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Enforceability of Debenture via Appointment of Administrators

Kunal Gadhvi - Partner in our London Restructuring and Insolvency team - considers the recent court ruling on the enforceability of debenture via appointment of administrators, and what this might mean.

The recent case of Arlington v Woolrych has provided some useful clarification on whether junior creditors, without senior creditors consent, can seek to appoint administrators pursuant to paragraph 14 of Schedule B1 of the Insolvency Act 1986 (IA 1986).

The relevant provisions of the IA 1986 in this case were as follows:

  • IA 1986, Sch B1 para 14 – this permits a qualifying floating chargeholder to appoint administrators of a company out of court; and
  • IA 1986, Sch B1 para 16 – this provides that: "An administrator may not be appointed under paragraph 14 while a floating charge on which the appointment relies is not enforceable".

The background

The First Applicant, Arlington Infrastructure Ltd (AIL), was the sole shareholder and parent company of the Sixth to Eighth Respondents (the Subsidiaries).

Three of the Respondents (the Junior Creditors) loaned approximately £39m to AIL pursuant to facility agreements secured by debentures which constituted qualifying floating charges (QFCs) over AIL and the Subsidiaries, together with a first fixed charge over AIL's shares in the Subsidiaries.

A group of lenders (the Senior Creditors) subsequently lent approximately £5 million to AIL, secured by a QFC over AIL but not over the Subsidiaries.

The Junior Creditors, Senior Creditors and AIL entered into a Deed of Priority (DOP). Under the DOP, it was agreed that the Senior Creditors' QFC over AIL would rank ahead of the Junior Creditors' QFC and the Junior Creditors agreed not to take ‘any step’ to enforce its qualifying floating charges over the Subsidiaries, ‘whether by appointing a Receiver, exercising its power of sale or otherwise’, without the prior written consent of the Senior Creditors.

The Senior Creditors subsequently appointed administrators over AIL. The Junior Creditors then purported to appoint administrators over the Subsidiaries without seeking or obtaining the written consent of the Senior Creditors in accordance with the DOP.

The issue in this case was whether the Junior Creditors' QFCs over the Subsidiaries were "enforceable" within the meaning of IA 1986, Sch B1, para 16. The Applicants contended that, by failing to obtain prior written consent, the appointments of administrators over the Subsidiaries were rendered invalid because the QFCs were not enforceable by the Junior Creditors at the relevant time and the appointments did not therefore comply with IA 1986, Sch B1, para 16. 

The decision

The Court held that the question of enforceability under IA 1986, Sch B1, para 16 was to be assessed objectively and that such assessment involves consideration of all the circumstances, including:

the terms of the debenture or other security documents between the parties

any collateral contract or agreement, including any contracts or agreements between the floating chargeholder and a third party

any promissory estoppel, and

any statutory provision

In view of this, the Court found as follows:

  • The DOP was part of the surrounding circumstances in which the question of enforceability for the purposes of paragraph 16 had to be determined and it could not be ignored;
  • The meaning and effect of the relevant clause of the DOP was clear - the Junior Creditors had agreed that they would not take any step to enforce their QFCs against the Subsidiaries without first obtaining the prior written consent of the Senior Creditors; 
  • The Junior Creditors had therefore willingly chosen to fetter their ability to enforce their security;
  • This agreement therefore represented a condition precedent to the enforcement of their QFCs which had not been satisfied;
  • Putting it another way, the Junior Creditors’ QFCs were not capable of being enforced because prior written consent from the Senior Creditors had not been obtained;  
  • The unenforceability of the QFCs was a fundamental breach, so much so the purported appointments of the administrators were nullities. It was not a mere procedural irregularity that could be cured; and
  • It was clear that, were consent now to be sought from the Senior Creditors, it would not be provided.

Accordingly, the QFCs were not enforceable within the meaning of IA 1986, Sch B1, para 16 at the relevant time and the purported appointments of administrators made by the Junior Creditors over the Subsidiaries were therefore invalid.

The impact

This case highlights the importance of adhering to DOPs. It is clear from this case that junior creditors will be unable to appoint administrators without the consent of senior creditors where this is a strict requirement under the DOP despite their ability to do so under their QFC. Junior creditors should therefore be wary of agreeing to fetter their discretion to enforce their security, and Administrators should carefully check any such agreement before agreeing to accept such an appointment.