Insolvency Law Update - Marshalling and Recovery of Fees

In May 2020, the Court of Appeal gave judgment in Burness v Hill (Hill),1 an important decision on the equitable doctrine of marshalling and an illustration of how it can be used by a solicitor to recover fees from an insolvent former client. It allowed a solicitor to be treated as a secured creditor of a bankrupt estate and receive the proceeds of sale of a property owned by the former client, even though the solicitor had not taken security over that property.

Mr Hill had been the solicitor for Thomas Love in long-running Supreme Court litigation against the Roads Corporation. Mr Love had granted Mr Hill a second-ranking mortgage over a property he owned, but declined to grant security over two others. By the time of the trial before Sifris J, Mr Love had been made bankrupt and the property over which Mr Hill held a mortgage had been sold by the first-ranking creditor, the Commonwealth Bank (CBA), leaving no surplus. Nonetheless, Mr Hill succeeded in establishing a secured interest in the proceeds of the sale of another property belonging to Mr Love. Sifris J and the Court of Appeal accepted that equity provided a marshalling right, effectively giving Mr Hill priority over Mr Love’s unsecured creditors.

Before turning to the facts of the case, it is worth setting out the fundamental principles of marshalling. A right to marshal arises where there are two or more funds to which a creditor has a claim, at least one but not all of which are subject to the claim of another, more junior, creditor.2 A typical example is a person who owns two properties both mortgaged to a bank, and then grants a second-ranking mortgage over one of them (but not the other) to another creditor. Where the holder of the first-ranking mortgage has recourse to the double-mortgaged property, and thereby prevents the holder of the second-ranking mortgage from accessing it, equity permits the latter to have recourse to the other property in which the senior creditor has an interest. The purpose of marshalling is said to be preventing the junior creditor from the caprice or self-interest of the senior creditor in choosing to realise one property over the other.

To illustrate how the doctrine works, consider two properties, Blackacre and Whiteacre, each owned by A and worth $100. A owes $100 to a bank under a loan facility, and owes a $50 debt to B. A grants the bank first-ranking mortgages over both properties, and grants B a second-ranking mortgage over Blackacre alone. A defaults in his obligations to the bank. The bank has a choice of which property to sell to recover its debt. If it chooses to sell Blackacre first, then B is disadvantaged because her security over Blackacre is junior to the bank’s and she will not receive any of the proceeds of the sale. In addition, she has no security over the remaining property, Whiteacre. However, if the bank sells Whiteacre first, then B is not disadvantaged because she can still realise Blackacre. The effect of marshalling is to ameliorate the disadvantage occasioned by the bank’s choice to realise Blackacre first. The doctrine operates so that if the bank chooses to sell Blackacre first, then B’s second-ranking security allows her to be subrogated3 to the bank’s interest in Whiteacre.

The facts

In order to fund his litigation, Mr Love borrowed money from CBA and granted mortgages over three properties as security. In due course, Mr Love defaulted on his CBA loan facility and also owed significant sums to Mr Hill. He then granted Mr Hill a second mortgage over one of the three properties already mortgaged to the CBA. He was unwilling to grant mortgages over the other two. This second mortgage was an all-moneys mortgage.

Two years later, with his fees still outstanding, Mr Hill sued Mr Love in the County Court for recovery of his fees. The proceeding was settled on terms including that Mr Love pay Mr Hill the sum of $2.2 million. Payment was stayed for a short while. By this time, CBA had sold the first of the three secured properties. Critically, this was the property over which Mr Hill held his second-ranking mortgage. The proceeds were insufficient to repay all of the moneys owed to CBA – Mr Hill received nothing and his mortgage was removed from the title. Following the County Court proceeding, CBA sold the second property and again the proceeds were insufficient to discharge Mr Love’s debt. Finally, the third property was sold. This time, there were sufficient funds to repay the loan to CBA, and the balance of the proceeds of sale was paid into Court.

