Swelling Assets
Cases
Hughwe v Htachi Koki Imaging Solutions Europe and another
[2006] IEHC 233
Mr. Justice Clarke delivered 21st July, 2006.
!3. The Law
3.1 In Bambrick v. Cobley [2006] ILRM 81 at p. 90 I noted the following:-
“It is trite to say that a plaintiff is not entitled to security for every claimed liability. The mareva injunction is not intended to provide plaintiffs with security in respect of all claims in relation to which they may be able to pass an arguably test. The true basis of the jurisdiction is the exercise by the court of its inherent power to prevent parties from placing their assets beyond the likely reach of the court in the event of a successful action”.
3.2 That passage was based, in part, on the judgment of Hamilton C.J. in O’Mahony v. Horgan [1995] 2 IR 411 at p. 419 from which it is clear that, before a plaintiff will be entitled to a mareva injunction, “there must be an intention on the part of the defendant to dispose of his assets with a view to evading his obligation to the plaintiff and to frustrate the anticipated order of the court.”
3.3 However it is clear that the jurisprudence in respect of what might be called the “requisite intention” has developed since O’Mahony. In Bennet Enterprises Inc. v. Lipton [1999] 2 IR 221 O’Sullivan J. acknowledged that direct evidence of an intention to evade will rarely be available at the interlocutory stage and concluded that it was legitimate to consider all the circumstances of the case in reaching a decision on whether to grant relief in the form of a mareva injunction.
3.4 In Tracey v. Bowen (Unreported, High Court, Clarke J. April 19th 2005) I considered the judgment of O’Sullivan J. in Bennet Enterprises and the judgment of Kearns J. in Aerospace Limited v. Thompson (Unreported, High Court, Kearns J. January 13th 1999) and expressed the view that those cases were authority for the proposition that:-
“In assessing the risk of dissipation the court is entitled to take into account all the circumstances of the case which can include, in an appropriate case, an inference drawn from the nature of the wrongdoing alleged, which, if fraudulent or unconscionable, may lead to the establishment of a risk that further fraudulent or unconscionable actions will be taken so as to place any assets of the defendant outside the jurisdiction of the court.”
3.5 I followed the same approach in McCourt v. Tiernan (Unreported, High Court, Clarke J. July 29th 2005).
3.6 While all of the above cases were concerned with circumstances where the court was invited to infer from the nature of the contended for cause of action that there was a real risk that assets might be placed beyond the jurisdiction of the court, those cases are, in my view, nonetheless examples of a more general consideration. For the reasons pointed out by O’Sullivan J. in Bennet Enterprises it will rarely be possible to produce direct evidence of the intention of a defendant against whom a mareva injunction is sought. The “requisite intention” will, therefore, in most cases, have to be established by inference from other facts. It will, therefore, in some cases be appropriate to infer the intention of the defendant concerned from what can be established about the way he has, or intends to, deal with his assets.
3.7 Most of the cases involve a situation where the contended for fear of the plaintiff is that the defendant will retain ownership of the assets concerned but move the assets to a place where they are outside the reach of the courts. It is, however, possible that assets might be placed outside the reach of the court by other means. While O’Mahony v. Horgan is clear authority for the proposition that the payment of lawful debts in the course of an ongoing business should not give rise to any inference sufficient to justify the grant of a mareva injunction, it seems to me that there is, at least in principle, a necessity to give different consideration to a corporate entity which may be insolvent. In Re Frederick Inns Limited [1994] ILRM 387 the Supreme Court had to consider the question of the duties of the directors in a situation where a company was being wound up or where any creditor could have it wound up on the ground of insolvency. Blayney J., in giving the judgment of the court, found that in such circumstances the directors owed a duty to the creditors to preserve the assets so as to enable them to be applied in pro tanto discharge of the company’s liabilities.
3.8 In the context of an application under s. 150 of the Companies Act 1990 in McLoughlin v. Lannon [2005] IEHC 341, and having referred to Frederick Inns I noted that:-
“there can be little doubt, therefore, that amongst the important duties of directors is to ensure that, when it becomes clear that a company is insolvent, the assets are preserved and dealt with in the way in which the Companies Acts require. There would not seem to be any real doubt but that the directors in this case did not comply with that obligation.”
