Rights of a subrogated creditor

22nd October 2014

Background
In Day v Tiuta International Ltd [1], the claimant had borrowed funds from a lender, S, to refinance a property. That lending was secured by a charge in S’s favour. He then entered a facility agreement with the defendant to refinance his existing borrowings and to redevelop the property. This lending was supported by a charge in the defendant’s favour. He used the first tranche of funds from the defendant to repay the loan to S. The defendant was then placed in administration, leaving the claimant without access to the funds necessary to complete the development.

The claimant failed to repay the loan to the defendant who appointed receivers. A number of issues arose at the summary judgment hearing. One concerned the doctrine of subrogation.

Subrogation is a remedy allowing a party to step into the shoes of another party assuming the benefit of any rights that second party may have in relation to a liability. Two scenarios in which it is commonly encountered are:

• a person discharges the debt of another person may be subrogated to any security on which the original debt was held
• a lender who expected to receive security may be subrogated to another secured lender’s security if it does not get the security it expected.

In this case, there was an allegation that the defendant’s charge could be rescinded for fraud (i.e. its security was “voidable”). The defendant argued that, even if this were the case, it would be subrogated to the S charge as it had paid funds in discharge of S’s loan and security.

Issues
The High Court having given summary judgment for the defendant, the Court of Appeal was asked to determine the following issues:

• If a lender is claiming subrogation on the basis that it did not get the security it expected, must the security actually be void before the lender can claim it did not get the security it expected or is it sufficient that the security is voidable, as was the case here?
• If a lender has already appointed receivers under its defective security, can it continue to rely on that defective security or must it re-appoint the receivers, relying on the subrogated charge?

Judgment
The Court dismissed the appeal. It held:

• a security interest that is voidable is ineffective as a security interest. A secured creditor who has a voidable security interest and has not obtained all that it bargained for can claim subrogation
• there is no need to re-appoint the receivers as the right to subrogation existed at the time the receivers were appointed.

All that was needed in this case for the defendant to be able to rely on the doctrine of subrogation was for it to show that, pursuant to the terms of its contractual arrangements with the claimant, it had either demanded payment of its indebtedness or there had been a breach by the claimant of any of its contractual obligations to it, or there had been an event of default as defined in its contractual arrangements. That the defendant had not relied on S’s charge when appointing the receivers was immaterial.

Points to consider
By refusing to narrow the scope of the doctrine of subrogation, the Court of Appeal has ensured that its potential as a remedy for lenders remains considerable. The decision is a commercially sensible one as requiring the defendant lender to reappoint the receivers would not have served any useful purpose.

[1] [2014] EWCA Civ 1246