Marshalling Between Mortgagees – A forgotten power
4th February 2016
You may be forgiven for thinking that court marshalling is something that happens in the military rather than the financial world. You would, however, be mistaken, and not only in light of the appallingly poor syntax involved in that opener.
In fact, the equitable doctrine of marshalling, which seeks to regulate creditors’ interests in a debtor’s assets as between themselves, can be a valuable weapon in a creditor’s security-enforcement arsenal. However, the remedy is all too often overlooked in favour of better-known methods of enforcement or when writing debts off. This article seeks to explain the doctrine of marshalling, and why you should know about it.
The doctrine of marshalling is predicated on the principle of law that a creditor who has security over several properties (“the doubly-secured” creditor) and thus a choice of which fund to resort to, should not when realising that security disappoint a creditor who has security over only one of these properties (“the singly-secured creditor”).
By way of an example, imagine ABC property developer owns a portfolio of properties, two of which are subject to a mortgage in favour of XYZ Bank. Later on, 123 Building Society registers a second legal mortgage over property two. 123 Building Society is able to require the securities vested in both properties to be marshalled, with the result that all of XYZ Bank’s security is paid out of property one, leaving property two free for 123 Building Society to realise its interest without being subject to any prior claim on the proceeds from the first charge holder, XYZ Bank. This potential to marshall remains subject to the value of the security and the amount of the primary lender’s debt.
In this way, the doctrine seeks to achieve fairness between creditors, without allowing the debtor to avoid liability for a debt by allowing the first creditor to swallow up all of the liquidity in the secured asset before the second creditor can get its hands on it. So far, so sensible.
But what if (using the above example) property two turns out to be a better prospect for the Bank because it is located in a nicer area and will sell more quickly – does the doctrine of marshalling mean that XYZ Bank will be restricted in which of its securities it is able to realise? The answer is no. The primary creditor remains free to realise its security in any way it chooses. In the above example, XYZ Bank is thus entitled to look to property two for the repayment of its debt, in spite of the fact that it may leave 123 Building Society with a worthless charge against that title. However, if XYZ chooses to do this, a remedy is nonetheless available to 123 Building Society under the doctrine of marshalling as in these circumstances it is able to step into the Bank’s shoes in respect of property one, and enforce that security to the value of its own secured sum despite not being the owner of the charge over property one. This is known as being “subrogated” to the Bank’s rights.
Nevertheless, the doctrine is not so wide as to enable a second creditor to prejudice the rights of a third creditor. So, to take the above example one step further, say property one was also the subject of a second charge in favour of another creditor, 666 Finance LLP. If XYZ Bank was forced to take all its security from property one so that 123 Building Society could take its security unencumbered from property two, 666 Finance LLP would be prejudiced (assuming there was not sufficient equity in property one). A similar prejudice would arise if 123 Building Society were able to step into XYZ Bank’s charge over property one to take its debt from that security in priority to 666 Finance LLP. The court will not permit this to happen. In this way, marshalling is an equitable remedy potentially available to a creditor, but marshalling will not be ordered if the order would be made at the expense of another secured creditor.
That said, if marshalling is available to a creditor the remedy has wide scope. For example, it is not just the mortgagor who is bound by the doctrine; the ability to marshall securities also applies against the mortgagor’s trustee in bankruptcy, his personal representatives and even against the mortgagor’s own simple contract creditors. It can also arise against the wife of the mortgagor if she has charged her own property to her spouse’s debt. However, save for that exception the doctrine only operates in relation to securities given by the debtor and not against collateral security given by, for example, a company.
A further caveat is that the common property must secure a debt due to the singly-secured creditor, and not merely stand as security to, for example, a deed of settlement. Care should therefore be taken when settling disputes to ensure that the ability to marshall is preserved when property is offered as security for the settlement.
It will be seen from the above that the right to marshall securities is potentially a very valuable one from a second (and subsequent) mortgagee’s point of view, and those advising mortgagees and mortgagors alike should be aware of its implications. This is so, not least because the court can order securities to be marshalled even if this remedy has not been claimed in court proceedings. Indeed, if the court notices in proceedings that a creditor will be deprived of its security because of claims by another creditor, it should make an order directing the assets to be marshalled without being called upon to do so. Those advising creditors and debtors should be aware of the potential for such an order being made of the court’s own motion.
On a practical level, the doctrine will often mean that creditors have to work closely together if their securities are being marshalled. This is especially so where creditor Y is being subrogated to the rights of creditor X – creditor X will have already realised its security but it cannot walk away because creditor Y will be enforcing under creditor X’s registered charge. In order for creditor Y to do this, creditor X will need to disclose the particulars of its charge to creditor Y.
It will be seen from the above that marshalling is an important tool which seeks to achieve a level of fairness between creditors. Given its wide scope, it is perhaps surprising that it is not amongst better-known methods of enforcing security.