3.9 It is, therefore, clear that the directors of any company are under a fiduciary obligation (which arises in circumstances where the company does not have sufficient assets to meet its liabilities) to have regard to the insolvency provisions of the Companies Acts in the way in which the assets are managed. While an inappropriate disposition of the company’s assets in such circumstances might not act for the benefit of the company itself, it seems to me that, nonetheless, in an appropriate case, it may be open to a plaintiff to seek mareva relief where it can be shown that an insolvent company intends to deal with its assets in a manner which would prevent those assets being dealt with in accordance with the provisions of the Companies Acts. In the ordinary way such a company must be taken, at least prima facie, to intend the natural consequences of its acts. Where it can be demonstrated that the company concerned intends to deal with its assets in such a manner as would be in breach of the obligations of the company and its directors under Frederick Inns and where such action would be likely to affect the position of the plaintiff, it seems to me that “requisite intention” required to justify the grant of a mareva type injunction would be established.
3.10 I am, therefore, satisfied that, in principle, it is open to a plaintiff to seek a mareva type injunction in circumstances where it can be shown that an insolvent corporate entity intends to deal with its assets in a manner which would be in breach of the obligations on the company and its directors to ensure that those assets are maintained in a fashion which would enable them to be applied in accordance with corporate insolvency law. This situation may arise even where the company proposes to pay its lawful debts. It should, however, be emphasised that the primary means available in law for the enforcement of any such entitlement is to seek to place the company in liquidation so that the assets would, then, be dealt with by the liquidator in accordance with corporate insolvency law. However where, for whatever reason, it may not be possible for the plaintiff to seek to have the company put into liquidation or where, for whatever reason, liquidation may not be appropriate at that stage, it seems to me that it is open to a plaintiff, in such circumstances, to seek a mareva type injunction.”
Ballymitty Supplies Stores Ltd [in liquidation] -v- Companies Acts
[2011] IEHC 471
Laffoy J.
1. On this application, Philip Tubritt (the applicant), who is the liquidator of Ballymitty Supplies Stores Ltd. (the Company) in a creditors’ voluntary winding up, seeks leave pursuant to s. 290(1) of the Companies Act 1963 to disclaim certain property owned by the Company, which it is contended is “onerous”.
2. Sub-section (1) of s. 290 provides as follows:
“Subject to sub-sections (2) and (5), where any part of the property of a company which is being wound up consists of land of any tenure burdened with onerous covenants, of shares or stock in companies, of unprofitable contracts, or any other property which is unsaleable or not readily saleable by reason of its binding the possessor thereof to the performance of any onerous act or the payment of any sum of money, the liquidator of the company, notwithstanding that he has endeavoured to sell or has taken possession of the property or exercised any act of ownership in relation thereto, may, with the leave of the court, and subject to the provisions of this section, by writing signed by him, at any time within twelve months after the commencement of the winding up or such extended period as may be allowed by the court, disclaim the property.”
3. On 24th August, 2011, the applicant, by a document addressed to “To Whom It May Concern” and signed by him, sought to disclaim the property the subject of this application on the basis that the property is burdensome, onerous and a liability, and its continued presence within the liquidation will unnecessarily and “unfairly” impede the winding up process. This application for leave to disclaim was initiated by a notice of motion which, on foot of directions given by the Court (Hogan J.) on 29th August, 2011, was served on Bank of Ireland, Wexford County Council, Padraig Kelly, Bridie Kelly and Lena Kelly. None of the notice parties appeared on the hearing of the application.
4. The property the subject of this application comprises the following two properties held under separate titles:
(a) The lands registered on Folio 11834F of the Register of Freeholders, County Wexford containing 0.202 hectares. At present, these lands consist of a secure concrete yard upon which stands a selection of sheds extending to 609 square metres. The yard is fenced and secure and its boundaries are clearly defined. The premises were formerly used as a builders’ providers yard. The Company is registered as full owner of this land on Folio 11834F, subject a charge in favour of Bank of Ireland which is registered as a burden on the Folio. No other burden is registered on the Folio.
