Development property – purchasers' liens trump new creditor interests

Briefing

Sky Building Ltd (the Company) owned a development property (the Property) and granted leases for 145 flats. Leasehold contracts were exchanged in relation to 143 flats, giving rise to purchasers' liens. Some of the purchasers' liens (securing liabilities of approximately £6.5 million) were protected by registration of notices against the title to the Property, conferring a priority interest in the event of a sale of the Property.

By 2018, the Company had encountered serious financial difficulties and refinanced with secured creditors (the Riley Creditors) on terms that included a transfer of the freehold interest in the Property to Sky Apartments (2018) Limited (Sky 2018). Sky 2018 granted a debenture in favour of the Riley Creditors and a charge over the Property. As the Riley Creditors' security was granted after the liens, it ranked behind them in terms of priority.

On 10 November 2020, the Company entered into a contract with Sky 2018 to re-purchase the Property for £2,747,000, subject to the liens. The Company also entered into a back-to-back sale contract with its parent company, Daisy Property Investments Limited (DPIL) to transfer the Property to DPIL for £3,347,000 immediately following its re-purchase from Sky 2018. Completion of the proposed transaction was due to take place shortly thereafter, on 20 November 2020.

Completion of the transaction was conditional upon:

administrators being appointed over the Company
an order being made under Paragraph 71 of Schedule B1 of the Insolvency Act 1986 for the Company's sub-sale of the Property to DPIL to take place without regard to the equitable liens, and
the Company having funds from the onward sale to DPIL to fund the purchase price.

A valuation of the Property was obtained by the Company which produced a market value of £600,000.

Purchasers' liens and court order

Provided that a company is in administration, Paragraph 71 of Schedule B1 of the Insolvency Act 1986 (Paragraph 71) confers a discretionary power on the Court to order a sale of assets as if those assets are not subject to prior security, such as the purchasers' liens. Such an order, however, can only be made where the court thinks that the sale will be likely to promote the purpose of the administration and the court has the right to exercise its discretion.

Paragraph 71(3) provides that any order by the Court is subject to the condition that the net sale proceeds must be applied towards discharging the sums secured, as well as any additional sums required to produce the net amount that the Court determines would be realised on a sale of the asset at market value.

Counsel for the applicants argued that the Court should exercise its discretion and grant an order pursuant to Paragraph 71 on the basis that it was in the creditors' best interests since there was no realistic alternative proposal and the Court should not deprive the lien holders of the certain chance of receiving some form of distribution (10p in the £1).

Judgment

In its judgment, the High Court was clear that it is important to distinguish commercial decisions from legal decisions; the former are questions for the administrators and the court noted that it will not become a commercial decision maker. It is for the Court to apply and decide the legal tests.

In applying the requirements of paragraph 71, the Court was satisfied that the first requirement was met: the disposal of the Property to DPIL would be likely to promote the purpose of the administration as it would result in a distribution to one or more secured creditors.

In relation the second question, whether the requirements of paragraph 71(3)(b) had been met, the Court noted that it required reliable evidence of the market value of the Property to be able to determine whether the net proceeds would provide sufficient compensation for those whose rights were being removed. Considering the adequacy and reliability of the valuation instructed by the Company, the Court had the following reservations:

the valuation had to be conducted within a short timeframe, due to the completion deadlines in the contract that the Company had entered into with DPIL and Sky 2018, meaning that the report was subject to various assumptions and limitations
the valuer had not conducted a site visit
information supplied to the valuer for the purposes of the valuation came from one of the creditors who would benefit from the order being made and there was therefore a conflict of interest
the valuer noted that a "red book" valuation could have been completed within two to three weeks, which would have produced a more reliable market value, and
there was a purchaser, DPIL, willing to pay £3,470,000, considerably more than the valuation of £600,000.

In the light of the valuation's limitations, the Court could not be satisfied of the market value of the Property and therefore could not be satisfied that the conditions of Paragraph 71(3)(b) had been met. The absence of a realistic alternative proposal did not justify the exercise of the Court's discretion as this would stray into the territory of commercial decision-making.

The Court also noted that the transactions proposed between the Company, Sky 2018 and DPIL, were designed to bring those with notices registered against the title of the Property into the administration, but for those transactions, there would be no power to require them to accede to the sale.

Instead, they would remain with their leverage of being the only parties who would benefit from a sale, as the highest-ranking charge-holders and with the option of realising a return in excess of that which the transaction in question produced.

An order pursuant to paragraph 71 would "white-wash" over the fact that the Riley Creditors were to be paid £2,747,000 despite having security which should have been worthless given that it ranked behind that of the noticeholders.

The Court therefore declined to exercise its discretion to make an order under paragraph 71 to allow the sale of the Property as if the purchasers' liens were not in existence.

Comment

Securityholders may take some comfort from the caution that the Court displayed in determining whether to exercise its discretion under Paragraph 71. Robust evidence of the market value of the property in question was required.

Furthermore, the Court had regard to the reality of the transaction. This may provide reassurance that the Court is reluctant to exercise its discretion where to do so would undermine the priority of security interests unless it is satisfied that the priority security holders will be adequately repaid.