Marshalling – nothing and then two come along at the same time

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Julie Killip's article was published by Insolvency Intelligence on 13 November 2015

Marshalling is an equitable principle. It has been explained as follows;

“The doctrine of marshalling applies where there are two creditors of the same debtor, each owed a different debt, one creditor (A) having two or more securities for the debt due to him and the other (B) having only one.  B has the right to have the two securities marshalled so that both he and A are paid so far as possible.  Thus if a debtor has two estates (Blackacre and Whiteacre) and mortgages both to A and afterwards mortgages Whiteacre only to B, B can have the two mortgages marshalled so that Blackacre can be made available to him if A chooses to enforce his security against Whiteacre.  For the doctrine to apply there must be two debts owed by the same debtor to two different creditors.” Re Bank of Credit and Commerce International [1998] AC 214: Court of Appeal Lord Justice Rose.

Marshalling is a slightly arcane doctrine straddling the world of normal commercial dealings with that of insolvency and often mixed up with questionable conduct.  The huge opportunity to understand and apply the doctrine lies in the fact that many commercial actions can unwittingly be caught by the principles.  The most senior creditor, often cocooned by a false sense of invulnerability,  is actually subject to more restrictions on their freedom of action than the casual observer might imagine. Marshalling has many pitfalls for the unwary and tactical and legal opportunities for the informed practitioner. It has few precedents but therein lies some evidence that it could be applied more vigorously and to great effect.

When I attempted to explain marshalling to a lay friend, he inquired if it was related to the debtor prison at Marshalsea, made famous by Dickens. It was a privately run extortion racket whereby you could only be released upon repayment of the debt, a task made harder by the fact of incarceration. In fact, the connection is less strained than might at first appear.  The leading cases which established the classic statements of principle of the doctrine of marshalling were heard in the heyday of the Marshalsea in the 1700-1800’s and those principles have since remained largely undisturbed with relatively few cases having been cited since that time.

Like the Marshalsea, at the heart of the matter is debt and the ranking of security for repayment. The Marshalsea favoured the complainant, not necessarily the most deserving of creditors. Locking up the debtor advanced the cause of one creditor at the expense of all others. Marshalling, by contrast, concerns itself with maximising the benefit of whatever security exists among all ranking creditors. The Marshalsea has long since been abolished but the slightly arcane doctrine of marshalling has been given a thorough review in two recent cases – Szepietowski v The National Crime Agency [2013] UKSC 65 and Highbury Pension Fund Management Company (1) and Cezanne Trading (2) v Zirfin Investments Management Limited and Others [2013] EWCA Civ 1283 in which I acted for Highbury and Cezanne having identified the potential marshalling claim.

The doctrine of marshalling is imposed to prevent one party from depriving another party from relying on security.  The classic form of marshalling applies where two or more creditors are owed debts by the same debtor where one of the creditors has security over more than one asset or fund whilst another creditor can resort to only one security or fund.  In these circumstances the doctrine of marshalling gives the second creditor a right in equity to require the first creditor to satisfy himself, or be treated as having satisfied himself so far as possible, out of the security or fund to which the second creditor has no claim. This classic form was extended in the two recent cases.

In the case of Szepietowski marshalling was examined in detail when The National Crime Agency (formerly the Serious Organised Crime Agency “SOCA” and which incorporated the Asset Recovery Agency “ARA”) sought to marshal a charge granted to the Royal Bank of Scotland over the home of Mrs Szepietowski and an investment property she owned, with a later charge granted to SOCA over the investment property alone.  SOCA looked to Mrs Szepietowski’s home to satisfy the sum secured by the second charge.  This was challenged by Mrs Szepietowski.

