Survey on: Claw-back of security in insolvency Questionnaire IRELAND. William Johnston, Arthur Cox

Transcription

1 Survey on: Claw-back of security in insolvency Questionnaire IRELAND William Johnston, Arthur Cox and Adrian Farrell, McCann FitzGerald 1. Introductory questions 1.1 Please briefly describe the main type of security in your jurisdiction (per type of asset; per perfection technique; per type of secured obligation). The following are the main types of security: Fixed Charge a fixed charge confers a right on the charge holder to look to a particular asset in the event of default by the chargor, which is enforceable by either power of sale or appointment of a receiver. It is the most common form of security taken over assets. Where title to registered land is charged, the charge will be recorded against the chargor s property at the Property Registration Authority. A fixed charge can be created over assets other than land, provided effective control of the charged asset rests with the chargee. Floating Charge a floating charge is a charge which floats and does not attach to any of the chargor s assets so the chargor remains free to deal with such assets in the ordinary course of business without any restrictions from the chargee. Upon the happening of certain events (including certain insolvency events and the appointment of a receiver), the floating charge will crystallise, thereby converting into a fixed charge over all assets which were at the time of crystallisation, covered by the floating charge. For the conversion to be effective, recent case law indicates the security must provide that upon crystallisation the chargor can only deal with the assets which are the subject of the charge at the will of the charge holder. Accordingly, following crystallisation, the chargor will not have the freedom to deal with those assets in the normal course of business. Mortgage a mortgage is the transfer of the mortgagor s title to the asset in favour of the mortgagee subject to a right to have the asset retransferred once the debt has been repaid by the mortgagor (this form of security has recently been effectively replaced by a fixed charge). Security Assignment - a security assignment (which is similar to a mortgage but still an effective form of security), involves the assignor assigning the assignor s title to the asset in favour of the assignee to secure its obligations to the assignee; once these obligations have been met/re-paid, the title will be returned to the assignor. A common example would be a security assignment taken in respect of an assignor s rights under a contract or other chose in action. A security assignment may be perfected into a legal assignment by serving notice of the security assignment on the counterparty to the contract or chose in action. MKD/119/AC#

2 Pledge a pledge is a form of possessory security, whereby the asset being pledged is physically delivered to the pledgee and held by the pledgee as security for the payment of a debt or other obligation. Lien A lien is a right given to a person, under a contract for the provision of services, to retain possession of the goods belonging to the other until the other has paid for his services. It is essentially a passive right to retain (but not sell) property until the debt or obligation is discharged. 1.2 Please briefly describe whether your jurisdiction provides for a procedure of protection against creditors (usually initiated by a debtor at a time when the debtor is yet not insolvent) and if so what are its basic assumptions? Examinership This is a procedure for the rescue of a company in financial difficulty and protection against its creditors. Where a company is or is likely to be insolvent and has not been wound up, a petition may be presented to the High Court (by the company, its directors, any creditor, or shareholders with a minimum 10% shareholding) seeking protection of the court and the appointment of an examiner. If the court considers that the company has a reasonable prospect of survival as a going concern, it may appoint an examiner. For a period of 70 days from the date of the petition (which the court can extend to 100 days), the creditors of the company are prevented from taking action to enforce any security which they hold from the company. Furthermore, no winding-up proceedings against the company can be commenced and no receiver can be appointed. The examiner will prepare a report for the court on the viability of the company. The proposals developed for a scheme of arrangement by the examiner may involve a combination of new investment, a write-down of creditors claims and payment of a dividend to creditors over a period of time. The company will continue to trade during the period of examinership. The court will either confirm or reject the proposals made by the examiner. If the court decides to confirm the proposals it will fix a date for implementation of the proposals, no later than 21 days from the date of confirmation. This will be the date the company comes out of court protection and the role of the examiner ceases. If the proposals are not confirmed by the court, it can then make such an order as it deems fit, which is most likely to be an order for the winding up of the company. 1.3 Please briefly describe the types of insolvency proceedings contemplated by your legislation (liquidatory proceedings; reorganisation or recovery proceedings). Liquidation Proceedings - Winding Up there are three types of winding up: Members Voluntary Winding Up For a members voluntary winding up, the company must be solvent (so it is not strictly an insolvency procedure). The members of the company must resolve by 75 per cent majority to have the company wound up. The directors of the company must make a statutory declaration that they have made a full enquiry into the affairs of the company and having done so, they are of the opinion that the company can pay its debts in full within a period of 12 months from the commencement of the winding up. Failure to do so may leave the directors open to personal liability in respect of the debts owed.

