BANK
OF INDIA (U) LIMITED VERSUS NC BEVERAGES LIMITED & UGANDA REVENUE AUTHORITY
HIGH COURT (COMMERCIAL DIVISION) CIVIL SUIT NO. 0009 OF 2021 (OS)
(Floating
and fixed charge – commencement of liquidation – Rights of a secured creditor –
Rights of unsecured creditors)
Before:
Hon Justice Stephen Mubiru.
JUDGMENT
The
Plaintiff advanced two credit facilities to the 1st defendant which were
secured by a debenture and further charge respectively over the 1st defendant’s
fixed and floating (present and future) assets. The charges were duly
registered. Around 30th 20 September, 2021 the 1st defendant had defaulted on the loans with an outstanding
consolidated debt of shs. 4,236,039,316/= inclusive of accumulated interest.
Before the plaintiff could realise the security, the 2nd defendant seized and
disposed of most of the assets mortgaged to the plaintiff in a bid to recover
unpaid tax of shs. 457,360,192/= under a warrant of distress issued on 26th
May, 2021. The plaintiff seeks the enforcement of its rights as mortgagee
despite the 2nd defendant’s execution of the warrant of distress.
Issues:
1. Whether the plaintiff is entitled to foreclosure and sale of the mortgaged
assets.
2. Whether the plaintiff is entitled to take possession of the charged assets.
3. Whether the defendants should pay the costs of the suit.
Resolution.
1. The plaintiff’s claimed right of foreclosure.
A secured party may apply to court for an order to foreclose the right of a
debtor to redeem the collateral. Foreclosure is the legal process that allows lenders to recover the
balance owed on a defaulted loan by taking ownership of and selling the
mortgaged property as collateral. The equity of redemption is a right given to
the mortgagor over the mortgaged property, which includes the right to redeem
the property on full repayment of the secured debt (see section 54 of The
Security Interest in Movable Property Act, 2019). The mortgagor may redeem
the mortgaged property on paying the full amount, including costs found due to
the plaintiff. A final order of foreclosure usually puts an end to the equity
of redemption and is valid against all defendants. Once obtained, the plaintiff
obtains title to the property free and clear of the interests of the defendants
and may therefore proceed to take possession or transfer the property to a
purchaser.
Suits for foreclosure appeal to mortgagees where the value of the property at
the time is not sufficient to repay the mortgage debt.
The plaintiff is the holder of a chattels mortgage and debenture charge dated
26th March, 2019, which incorporated a fixed charge over the 1st defendant’s
fixed assets and a floating charge over other assets. According to clause 3.1
(a) – (x) thereof the fixed charge registered on 28 20 th March, 2019 covered
the 1st defendant’s “estates and other interests in freehold, leasehold and
other immoveable property. Clause 3.1 (b) of the same debenture deed comprises
a first floating charge registered on 28th March, 2019 over all the 1st
defendant’s “undertaking, revenues, property right and assets (including
without limitation, stock in trade) whatsoever and whosesoever situated, both
present and future as are not for the time being or form time to time, subject
to an effective fixed charge in favour of the bank under sub-clause 3.1 (a) or
the provisions of any deed or other instruments executed pursuant thereto.”
Fixed and floating charges.
The
key feature of a floating charge is that, until it crystallises, the chargor is
entitled to deal with the charged assets in the normal course of business
without any further consent from the chargee (see Robson v. Smith [1895] Ch
D 118 and National Westminster Bank Plc v. Spectrum Plus Ltd [2005] 2
All ER 1000). The central feature which distinguishes a floating
charge from a fixed charge lies in the chargor’s ability to control and manage
the charged assets freely and without the chargee’s consent. The essence of a
floating charge is that it is a charge, not on any particular asset, but on a
fluctuating body of assets which remain under the control of the chargor (see
Agnew and Kevin James Bearsley v. The Commissioner of Inland Revenue, and
Official Assignee for the Estate In Bankruptcy of Bruce William Birtwhistle and
Mark Leslie Birtwhistle [2001] 2 AC 710; [2001] Lloyd’s Rep Bank 251, [2001] 3
WLR 454). It “is ambulatory and shifting in its nature, hovering over and
so to speak floating with the property which it is intended to affect until
some event occurs or some act is done which causes it to settle and fasten on
the subject of the charge within its reach and grasp” (see Illingworth v.