Prior to the sale of the third property, Mr Hill had begun his Supreme Court proceeding in which he sought to establish a marshalling right, having the effect of treating his second mortgage as if it applied to the third property in the same way it did to the first. The proceeding was defended, initially by Mr Love and, after he was made bankrupt, by his trustees. The two major issues were whether the marshalling claim was made out and, if so, whether the terms of settlement in the County Court released that claim.

The decisions in Hill

In National Crime Agency v Szepietowski4 Lord Neuberger explained that marshalling was available to a creditor where:

“(i) his debt is secured by a second mortgage over property (‘the common property’), (ii) the first mortgagee of the common property is also a creditor of the debtor, (iii) the first mortgagee also has security for his debt in the form of another property (‘the other property’) (iv) the first mortgagee has been repaid from the proceeds of sale of the common property, (v) the second mortgagee’s debt remains unpaid, and (vi) the proceeds of sale of the other property are not needed (at least in full) to repay the first mortgagee’s debt. In such a case, the second mortgagee can look to the other property to satisfy the debt owed to him”.

The leading textbook says that marshalling is available where two rules are met: the common debtor rule and the proprietary securities rules. The common debtor rule requires that the debts secured by the two securities must be owed by the same debtor and the assets secured by those securities owned by the same debtor.5 The proprietary securities rule is that the securities held by the two creditors must both be proprietary in that each gives a proprietary interest in the relevant asset.6

In Hill, the difference between the parties largely came down to whether the fulfilment of these requirements was sufficient to establish a marshalling claim or whether, as the trustees argued, there were further requirements that could not be met by Mr Hill. A number of the trustees’ arguments were rejected by Sifris J at first instance and not pursued on appeal. Others were considered by the Court of Appeal.

Both Sifris J and the Court of Appeal held that Mr Hill’s marshalling claim was made out. Each of the reasons raised by the trustees as a basis for not permitting marshalling was rejected. In doing so, the Court established some key propositions about marshalling. First, the second mortgagee’s marshalling right is not “limited to the exact amount and legal character of the secured debt at the time the first mortgagee chooses to sell the commonly mortgaged property”.7 Therefore, it did not matter that the amount and character of the secured debt changed over time, as the debt merged in the judgment of the County Court. Nor does it matter if the debt reduces to nil at times, such as where a mortgage secures a fluctuating line of credit or a contingent or future debt.8 Second, the rule that marshalling does not operate where the senior creditor is compelled to sell the secured properties in a particular order does not extend to informal arrangements. Although the cases speak of marshalling having a rationale of protecting a junior creditor from the “caprice” or “arbitrariness” of the senior creditor’s choice of sale order, these words are not used pejoratively and it is not necessary to prove that the decision was arbitrary or capricious.9 The senior creditor must by contract, statute or estoppel be bound to realise properties in a particular order in order to defeat marshalling.10

Before Sifris J, the trustees submitted that equity should not assist Mr Hill because of certain features of the case. These included complaints about fee estimates and bills and the manner in which the second mortgage was taken. Sifris J held that none of the complaints were made out, and the issue was not pursued on appeal. Nonetheless, there is no reason why, in appropriate circumstances, conduct of the junior creditor may disentitle them from a remedy.

What does this mean for solicitors seeking to recover unpaid fees ?

Marshalling may assist in the recovery of unpaid fees where a solicitor has taken a second-ranking mortgage or other security over property of their client. It potentially allows the solicitor to claim a security interest in property owned by the client that is not itself the subject of the second-ranking mortgage.

In order to successfully establish a marshalling claim in practice, the following conditions must be met:

• the creditor is owed a debt by the debtor
• the debtor is insolvent and has other unsecured creditors. Although this is not a requirement of a marshalling claim, in practice if the debtor is not an insolvent with other creditors, marshalling has no work to do
• the creditor holds or held security over property owned by the debtor but this security is insufficient to secure the whole of the debt to the creditor, because of the claim of a more senior creditor
• the senior creditor also has security over other properties owned by the debtor
• the value of the other secured properties is sufficient to leave some amount for the creditor after the senior creditor has been paid out.