The ARA had brought civil proceedings against Mr and Mrs Szepietowski seeking to confiscate various properties allegedly acquired with proceeds of mortgage fraud and over which they had obtained a receiving order under section 266 Proceeds of Crime Act 2002.  Mr and Mrs Szepietowski and the ARA settled the proceedings on terms contained in a Settlement Deed in full and final settlement of all of the ARA’s claims against Mr and Mrs Szepietowski to which three annexes were attached.  Annex A contained properties which remained with Mr and Mrs Szepietowski and included Ashford House recorded as having a value of £2.3million and charged to The Mortgage Business plc (TMB) and RBS for £1.46million; Annex B contained properties vested in the Trustee for Civil Recovery on behalf of the ARA (“The Trustee”) and included Thames Street and Church Street (“the RBS properties”) both charged to RBS; Annex C contained two properties, Torrington Close and Hare Lane referred to as “the Claygate properties” vested in The Trustee but subject to RBS charges.  All properties remained subject to existing charges.

In the Settlement Deed there were clauses which provided for circumstances in which Mrs Szepietowski had to grant charges to the ARA over certain of the properties in the annexes.  A dispute then arose as to which properties these were and resulted in an Order by Henderson J when it was decided that the Claygate Properties would re-vest in Mrs Szepietowski pursuant to the Settlement Deed and she would give a charge to SOCA over the Claygate Properties and not Ashford House as argued for by SOCA.
The Charge contained a covenant that on completion of any sale of the charged property the proceeds of sale would be applied in settlement of the secured amount. The charged property and the proceeds of sale were charged by way of legal mortgage as continuing security for the settlement of the secured amount.  The Charge provided that the security became enforceable on certain events but for the avoidance of doubt this did not constitute a covenant by Mrs Szepietowski to pay the secured amount to SOCA.

The Claygate Properties were sold and all monies went to RBS.  SOCA argued this gave rise to a classic case of marshalling in that (1) the Claygate Properties and Ashford House were both owned by Mrs Szepietowski (2) both properties were subject to an RBS charge (3) the Claygate Properties were subject to a second charge in favour of SOCA (4) RBS was repaid from the Claygate Properties and not Ashford House which remained unsold and (5) the SOCA charge remained unpaid.

Whilst successful at first instance and in the Court of Appeal, SOCA’s marshalling claim was defeated on appeal to the Supreme Court.  The Supreme Court held that the terms of the Settlement Deed were concerned with the ownership of, and rights over, property and not with creating or acknowledging debts.  The Charge was absent any provision which created or acknowledged an obligation on Mrs Szepietowski, the mortgagor, to pay the secured amount.  All she was obliged to do was to do was to pay SOCA an amount of up to £1.24m out of the proceeds of sale of the Claygate Properties after paying RBS.  As there was no underlying debt the principles of marshalling did not apply.

In the Highbury case extended principles of marshalling in relation to the “common debtor” rule were applied.

Barclays Bank had lent money to Zirfin Investments Limited secured by a charge over 31 Brompton Square, London. It also lent money to companies associated with Zirfin (“Affiliates”) secured by charges over the Affiliates’ properties.  Zirfin guaranteed the loans to the Affiliates and the guarantee was secured by a charge over 31 Brompton Square.  Highbury and Cezanne lent money to Zirfin secured by second and third charges over 31 Brompton Square.  Barclays called in its loans and appointed Receivers who sold 31 Brompton Square as Zirfin’s agents.  The proceeds of sale repaid Zirfin’s own debt and there would have been sufficient to repay Highbury and Cezanne but, after payment of Receivers’ costs, Barclays applied the surplus in discharge of Zirfin’s guarantee liability leaving a shortfall due to Barclays plus costs.  Highbury and Cezanne no longer had any legal security for their debts.  The value of the Barclays additional securities was more than enough to discharge the outstanding debts owed to Barclays, Highbury and Cezanne.  For reasons unknown Barclays did not wish to enforce its security over the Affiliates properties.

Achilleas Kallakis who was charged with conspiracy and fraud charges was made the subject of a Restraint Order under the Proceeds of Crime Act 2002 and was forbidden from disposing of or dealing with assets worldwide.  This was held to include shares in The Hermitage Syndicated Trust which held the shares in Zirfin and the Affiliates.

