Editor’s Note:  Our good London colleague Ed Marlow recently published this as a Bryan Cave client advisory.  When we Yanks saw it, we found it fascinating, not only based on the arcane facts, but also to realize that British tribunals struggle with the same things we do here in the States – whether (or how) to protect junior creditors which allege that a secured creditor did not maximize value in disposing of the collateral.  Different countries, same insolvency challenges!  Our sincere thanks to Ed for this analysis; for a introduction to how Bryan Cave can assist with your corporate trust matters in England, France, Germany, or other EU countries, please click here.

Summary and Holding:

Including an unsecured creditor in an agreed payments waterfall does not by itself confer on that unsecured creditor the benefit of a mortgagee’s usual duties on enforcement of security, or a direct claim against the sale proceeds.

Background, Facts, and Reasoning:

The English Court of Appeal in PK Airfinance v Alpstream had to address a mortgagee’s duties on the enforcement of security (in this case over a number of aircraft).  In a reassuring case for secured lenders, the Court’s judgment confirms existing English law both as to the time and manner of realisation of the secured assets and when a mortgagee might buy the secured assets. Interestingly, the Court also had to consider whether the position of an unsecured creditor as a party in the agreed payments waterfall (of the realisation proceeds of the security), resulted in an exception to the principle that a mortgagee’s duties on enforcement do not extend to unsecured creditors.

Overturning the judge at first instance, the Court held that a mortgagee only owes its duties on enforcement, such as the duty to take reasonable care to obtain a proper price, to persons with an interest in the value of the equity of redemption in the secured assets. Those persons are the mortgagor, a subsequent mortgagee and (because of a guarantor’s subrogation rights) any guarantor of the mortgage debt. This was so even though in this case the relevant unsecured creditor, Alpstream, appeared in the agreed payments waterfall (albeit at the bottom) and so had a contractual right to repayment out of the balance of the sale proceeds after the secured creditors had been repaid in full. Holding otherwise would involve a departure from established authority, which the Court did not believe to be justified. Alpstream had expressly agreed in the intercreditor arrangements that its debt would be subordinated to the mortgagee and that it would not take any security in respect of its debt.

Therefore unsecured creditors are not owed the mortgagee’s usual duties when the mortgagee realises the secured assets, even though it may be foreseeable that the unsecured creditors might be adversely affected by the outcome of the sale. Nor will an unsecured party’s contractual right to receive payment out of the balance at the end of the payments waterfall confer a direct claim against the secured assets or their proceeds.

The Court was also concerned to give effect to the transaction documents to which the parties had agreed. Equitable duties (a mortgagee’s duties arise in equity) can be amended by agreement. The Court’s decision was consistent with the transaction documents.

There is an increasing trend in Europe for secured financings to permit unsubordinated unsecured debt. This case is perhaps a timely reminder of exactly where unsecured creditors stand.

A final observation: the Court was satisfied that the proceeds in this case from the sale to the mortgagee were higher than anyone else would have been willing to pay in the circumstances. The mortgagor had therefore benefited (and potentially Alpstream as unsecured creditor). Would the court have taken a different view on any of the issues if this had not been the case?