GMH provided loans to Qucomhaps of around $4,000,000 to assist it in purchasing the business of the aircraft manufacturer, Moravan. Repayment was secured by a personal guarantee from Mr Harkin, Qucomhaps’ managing director. Further GMH was granted fixed and floating charges over the assets of Moravan Aviation, a wholly owned subsidiary of Qucomhap which had acquired the assets of Moravan.
The present dispute arises out of an alleged tunnelling fraud that Moravan Aviation fell victim to. The fraudsters had presented themselves as creditors of Moravan Aviation, and the company went into administration in accordance with Czech law. However, GMH, as the holder of the charges, did not file a claim as a secured creditor in the administration despite being advised to do so.
The defendants’ argument was that GMH owed them an equitable duty to take reasonable steps to protect its security over Moravan Aviation’s assets, and that by failing to file a claim as secured creditor, that duty had been breached. The effect of that breach was to discharge the repayment obligations of Qucomhaps and Mr Harkin.
Sir David Eady, sitting as High Court Judge, held that there was no such positive duty incumbent on GMH as creditor to file a claim in the Czech administration procedure. The defendants appealed.
Newey LJ, giving the judgment of the Court of Appeal, dismissed the appeal. In doing so, he held that the duty of the creditor extended beyond merely taking reasonable steps to perfect the security, but also included maintaining the security.
In Wulff v Jay (1872) LR QB 756, the creditor failed to perfect a bill of sale by failing to register it and did not take possession of the assigned assets. As a result the guarantee was partially discharged. That case was referred to by GMH to show that the duty of the creditor went no further than perfecting the security.
Newey LJ disagreed. Giving the example of a hypothetical security that required both registration and annual fee, he stated that it was unlikely that a creditor’s obligations would be wholly satisfied by the act of registration. A case could surely be made that the creditor was also obliged to pay the annual fee.
On the facts of the present case, however, there was no positive duty on the creditor to file a secured claim despite the fact that would maintain the security. This was for three reasons.
First, the Defence provided insufficient details as to what steps the creditor was meant to take and why failure to do so resulted in the negation of the assets.
Second, the duty to maintain the security was not absolute and it could not be too onerous. It was relevant in this case that evidence suggested that GMH would have to pay compensation equal to the amount of the claim in the event that its claim failed. GMH could not have been obliged to undergo such an onerous risk to maintain its security.
Third, whilst it was possible for a creditor to owe obligations to a guarantor to maintain the security, it was not plausible that the same obligation would be owed to the principal debtor in respect of security granted by a third party. On the contrary, the principal debtor, Qucomhaps, would have owed an indemnity to Moravan Aviation if the secured assets had been used to pay off the debt it owed to GMH.
This case highlights, the often-forgotten fact, that there are duties incumbent on a creditor who is provided security. Moreover, the scope of a creditor’s duty goes beyond perfecting security. It is likely to require maintaining security too, provided the obligation is reasonable and not onerous. The practical effect of this is that there is a risk that a guarantee or other security is discharged if the creditor does not ensure he is taking reasonable steps to maintain his security.
That risk is best managed by ensuring that the terms of any security or guarantee stipulate that the obligations of the guarantor or security giver are not reduced or discharged by the failure of the creditor to maintain its other security.
Hardwicke has extensive experience of dealing with insolvency issues in relation to construction projects. If you would like more details about this or would like to attend our Construction Insolvency Forum on 7th February 2019, please contact firstname.lastname@example.org.