Houldsworth [1904] AC 355 at 357).
Clause 3.4 (c) and (d) of the debenture deed provides that the floating charge
created by sub-clause 3.1 (a) was to automatically and without notice be
converted into a fixed charge in respect of the charged assets subject to the
floating charge, if and when the company ceases to carry on business or to be a
going concern, or upon the occurrence of a potential event of default and / or
an event of default. Upon crystallisation of a floating charge, the floating
charge attaches to all existing assets that are within the scope of the charge
and becomes fixed.
The main consequence of crystallisation is that the chargor's authority to
dispose of or to deal with those assets without the consent of the chargee
comes to an end. It is accepted that crystallisation will occur automatically
upon the winding up (or other business cessation event) or the appointment of a
receiver of the chargor (see In Re Portbase Clothing Ltd; Mould v. Taylor
[1993] Ch 388). When a floating charge crystallises, it becomes a fixed
charge attaching to all the assets of the company which fall within its terms.
Thereafter the assets subject to the floating charge form a separate fund in
which the debenture holder has a proprietary interest. For the purposes of
paying off the secured debt, it is his fund. The company has only an equity
of redemption (see Buchler and another (as joint liquidators of Leyland
DAF Limited) v. Talbot and another (as joint administrative receivers of
Leyland DAF Limited) and Stichting Ofasec and others, [2004] 2 WLR 582; [2004]
AC 298).
In the instant case, the plaintiff’s floating charge crystalized on 21st April,
2021 upon the 1st defendant’s filing of a petition for winding up. According to
clause 7.1 (c) of the debenture deed dated 26th March, 2019, a default would be
deemed to have occurred upon the 1st defendant’s passing of a resolution or
filing a petition for the winding up of the company. Therefore, not only did
the filing of the petition for winding up crystallise the floating charge, but
it also constituted an act of default on the part of the 1st defendant. It
is trite that the mortgagee or charge may exercise his right of recourse against
the security whenever he pleases after default (see Governments Stock and other Securities Investment Company v. Manila Railway Company [1897] A.C.
81).
Section 44 (1) of The Security Interest in Movable Property Act, 2019
provides that where a debtor defaults on the obligation to pay or where another
event of default occurs, the security interest becomes enforceable. Upon
default, the chargee or mortgagee has the option of taking possession of the
assets of the charger or mortgagor that form the subject of that security,
until the default which was the cause of the entry into possession has been
rectified through the possession of the mortgagee, or until the mortgagee has
exercised the power of sale (see section 47 (1) of The Security Interest in
Movable Property, Act 2019). In a suit for foreclosure, following a
final order of foreclosure, the mortgagor and subsequent encumbrancers are
absolutely debarred and foreclosed of and from all right, title and equity of
redemption of, in and to the mortgaged lands. This means that the
mortgagors no longer have equity in the property which could support a claim to
any right to request relief. An order of “foreclosure and sale” would thus be
preferable for a defendant in situations where the value of the property
exceeds the amount owing on the mortgage.
URA’s claim under warrant of distress.
Slightly
over one month following the 1st defendant’s filing of a petition for winding
up on 21st April, 2021, before the plaintiff had taken any step towards the
realisation of the security, the 2nd defendant on 25th May, 2021, issued a
warrant of distress authorising the attachment and sale of the 1st defendant’s
“goods, chattels, or other distrainable things [of the 1st defendant] wherever
the same may be found, for recovery of shs. 457,360,192/= in unpaid taxes. It
is on that basis that the 1st defendant’s assets, already the subject of the
plaintiff’s chattels mortgage and debenture charge, were attached.
The 2nd defendants seized the assets on 26th May, 2021 and advertised them for
sale that was scheduled to take place on 15th June, 2021. That attachment
prompted the plaintiff on or about 7th June, 2021 to file an application for an
interim injunction order restraining the 2nd defendant from auctioning,
selling, transferring or alienating the 1st defendant’s assets until the
determination of the main application for an interlocutory injunction order.
The interim injunction order was granted on 14th June, 2021 lasting until 14th
July, 2021. The sale eventually took place on 20th November, 2021.
When liquidation commences.
