he is obliged to do) out of the proceeds, C has no other security and, on the face of it, he has lost out. This is where the doctrine of marshalling comes to C’s rescue. C is entitled to stand in B’s shoes (or “subrogate”) in relation to B’s other security, until C has recovered the value attributed to the head office, over which he had his second charge. As a result, C is placed in the position he would have enjoyed if B had been paid out of realisations from other assets.
Before Highbury, it was thought that the doctrine only applied to “marshal” security given to two creditors by the same debtor. This is known as the Common Debtor Rule.
In Highbury, Zirfin Investments Limited (Zirfin) had borrowed money from Barclays Bank (the Bank), secured by a charge over a property (Number 31). The Bank also made loans to companies affiliated to Zirfin (the Affiliates) which were secured by charges over the Affiliates’ own properties. In addition, the Bank 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, the Bank 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 the Bank had looked to the Affiliates own assets as security, there would have been enough surplus from the sale of Number 31 to satisfy the Zirfin’s obligations to Highbury.
On the face of it Highbury was left as an unsecured creditor of Zirfin. Highbury could not stand in the Bank’s shoes in relation to other security given by Zirfin to the Bank, as there was none.
The issues were:
- whether the doctrine permitted the marshalling of securities held over property that did not belong to the common debtor; and in particular
- 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 court gave judgment for Highbury, ruling that it 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 the Bank.
The court held that where an independent and separate equity existed, such as a surety’s equitable right to call upon a principal debtor to discharge the guaranteed obligations, then an exception to the Common Debtor Rule would apply, and a second ranking creditor could look to security given to the first ranking creditor by a third party.
In this case, Zirfin had a right of indemnity and subrogation against the Affiliates to the extent Zirfin had paid the Bank under its guarantee of the Affiliates liabilities. The Court concluded that Highbury was entitled to benefit from these rights.
This benefit was qualified so that Highbury could only participate in the proceeds of realisation of the Affiliates’ properties after the Bank had been repaid in full to ensure that the application of the equitable remedy did not prejudice the Bank, by giving Highbury any greater right than Zirfin would have had to subrogate to the Bank’s security.
The terms of Zirfin’s guarantee to the Bank provided that Zirfin could not be subrogated to the rights of the Bank under the Affiliates’ loans until all sums due by the Affiliates to the Bank had been repaid in full.
The Court made clear that the Bank could not be criticised for choosing to enforce against Number 31 and not the Affiliates’ property. A creditor cannot be compelled when or how it is to enforce its security against a debtor. It has absolute discretion to decide from which of the secured assets to seek recovery.
This is an important case for office holders preparing outcome statements in the context of group insolvencies. Where there would otherwise be no return for subordinated secured creditors (by virtue of a senior secured creditor being entitled to, and exhausting, realisations) this case could operate to provide opportunities for subordinated secured creditors to be paid out of asset realisations made in another group company. Prior to the decision in this case, it was thought that the Common Debtor Rule would prevent this.
  EWHC 238