Creditors not obliged to protect security interest by taking step in foreign insolvency proceedings
25 July 2017
A borrower and a guarantor had no realistic prospect of successfully arguing that their obligations to repay a loan had been discharged due to a secured creditor’s failure to take steps to protect its security interest under the loan. There was no implied duty on the creditor to have filed a claim in foreign insolvency proceedings in order to protect the security it had over assets held by a Czech company. The borrower was therefore still liable to repay the loan, despite the fact that the security for the loan had been distributed in the Czech insolvency rather than preserved for the secured creditor: General Mediterranean Holding SA.SPF (aka General Mediterranean Holding SA) v Qucomhaps Holdings Ltd (and others)  EWHC 1409 (QB).
Benefit of security lost by creditor’s refusal to claim in administration
The claimant creditor had made loans to the borrower to finance the purchase of the assets of a Czech aircraft manufacturing company. Although the original advances were not documented in any binding loan agreement, agreements were later signed under English law to document the loan and provide a guarantee. Security was then provided by a charge over the assets of a new company "Moravan". Moravan subsequently went into administration in the Czech Republic. The creditor declined to file a secured creditor’s claim in the Czech administration and the charged assets were therefore released to other, allegedly fraudulent, purported creditors of Moravan.
When the creditor sought repayment, the borrower and guarantor argued that their obligations had been discharged by the creditor’s refusal to take steps to protect its security in the Czech administration. The security, to which the defendants would otherwise have had recourse, had been lost. In order to rely on the creditor's omission, the question to be asked was whether the creditor was under a duty to take the required steps in the Czech proceedings to preserve its rights in respect of the security?1 No such term was expressed in the loan documentation, so the defendants sought to imply two terms:
- that the creditor should co-operate with the borrower in relation to the performance of the loan agreements and should not do or omit to do anything which would prevent the borrower from fulfilling its obligations under the loan agreements; and
- the creditor would not rely on any event of default or demand repayment of the advances or any sums due under the loan agreements in circumstances where the creditor’s own act or omission had caused the event of default and/or the debtor to be unable to repay the amounts due.
Equity default position – no duty to protect security
The court acknowledged that the default position in equity is that a creditor is not obliged to take any steps to enforce its security unless specified in the loan or guarantee agreement.2 It would therefore normally require clear words in the loan agreement to find otherwise. This case was distinguished from the situation where security is lost or not perfected through the negligent act or omission by a creditor in respect of a duty it owed to the borrower or guarantor, in which case the obligations of a guarantor, who would have had recourse to the security, may be discharged.3
No chance of implying term to protect security
Sir David Eady (sitting as a Judge of the High Court) stated that the court will be reluctant to imply a term into a contract where no duty exists in equity.4 The defendants argued that it was appropriate to imply such a term in this instance as the creditor would have known that the borrower and guarantor could only repay the loan using the secured asset. The court disagreed, as the ability to repay a loan usually depends on a range of factors. In any case it did not necessarily follow that if the creditor had known this it would have given rise to the contended duty.
The court concluded that there was no chance of implying the terms proposed as they were not necessary to give business efficacy and, far from being the “obvious” intention of the parties, the situation was one which almost certainly would not have crossed the parties’ minds. There was no realistic prospect, therefore, that the creditor was under a duty to take a particular step in foreign court proceedings merely because it would or may have preserved the security.
This summary judgment ruling is unsurprising but will provide comfort to creditors that they will not be obliged, without express wording, to take steps to enforce or protect their security. This is consistent with the principle established by the Privy Council in China & South Sea Bank v Tan Soon Gin that a creditor is not obliged to exercise its powers in relation to its security in any particular way. It also echoes a previous decision in Kotonou v National Westminster Bank Plc  EWHC 1659 (Ch) where a creditor was found to owe no duty of care to a borrower to call on a letter of credit securing a loan.
This position is buttressed in market standard documentation, whereby parties typically agree that:
(a) any failure by a creditor to exercise a right or remedy under a loan document does not act as a waiver of that right;
(b) guarantors or providers of third party security explicitly waive any defence arising from the failure of a creditor to perfect or enforce security over any secured assets; and
(c) borrowers waive any right, subject to certain exceptions, that they have to require that the security be enforced in any particular order or manner or at any particular time.
This is a sensible position that leaves it up to the creditor’s commercial judgment as to how to deal with its security. If creditors were obliged to take steps that amounted to enforcing their security this could damage the prospects of a consensual restructuring as creditors may act defensively by enforcing their security immediately.
The case provides an example of the English court taking a robust approach to borrowers or guarantors trying to avoid their obligations to repay a loan.
Whilst this is an unusual situation, it serves to further illustrate the criteria that need to be satisfied to persuade a court to imply a term into an agreement more generally. Implied terms cannot simply be relied on in circumstances where a certain scenario has not been addressed in the documentation, and if it had been, it is not clear exactly how it would have been addressed. In this case, accepted market practice would suggest that if such a situation had been addressed in the loan documentation no such obligations on the creditor would have been included; in fact they are more likely to have been explicitly ruled out. Explicit wording to this effect may well have avoided the need for the litigation.
This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication. For more information please contact Amy Edwards at email@example.com.
1 Following Barclays Mercantile Business Finance Ltd v Marsh  EWCA Civ 948
2 China & South Seas Bank Ltd v Tan  1 AC 536.
3 Wulff v Jay (1872) LR 7 QB 756
4 Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd  UKSC 72