Court dismisses appeal where receiver proves lessee knew of negative pledge clause despite company claims.

THE SUPREME COURT

Record No. 2004/492

Fennelly J.

McCracken J.

Kearns J.

IN THE MATTER OF SALTHILL PROPERTIES LIMITED (IN RECEIVERSHIP)

AND IN THE MATTER OF THE COMPANIES ACTS 1963-2001

Judgment of McCracken J. delivered the 29th day of May 2006

Background

1. By deed of appointment of receiver dated 9th April 2003 Mr Ray Jackson, chartered accountant, (hereinafter called “the receiver”)

was appointed receiver and manager over all the undertaking property and assets of Salthill Properties Limited (hereinafter called “the

company”) by First Active Plc (hereinafter called “the bank”).

2. By a notice of motion dated the 15th January 2004 the receiver sought certain directions from the High Court pursuant to section

316 of the Companies Act 1963 concerning three leases all dated 22nd December 1999 and made between the company and

Porterridge Trading Limited (hereinafter called “Porterrridge”). For the purpose of this appeal the relevant direction sought was:-

“(c) Did the purported leases contravene the negative pledge clause contained in the three indentures of mortgage dated the

29th day of October 1999, the 12th day of December 1999 and the 20th day of December 2001 between the company and

First Active Plc?”

3. The motion was heard in the High Court before Laffoy J. who held that the leases did contravene clause 6 contained in each of the

prior mortgage debentures. Porterridge, which was the notice party to the said application, has appealed that finding to this court.

The agreed facts

4. The company was incorporated on 14th January 1998 for the purpose of developing a site at Salthill in Co. Galway, and was one of

a group of companies known as the Cunningham Group. The greater part of the site was within a seaside renewal tax designated area

which would allow for certain tax reliefs on a development within that area.

5. By a mortgage debenture dated 29th October 1999 and made between the company and the bank the company agreed at clause

6:-

“The company shall not except with the prior consent of the bank

(a) create, extend or permit to subsist any encumbrance over the secured assets or any of them ranking in priority to

or pari passu with or after the security hereby created, or

(b) part with, sell, transfer, lend, lease or otherwise dispose of, whether by means of one or of a number of

transactions related or not and whether at one time or over a period of time, the whole or any part of the secured

assets…”

6. The company entered into two further mortgage debentures with the bank dated respectively 12th November 1999 and 20th

December 2001, both of which contained identical clauses.

7. By three leases dated the 22nd December 1999 the company leased three separate commercial units in the development to

Porterridge for a term of twenty five years. These leases were created to take advantage of the taxation relief available but to be

enabled to achieve this end it was necessary that the leases were created at arms length with an unconnected third party prior to

31st December 1999. The units which are the subject matter of these leases formed part of the property charged by the mortgage

debenture, but no consent of the bank was obtained to the creation of these leases.

The judgment in the High Court

8. The learned High Court judge held that the proceedings were properly before the court pursuant to section 316 of the Companies

Act 1963 as amended. She then proceeded to determine the matter on the evidence which was before her, having held as a matter

of law that the onus was on Porterridge to prove that it did not have actual notice of the negative covenants in the mortgage

debentures. She cited a passage from page 228 of Gough on “Company Charges” (2nd edition 1996), which seems to me to

encapsulate the applicable principles. This passage reads:-

“Although creating no more than a negative contractual right, a restrictive clause can affect the quality of, and therefore

bind, a subsequent proprietary interest through actual notice of the restriction. In equity it would be unconscionable to permit

a subsequent third party to take his interest free of the restrictive right in spite of his actual knowledge that to do so would

constitute a breach of a floating charge contract by the charger.”

9. The learned trial judge then summed up her findings in this regard at page 22 of her judgment where she said:-

“It was submitted that the company and the lessee are two separate legal entities. That is undoubtedly the case. It was also

submitted that the evidence did not establish that Mr Cunningham controlled the company and that the control of the lessee,

through its board of directors, was independent of Mr Cunningham. In my view, those arguments are specious in a context of

the reality of the transactions between the company and the lessee at the end of December 1999 judged by documents which

are properly before the court. Mr Cunningham, as a director of the company, witnessed the execution of the mortgage

debentures, each of which contained clause 6. In the absence of evidence to the contrary, it must be assumed that he was

aware of the contents of those instruments. On the day the leases were executed he obtained from the two shareholders of

the lessee, Ms Hynes and Mr Quinn, declarations that proved that between them they held the entire share capital of the

lessee in trust for Mr Cunningham. In return for each trustee shareholder becoming a director of the company, on the same

day Mr Cunningham gave each full indemnity in respect of all costs, expenses and such like, including consequential fees,

expenditure and VAT, in respect of or arising out of that office.

In my view, the core issue is whether the beneficial owner of the entire share capital of the lessee, who became the beneficial

owner of the leasehold interest through the medium of the lessee, had actual notice of clause 6. I am satisfied that the

evidence on the material facts, which I have just outlined and is not in controversy, clearly shows that he did. This conclusion

does not impute any propensity to have anything other than proper regard for company law and regulation to the directors of

the lessee. It merely reflects the reality of the situation which prevailed.

Accordingly, I am satisfied that the lessee has not discharged the onus of establishing that it did not have actual notice of

clause 6.”

