Look Before You Leap: A Warning to Creditors on the Importance of Considering the Consequences of Intercreditor Arrangements when Seeking to Enforce

The recent case of Arlington Infrastructure Limited (in administration) 1 demonstrates the importance of complying with the conditions set out in intercreditor arrangements when seeking to enforce security and/or appoint administrators. Considering this against the outcome of Re Tokenhouse VB Ltd 2, it is clear that certain provisions of the IA86 are considered procedural rather than fundamental to the appointment of administrators, breach of which can be cured, whereas breach of fundamental provisions relating to the administration itself, including third party arrangements, is more likely to result in the appointment of an administrator being nullified ab initio.

The background to the case is not unusual. Certain creditors (the Junior Creditors) granted a loan to Arlington Infrastructure Limited (AIL) pursuant to a facility agreement, secured by a debenture which constituted a qualifying floating charge (QFC) over AIL and over its subsidiaries, together with a fixed charge over AIL’s shares in its subsidiaries. Subsequently, different creditors (the Senior Creditors) granted a loan to AIL, secured by a debenture which constituted a QFC over AIL (but notably not over the subsidiaries). While the Junior Creditors were first in time, the ranking between the creditors was determined by a deed of priority (the Deed of Priority) which agreed that the Senior Creditors’ QFC would rank ahead of the Junior Creditors’ QFC. The Deed of Priority set out:

“9.1 Except with the prior written consent of the Senior Creditors, the Junior Creditors shall not:

9.1.4 take any step to enforce any Junior Security Interest, whether by appointing a Receiver, exercising its power of sale or otherwise; or

9.1.5 present, or join in, an application for an administration order or a petition for a winding-up order to be made in relation to [AIL] or initiate, or support or take, any step with a view to any voluntary arrangement or assignment for the benefit of creditors or similar proceedings involving [AIL] or issue a notice of intention to appoint an administrator or appoint an administrator of [AIL].”

On 17 August 2020, the Senior Creditors appointed administrators to AIL pursuant to paragraph 14 of Schedule B1 of the Insolvency Act 1986 (IA86). On 28 September 2020, the Junior Creditors appointed administrators over the subsidiaries. Prior to the Junior Creditors appointment of administrators, no prior written consent was received, nor indeed sought, from the Senior Creditors pursuant to the Deed of Priority.

AIL acting by its administrators (the Applicants) contend that the failure to obtain such prior written consent renders the appointment over the subsidiaries null and void as the Junior Creditors’ QFC was not enforceable at the relevant time and, as a result, the appointments did not comply with paragraph 16 of Schedule B1.

The application raised the following questions:

1. Did the appointment of administrators by the Junior Creditors constitute “enforcement” under the Deed of Priority?
2. Pursuant to paragraph 16 of Schedule B1 IA86 an administrator may not be appointed under paragraph 14 while a floating charge on which the appointment relies is not enforceable. It was not contested that a non-payment event of default had occurred under the junior facility, making the Junior Creditor QFC enforceable in its own right. However, did the failure to obtain Senior Creditor consent pursuant clause 9.1 of to the Deed of Priority render the Junior Creditor QFC unenforceable at the relevant time?
3. If the security was unenforceable, did the failure to obtain the Senior Creditor’s consent constitute a fundamental defect rendering the Junior Creditor appointment of administrators null and void, or was it a procedural defect which could be cured by the court?

Is the appointment of administrators “enforcement” of security?

The Junior Creditors argued that administration is not an enforcement procedure and the appointment of administrators does not constitute “enforcement” of security, but rather the purpose of administration is to rescue the company as a going concern (per limb (a) 3) and contrasted the duties of administrators to those of a receiver. They further argued that the power to appoint administrators is not reserved to qualifying floating chargeholders, but is a process which may be effected by the company or its directors, and the purpose of the administration, and the duty of administrators to act in the best interests of creditors as a whole, is the same regardless of the appointee. The alternative purposes (being to achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up, failing which the purpose was to realise property in order to make a distribution to one or more security creditors) only come into effect if limb (a) fails, and therefore may never come into effect.

This argument was rejected by the court. Relying on Briggs LJ in SAW (SW) 2010 Ltd v Wilson 4 at [35]: "The power to appoint administrators is in my judgment itself a means of enforcement", the court confirmed that an out of court appointment of administrators under paragraph 14 amounts to enforcement of a floating charge “otherwise, it would make no sense for paragraph 16 to provide that an administrator may not be appointed under paragraph 14 while the floating charge on which the appointment relies is not enforceable.”

Was the Junior Creditor QFC “enforceable” under paragraph 16 of Schedule B1 IA86 at the relevant time?

The Junior Creditors argued that paragraph 16 of Schedule B1 is concerned with the enforceability of the QFC, and whether the QFC is enforceable against the chargor; the Deed of Priority constituted a “mere contractual promise” between the Junior Creditors and the Senior Creditors, which did not affect the enforceability of the QFC against the subsidiaries, nor did it create any security interest, or any interest in the assets of the subsidiaries.

Both the Applicant and the Junior Creditors again relied on the decision in SAW (SW) 2010 Ltd v Wilson at [33] “that the requirement in paragraph 16 of Schedule B1 that the floating charge relied upon for the appointment of administrators "be enforceable" is concerned with the question whether the chargee has a right to enforce, rather than with the question whether there are free assets to which the chargee can have recourse for the purposes of enforcement. A floating charge is … enforceable if any condition precedent to enforcement has been satisfied (such as an event of default) and there remains a debt for which the floating charge stands as security".