(b) Unregistered land the subject of a conveyance dated 17th December, 1981, made between John Bennett of the first part, John Bennett of the second part and Kelly & Hannon Supplies Ltd. (the former name of the Company) of the third part, which land was described as being part of the lands of Kilderry containing 0.070 hectares as described on a map annexed to a Land Commission consent to subdivision dated 9th November, 1981. That property, which is on the opposite side of a tertiary road to the property referred to at (a) above, now comprises a large retail and storage premises, which was formerly a convenience store, hardware shop and post office. By virtue of the conveyance dated 17th December, 1981, the Company acquired that property in fee simple free from encumbrances. It is subject to an equitable mortgage by deposit of title deeds in favour of Bank of Ireland, which was created in or about May 1983.
5. The position, accordingly, is that when the Company acquired each of the properties, it was not subject to any covenants of any nature whatsoever.
6. The Company was party to a Deed of Grant of Easement dated 6th June, 2006, with three adjoining owners, Lena Kelly, Padraig Kelly and Bridie Kelly. That deed discloses that the Company’s property and the properties of two of the adjoining owners are serviced by a septic tank located on the property of the third adjoining owner and a percolation area located on the lands registered in Folio 11834F. The effect of that deed was to create reciprocal wayleaves and easements for the benefit of the Company’s property and the property of the two adjoining owners in relation to the septic tank, the percolation area and the service pipes serving both. The Deed contained a covenant by the three parties who obtained the benefit of the easements and wayleaves, including the Company, wherein they covenanted with each other to bear the expense of the maintenance of the septic tank system and the percolation area and connecting pipes equally between them and to indemnify the third adjoining owner, on whose land the septic tank is located, against such costs and expenses. That Deed was well drafted and, in my view, there is nothing onerous or burdensome about the obligations thereby undertaken by the Company, such obligations being proportionate to the benefit the Company acquired under the Deed.
7. As of May 2011, the estimated market value of the properties was €180,000 according to a valuation carried out by Sherry Fitzgerald Haythornthwaite. The matters which are cited by the applicant as liabilities due on the properties referred to at para. 4 above, apart from the charge and the equitable mortgage in favour of the Bank of Ireland, on foot of which in excess of €183,000 was due on 16th September, 2010, are the following:-
(a) sums aggregating in excess of €31,000 due to Wexford County Council in respect of outstanding financial conditions attached to a planning permission in relation to part of the property, unpaid commercial rates from 2009 to date, and unpaid water rates; and
(b) the costs which have been incurred by the applicant in maintaining and insuring the properties, which are covered up to the start of December 2011.
8. The applicant, in his grounding affidavit sworn on 24th August, 2011, has set out the difficulties he has encountered in endeavouring to sell the properties. He has elaborated on those difficulties in a supplemental affidavit sworn by him on 24th November, 2011. He has exhibited a report of a civil engineer, who was retained by prospective purchasers of the properties, which identified planning problems with the properties, the most significant problem relating to the septic tank system and the associated percolation area. The applicant has averred that these problems add to the difficulties in relation to selling the property. In addition, in the supplemental affidavit, the applicant has expressed concern in relation to the entitlement of the Company to access the yard on the land referred to at (a) in para. 4 above via a laneway, which is not in charge of the local authority and which is merely subject to consents in favour of the Company from five adjoining landowners, including the three parties to the Deed of Grant of Easement referred to at para. 6 above, which the applicant considers to be “quite limited”.
9. The core issue on this application is whether the property referred to at para. 4 above constitutes onerous property which may be disclaimed pursuant to section 290(1). In my view, it does not, unless it “consists of land of any tenure burdened with onerous covenants”. As a matter of construction, it does not come within “any other property which is unsaleable or not readily saleable by reason of its binding the possessor thereof to the performance of any onerous act or the payment of any sum of money”, which on a plain reading appears not to encompass land, shares or stock, or unprofitable contracts.
10. Having considered the title to both properties, I am of the view that neither property constitutes land which is “burdened with onerous covenants”. As I have stated, the Company obtains a proportionate benefit for the obligation it undertook in the Deed of Grant of Easement to pay one third of the cost of the maintenance of the septic tank system, the percolation area and the connecting pipes, which, insofar as it is a burden on the land and not merely personal, is the only burden which affects the properties. The fact that the Company, and the liquidator standing in the shoes of the Company, has liability for payment to the local authority of rates and such like and considers it prudent to maintain and insure the properties does not mean that the property comes within section 290(1).
11. In reaching that conclusion, I have considered the two authorities to which the court was referred by counsel for the applicant. However, in my view, they do not assist the applicant.
