Personal Insolvency Update Spring 2020

Personal Insolvency Law Update: The Debt For Equity Experiment Falls At First Hurdle

A recent decision of the High Court in Re: Lowe and the Personal Insolvency Acts, has dealt a fatal blow at efforts to force creditors into so called debt for equity swaps against their will, writes Andrew Croughan.

In this case the Debtor owed €358,000 to her home lender. The agreed valuation of the property was €300,000. The PIP proposed servicing a debt of just €170,000 and giving the Bank €130,000 “equity” in the property or what the PIP set out as a 43.3% equity in the secured property. If the Debtor was able, in the lifetime of the mortgage, it was open to her to buy back her equity at a “par value” at any time during the lifetime of mortgage term.

The Court stated that a key provision in the protection of secured creditor’s rights in personal insolvency is section 103 of the Act. Section 103 (2) is the crucial subsection which states “A Personal Insolvency Arrangement which includes terms providing for—(a) retention by a secured creditor of the security held by that secured creditor, and (b) a reduction of the principal sum due in respect of the secured debt due to that secured creditor to a specified amount, shall not, unless the relevant secured creditor agrees otherwise, specify the amount of the reduced principal sum referred to in paragraph (b) at an amount less than the value of the security determined in accordance with section 105.” (emphasis added). In other words, secured creditors cannot be crammed down below the value of their security. 

Some consideration was given by the Court, as to the meaning to be given to the word “shall” in the related subsection 1 , as to whether the Court should treat it as mandatory (creating an obligatory requirement) or directory (merely a direction which is not the substance of the aim and scheme of the statute). The Court after careful consideration of section 103 determined that the requirement was an obligation of the Act and not simply directory when it stated “In my view, the protection available under s. 103(1) would be illusory if practitioners, in formulating arrangements, were free to depart from the requirements set out in the subsection.  That would make a nonsense of the subsection.  Accordingly, I cannot see any basis on which s. 103(1) could be construed as merely directory rather than obligatory” The Court made a similar finding in terms of section 103(2) which covers an Arrangement where the security is retained.

It was the fixed position of the PIP that in the Debtor’s proposed arrangement, that the debt for equity swap to be implemented was not a write down of the secured debt to below the market value of the secured property, and therefore not an infringement of section 103(2). The Bank’s position was steadfastly, that it was a significant infringement.  In this crucial aspect of the case,  the Court agreed with the Bank, and stated “I do not believe that one can plausibly treat the amount of principal due under the arrangement proposed here as being €300,000 rather than €170,000.  This is for the simple reason that, while the element represented by the “equity” to be given to the bank under the arrangement may have had a value of €130,000 at a particular point in time, that value will fluctuate with the highs and lows of the property market. This makes it impossible to say, at any given moment, what is the principal sum specified for the purposes of the arrangement… it seems to me to follow that one could not properly conclude for the purposes of s. 103 (2) that the reduction in value of the principal debt here was specified at €300,000.  The reality is that the principal sum has been reduced to €170,000.  That is the sum which, under the terms of the proposed arrangement, Ms. Lowe will be required to repay by instalments over the remaining term of the mortgage.  The fact that the arrangement provides some other form of value to the bank does not, in my view, alter the fact that the principal sum has been reduced to €170,000.”

Therefore, the debt for equity swap proposed by the PIP, fundamentally contravened the main protective provision in the legislation for secured creditors. The PIP had tried to avail of  section 102(6)  of the Act which sets out a number of possible debt treatment options which are permissible  under the Acts. This non exhaustive list included debt for equity swaps. However as the Court observed section 102(6) is subject to sections 103 to 105 and stated “any reduction in the principal sum due in respect of secured debt (on the basis that the relevant secured creditor will be granted a share in the debtor’s equity in the secured property) cannot be set at a figure less than the market value of the secured property without the consent of the relevant secured creditor”. (emphasis added)  The protections afforded to creditors under section 103 (2) of the Act cannot be overridden by section 102(6) of the Act. 

As the proposal regarding the treatment of secured debt is a gateway provision under section 115A of the Act, the Court held that it was enjoined (prohibited) from considering the application any further.  Thus the Debt for equity experiment has failed, at the gateway stage, for the very reason many creditors  had objected to it from the very outset, that it breached the protections afforded to creditors under section 103 of the Act, particularly section 103(2). It does remain to be seen whether a PIP may try to get a debt for equity case through, where there is positive equity in the property. However, for the time being, debt for equity is off the table.

For further information on these judgments or any aspect of personal insolvency, contact Andrew Croughan, Partner