3 Creditors Voluntary Winding Up Where a company is insolvent, the directors may convene a meeting of the members with a view to the members passing a resolution to wind up the company and appoint a liquidator. A meeting must also be convened of all creditors of the company to inform the creditors of the winding-up resolution passed by the shareholders. Once appointed, the liquidator realises all of the company s assets and distributes the proceeds to the creditors. Compulsory Winding Up The High Court has the power to order the winding up of a company and appoint a liquidator. A creditor who is not paid monies due to it, may present a petition to the High Court that the company is insolvent and unable to pay its debts as they fall due. The insolvency procedure in a compulsory winding up differs in that the appointment of a liquidator arises not from meetings of members and creditors, but by order of the High Court. The obligation of the liquidator is to take control of all the company's assets, realise the assets so as to discharge the company s liability and pay the company's creditors. Reorganisation Examinership See above under paragraph 1.2. Recovery Proceedings Receivership This is a remedy available to a secured creditor for the enforcement of a security interest. Where a company defaults on its secured obligations, the creditor which has security from that company may, under the terms of the security document, appoint a receiver over the company's charged assets with a view to realising those assets and paying the proceeds to the secured creditor. Where the assets are subject to a floating charge, the company s preferential creditors (principally certain amounts due to the Revenue Commissioners and employees) are paid from the proceeds of sale of assets (subject to the floating charge) ahead of the chargeholder. 1.4 Please briefly describe the types of claw-back actions available in your jurisdiction. Please address, in particular, any of the following questions: (a) (b) (c) Is claw-back automatic or does it require a positive assessment of the existence of the relevant conditions by the court or the receiver? Does your legislation differentiate between transactions (including the granting of security) with consideration and without consideration? Does your legislation differentiate, in cases of security in general, between security taken concurrently with the granting of the secured debt and security taken in a different period of time? (d) Are there special provisions for intra-group transactions and transactions between related parties? The following are the various claw-back options available: Floating Charge [under Section 288 of the Companies Act 1963]: If a floating charge has been created within twelve months of the commencement of the winding up of a company, it will be invalid save to the extent of money actually advanced or paid, or the actual price or value of goods or services sold or supplied to the company at the time of or subsequently to the

4 creation of, and in consideration for the charge together with interest at the rate of 5% per annum, but not more. Section 288 (3) provides that where the floating charge was created in favour of a connected person, the relevant time period is two years from the commencement of the winding up. Where a floating charge is invalid, the debt remains valid and the charge holder ranks with the company s other unsecured creditors. A floating charge will not, however, be invalid if it can be demonstrated that the company was solvent immediately after the charge was created. Section 288 (1) creates a presumption that a floating charge created within the prescribed period is invalid. It then becomes a matter for the charge holder to establish that the company was solvent immediately after the floating charge was created. Fraudulent Preference [under Section 286 of the Companies Act 1963]: Section 286 sets out circumstances where the payment of any sum, transfer of property or the creation of any security by a company within the six months prior to its winding up is invalid. The section applies where it is shown that the payment, transfer or creation of the security was made with the intention to prefer the secured creditor to the detriment of other creditors. A common example under this section would be for a company s board of directors to resolve that the company repay a bank loan which they, the directors, have personally guaranteed. If the transaction is held to be invalid, the bank is required to pay back the preferred loan repayment, and the directors will become liable under the personal guarantee. In order for section 286 to become operative, the payment, transfer or creation of security must have been made at a time when the company was unable to pay its debts as they became due. In order to successfully challenge a payment, transfer or creation of security the onus of proof rests with the liquidator and it can be a difficult task for the liquidator to prove the intention to prefer one creditor over another. The six month ( hardening ) period is extended to two years where the payment/or creation of security was made in favour of a connected person. A connected person includes a director or a shadow director of the company or a person connected to such director. In addition to this extension of the hardening period for connected party transactions, an automatic presumption of fraudulent preference arises. The burden of proof shifts from the liquidator to the company who must demonstrate that the relevant transaction was not a preference. Improper transfer of property [under Section 139 of the Companies Act, 1990]: This section enables a liquidator or creditor on a winding up of a company (or an examiner or receiver) to request the court to make an order for the return or claw-back of property where the disposal of the property had the effect of perpetrating a fraud on the company, its creditors or members. There is no need to prove any intent to defraud. The court will order the person in receipt of the transfer to re-transfer it to the transferor only if the court considers "it just and equitable to do so". In

