Recent and ongoing litigation has seen the return to prominence of the anti-deprivation principle (sometimes known as the British Eagle principle) whereby "there cannot be a valid contract that a man's property shall remain his until bankruptcy, and on the happening of that event go over to someone else, and be taken from his creditors" (per Lord Justice Cotton in Ex p Jay in 1880).
The principle has been the subject of two recent cases, Perpetual and Butters. In each, it was argued that this principle rendered unenforceable parts of the complex contracts which the parties had entered. In an unusual step arising from their coincidental timing, appeals in each case were heard together. They are the subject of a combined judgment delivered by the Court of Appeal on November 6 2009 (Perpetual Trustee Company Limited v BNY Corporate Trustee Services Limited and Another; Butters and others v BBC Worldwide Limited and others [2009]).
The principle operates to support the fundamental tenet of insolvency law that (absent security rights or statutory exceptions) a debtor's assets should be applied pari passu and in accordance with creditors' rights at the outset of any insolvency process. Unfortunately, the scope and application of the principle is hard to define clearly. As the Master of the Rolls himself said in the case: "It is not entirely easy to define the rule's precise limits, or even its precise nature as the reasoning in the various judgments in which the rule has been considered is often a little opaque, and some of the judgments are a little hard to reconcile."
So, following Perpetual and Butters, where is the principle now?
Butters: the facts
The Butters case was an intellectual property licensing dispute arising from the collapse of the Woolworths retail chain. BBC Worldwide (BBCW) had entered into a joint venture with Woolworths Group (Group) and its subsidiary, Woolworths Media (Media). The joint venture vehicle was a company called 2 Entertain Limited (2E) in which 60% of the shares were held by BBCW and 40% were held by Media. BBC Video Limited (Video) was a subsidiary of 2E.
The dispute surrounded two closely related contractual documents:
- a joint venture agreement (JV agreement) to which BBCW, Group, Media and 2E were parties; and
- a master licence agreement (Licence) between BBCW and Video by which BBCW licensed various intellectual property rights, including the right to manufacture and distribute DVDs, to Video.
The JV agreement provided that if Media or Group suffered any of various defined "insolvency events", BBCW could serve a notice compulsorily to acquire Media's shares in 2E for "fair value" as determined by an investment bank. Essentially this was the market value of the shares, except that no discount was to be made for the fact that the shares represented only a minority (40%) holding in 2E.
The Licence also contained a provision whereby, if Media or Group suffered an insolvency event and BBCW served a notice to acquire Media's shares in 2E, BBCW's licence with Video would terminate immediately. The effect of this termination would in practice be to reduce the market value which BBCW had to pay for Media's 40% shareholding in 2E, because Video (2E's subsidiary) would cease to enjoy the benefits of the valuable Licence.
In December 2008, Group was the subject of a winding up petition which was not withdrawn within 15 working days. This constituted an insolvency event for the purposes of the relevant contractual provisions. Further such events followed on January 27 2009 when Group went into administration, and on 11 February 2009 when Media went into administration. On February 2 2009, in the light of two insolvency events having occurred in respect of Group by that point, BBCW served notice to acquire Media's shares in 2E.
Mr Butters and the other administrators of Group and Media contended that the combined operation of the compulsory acquisition of the shares in 2E and the automatic termination of the Licence offended the anti-deprivation principle, an argument which succeeded before Mr Justice Peter Smith at first instance. They argued that the provisions were designed to enable BBCW to acquire Media's shares in 2E at a discount in the event of Media's insolvency, pointing to the fact that the Licence did not simply terminate if Media became insolvent but only if in addition BBCW had elected to buy-out Media's rights. The fact that, in effect, the joint venture only became less valuable if BBCW was seeking to acquire Media's interest in it was said to be objectionable and contrary to the anti-deprivation principle.
Reversing the first instance judge, the Court of Appeal was unanimous that these provisions did not offend the principle and were enforceable.
Perpetual: the facts
Pursuant to the Dante Finance Multi-Issuer Secured Obligation Programme established by Lehman Brothers in 2002, special purpose vehicles (SPVs) were set up to issue notes. The notes were subscribed for by noteholders, and the subscription money from the notes was used by the SPVs to acquire "credit worthy" collateral. The collateral was held by BNY Corporate Trustee Services as trustee for the parties, and was charged by the issuer to secure the issuer's obligations to the noteholders. In each case, the relevant issuer SPV also entered into a credit default swap with Lehman Brothers Special Financing (the swap counterparty), whose obligations were guaranteed by Lehman Brothers Holdings (the swap guarantor). The swap agreements were in each case embodied in (amongst other documents) Isda master agreements expressed to be governed by English law. The charge over the collateral was also expressed to secure the issuer's obligations to the Swap Counterparty.
