Author Brightstone Law LLP

You Would. Why Wouldn’t You?

The true value of a debenture may go over and beyond its intrinsic asset value.

While most of the nation became obsessed with heat, air conditioning, and whose journey to work was most intolerable, Appeal Court judges were hard at it making law, and looking after the short-term finance industry. July saw an important judgment which brought increased clarification to the nature, force and effect of floating charges.

Lawyers tend to get excited about security documents, lenders do not! Intermediaries know what they are, not necessarily what they do, or how important they can prove to be.

What makes Saw(SW)10 and Another v Wilson & Others (2017) exciting (how sad am I?) is that this judgment brings debentures, and floating charges back into the spotlight. It highlights the strategic, not just monetary value, in a debenture, which is often overlooked by inexperienced underwriters who can be persuaded by experienced commercial borrowers to do without. With so much short term finance being advanced to companies and special purpose vehicles, the importance of the debenture is worth emphasising.

Let me explain.

The Facts

Saw SW (10) was essentially a fight about administrators and the validity of their appointment under a debenture. In 2007, Capital Home Loans lent £1.25m to a company by the name of PELL. The loan was secured by six fixed charges over individual flats in a block. Each fixed charge contained a floating charge clause over the assets, existing and future, of the company. Each charge also included an automatic crystallisation clause which triggered in the event that the borrower created other security interests without lender’s consent. In 2008, PELL borrowed £3.9m, this time from a different lender, Salt (succeeded by Nationwide) to develop an altogether different property, and granted a debenture to them, in breach of its security document with CHL which required lender consent. Nationwide appointed administrators under their debenture, and their appointment was challenged on the grounds (1) that the debenture crystallised the first lender’s charge, which then became fixed as to the second property, and (2) the debenture (later charge)  was unenforceable by reason of there being no assets to attach to (these having been caught by the first floating charge).

So, here’s the exciting bit………….

The Court of Appeal held that;

• The validity of a debenture/ floating charge is not dependent on the existence of uncharged assets
• Automatic crystallisation affected the priority but not the validity of later debentures
• A floating charge remained enforceable if any condition precedent to enforcement has been satisfied and there remains a debt for which the floating charge has been given for security

What does that mean in English?

It means

• A debenture can gain extra value by attaching to later acquired assets
• Even a later and second debenture can have real value by enabling a lender to appoint administrators over a company, and gain control

Why is this so important for lenders?

Because, with legitimacy for a second charge debenture affirmed, lender’s should appreciate how powerful a weapon the debenture can be, not just in monetary, but also in strategic terms.

This brings to mind two fairly complicated and litigious matters I have personally been involved with in the last 12 months which illustrate this very point; the first had the benefit of a debenture, the second did not.

Case Study 1
A lender lent to a single asset, special purpose vehicle, and took fixed charge security and debenture. A complicated multi-party piece of litigation ensued, the detail of which for this piece is not particularly relevant. Settlement on terms acceptable to all parties was agreed, but the defendants, two of whom were professional firms, and insurance backed, would not sign off settlement with the lender without borrower/guarantor consent, seeking to protect themselves against potential future claims by the borrower/ guarantor. The borrower, a company, with sole director held the key, and he/ they knew it. He could not repay the lender, but he could prevent the lender recovering elsewhere. And the borrower wanted reward to cooperate, even though he could not repay.

The lender appointed administrators under the debenture, as entitled so to do, and administrators stepped in, agreed terms, settled with all parties, with no ransom paid.

The debenture held no intrinsic asset value, (certainly no more than the fixed charge) but strategically its existence unlocked the door to lender recovery because the borrower  was removed from the legal equation. And of course, as debenture holder, the lender had first priority over any recovery under any borrower claims settled by administrators.

Case Study 2
This again involved a piece of lending to a single asset, SPV. In this case a lender was persuaded by the borrower to rely upon fixed charge security only. No debenture was taken. Default arose, the lender sought to recover. Dispute arose between directors as to director authority, and use of company monies. The remaining director argued as against the lender, that the company had not received total benefit of monies advanced, and should not be liable for the entire advance. The lender was dragged into a dispute not of their making, and though the lenders position was completely defensible, there was no alternative but to incur internal time and resource in answering unsustainable allegations, as well as significant external legal cost. The borrower clearly had an interest in getting to the best bargaining position he could, by pursuing every allegation, complaint and dispute, in an effort to exhaust the resolve of the lender. But a lender who had taken a debenture, could have appointed an administrator under the powers contained therein. Administrators would have been obliged to sensibly assess the costs and risks of pursuing weak claims with little prospect of success, before embarking on costly litigation – I doubt that sensible administrators would have pursued the same claims. And so, recovery would have been significantly faster and cheaper, costs saved, had a debenture been in place and administrator appointed.

So there you have it………

A floating charge can

• Give security over later acquired assets.
• Allow a lender to place a company into administration, and take control.
• Fix recovery problems sooner rather than later, and avoid spurious claims being taken.
• Provide the lender with an additional route to recovery via company claims which an Administrator can advance for the benefit of debenture holder (e.g. surveyor negligence claims), claims which the company may have but are disinclined or unable to pursue.

Why wouldn’t you?

Jonathan Newman