5 2. 2. Specific questions deciding whether it is just and equitable, the court shall have regard to the rights of persons who have bona fide and for value acquired an interest in the [transferred] property. An example of this would be where a company makes a gratuitous disposition of its property to a third party for no consideration. Instead of ordering the return of the property, the court can also order that the person who appears to have benefited from the disposal pay back to the company a sum in respect of the property. In a recent case on this provision, the High Court held that section 139, unlike section 286 which focuses on an intention to prefer, merely requires that the company, its creditors or members are deprived of something to which it is or to which they are lawfully entitled. The decision in Re: Frederick Inns: In this case a number of companies made payments to the Revenue Commissioners not only for their respective company s debts but also for the debts of other companies within the same group. These payments had taken place in the six months immediately preceding the winding up of the holding company. It was held that the payments to the Revenue Commissioners by any of the companies of a sum in excess of its own particular tax liability was ultra vires the paying company. Such payments over and above the company s tax liability, for the purpose of reducing the tax liabilities of other companies in the same group, were held to be voluntary payments made without consideration for the benefit of third parties and were therefore clearly ultra vires and the payments were reversed. Fraudulent Dispositions: Section 74 of the Land and Conveyancing Law Reform Act 2009 provides that any conveyance (which includes an assignment, charge or mortgage) of property made with the intention of defrauding a creditor or other person is voidable by any person thereby prejudiced. This section does not apply in the case of a transfer for valuable consideration to any person in good faith and where that person does not have notice of fraudulent intention. Failure to Register of Charges: A company incorporated in Ireland is required to deliver particulars of certain charges and security interests to the Register of Companies within 21 days of their creation. Irish company law lists the types of charges which are registerable. In practice, most charges and security interests created by an Irish company are registered under this provision. If a relevant charge is not registered within 21 days then it is void against a liquidator and other creditors of the company. In effect, any debt secured by a charge which is not registered within the relevant timeframe would become an unsecured claim. Strictly speaking, this provision may not be a claw-back measure, although failure to observe the applicable registration requirement will have a similar impact on any affected security. 2.1 Is claw-back subject to specific rules with respect to any type of security available in your jurisdiction? If so, please describe any such rules. As discussed above, the claw-back option pursuant to section 288 of the Companies Act 1963 is available only in respect of floating charges. The other claw-back provisions apply to voluntary grants of security generally.

6 2.2 Are there any total or partial exemptions from claw-back, depending on (for example): (a) (b) (c) (d) (e) (f) The type of security; The type of transaction secured (including its legal form); The type of (wider) transaction within which the financing is granted and the relevant security is taken (e.g. financings granted in the context of certain reorganisation proceedings); The nature of the grantor of security; The nature of the beneficiary of security; Other. There are no general exemptions from claw-back under any of the above headings. However, there is a partial restriction with regard to fraudulent preference under Section 286 of the Companies Act 1963 in that the allowable period of claw-back of two years for connected persons is reduced to six months where the disposal does not involve a connected party. Similarly, with regard to section 288, the two year claw-back period for connected persons is reduced to one year for non-connected persons. 2.3 How does your legal system address the claw-back of quasi-security transactions, e.g. a sale of a property in return for a price payable in instalments may hide a financing transaction secured by the property; which legal regime applies in this case: that of the claw-back of security, or that of the termination of pending (sale and purchase) agreements? Potentially both. There is some case law which indicates that a transaction which purports to take effect as an absolute transfer by way of sale can be recharacterised as a secured loan. If a transaction is recharacterised in this way and the obligor is a company, then there is a risk that the security will be held to be void for failure to register it as a charge or security interest in the Companies Registration Office within 21 days of its creation. Even if the transaction is not recharacterised as a secured loan, a transaction which takes effect as a transfer by way of sale may still be vulnerable to claw-back under the provisions referred to above. 2.4 What are the legal consequences of the claw-back for the parties involved? For example: (a) (b) Is an agreement, deed or transaction subject to claw-back invalid or just ineffective between the debtor and the party to the agreement; To what extent can claw-back affect the successful exercise or enforcement of security rights as may have occurred prior to the adjudication in bankruptcy (e.g. claims cashed by the secured lender under a security assignment of receivables prior to the adjudication in bankruptcy)? Is there any difference between the case of self-enforcing security (e.g. the cashing of claims referred to above) and a court-driven enforcement (e.g. the enforcement of a mortgage)? Where claw-back arises in respect of a security interest, the legal consequence of the claw-back for the parties involved will be that the security or payment in question

