Citation(2008) 20 SAcLJ 495
Published date01 December 2008
Date01 December 2008

When a company becomes subject to winding-up proceedings, it is widely thought to lose beneficial ownership of its property. The property is held, instead, on a “statutory trust” to discharge the company’s liabilities. The attribution of this “proprietary” effect to the commencement of winding up has, however, created significant confusion. Faring particularly poorly is our understanding of the status of those of the company’s assets in which others held proprietary rights prior to this point, notably, assets the company’s title to which is encumbered by security interests. The confusion takes many forms and infects several areas of analysis. This article undertakes a fresh analysis of these complicated issues at the intersection of the laws governing property and insolvency.

I. Introduction

1 Dramatic things happen when a company becomes subject to winding-up proceedings. On a view widely2 (though not universally3) accepted in the common law world, the commencement of its winding

up deprives the company of beneficial ownership of its property. (The position in Singapore is unclear,4 but it is more likely than not that Singapore courts would also take the view that the onset of liquidation divests the company of beneficial ownership of its property.5) The company holds its assets thenceforth on a “statutory trust” for the benefit of its creditors. The attribution of this “proprietary” effect to the commencement of the winding up has, however, created significant confusion about the status of assets which were already, prior to winding up, subject to the proprietary rights of others. What are the legally causative factors behind the loss of beneficial ownership? And what happens to those of the company’s assets in which, even prior to the commencement of its winding up, others had held proprietary rights?

2 Over the last many decades, courts and commentators have asserted that the statutory trust does not extend to assets subject to security interests. This proposition has been reiterated, and it is submitted, the confusion of which it is a product was on display, in Buchler v Talbot (“‘Leyland Daf”),6 a decision of the House of Lords. Their Lordships propounded the view that assets subject to a security interest fall into a “fund” beneficially owned by the secured creditor to the extent of the secured liability. This decision has been extensively discussed and criticised,7 and its actual effect has been legislatively

reversed.8 Nevertheless, two distinguished commentators, John Armour and Adrian Walters (“A&W”), have argued that the broader principles enunciated by their Lordships should be considered as having been touched neither by academic criticism nor by parliamentary intervention.9 Previous criticism of their Lordships’ judgment had focused (though not exclusively) on property law, arguing that it is fundamentally inconsistent with the nature of a security interest to regard assets subject to it as being beneficially owned by the secured creditor. Attempting to sidestep this criticism, A&W turn from property to insolvency law itself. They argue that some interplay between the statutory trust of the insolvent company’s property and the “hindsight principle” of insolvency law helps to explain how, upon the commencement of the debtor’s winding up, beneficial ownership of encumbered assets comes to be vested in the secured creditor. They also suggest that there might be something in the very notion of a “fund”, as invoked by their Lordships, which supports the same conclusion.

3 This article undertakes a fresh analysis of these complicated issues at the intersection of the laws governing property and insolvency. Part II summarises their Lordships’ decision in Leyland Daf and respectfully argues that neither its principles nor its conclusion are defensible as a matter of property law. Part III considers the origins and nature of the statutory trust said to apply to the property of the company in winding up. It is argued that, to the extent to which such a trust exists at all, it must — contrary to repeated judicial pronouncements — cover the insolvent company’s encumbered as well as unencumbered property. Part IV turns to the hindsight principle, and shows that it could not possibly assist in the alleged conversion of the company’s encumbered property into property beneficially owned by the secured creditor. Part V draws on the theory of property law to examine the concept of “fund”. It also unearths a misunderstanding of insolvency law’s pari passu principle, a misunderstanding which appears to motivate the misleading search for an illusory “separate fund” of encumbered assets. To highlight the untenability of Leyland Daf and its defence, two pairs of genuinely separate funds relevant to corporate insolvency are also considered. Part VI is a brief conclusion.