According to section 93 of The Insolvency Act, No. 14 of 2011, where, before
the presentation of a petition for the liquidation of a company by the court, a
resolution is passed by the company for voluntary liquidation, the liquidation
of the company is deemed to commence when the resolution is passed. In
all other cases, it is taken to commence at the time of presentation of the
petition for liquidation. The purposes of a liquidation are;
(a)
to ensure a just distribution of the company's assets among
creditors and contributories and
(b)
to terminate the company's existence by its eventual
dissolution.
The
winding up of a company is a form of collective execution by all its creditors
against all its available assets. The resolution or order for winding up
divests the company of the beneficial interest in its assets. They become a
fund which the company thereafter holds in trust to discharge its liabilities
(see Ayerst (Inspector of Taxes) v. C & K (Construction) Ltd [1976] AC
167).
It is a special kind of trust because neither the creditors nor anyone else
have a proprietary beneficial interest in the fund. The creditors have only a
right to have the assets administered by the liquidator in accordance with the
provisions of The Insolvency Act, 2011 (see In re Calgary 10 and Edmonton Land
Co Ltd (In liquidation) [1975] 1 WLR 355 at 359). But the trust applies only to
the company's property. It does not affect the proprietary interests of others.
Secured creditors.
According
to section 2 The Insolvency Act, No. 14 of 2011, “secured creditor” means a
creditor who holds in respect of a debt or obligation a charge over property.
Section 11 (2) (a) and (3) of the Act provide that a secured creditor may
realise any asset subject to a charge, where he or she is entitled to do so,
and after realising an asset subject to a charge may claim as an unsecured
creditor for any balance due, after deducting the net amount realised, or
account to the liquidator for any surplus remaining from the net amount
realised after satisfaction of the whole debt, including any interest payable
in respect of that debt up to the time of its satisfaction and after making
proper payments to the holder of any other charge over the asset subject to the
charge. Therefore, a secured creditor’s rights are discretionary. A secured
creditor may realise any asset subject to a charge, where they are entitled to
do so, can claim as a secured creditor in the order of preferences, or
surrender the charge for the general benefit of all creditors and claim as an
unsecured creditor.
The implication of the above provision is that the rights of the secured
creditor to deal or realise security over company assets are not affected by
the petition for winding. In the event of default, secured creditors can
exercise their powers to sell the company’s assets which have been charged to
them as security in order to satisfy the debts in accordance with the law.
Should there be any shortfall therefrom, secured creditors may file proof of
debt and they will consequently be regarded
as unsecured creditors. Secured creditors are required to hand over the
remaining proceeds from the sale of the company’s asset to the liquidator to be
credited into the estate of the company.
Creditors generally seek security for the purpose of protecting their interests
if the debtor fails to repay. If security is to achieve this objective, upon
the commencement of insolvency proceedings, the secured creditor should not in
any way be delayed or prevented from immediately foreclosing upon its
collateral.
A secured creditor “stands outside the winding up” and can realise and
enforce its security by sale de hors the winding up proceedings or without
intervention of the court (see Wrenbury in Food Controller v. Cork, [1923] AC
647; Kenya National Capital Corporation Ltd v. Albert Mario Cordeiro &
another [2014] eKLR (Civil Appeal 274 of 2003); (27 February 2014); Siraje
Ndugga v. Kabito Karamagi and another (Receivers of Spencon Services Limited in
Receivership) H. C. Misc. Cause No. 219 of 2020 and African Textile Mill Ltd (in
liquidation) v. Co-operative Bank Ltd (in liquidation), H. C. Civil Suit No. 20
of 2005). Therefore, creditors with a mortgage or fixed charge over
assets secured in this way are outside the scope of the insolvency. A sale
outside the winding up or without the intervention of the Court would be valid
and cannot be challenged as invalid nor can it be challenged as void.
Questions of priority arise only between interests which compete with each
other for payment out of the same fund. According to section 12 (6) (a) of
The Insolvency Act, No. 14 of 2011, in the distribution of non-charged assets
of the company, tax obligations rank second last after claims of other
preferential creditors including; remuneration and expenses properly incurred
by the liquidator, the reasonable costs of any person who petitioned court for
a liquidation, all wages or basic salary of employees, etc. It is after paying
preferential debts in accordance with the above order of priority, that the
liquidator applies the assets in satisfaction of all other claims (see section
13 (1) of the Act). The general rule is that unsecured creditors are entitled
to share pari passu in the company's fund (see section 13 (2) of the Act).