7 will not be effective. However, despite the security being invalid, the debt will still stand and the creditor will then become an unsecured creditor. In cases where a creditor is preferred to another group of creditors, and the payment is deemed unenforceable, the creditor can be required to pay back the money, and the payment is negated. In terms of self-enforcing claims, in most cases, security interests, including mortgages, would be capable of enforcement by a power of sale or the appointment of a receiver without court proceedings, and prior to any formal bankruptcy adjudication. In principle, the fact that the security has been enforced prior to winding-up, would not prevent an affected party from applying to court seeking to set aside such a transaction using claw-back rules. 2.5 What are the rights of the parties involved once the claw back had been enforced (as a result of operation of law or court ruling)? See 2.4 above a party deprived of its security interest through claw-back would, in most circumstances, be in a position to maintain an unsecured claim against the relevant company. 2.6 What is the claw-back regime for security granted by third parties/in respect of third party indebtedness? Please analyse from the perspective of the insolvency of the debtor and of the insolvency of the third party grantor of security. Does the possibility for the third party grantor to act in recourse against the insolvent debtor make a difference? There is no separate claw-back regime in place for security granted by third parties/in respect of third party indebtedness the general provisions summarised above apply. However, where the security is for a debt owed by a third party, the issue of whether corporate benefit accrued to the grantor may come into focus in the event of an insolvency of the company granting the security. If it is determined that no such benefit accrued there is a risk that the grant of security may be overturned as ultra vires and potentially void. Once the guarantor has paid the creditor, the guarantor would have a right of subrogation, although it would be common to agree to postpone such rights to the claims of the relevant secured party. A right of subrogation entitles the payor to a right of reimbursement, whereby it stands in the creditor s shoes to recover the money from the debtor. In terms of claw-back risk, the fact that the third party grantor has recourse against the insolvent debtor will not make a difference in practice - although it may be one of a number of relevant factors for the directors of the company to take into account when they are considering the overall corporate benefit which may accrue to the company from the relevant transaction 2.7 What is the claw-back regime for security which has been agreed (i.e. the relevant security agreement has been executed) but not yet perfected at the time of the adjudication in bankruptcy of the debtor/grantor? Assuming the security is not ineffective for want of registration, it will be open to claw-back if any of the categories under paragraph 1.4 above apply. 2.8 Other? Section 60 of the Companies Act 1963: This provision prohibits financial assistance directly or indirectly by means of a loan, guarantee or otherwise for the purpose of or in connection with a purchase made by any person of shares in a company or a company s holding company. The motivation behind this provision is to prevent the reduction of share capital of the company and asset stripping, which would have a negative effect on the creditors of a company.

8 Any transaction in breach of section 60 is voidable at the instance of the company against any person with notice of the facts which constitute the breach. High Court decisions set down that the notice required in such cases was actual notice rather than constructive notice. Therefore, where a bank is not on notice of the circumstances giving rise to a breach of section 60, the security will not be unenforceable by virtue of a breach of section 60. In cases where there is actual notice that security is given in breach of section 60, the security will be unenforceable. Section 31 of the Companies Act 1990: This provision prohibits a company from making loans or quasi-loans, entering into credit transactions or providing guarantees or security with respect to the loans, quasi-loans or credit transactions in favour of a director or connected person. This provision was introduced to stop directors taking loans from their companies and having personal loans guaranteed by their companies to the detriment of the company s creditors. Exemptions to this prohibition apply whereby the arrangement is within 10% of the companies relevant assets, including where the arrangement is in the context of an intra-group transaction. Where there has been a breach of section 31, the transaction may be voidable at the instance of the company under section 38 of the Companies Act Any security in breach of section 31 is therefore unenforceable. A person who benefits from a relevant transaction or arrangement can be held personally liable for some or all of the company s debt if the company is being wound up and the company is unable to pay its debts.