Cutting off your nose to spite your face – could suing for a debt affect your security?
18 December 2020
A new Jersey case on the validity of security
There are very few Jersey cases concerning the validity of Jersey security. When such a case arises, it is important for secured parties and their advisers to consider the implications of the case.
The Jersey Court of Appeal considered the effectiveness of a Jersey security agreement in the recent case of Energy Investments Global Limited and Heritage Oil Limited v Albion Energy Limited  JCA 258.
Bedell Cristin's litigation practice acted for the grantor of the security interest in this case.
In this case, a Jersey security agreement had been given in respect of shares in a Jersey company.
Under the Jersey security agreement, the secured liabilities were defined as the grantor's obligation to pay consideration pursuant to a share purchase agreement (the "SPA").
The secured party had obtained summary judgment in England for the unpaid consideration under the SPA and also sought the assistance of the Jersey courts to enforce the Jersey security interest.
The argument – no secured liabilities
The grantor of the security interest questioned whether the secured liabilities existed at all given that the secured party had obtained summary judgment.
The arguments put forward were technical in nature. The arguments concerned:
- the doctrine of merger and its effect on the security agreement; and
- the construction of the security agreement (as a matter of general contract law).
Under the doctrine of merger, where a person obtains a judgment in respect of a cause of action (e.g. a breach of contract), the doctrine provides that the cause of action is extinguished and merges into the judgment. In broad terms, the cause of action is superseded (i.e. replaced) by the judgment.
This legal doctrine prevents the abuse of the courts. It prevents a plaintiff from launching multiple actions in respect of the same cause of action. Once a judgment has been obtained, the recourse of the plaintiff is to enforce that judgment and not to sue in respect of the same matter again.
The grantor argued that the right to payment pursuant to the SPA had merged into the summary judgment. As a consequence, the grantor asserted that there were no longer any secured liabilities. The secured liabilities were defined as the unpaid consideration pursuant to the SPA. On the basis that this payment obligation had merged into the judgment, it was argued that there were no longer any amounts owing pursuant to the SPA. Instead, the amounts were now owed pursuant to a judgment.
In addition, as a matter of contractual interpretation, it was argued that the security agreement only secured the amount payable pursuant to the SPA and not the amount payable pursuant to the English judgment. It was therefore asserted that the secured liabilities did not extend to the resulting judgment debt.
Merger does not extinguish the obligation to pay
The Court of Appeal considered that the doctrine of merger formed part of Jersey law.
A number of English law cases were considered by the Court of Appeal. Some of these English authorities were quite historic (going back to the 19th century).
The Court of Appeal considered that a secured party would find it "startling" to discover that if it sued for the debt, it would automatically lose its security for the debt as a consequence.
The Court of Appeal considered that when a judgment is obtained, the cause of action which the judgment sustained is extinguished, but the obligation to pay remains. The Court of Appeal stated that "[t]he obligation to pay because of the contractual arrangements has not been extinguished."
Instead, the Court of Appeal saw merger more as a procedural rule. To prevent double recovery and the harassment of a debtor, a creditor cannot sue again on a cause of action in respect of which the creditor has obtained a judgment. However, the Court of Appeal confirmed that the obligation to pay, and the right to receive payment, are not lost as a consequence of the judgment.
The Court of Appeal therefore held that the doctrine of merger does not extinguish the underlying contractual obligations.
In addition, the Court of Appeal held that security rights do not merge into the judgment. The Court of Appeal emphasised that suing for a debt and enforcing security for a debt are different rights and remedies (see paragraphs 33 and 59 of the judgment). The doctrine of merger prevents a person from suing for the same debt twice. But the doctrine of merger does not prevent a person from suing for a debt and then enforcing security for that debt.
This is therefore positive news for secured parties. The doctrine of merger does not operate in a way which may prejudice security enforcement.
Construction of the security agreement
The Court of Appeal also reviewed the terms of the security agreement to see whether the security rights were lost as a consequence of obtaining judgment.
In construing the terms of the security agreement, the Court of Appeal looked at the document as a whole and also at the intention of the parties. Importantly, the security agreement provided that the security interest was not to be prejudiced by any act of the secured party or by any other right or remedy available to the secured party.
Taking all these matters into account, the Court of Appeal considered that the security agreement secured the unpaid consideration. The consideration quite simply remained unpaid (subject to the escrow arrangements considered below) and therefore the security was not impaired by the summary judgment.
Again, the approach of the Court of Appeal is positive news for a secured party. The Court of Appeal did not look solely at issues of narrow drafting but looked at the overall purpose of the security agreement and the intention of the parties. The security agreement was put in place to secure the unpaid consideration and that unpaid consideration remained outstanding.
Escrow arrangements save the day for the grantor
Up to this point, the Court of Appeal found against the grantor.
However, escrow arrangements were then considered.
In broad terms, the grantor had previously placed amounts into escrow with English solicitors and these escrow monies had been released to the secured party.
The secured party argued that it was entitled to apply the escrow amounts towards the payment of other debts owed by the grantor and not just to the unpaid consideration under the SPA. The grantor argued that the secured party was not entitled to appropriate the released funds in this way and that the released funds had discharged the outstanding consideration under the SPA.
The Court of Appeal found in favour of the grantor and held that the escrow release had discharged the outstanding consideration.
As the consideration had now been paid, the security no longer had any purpose.
Therefore, the Court of Appeal found in favour of the grantor and the secured party was not entitled to enforce the security.
The orders of the lower court facilitating the enforcement of the Jersey security interest were therefore dismissed.
The case is fact specific. In practice, it is unlikely that a secured party would find itself in a similar position to the secured party in this case. If a secured party has security for a debt, it would usually simply enforce the security first, without any need to obtain any judgment in respect of the debt. Indeed, that is one of the reasons why security is taken in the first place: to provide the secured party with clear and effective enforcement rights without the need to commence any legal proceedings.
However, if the secured party does need to obtain judgment, the case is positive news for secured parties as it shows that the Court of Appeal was not prepared to allow technical arguments to defeat a valid security interest:
- the Court of Appeal did not allow arguments concerning the doctrine of merger to defeat a security interest; and
- the Court of Appeal also upheld the commercial intent and purpose of the security agreement and did not allow arguments about the precise scope of contractual wording to defeat the commercial expectations of the secured party.
That being said, to mitigate against the risk of a grantor raising similar drafting issues in the future, secured parties may wish to consider including appropriate wording in their security agreements going forward to make it abundantly clear that the secured obligations extend to any judgments given in respect of the underlying obligations.