The rights of unsecured creditors over the company’s assets are virtually
“frozen” upon the commencement of the liquidation to avoid a further
deterioration of the company’s financial position and proliferation of its
liabilities. After a petition for winding up has been presented, no
creditor is allowed to take out or continue attachment or execution proceedings
against the company. After a company goes into liquidation, unsecured creditors
cannot commence or continue legal action against the company, unless the court
permits it. A creditor must complete execution before the winding up
application has been presented. Otherwise, a creditor cannot retain the assets.
Any disposition or sale of the company’s assets, transfer of shares or
alteration in the status of company’s contributories made after the
commencement of the winding up by the Court without the Court’s sanction or
approval is void.
Section 97 (1) (c) specifically prohibits the levying of distress against
the company or its property, upon the commencement of liquidation. Therefore,
once the petition was filed on 21st 5 April, 2021, it follows that the 2nd
defendant’s warrant of distress issued on 26th May, 2021 in a bid to recover
unpaid taxes of shs. 457,360,192/= was illegal and void. The sale that
eventually took place 20th November, 2021 too was illegal.
Upon the 1st defendant’s default, the plaintiff was entitled to foreclosure and
sale of the mortgaged assets, but for the 2nd defendant’s unlawful actions. As
a borrower, the 1st defendant could have stopped the process of foreclosure by
redeeming its property before a foreclosure sale (see section 54 of The
Security in Movable Property Act, 2019). To redeem the property, the 1st
defendant had to pay the full balance due before the foreclosure sale.
Alternatively, the 1st defendant was required to prove that the plaintiff as foreclosing mortgagee did not comply with the
foreclosure laws or the terms of the mortgage. The 1st defendant not having
sought to assert its right of redemption, and not having challenged the
process, I find that the plaintiff is entitled to foreclose.
2. whether the plaintiff is entitled to take possession of the charged
assets.
A charge or mortgagee has the option to enforce their mortgage security through
a foreclosure or judicial sale but for the most part, the exercise of a contractual
or statutory power of sale is the more favourable remedy for mortgagees. If the
deed does not contain a power of sale clause, statutory power of sale
provisions are set out in section 48 of The Security Interest in Movable
Property Act, 2019. According to that section, where a debtor is in default,
sell any or all of the collateral in its condition. For that purpose, unless
otherwise agreed, a secured party has the right to take possession of the
collateral without a court order, provided this can be effected without a breach of the peace (see as well section 47 (2) (c) of The Security in Movable
Property Act, 2019).
The defendants’ right, title and equity of redemption to and in the mortgaged
property having been foreclosed, it is ordered and adjudged that the defendants
forthwith deliver to the plaintiff or as the plaintiff directs, possession of
the mortgaged property or of such part of it as is in the possession of the
defendants.
As regards those assets already disposed of by the 2nd defendant in
execution of the warrant of distress, the right of the secured creditor to
avoid preferences and fraudulent transfers is fundamental to corporate insolvency policy. Only in corporate insolvency
proceedings are preferences subject to attack; transfers made by an insolvent
debtor with intent to prefer one creditor over another (see Accord Iraqi Min.
of Defence v. Arcepey Shipping Co., S.A. [1980] 1 All E.R. 480 and Polly Peck
Intern., P.l.c. v. Nadir (No. 2) [1992] 4 All E.R. 769).
Of similar importance is the fundamental policy of corporate insolvency to
ensure that similarly situated creditors are given equal treatment. A
preferential transfer focuses on whether a creditor has received a payment that
results in that creditor getting better treatment than other creditors in light
of the insolvency.
I find in this case that not only was the action of the 2nd defendant in
issuing the warrant of distress of 26th May, 2021 after the 1st defendant had
filed for winding up on 21st April, 2021 a contravention of section 97 (1) (c)
of The Insolvency Act, No. 14 of 2011, but also the sale that took place on
20th November, 2021 provided a benefit to the 2nd defendant as creditor, out of
turn and possibly in excess of what the 2nd defendant as creditor would have
received in liquidation if that sale had not been made. From both perspectives,
recovery by the 2nd defendant as an unsecured creditor depletes the insolvent
debtor's estate to the disadvantage of other creditors and the proceeds of that
sale ought to be recovered from the 2nd defendant.
On the other hand, a secured creditor is entitled to receive the value of its
collateral up to theamount of its debt. Thus, payment to a fully secured creditor does not deplete
the insolvent debtor's estate to the disadvantage of other creditors.
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