II. Leyland Daf: Property, priority, and propriety

4 In Leyland Daf, their Lordships were called upon to determine the correct priority as between themselves of the expenses properly incurred by the liquidator of an insolvent company (“liquidation expenses”), and debt claims against the company secured by a floating charge (“floating charge claims”).10 The statutory context was s 175 of the Insolvency Act 1986 (“IA 1986”).11 This provides that the company’s statutory preferential debts should be paid in priority to “all other debts”, and should rank behind liquidation expenses. If “the assets” are insufficient to meet them, preferential claims should abate in equal proportions. And “so far as the assets of the company available for payment of general creditors” are insufficient to meet them, preferential claims should have priority over a floating charge claim with respect to “any property comprised in or subject to that charge”.

5 The crucial question for their Lordships in Leyland Daf, then, was whether assets subject to a floating charge are “assets of the company” for the purposes of s 175 of the IA 1986. Overturning long-established Court of Appeal authority,12 they replied that they are not.

A. The fundamental issue

6 The nub of their Lordships’ reasoning was provided with characteristic crispness by Lord Millett: “Questions of priority arise only between interests which compete with each other for payment out of the same fund.”13 The “real question” is, therefore, “whether the expenses of a winding up are payable out of charged assets at all”.14“If they are”, Lord Millett conceded, then “there is no doubt that they are payable in priority to the claims of the charge holder”. But if they are not, then “questions of priority do not arise”.15“The significance of the floating charge”, his Lordship went on to explain, “is, not that it alters priorities for payment out of a single fund, but that it brings a second fund into existence with its own set of priorities”.16

7 The “assets subject to the floating charge form a separate fund”, agreed Lord Hoffmann, because they “belong beneficially to the [charge]-holder … The [debtor] company has only an equity of redemption; the right to retransfer of the assets when the debt secured by the floating charge has been paid off”.17 Lord Nicholls was of the same view: “In distribution of non-charged assets of the company liquidation expenses rank ahead of the claims of preferential creditors”, he held; but “unlike the non-charged assets, the charged assets belong to the debenture holders to the extent of the amounts secured.”18 It follows that there is “nothing inherently surprising in Parliament deciding that in future the proprietary interests of a debenture holder in his fund, that is, the charged assets, shall be eroded to the extent of the claims of preferential creditors without making any similar incursion in respect of liquidation expenses”.19

8 The issue, to reiterate, was not one of priorities in “one fund” at all, since if it were, then there would be “no doubt” but that liquidation expenses enjoyed priority over floating charge claims. The issue was of “property” in two “separate funds” which “belonged”, respectively, to the company and the debenture holder, and each of which was governed by “its own set of priorities”. Liquidation claims, in short, were not “payable out of the charged assets at all”. All of this, held their Lordships, was clear from the late Victorian history of the statutory antecedents of s 175 of the IA 1986.

B. The property law response and the charge/mortgage critique

9 With respect, neither the reasoning nor the conclusion is at all satisfactory.20 Since the governing statutory phrase “assets [of the company]” has not been given a specific statutory meaning, this meaning must, prima facie, be gathered from the general (property) law, subject to any countervailing reasons of principle or policy.21 As for the general law, the effect of a floating (and indeed, of a fixed) charge, and even of a mortgage, is never to split the debtor company’s estate into two funds, one of which is beneficially “owned” by or “belongs” to the charge holder. At all times during the existence of the charge or mortgage, the beneficial ownership of encumbered assets remains vested in, and the assets themselves, therefore, remain “assets of the company”. Instead, the effect of a charge is precisely to reorder the priorities for payment out of

the charged assets in favour of the charge holder. This remains true throughout the existence of the charge.

10 This point has apparently been misunderstood, so we should proceed with care. One of the critiques (“the charge/mortgage critique”) of their Lordships’ judgment in Leyland Daf had focused —“initially” and merely “as a pedagogical tool”22 or “heuristic”23— on the distinction between charges and legal mortgages. The argument was that, at least in the case of a legal mortgage, the legal title to the collateral is vested in the secured creditor, with the result that it is “at least possible to construct an argument in...

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