The questions to be answered were (1) Does the doctrine of marshalling permit the marshalling of securities held over property that does not belong to the “common debtor”?  In particular is a creditor of a guarantor entitled to marshal or be subrogated to securities which have been granted to another creditor of the guarantor by the primary debtor liable under the guaranteed debt? (2) Does the answer depend in any way on the rights which the guarantor has as against the holder of the guarantee or as against the primary debtor? And (3) Does any such claim to marshalling or subrogation take precedence over prohibitions contained in the Restraint Order either as of right or by virtue of the exercise of some discretion of the Crown Court?

Barclays did not consent to nor contest the claim provided that any relief was subject to and without prejudice to its rights to enforce its securities generally at such time as it thinks fit.  Zirfin and the Affiliates took a neutral stance and the argument was between Highbury and Cezanne and the SFO who would only recover after Highbury and Cezanne if they were successful in their marshalling claim.

It was held that Highbury and Cezanne were entitled to the benefit of the equitable principle of marshalling as Zirfin was entitled to ensure that the Affiliates bore ultimate liability for their own debts.  Therefore Zirfin was entitled to be subrogated to Barclays’ rights over the properties charged to it by the Affiliates.  However Norris J held that by virtue of clause 8 of the guarantee between Zirfin and Barclays, which provided that until payment of the balance due to Barclays, no guarantor was entitled to participate in security held or money received by Barclays or to stand in the bank’s place in respect of any security or money.

This led to an appeal on that issue alone by Highbury and Cezanne on the basis that the judge should not have taken the point as it was not one taken by Barclays, clause 8 did not apply to or restrict Highbury and/or Cezanne’s right to require Barclays to marshal its securities and, if it did apply, Barclays had waived reliance upon it.

It was held on appeal that if Barclays resorted to the fund over which they and Highbury and Cezanne have security then Highbury and Cezanne were entitled to stand in the shoes of Barclays over the remaining securities and the equity arising between Barclays and Highbury and Cezanne is not the same as the security arising between Zirfin and the Affiliates and the latter should not affect the former.  The equity between Zirfin and the Affiliates was the equity of exoneration and this equity was not dependent on actual payment by the secondary debtor – the Affiliates.  Clause 8 of the guarantee was directed at preventing Zirfin from becoming subrogated to Barclays rights before payment of Barclays in full and would not prevent Zirfin taking action against the Affiliates based on the equity of exoneration.  Clause 8 also was held not to prevent Highbury and Cezanne from relying on its own right in equity as between itself and Barclays as Highbury was not competing with Barclays.

So why are there so few marshalling cases in modern times?  One reason is that the contracts drawn up between lenders and borrowers and senior and junior lenders can exclude marshalling as considered in the Highbury case which provided that the contract, in that case, would have to be between the competing creditors themselves rather than between the guarantor and the doubly secured lender.  Junior lenders would be well advised however to think about the implications of the recent cases in terms of strategy options and scenario planning.

What is clear is that marshalling comes into its own where the mortgagor/debtor is insolvent as marshalling improves the position of the second mortgagee as against the unsecured creditors of the debtor.  In the two recent cases of Szepietowski and Highbury it has been the position of the SFO/SOCA and their rights following proceedings under the Proceeds of Crime Act 2002 which have driven the proceedings.  Both cases made new law.  Whilst marshalling claims will remain rare both decisions may prove to be significant in the future.

French law has a general principle of abus de droit to prevent an entirely prejudicial application of a nominal right. This was developed when the neighbour of the Montgolfier brothers erected huge spikes to discourage their hot air ballooning experiments.  English law has baulked at creating such a general principle, but Marshalling is about as close as we get, typically tied up in labyrinthine rules which the judiciary have found difficulty applying evidenced  by dissenting judgments on the leading case.