Each issue of notes was constituted by, amongst other things, a principal trust deed and a supplemental trust deed (the trust deeds), which were also expressed to be governed by English law. In essence, the trust deeds provided that upon the occurrence of certain enforcement events, after defraying various fees, costs and expenses, the available collateral within the transaction should go:
- first, to pay any close-out amounts due from the issuer to the swap counterparty under the swap, and thereafter towards sums due by the issuer to noteholders under the notes; unless
- a default had taken place under the relevant swap agreement and the swap counterparty was the "defaulting party" (as that term is used in the Isda master agreement), in which case the priority was to be reversed so that the noteholders ranked ahead of the swap counterparty for repayment from the collateral.
Such clauses altering the waterfall priority of payments in different circumstances (referred to as a "flip clause" by the Court of Appeal) are common in a number of structured finance contexts.
The Lehmans collapse involved, amongst other things, the swap guarantor filing for Chapter 11 bankruptcy protection on 15 September 2008, with the swap counterparty following suit on October 3 2008. Each of these filings constituted a bankruptcy event of default under the swap agreement, with the swap counterparty in each case being the "defaulting party". Each of these events was, on the face of it, sufficient to trigger the flip in priority described above.
Following the bankruptcy filings, certain noteholders required the trustee to enforce the collateral, and to make payments in accordance with the flipped priority. The swap counterparty contended that the contractual provisions which purported to demote its priority status upon its bankruptcy were unenforceable by virtue of the anti-deprivation principle.
Upholding the first instance decision of the Chancellor (Sir Andrew Morritt), the Court of Appeal unanimously rejected the swap counterparty's argument for reasons described further below.
The decision
In many ways, Butters can more readily be categorised within previous authorities, which is to be expected given the complex structured finance aspects of Perpetual. It has long been recognised that a provision within a lease whereby it comes to an end on the insolvency of the tenant is not contrary to the anti-deprivation principle. This is because there is no property of the tenant which is being taken out of his insolvency – he only ever had a determinable interest which is being brought to an end by the third party who created the interest in the first place (the landlord). This applies to licences also, as the administrators conceded in Butters. In principle, a provision within a licence by which the licensor can terminate upon the licensee's insolvency is unobjectionable, and is indeed commonplace.
Further, the anti-deprivation principle does not strike down fairly drawn pre-emption provisions. Thus (absent special facts) a contractual provision whereby A agrees that, upon his insolvency, he will sell a particular asset to B is unobjectionable so long as B has to pay market value for the asset. Such clauses often appear in partnership deeds and shareholder arrangements. They would fall foul of the anti-deprivation principle if they required the insolvent company to sell them at an undervalue.
In these circumstances, perhaps unsurprisingly the Court of Appeal upheld the contracts in the Butters case. The termination of the Licence was valid – the fact that the triggering insolvency was that of the joint venture vehicle (Media) who co-owned the licensee and not the licensee itself (Video) was not sufficient to displace the approach to licences described above. Likewise, the right for BBCW to purchase Media's shareholding in 2E for (at least) market value upon Media's insolvency was unobjectionable: the fact that the price paid would be reduced by the termination of the Licence did not mean the price was not the proper market value.
This was because the licence termination was itself legitimate and could therefore be taken into account in the valuation process. Rather than considering that the linkage of these two provisions offended the anti-deprivation principle, Lord Neuberger MR considered that if anything the linking of the clauses favoured Media. If the two provisions had been independent, BBCW could simply have terminated the Licence without any obligation to buy Media's minority stake in the joint venture.
In Perpetual, Lord Justice Patten noted that the anti-deprivation principle sought to negate contractual provisions which purported to apply an asset of the insolvent debtor in a manner other than required by the pari passu rule, as set out above. Lord Justice Patten considered that the anti-deprivation principle was at its core a principle of public policy which prevented "contracting out" of the Insolvency Act. Looked at from that perspective, in Perpetual there was simply no asset of the swap counterparty which was being removed from its estate upon the swap counterparty's filing for bankruptcy to be applied in some other way, and thus the anti-deprivation principle was not offended:
"The only interest or property which the [swap counterparty] ever enjoyed in the collateral was a charge granted by the [SPV] on the terms of the [trust deeds]. That security interest remained part of the property of the [swap counterparty] unchanged by the event of its bankruptcy. The reversal of the order of priority... was always a facet of the security designed to regulate the competing interests over the collateral... To say that its operation in the event of the [swap counterparty's] bankruptcy constitute the removal of an asset from the liquidation is to confuse the security itself with the operation of its terms in the events prescribed by the charge."
Lord Neuberger MR expressed considerable sympathy with Lord Justice Patten's reasoning, but adopted a slightly different approach. He concluded that an additional element was at least arguably critical to the outcome in Perpetual, namely that the collateral had originally been purchased wholly (or in certain transactions, largely) with the noteholders' funds. Thus the Master of the Rolls placed weight upon the fact that:
"the assets over which the charge exists were acquired with money provided by the [noteholders] in whose favour the flip operates, and ... the flip was included merely to ensure, as far as possible, that the [noteholders were] repaid out of those assets all that [they] provided... before the [swap counterparty] receives any money from those assets pursuant to its charge".