The Applicants argued that there were two conditions precedent: (i) an event of default having occurred (and it was agreed that this was satisfied), and (ii) the written consent of the Senior Creditors being obtained.

The court found in favour of the Applicants. The question of whether a floating charge is or is not enforceable within the meaning of paragraph 16 should be assessed objectively, assessing all the circumstances, including the terms of the debenture or other security documents between the parties and any collateral contract or agreement, whether between the parties or between the floating chargeholder and a third party, any promissory estoppel and any statutory provision. It was held that, “If the chargee has made a promise to [a] third party that it will only enforce its charge if a certain condition has been met, that is a matter the court is entitled to take into account in determining the question under paragraph 16 of whether the charge pursuant to which the chargee purported to appoint an administrator is or is not enforceable. In my view the Deed of Priority is part of the surrounding circumstances in which the question of enforceability for the purposes of paragraph 16 has to be determined. It cannot be ignored.” By entering into the Deed of Priority, the Junior Creditors “willingly chose to fetter their ability to enforce their security”.

The court found that the Junior Creditors’ QFC was unenforceable for the purpose of paragraph 16 of Schedule B1 IA86.

A mere irregularity or “fundamental” breach invalidating the appointment?

The final question to determine was whether the failure to obtain the Senior Creditors’ consent and comply with the conditions to appointment resulted in an irregularity which could be cured by the court, or made the appointment of administrators to the subsidiaries entirely null and void.

The Junior Creditors relied on Re Care People 5, whereby the failure of the floating chargeholder to give sufficient time between serving demand and appointment was found to be a defect and not an automatic nullity, as was equally found to be the case Re Tokenhouse VB Ltd. where it was held that the failure to give notice to a qualifying floating chargeholder of a director’s intention to appoint administrators was an irregularity, not linked to the issue of validity.

In this case, the Junior Creditors argued that Parliament could not have intended a breach of paragraph 16 to result in an automatic invalidity where the companies over which the administrators were appointed are clearly insolvent, the persons were connected to the subsidiaries, the chargeholder was protecting its security and the remedy for a chargeholder acting without proper motive could be remedied under separate statutory provision.

The court made short work of these arguments and held that the failure was a fundamental defect which could not be described as procedural.

“…it is clear that if the Senior Creditors' written consent were now to be sought, it would not be provided. In those circumstances, in view of my conclusion that the Junior Creditors' QFCs were not enforceable at the time of their purported appointment of administrators over the Subsidiaries, I must also conclude that such purported appointments were a nullity and cannot be cured.”

Conclusion

The outcome of this case is important for borrowers and creditors equally and gives additional strength to the terms of intercreditor arrangements. For creditors, particular care and thought needs to be given, at the drafting stage, to the terms being agreed between different classes of creditors, and creditors need to be conscious of those terms as they apply to each class and the impact it may have on their ability to enforce. It seems that failure to comply with contractual arrangements is, arguably, given more importance than a failure to comply with certain provisions in the IA86 (contrast with Re Tokenhouse VB Ltd 6). In circumstances where there are multiple creditors, borrowers may be subject to stricter negotiations with incoming creditors, and creditors themselves will need to be mindful of the fact that a court may nullify enforcement action where conditions (even conditions agreed by contractual arrangement away from the borrower group) have not been satisfied – ultimately the risk of ignoring such conditions is greater than one only of damages for breach of contract. 

1 Arlington Infrastructure Limited (in administration), Mark Agrasut v Ben Woolrych, Paul Allen, Jason Baker as purported administrators of ARL O09 Limited, ARL 011 Limited and BRK 001 Limited, Strategic Advantage SPC Arlington 1 SP, Strategic Advantage SPC Arlington 3 SP, ARL O09 Limited (purportedly in administration), ARL 011 Limited (purportedly in administration), BRK 001 Limited (purportedly in administration), Strategic Advantage SPC [2020] EWHC 3123 (Ch)

2 [2020] EWHC 3171 (Ch)

3 Paragraph 3 Schedule B1 IA86.

4 [2017] EWCA Civ 1001

5 [2013] BPIR 959; [2013] EWHC 1734 (Ch)

6 ICC Judge Jones decided that the applicant (a qualified floating chargeholder) should have been given at least 5 days' notice of the director's intention to appoint an administrator as required by paragraph 26(1)(b) of schedule B1 but the failure of this notice did not nullify the appointment. It was argued by the applicant that failure to give notice deprived the chargeholder of its ability to appoint its own administrator or agree to the proposed appointee. Here, Judge Jones identified three categories which should be applied when deciding the consequences of a breach of the requirements for an out-of-court appointment, being “(i) the breach is fundamental, (ii) not fundamental but have caused no injustice, and (iii) not fundamental but have caused substantial injustice. When answering the question of Parliamentary intention and for the purpose of categorising the breach, the provisions concerning the appointment of administrators out of court are to be interpreted within the context of the statutory scheme for administrations "as a whole"”. Following Re Euromaster Ltd [2012] EWHC 2356 (Ch), which stated that paragraphs 26-32 of schedule B1 IA86 are procedural and “naturally fall to be treated as irregular”, it was found that the outcome of failing to give such notice did not prejudice the main purpose of the administration such that it be found automatically void, but that rather the breach should be treated as an irregularity allowing the chargeholder to apply to court for discretionary relief – “the requirement to give notice is not linked to the issue of validity”. Reference was also made to the general intention of Parliament being that defects in appointment should not affect the validity of actions taken.