3 April, 2019
The Singapore High Court (“Court”) recently ruled against a bank seeking to enforce its security over assets charged by way of a fixed and floating charge against a third party purchaser. The Court considered the various conflicting and competing interests between a secured creditor under a debenture and the rights of a third party purchaser.
Facts
Malayan Banking Bhd (“Bank”) extended credit facilities to a shipbuilder – NGV Tech Sdn Bhd (“NGV”), secured by a series of six debentures (“Debentures”) executed by NGV in favour of the Bank. The Debentures created fixed and floating charges as well as negative pledges in favour of the Bank. NGV also assigned the proceeds of the contract by way of security to the Bank (“Assignment”).
NGV subsequently entered into a shipbuilding contract (“Contract”) with Bakri Navigation Company Ltd (“Bakri”) for, amongst others, Hull No. 1118 (“Ship”). Bakri and NGV later novated the benefit of the Contract to Red Sea Marine Services Ltd (“Red Sea”) (Bakri and Rea Sea together, the “Purchasers”). The Bank sought to enforce its rights over the Ship pursuant to the Debentures and the Assignments against the interest of the Purchasers.
Issues
The Court had to decide on the following issues:
(a) does the right of the Bank over the Ship pursuant to the Debentures and the Assignments prevail over the interest of a third party purchaser without notice?;
(b) is a fixed or floating charge created over the Ship?;
(c) did the floating charge automatically crystallise into a fixed charge?;
(d) do the Purchasers have knowledge of, and hence bound by, the restrictions under the Debentures and Assignment?;
(e) can the Purchasers exercise their right of set-off against the Bank?; and
(f) was there conspiracy to cause loss to the Bank?
Decision
Does the right of the Bank over the Ship pursuant to the Debentures and the Assignments prevail over the interest of a third party purchaser without notice?
A chargor cannot freely deal with its assets that are subject to a fixed charge without the consent of the chargee. On the other hand, a chargor has implied authority and can freely deal with its assets that are subject to a floating charge in its ordinary course of business. As such, a third party who obtains an asset that is subject to a floating charge in the ordinary course of the chargor’s business will have priority over the chargee when the charge crystallises. That is so even if the third party had knowledge of the existence of the floating charge. However, if a debenture contained restrictions on dealing and the third party obtained such assets with knowledge of such restrictions, the chargee would have priority over the third party.
Conversely, a third party who obtains such assets outside the ordinary course of the chargor’s business would only take the assets free of the chargee’s interest if the third party was equity’s darling (ie a bona fide purchaser of legal title for value without notice).
Is a fixed or floating charge created over the Ship?
The Court held that the Debentures did not create a fixed charge over vessels under construction at NGV’s shipyard, and in particular over the Ship. The assets that were expressly provided to be subject to the fixed charge did not expressly include, nor could it be interpreted to include, the vessels under construction and the Ship.
Further, the Court held that it was not the commercial intent of the Bank and NGV for a fixed charge to be created over the vessels under construction at NGV’s shipyard. These vessels were NGV’s “stock in trade”, and a fixed charge would have rendered NGV being unable to deal with vessels in its ordinary course of business without the Bank’s concurrence.
Did the floating charge automatically crystallise into a fixed charge?
The Court had to consider if the floating charge was automatically crystallised to a fixed charge by the sale of the Ship to the Purchasers. Under the Debentures, the floating charge over the assets automatically crystallises if:
(a) NGV pledges or otherwise encumbers in favour of a third party such assets; or
(b) any person attempts to levy any distress execution, sequestration or other processes against such assets.
The Court cautioned against a lavish interpretation of automatic crystallisation clauses. The sale (and transactions related to the sale) by NGV to the Purchasers, was not an “encumbrance” or “other processes” under the aforesaid automatic crystallisation provisions of the Debentures. An “encumbrance” is a right created over the debtor’s property in favour of a creditor to facilitate the satisfaction of some other rights vested in the creditor (this is commonly a security interest). Likewise, the term “other processes” must be read ejusdem generis (the general term follows particular things of the same kind) with the whole phrase, such processes are thus processes that are put in place through the coercive power of the courts.
In addition, the Court also held that merely dealing with an asset which was subject to a floating charge outside the ordinary course of a chargor’s business did not crystallise a floating charge. Only if the dealing was otherwise than with a view to continuing to carry on the chargor’s business, would the floating charge be crystallised.
Do the Purchasers have knowledge of, and hence bound by, the restrictions under the Debentures and the Assignment?
The Court held that the Purchaser had no knowledge of the restrictions (including restrictions on dealings and price adjustments) and negative pledge in the Debentures and the Assignment. Although the Debentures and the Assignments were registered in accordance with the laws of Malaysia, it was still not sufficient to fix the Purchasers with constructive notice of the terms of the Debentures and Assignments. The particulars of the Debentures and the Assignments lodged with the Registrar of Companies in Malaysia also did not make any mention of such restrictions on the secured assets.
Can the Purchasers exercise their right of set-off against the Bank?
In the event that the Bank succeeded in its claim as chargee, the Court also commented on whether Red Sea could set-off its expenses on the Ship against the Bank’s claim on the same. Given the absence of a contract providing for a right of set-off between Red Sea and the Bank, only an equitable right of set-off was available to Red Sea against the Bank. This equitable right however, was premised on mutuality – that the debts be due between the same parties, in the same right. Prior to the crystallisation of the floating charge, the Bank had no interest in the Ship and Red Sea would only be able to claim against NGV for the expenses. On the other hand, once the floating charge was crystallised, the Bank would have a proprietary interest in the ship and Red Sea might then be able to claim against the Bank for the expenses.
Whether there was conspiracy to cause loss to the Bank?
The Court held that the high threshold required for conspiracy, whether unlawful means or lawful means conspiracy, was not met in the case. While there were evidential inconsistencies in how the certain contracts related to the sale were arrived at, these in itself were insufficient to show that the Purchasers (amongst others) intended to conspire and injure the Bank.
Conclusion
This case illustrates the complexities involving a third party purchaser without the notice of a bank’s security interest as well as certain inherent limitations of a fixed and floating charge. Banks need to be fully aware of such complexities and limitations, and also take steps to mitigate such risks. These steps include:
(a) the proper categorisation of the different types of assets that are, or can be, subject to a fixed or floating charge;
(b) the comprehensive review of the coverage, practicality and effectiveness of the automatic crystallisation events and restrictions on dealing with secured assets;
(c) the binding of third party purchasers to the restrictions in the security documents on dealing with secured assets whether by way of imputation of knowledge or otherwise;
(d) understanding the chargor’s business and modus operandi (method of doing business); and
(e) other legal and practical safeguards to complement the security structure which will depend on the facts of each case.