Seeking to draw guidance from the earlier authorities, Lord Neuberger MR considered that certain factual aspects of the Perpetual case brought into play a number of principles evident in earlier decisions, including the suggestion that "the [anti-deprivation principle] may have no application to the extent that the person in whose favour the deprivation of the asset takes effect can show that the asset, or the insolvent person's interest in the asset, was acquired with his money".
Commentary
The Court of Appeal's decision helpfully clarifies various aspects of the anti-deprivation principle. It is particularly valuable in the Perpetual context through its upholding the validity of provisions commonly used in the market. That said, a number of uncertainties remain. The difficulty in shaping a coherent theory to explain the scope of the principle is reflected in the fact that Lord Neuberger MR and Lord Justice Patten adopted different approaches.
A positive theme to emerge strongly from the Court of Appeal's judgment is that the anti-deprivation principle operates in support of the insolvency legislation, and that this is a key touchstone when considering its ambit. Indeed Lord Justice Patten went so far as to suggest, drawing on the somewhat opaque 1970s House of Lords decision in British Eagle International Airlines v Compagnie Nationale Air France, that in truth the anti-deprivation principle was little more than the direct application of the Insolvency Act to the provisions under consideration and the only rationale for the principle.
Whilst Lord Neuberger MR's approach was perhaps not quite so narrowly drawn, he too accepted that the principle was "dependent... on the operation of the [Insolvency] Act". It is suggested that this is a helpful starting point for practitioners who, as seems increasingly likely in the current climate, are asked to advise on the applicability of the principle to novel scenarios.
Read in this way, it could be possible to determine whether the anti-deprivation rule will operate through application of the following principles. First, the rule should only apply where the debtor has become subject to a formal insolvency process, in other words, administration, liquidation or bankruptcy. In Perpetual and Butters, there were arguments as to when the alleged deprivation had taken place and indeed whether it could be of any relevance where a debtor had yet to enter into a formal insolvency process.
In Lord Neuberger's view, the anti-deprivation principle will be inapplicable where the debtor has been deprived of an asset before it becomes the subject of a formal insolvency process. The correctness of any allegation that the debtor had not received full value will then fall to be determined through the application of the rules on the adjustment of prior transactions (preferences, transactions at an undervalue and the avoidance of floating charges).
In all other cases, it is necessary to look at the nature of the right to which it is suggested the anti-deprivation rule applies. Where a limited interest, such as a lease or a licence, is brought to an end in accordance with its terms on the insolvency of the licensee or tenant, the anti-deprivation rule will have no application. In Perpetual, LBSF had concluded arrangements that set out from the outset the circumstances in which two secured creditors would be entitled to payment in alternative orders of priority. To that extent, LBSF's rights could be said to be no different to the limited proprietary interest given to a tenant or the licensee of property. Read in that light, the question of whether or not an insolvent company or individual has been deprived of an asset purely through becoming the subject of an insolvency procedure becomes as much a question of fact as one of law.
Not the end of the story
The swap counterparty in Perpetual, LBSF, did not accept the validity of the flip in priority and commenced parallel litigation in the US Bankruptcy Court (Lehman Brothers Special Financing v BNY Corporate Trustee Services). On January 25 2010 the Bankruptcy Court handed down a memorandum decision granting motion for summary judgment (the memorandum decision) with a declaratory judgment that that the flip was unenforceable as an ipso facto clause under Sections 365 and 541 of the Bankruptcy Code. In many ways similar to the English anti-deprivation principle, the Bankruptcy Code provides that certain contractual provisions which seek to modify rights upon the bankruptcy of one of the parties are unenforceable.
Both US and UK Courts had recognised to potential for conflicting judgments from the start of the litigation. On the application of certain noteholders (Perpetual Trustee v BNY Corporate Trustee Services), the English High Court sent a letter to the Bankruptcy Court which was reported in the Bankruptcy Court as follows:
"[t]he English court has confined itself to making a declaration that the relevant contractual provisions are 'valid, effective and enforceable as a matter of English law as the proper law of such contracts, so as to give effect to Noteholder Priority,'" and (ii) requesting that if this Court concludes that "the relevant provisions are void or otherwise unenforceable under US bankruptcy law" it "go no further at that stage than to make a declaratory judgment to that effect." At a hearing on the cross motions for summary judgment on November 19 2009, the parties agreed that it is appropriate for this Court to determine at this time only whether declaratory relief is appropriate in this matter and to further coordinate with the High Court should it become necessary after a decision is rendered". (This is taken from the memorandum decision)
So all parties to the litigation have been left with conflicting declaratory decisions, but with an indication from the courts on both sides of the water that there should be further co-ordination to resolve differences. It would be open to LBSF to try to have the US judgment recognised in England under the UNCITRAL Model Law on Cross-border Insolvency. However, it has recently been announced that Lehmans has been given leave to appeal to the English Supreme Court, with the hearing date set for March 1 to 3 2011 with a time estimate of 3 days. It seems likely that any attempt to reconcile the two judgments will wait until after the Supreme Court hearing. So it seems as though the anti-deprivation rule remains with us. For the moment, at least.