The correctness of the procedure

10. Section 316(1) of the Companies Act 1963 as amended by section 171 of the Companies Act 1990 permits a receiver to apply to

the court for directions:-

“in relation to any matter in connection with the performances or otherwise by the receiver of his functions.”

11. Where such an application is made the section then provides that:-

“the court may give such directions, or make such order declaring the rights of persons before the court or otherwise as the

court thinks just.”

12. Under Order 75, Rule 21 of the Rules of the Superior Courts it is provided that such applications shall be grounded on the affidavit

of the party making the application and shall be heard and determined on affidavit unless the court authorises otherwise. This, of

course, does not preclude the normal procedures whereby a person giving evidence on affidavit may be cross-examined on his

affidavit.

13. The purpose of the procedures set out in section 316, and indeed the equivalent procedures relating to applications by liquidators,

is to permit a person who has been effectively put in control of a company either on behalf of a specific creditor, in the case of a

receiver, or on behalf of creditors in general as in the case of a liquidator, to control the affairs of the company and obtain the

advices of the court in as efficient and speedy a manner as possible. It must be borne in mind that receivers and liquidators

frequently find themselves in a position where the knowledge which they have of the affairs of the company derives mainly or solely

from the written records of the company and documents in the possession of the company which may or may not be reliable, and

where at times, and I am speaking in general terms and not in relation to this particular company, the receiver or liquidator may

receive little or no co-operation from those who previously controlled the company.

14. I am quite satisfied that the directions sought by the receiver in this case clearly come within the provisions of section 316. The

primary issue is the priority of charges on the assets of the company. If a receiver is to perform his functions properly, and in

particular if he were to wish to sell the relevant assets, it is, of course, essential for him to know and identify such priorities.

Furthermore, the section specifically empowers the court to make orders declaring the rights of persons before the court, in this case

the rights of Porterridge as a lessee.

15. It is, of course, always open to the court to direct a hearing on oral evidence rather than on affidavit if the court feels this is

necessary to do justice between the parties. This is a power which the court may exercise at its discretion, and will usually do so if

there is a clear and direct conflict of evidence on affidavit. In those circumstances the correct procedure is for the court to direct

pleadings, as far as they may be necessary, within the motion before it under section 316, rather than to direct the receiver to

commence or join in plenary proceedings. In the present case, for reasons which I will indicate below, I am quite satisfied there was

no such clear and direct conflict of evidence.

Onus of proof

16. I have already cited with approval the passage from Gough which was referred to in the judgment of the learned High Court judge.

It is not disputed by Porterridge in this appeal that the onus is on it to show that it did not have actual knowledge of the negative

covenants, but say that it has satisfied that onus of proof by showing that Porterridge is an independent and arms length company,

as is averred by Ms Hynes in her affidavit. It is, of course, difficult for a party to proceedings to prove a negative, as is required in

the present case. However, the learned trial judge clearly did not decide the case solely on the lack of evidence on the part of

Porterridge to discharge the onus. As is shown by the passage of her judgment referred to above, she primarily relied on positive

evidence adduced on behalf of the receiver as to the relationship between the company, Mr Cunningham and Porterridge.

17. Porterridge primarily rely on the affidavit of Ms Hynes to show its lack of actual knowledge of the negative covenant. It was also

stated in court, although not put on affidavit, but accepted by the learned trial judge, that Ms Hynes had no personal knowledge of

the negative covenant. What she said in her affidavit was that, as directors, she and her co-directors were independent and she

rejected the assertion that Porterridge was “a mere puppet” of Mr Cunningham. She pointed to actions on the part of Porterridge,

such as the obtaining of planning permission, to show its independence. What she did not say in so many words was that Porterridge

as a separate legal identity had no actual knowledge of the negative covenants.

18. Much more seriously, however, was that Ms Hynes affidavit was the only evidence put forward on behalf of Porterridge to satisfy

the onus of proof that was on them. There was no affidavit from Ms Hynes’s co-director Mr Quinn making similar averments, and there

was no affidavit sworn by Mr Cunningham. This being so, as was pointed out by the learned trial judge, the evidence of the receiver

as to the relationship between Mr Cunningham, the company, Porterridge and the directors of Porterridge was not contested. It was

this uncontested evidence that was largely relied on by the learned trial judge.

Conclusion

19. I am quite satisfied that the evidence put forward on behalf of Porterridge did not discharge the onus of proof to show that it did

not have actual knowledge of the negative covenants. It is argued on behalf of Porterridge that, even assuming that Mr Cunningham

had actual knowledge of the covenant, the learned trial judge was incorrect in imputing that knowledge to the company as actual

knowledge rather than constructive knowledge. This depends on the closeness of the relationship between Mr Cunningham and

Porterridge, and the extent of the control which he exercised over the affairs of Porterridge, but in my view it would only be

necessary to decide that issue if the onus of proof had shifted from Porterridge to the receiver, and it was for the receiver to show or

prove that Porterridge had actual knowledge. I am quite satisfied that the evidence put forward on behalf of Porterridge was not

sufficient to shift the onus of proof. However, the learned trial judge was perfectly entitled to take into account the knowledge of Mr

Cunningham in assessing the strength of the evidence put forward by Porterridge. In my view she was quite correct in deciding on the

evidence that Porterridge did have actual knowledge of the negative covenants and I would dismiss this appeal.