A solicitor seeking to recover fees through litigation should first consider their security position and determine whether a marshalling claim may be available. If it is, a decision must be made whether to pursue the marshalling claim at the same time as a debt recovery proceeding. As the Court of Appeal recognised, a marshalling claim is likely to increase the complexity and expense of an otherwise straightforward debt recovery claim.11 If no marshalling claim is brought, care must be taken to avoid precluding the establishment of a marshalling right in a future proceeding. This could occur if inconsistent matters are alleged or if a right to marshal is released by terms of settlement. This latter issue arose in Hill, where the trustees unsuccessfully argued that the terms of settlement in the County Court were wide enough to release Mr Hill’s right to marshal.

Attention should also be given to the issue of whether a debt recovery proceeding without a marshalling claim may give rise to an Anshun12 estoppel or otherwise constitute an abuse of process.13 In Hill, the Court held that it was not unreasonable for the marshalling claim to have been brought in a separate and subsequent proceeding from that which established the debt,14 but different considerations will arise in each case.

If a solicitor has established a right to fees, then a separate proceeding may be available to establish their right to marshal. Importantly, if the solicitor’s security is appropriately drafted, the costs of such a proceeding may be recoverable on an indemnity basis, as occurred in Hill.15

Taking security from a client

Hill has some useful lessons for solicitors considering taking security from a client including:

• it is critical to ensure that the solicitor’s conduct in taking security is ethical and consistent with the solicitor’s statutory and other professional obligations. Because marshalling is an equitable doctrine, conduct on the part of the creditor may be disentitling16
• if the terms of the security provide that enforcement costs are recoverable on an indemnity basis, then the costs of bringing a security claim may be both secured and recoverable at a higher level
• taking security over one property may in practice give the solicitor interests in another property. This will be the case if both properties are mortgaged to the same senior creditor. However, a right to marshal is considerably weaker than a registered security interest. It only exists on the granting of an order by a court17 and will be lost if the property is sold by the owner.

This last point is important because it is probably the case that a right to marshal is a caveatable interest and so steps might be taken to seek to prevent a sale, but only if the solicitor is aware of her interest.

David Morgan is a barrister at the Victorian Bar. He appeared as junior counsel for the successful plaintiff/respondent in the Hill litigation referred to in this article. The views expressed here are those of the author alone and do not necessarily represent the views of his client.

1. [2019] VSCA 94.
2. See JD Heydon, MJ Leeming and PG Turner, Meagher Gummow and Lehane’s Equity Doctrines and Remedies, 5th edn, 2015, at [11-045]; ELG Tyler, PW Young and CE Croft, Fisher and Lightwood’s Law of Mortgage, 3rd Aust edn, 201, at [30.9]; Note 1 above, at [1].
3. Note 2 above, (Heydon, Leeming and Turner), at [11-045].
4. [2014] AC 338 at [31] (Lord Sumption and Lord Reed agreeing).
5. Paul Ali, Marshalling of Securities (Oxford University Press, 1999) [2.30], [2.32] and Ch 7.
6. Webb v Smith (1885) 30 Ch D 192; Paul Ali, Marshalling of Securities (Oxford University Press, 1999) [2.30], [2.39]-[2.40] and Ch 9.
7. Note 1 above, at [39].
8. Note 1 above, at [42].
9. Note 1 above, at [53]-[54].
10. Note 1 above, at [50].
11. Note 1 above, at [92]-[93].
12. Port of Melbourne Authority v Anshun Pty Ltd (1981) 147 CLR 589.
13. See UBS AG v Tyne (as trustee of the Argot Trust) (2018) 265 CLR 77.
14. Note 1 above, at [83]-[97].
15. Note 1 above, at [26].
16. This issue arose before Sifris J, where the trustees alleged that equity should not assist Mr Hill because of certain wrongful conduct on his part. His Honour held that there had been no wrongful conduct and so did not need to decide if any of the alleged matters would have been disentitling: see Hill v Love (2018) 53 VR 459 at [71]-[85].
17. Sarge Pty Ltd v Cazihaven Homes Pty Ltd (1994) 34 NSWLR 658; Note 16 above (Hill v Love) at [71]-[72].