Liquidators and administrations – in a dispute about priority between creditors, when will a judgment creditor prevail over a secured creditor?

Liquidation-books

 

  1. Generally, a secured creditor is entitled to stand outside the insolvency process and seek to have any secured property excluded from being used to satisfy the unsecured debts. In the case of a floating charge (a security interest held over a fund of changing assets), whether or not the asset is captured by the floating charge will depend on (among other things) the date at which the floating charge “crystallises”.

 

  1. In Brava Trading Pty Ltd v Leybourne Nominees Pty Ltd & Anor [2012] QSC 328, the Court held that if prior to the crystallising of a floating charge a judgment creditor receives judgment from the judgment creditor or garnishee, the mere existence of the floating charge is not sufficient to give the secured creditor or mortgagee a right to the debt.

 

The debt must be an actual security under the charge by its crystallisation before payment to the judgment creditor. Upon payment by the garnishee to the judgment creditor, the proceedings are complete. Where a debt has crystallised, a judgment creditor becomes a trustee to the secured creditor of funds received pursuant to a warrant of execution.

 

  1. Issues relating to the priority of security interests can be avoided by ensuring that they scrutinised to ensure that the events of default clause are appropriately wide enough, and are promptly registered on the Personal Properties Securities Register.

In the course of winding up or administering up a company, an external administrator or liquidator may be required to determine the priority of payment between certain classes of creditors. Occasionally, this may include a dispute between a secured creditor and a judgment creditor over money which is the subject of court proceedings.

In Brava Trading Pty Ltd v Leybourne Nominees Pty Ltd & Anor [2012] QSC 328 the Supreme Court of Queensland was asked consider whether or not certain funds held by a judgment creditor pursuant to a warrant of enforcement were held on trust for a secured creditor.

Background

On 31 March 2007, the plaintiff, Brava Trading, entered into a loan facility agreement with Brava Marine. Subsequently, Brava Marine granted the Plaintiff a fixed and floating charge over its assets, which was duly registered (the Charge). The Charge included a clause that would crystallised the floating charge “in the event of default (including an insolvency event)”. Brava Trading subsequently advanced approximately $2.9 million to Brava Marine in respect of the agreement and the Charge.

On 14 April 2009, the first Defendant, Leybourne, commenced enforcement proceedings in the District Court in respect of a default judgment in the amount of $66,366.69. Leybourne issued a warrant to the National Australia Bank (NAB), and NAB debited the sum of $67,321.53 from Brava Marine and drew a cheque in favour of Leybourne.

On 24 July 2009 Brava Marine successfully applied to have the default judgment set aside, and leave to file a defence. The District Court ordered that the sum of $67,321.53 was to be held in Leybourne’s solicitor’s trust account until otherwise agreed between the parties or ordered by the Court.

Subsequently, on 27 August 2009, a receiver was appointed over the assets of Brava Marine pursuant to the Charge and shortly thereafter liquidators were appointed to windup Brava Marine. On 10 February 2012, the District Court entered judgment against Brava Marine for the sum of $214,399.71 and costs in Leybourne’s favour. Leybourne sought to claim the $67,321.53 to partially satisfy the judgment, which was opposed by Brava Trading.

Parties’ submissions

Brava Trading argued that the enforcement warrant did not create a security interest because some of the events of default (as defined in the Charge) had occurred and the floating charge had crystallised prior to the issuing of the enforcement warrant. Further, the underlying default judgment on which the enforcement warrant was based was set aside.

Leybourne argued that any rights Brava Trading had as a charge over Brava Marine were lost upon the completion of the execution against NAB. In any event, the effect of the District Court order was to vest control of the funds in the Court and thus constituted a security created by the court pending finalisation of Leybourne’s claim against Brava Marine.

Court’s decision

After reviewing the terms of the Charge and case authorities submitted by the parties, the Court held that the winding up application on 20 July 2009 was an event of default which crystallised the Charge. Furthermore, Leybourne did not acquire any interest in or entitlement to the moneys prior to crystallisation of the Charge based on prior authorities stating that a garnishor does not enjoy a proprietary interest in respect of a relevant debt.

Citing the New South Wales decision of M G Charley Pty Ltd v F H Wells Pty Ltd [1963] NSWR 22, the Court held that “it is established that if prior to the crystallising of a floating charge a judgment creditor receives judgment from the judgment creditor or garnishee, the mere existence of the floating charge is not sufficient to give the secured creditor or mortgagee a right to the debt…upon payment by the garnishee to the judgment creditor the proceedings are complete.”

The Court noted that the present case was not one in which an asset which was “disposed of” after a warrant “attached”, rather it was a case of a floating charge crystallising before after the warrant was issued. After the Charge crystallised, the monies held by NAB were held on trust for Brava Trading. By virtue of the District Court order requiring payment into Leybourne’s solicitors’ trust account, Leybourne was precluded from receiving payment of the monies under the warrant.

The Charge crystallised prior to payment by the NAB sufficient to discharge its obligations under the warrant and it was not too late for Brava Trading to assert its rights in respect of the monies. The Court held that the discharge referred to in M G Charley was only against a judgment debtor and not against any third party who may claim the debt.

A judgment creditor cannot, by means of attachment, stand in a better position as regards the garnishee than did the judgment debtor – it could only obtain what the judgment debtor honestly gave him. Furthermore, the fact that the underlying default judgment founding the enforcement warrant was set aside gave additional weight to Brava Trading’s claims – the monies were not held on trust but rather remained subject to any pre-existing trust notwithstanding the payment in pursuant to the Court order.

The Court ultimately held that the sum of $67,321.53 held by Leybourne’s solicitors were held on trust for Brava Trading pursuant to the crystallised Charge. The payment into the solicitors’ trust account remained subject to any pre-existing beneficial interest of Brava Trading under the Charge and did not alter Brava Trading’s interest in the monies.

Summary

Generally, a judgment creditor does not take priority over a secured creditor if the secured creditor’s security has crystallised. If a judgment creditor executes a judgment after a secured creditor’s floating charge has crystallised, then the funds received by the judgment creditor in respect of the execution of the judgment will be considered to be held on trust for the secured creditor.

Charges/general security agreements should be properly drafted so that the “events of default” is broad enough to include an insolvency event so that any charge will crystallised before judgment is obtained by an unsecured creditor. The charge or general security agreement ought to be registered on the Personal Properties Securities Register to ensure that it ranks above other subsequent security interest. This will allow a secured creditor to take priority over a judgment creditor including receiving any proceeds of execution obtained by a judgment creditor.

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