Property Law UK

Introduction

Marshalling is an equitable remedy. It applies where the owner of two properties, X and Y, mortgages them both to lender A, and then mortgages one, say Y, to lender B. When A seeks to recover its debt, B can require that it does so first out of X. B is in effect (although not at law) subrogated to A’s rights under its security to the extent of the debtors secured liabilities to B.
It was explained by Patten LJ in Serious Organized Crime Agency v Szepietwoski (see below) at paras 1 and 2:

In re Bank of Credit and Commerce International S.A. (No. 8)

Common debtor rule

Exception

Highbury Pension Fund Management v Zirfin Investments
[2013] EWHC 238 (Ch)

Summary

As an exception to the “common debtor rule”, the equitable doctrine of marshalling can be invoked to require a creditor to discharge its debt out of security belonging to other debtors.

Facts

A bank lent money to company 1, secured by way of first charge on property 1. The bank subsequently lent money to four affiliated companies, secured on other properties. As additional security for these loans, company 1 gave the bank a guarantee that was also secured on property 1. Company 1 subsequently borrowed two further sums from two different lenders, secured by second and third charges on property 1.

Company 1 and the affiliated companies all defaulted. The bank made formal demand, appointed receivers and sold property 1. The net proceeds were sufficient to discharge company 1’s borrowings from the bank, but left a shortfall due under company 1’s guarantee liability. There was nothing left over for the other lenders.

Had the bank not discharged the guarantee liability out of property 1, but out of the other properties, there would have been sufficient to discharge the loans made by the other lenders.

Issue

The issue was whether, in these circumstances, the other lenders could invoke the equitable doctrine of marshalling. The doctrine and its ramifications was explained in Szepietowski v SOCA [2011] EWCA Civ 856 by Patten LJ as follows:

“So in a case where two or more creditors are owed money by the same debtor but only one of them has a charge over more than one of his properties equity empowers the court to marshal the securities so that the creditor with a choice of security satisfies his claims so far as possible out of the proceeds of the security over which the other creditors have no claim. This equitable principle does not extend to compelling a first mortgagee to realise any particular security in preference to another. He is entitled to realise them in whatever order he chooses. What amounts to a principle of maximum distribution therefore takes effect by permitting a second chargee of property which is realised and utilised by the first chargee to rely on the benefit of the surplus (and possibly unrealised) security of the first chargee over other property of the debtor in satisfaction of his own claim. He is in effect (but not as a matter of law) subrogated to the first chargee's rights under that security to the extent of the debtor's secured liabilities to him…".Two of the necessary conditions are:

Two or more creditors being owed money by the same debtor, and
Only one of those creditors having a charge over more than one of the debtor’s properties
(So, the two funds must be funds of the same debtor – the “common debtor rule”).

Decision

Here, the bank was doubly secured in respect of company 1’s guarantee liability – it had one charge over property 1 belonging to company 1 and other charges over other properties belonging to the affiliated companies. Can marshalling work in these circumstances?

After a review of the authorities, Norris J held that it could. The doctrine should be applied in an equitable manner. Accordingly the two further lenders were entitled to participate in the security of the charges provided by the affiliated companies to enable them to recover from those properties the amount it otherwise would have obtained from the surplus proceeds of sale of property 1.

Comment

The equitable doctrine of marshalling means that where A’s debt to lender 1 is secured on two properties X and Y, but A’s debt to lender 2 is only secured on one of them, say X, lender 2 can require lender 1 to discharge its debt out of property Y first.

This case extends the principle to where A’s debt to lender 1 is doubly secured on property belonging to A and property belonging to others. Lender 1 should discharge its debt out of the other properties first so as not to prejudice lender 2.

Proceeds of Crime Act 2002

Deed of settlement did not preclude marshalling

Serious Organized Crime Agency v Szepietwoski
[2011] EWCA Civ 856

Summary

Marshalling is an equitable remedy which was not precluded by the particular terms of a deed of settlement entered into between the owner of property and a secured creditor.

Facts

Mrs S was the registered proprietor of two properties – Ashford House, the matrimonial home, which was subject to a second charge to RBS ("the Bank"), and a group of investment properties, which was subject to a first charge to the Bank. The charges were in "all-monies" form.

The assets of Mrs S and her husband were frozen by interim receiving orders under the Proceeds of Crime Act 2002. Subsequent proceedings were compromised by a consent order and deed of settlement, whereby the investment properties were transferred to the Trustee for Civil Recovery. It was anticipated at the time that the net value of the additional properties, after deducting the sums due to the Bank would be sufficient to settle the sums due to SOCA (£5.375M) but it was agreed that if there was a shortfall, Mrs S would grant the Trustee a charge for the amounts paid over to the Bank.

The investment properties were subsequently sold at a sum sufficient to discharge the sums due to the Bank but leaving only £1,324.16 in satisfaction of the sums due to SOCA. SOCA sought to invoke the principle of marshalling on the basis that there was (a) a single debtor (Mrs S); (b) who owed debts to two creditors (the Bank and SOCA); (c) the Bank was able to enforce its claim against two securities (Ashford House and the investment properties); (d) whereas SOCA was confined to its security over the investment properties. In those circumstances it was argued that SOCA had an equity to require the Bank to be treated as having satisfied itself so far as possible out of Ashford House, and by a process akin to subrogation, SOCA should be entitled to enforce the Bank’s second charge against Ashford House to the extent of its shortfall.

The court had to deal with a preliminary issue of whether the compromise agreement implicitly excluded Ashford House from bearing any part of Mrs S’s liability to the Bank and if so whether it precluded the operation of marshalling

The judge at first instance held that SOCA was entitled to be subrogated to the Bank’s charge over Ashford House.

Mrs S appealed.

Issues

There were two issues (1) whether as a matter of construction the deed of settlement precluded SOCA from seeking to rely on the principle of marshalling; and (2) (assuming SOCA was not so precluded) whether the judge properly exercised his discretion to order marshalling.

Held

The Appeal was dismissed.

(1) As a matter of construction, the deed of settlement did not exclude the operation of marshalling. The deed did not limit SOCA to the proceeds of sale of the additional properties, and the value of the charge to be granted and did not address the issue of marshalling. The deed of settlement did not amount to an unconditional release of all possible claims by SOCA against Ashford House. The fact that there had been a significant downturn in property prices meant that the risk lay where it fell, and SOCA was entitled to exercise whatever rights as a secured creditor the law gives it unrestricted by the terms of the deed of settlement.

(2) Where a creditor in the position of a bank has realised a security which places the other creditor at a disadvantage, an equity arises to correct the imbalance so far as there is other available security to permit that. The fact that the parties negotiated terms of settlement on an assumption about values which turned out to be incorrect did not make it inequitable to grant the relief sought.

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