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When Does a Creditor Get Paid First? Priority of Security Over Company Assets
Corporate & Commercial Law
When Does a Creditor Get Paid First? Priority of Security Over Company Assets
Understanding creditor priority, secured lending, floating charges, crystallization and the enforcement of judgments against company assets.
01 Introduction
When a company is unable to pay all its creditors, an important question arises on who gets paid first. The answer may depend not only on the amount owed or whether a creditor has obtained a court judgment, but also on the nature and timing of the creditor’s security over the company’s assets.
A recent High Court decision involving Kenya Commercial Bank (KCB), Proctor & Allan (EA) Limited and EPCO Builders illustrates the importance of creditor priority, particularly where a secured lender’s floating charge competes with another creditor seeking to enforce a judgment against the same company assets.
02 Who Is a Secured Creditor?
A secured creditor is a creditor whose debt is backed by security over particular assets of the debtor. If the debtor defaults, the secured creditor may have priority rights to enforce its security over unsecured creditors and recover the debt from the secured assets on a priority basis, subject to the applicable law and the terms of the security.
Fixed Charge
A security interest attached to identified assets, restricting the company’s ability to deal with those assets without complying with the terms of the security.
Floating Charge
A security interest that may cover a changing pool of company assets, particularly circulating assets such as stock and receivables.
Key Legal Point
A debenture may contain both fixed and floating security interests over different categories of company assets.
03 What Is a Floating Charge?
A floating charge is a form of security that may cover a changing pool of company assets, such as stock, receivables and other circulating assets.
Unlike a fixed charge, the company may ordinarily continue dealing with assets subject to a floating charge in the ordinary course of business until the charge crystallizes.
What Is Crystallization?
Crystallization occurs when the floating security becomes fixed over the relevant assets following circumstances specified in the security document or recognized by law, commonly including events of default or steps taken by the secured creditor to enforce its security.
Once crystallized, the secured creditor’s interest may significantly affect the ability of other creditors to attach or sell the same assets.
04 Does a Court Judgment Give a Creditor Priority?
A creditor may obtain a judgment against a company and commence execution proceedings, but that does not automatically mean that the creditor ranks ahead of a secured creditor whose security already attaches to the relevant assets.
The existence of a judgment establishes the creditor’s right to enforce the judgment. However, the manner in which enforcement interacts with existing security interests may determine whether the creditor can ultimately realize the particular assets.
Judgment ≠ Automatic Priority
Obtaining a court judgment does not, by itself, necessarily place a creditor ahead of an existing secured creditor in respect of the same company assets.
This distinction is particularly important where a company has borrowed money against its assets while also owing money to suppliers, contractors or other unsecured creditors.
05 What Is the Significance of Proclamation?
Proclamation in execution proceedings is a formal notice issued by a court bailiff or auctioneer identifying and notifying the judgment debtor that specified property has been attached for purposes of satisfying a court decree, and warning that the property may subsequently be sold if the decretal amount is not paid.
Execution Proceedings
Proclamation is an important step in the execution process, but it does not necessarily mean that the decree-holder has acquired ownership of the proclaimed property.
In the KCB and EPCO dispute, the High Court found that EPCO’s execution had not been completed merely because an auctioneer had proclaimed the assets. The court considered that the proclamation preserved the property pending realization through sale and did not itself transfer ownership to EPCO.
The timing of the crystallization of KCB’s floating charge was therefore significant. The court found that the charge had crystallized before EPCO’s execution had progressed beyond proclamation, giving KCB’s security priority over EPCO’s attempt to sell the assets.
06 Why Timing Matters
The case demonstrates why creditors should establish the position of existing security interests before attempting to realize a company’s assets.
For a creditor seeking payment, it may not be enough to establish that money is owed. The creditor may also need to consider:
- Whether the company’s assets are already subject to security.
- Whether the security has been registered.
- Whether a floating charge has crystallized.
- The date on which the relevant security became enforceable.
- The stage reached in any execution proceedings.
- Whether another creditor has a superior proprietary or security interest.
What Businesses and Creditors Should Know
Companies should understand the extent of security granted over their assets before obtaining additional financing or entering into significant credit arrangements.
Creditors, on the other hand, should conduct appropriate due diligence before extending credit, particularly where repayment is dependent on the company’s assets.
A creditor who intends to enforce a judgment should also establish whether other creditors hold security over the assets targeted for execution. This can help avoid investing time and resources in enforcement that may ultimately be affected by a prior security interest.
- Review existing security interests before extending significant credit.
- Establish whether company assets are subject to fixed or floating charges.
- Check the relevant registration and security documentation.
- Consider the position of secured creditors before commencing execution.
- Obtain legal advice where competing creditor claims arise.
07 Role of Legal Practitioners
Legal practitioners can assist companies and creditors by providing advice on security, priority and enforcement risks before disputes escalate.
Advising on the creation and enforcement of security interests.
Reviewing debentures, charges and other financing documents.
Conducting appropriate searches and due diligence on company assets.
Advising creditors on priority and enforcement risks.
Advising judgment creditors before commencing execution proceedings.
Assisting with negotiations between secured and unsecured creditors.
Representing creditors and companies in disputes concerning competing claims over assets.
Advising companies on restructuring and insolvency options where multiple creditor claims arise.
Conclusion
Creditor priority is not determined simply by who is owed the most or who obtains a judgment first.
Where competing claims arise over the same company assets, the nature, validity and timing of the respective interests may determine who has priority.
It is important for creditors to undertake proper due diligence and understand existing security interests before pursuing enforcement. Obtaining appropriate legal advice at an early stage can help creditors understand their position and avoid enforcement strategies that may ultimately be affected by competing security interests.
Need Advice on Creditor Priority or Security?
Whether you are a company, secured lender, judgment creditor or business seeking financing, professional legal advice can help you understand security interests, priority and enforcement risks.
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