12. The earliest in time is the decision of Jessel M.R. in In re Mercer and Moore [1880] 14 Ch. D 287. The property at issue in that case was held under a fee farm grant, which contained a covenant to erect buildings within a year, to maintain the buildings in good repair, not to allow trades to be carried on and so forth. As Jessel M.R. pointed out, there were “all sorts of provisions, the neglect of which would certainly subject the legal owner of the land to an injunction, whether it would subject him to an action for a breach of covenant or not”. He held that the property was burdened with onerous covenants within the meaning of the section of the Bankruptcy Act 1869 similar to section 290(1).
13. The later authority was a decision of the Chancery Division of the English High Court in In re the Nottingham General Cemetery Company [1955] 1 Ch. 683. In that case, it was held that the court had jurisdiction to authorise the liquidator to disclaim a property which was used as a cemetery in Nottingham and which was subject to various restrictions created by a private Act of Parliament, which imposed restrictions on the manner in which grants could be made by the company of the right of burial or internment. Wynn-Parry J. rejected a submission that the obligation on the Company did not “touch or concern the land”, stating (at p. 691):
“Against this it was argued by [counsel for the liquidator]…that the restrictions are not personal but bind or touch and concern the land. The form of grant confers an exclusive right to burial in a specified part of the cemetery, a right which is evidenced by registration in the book kept for the purpose. It therefore necessarily follows that the land cannot be used for any purpose conflicting with that right. To adopt [counsel’s] test, let it be visualized that the land is sold. In such an event the purchaser must take with notice of the restrictions: and I cannot see that there would be any defence to an action for specific performance by the grantee against the purchaser. Nor is it any objection that the company’s obligations are negative in character: In re Mercer & Moore. I therefore hold that the land the subject of this summons is land burdened with onerous covenants within the meaning of section 323 of the Companies Act, 1948.”
I note that the Nottingham General Cemetery Company case is referred to in Forde and Kennedy on Company Law (4th Ed.) at p. 807 as “one instance” in which a liquidator was permitted to disclaim freehold land. However, the freehold land in that case was, as the Court found, unquestionably burdened with onerous covenants.
14. On this application, in my view, the applicant has not identified any covenant of a burdensome nature relating to the properties referred to in para. 4 above which touch and concern the land, in the sense of binding the possessor thereof qua possessor, unlike the situation which might prevail if the Company held the lessee’s interest under a lease or the interest of a grantee under a fee farm grant. Accordingly, in my view, the Court does not have jurisdiction to grant leave to the liquidator to disclaim the properties under s. 290(1) of the Act of 1963.
15. Although, having regard to the finding I have made, it is not necessary to consider the effect of a disclaimer on the notice parties, I consider it apt to make the following observations. If it were the case that I was satisfied that the properties do come within s. 290(1), the position of Bank of Ireland, which has chosen not to appear on the hearing of the application, would not militate against the making of the order sought, because disclaimer would not affect the securities held by Bank of Ireland (Tempany v. Royal Liver Trustees Ltd. [1984] ILRM 273). It appears that, prior to purporting to disclaim and prior to initiating these proceedings, the applicant requested Bank of Ireland to accept possession of the property. The response of Bank of Ireland was that it did not propose to accept possession of the property at that time, but that was without prejudice to its legal rights as mortgagee. It is clear from earlier correspondence exhibited by the liquidator that Bank of Ireland holds personal guarantees in relation to the indebtedness secured on the property. It was averred in the grounding affidavit of the liquidator that the guarantees were given by the directors of the Company, namely, Bridie Kelly and Padraig Kelly. While the directors as such guarantors would have a potential right of subrogation against the securities held by Bank of Ireland, they are on notice of this application and they have chosen not to appear.
16. The consequence of the finding that the property does not come within s. 290(1) is that it cannot be disclaimed so as to fall into what is referred as “the form of legal limbo” in the annotation on s. 290 contained in McCann and Courtney Companies Acts 1963 – 2009 (2010 Ed.). The property remains vested in the liquidator until the Company is dissolved, whereupon it will vest in the Minister for Public Expenditure and Reform by virtue of the provisions of the State Property Act 1954.
17. Unfortunately the Court does not have jurisdiction to assist the applicant in his endeavours to expedite the completion of the creditors’ voluntary winding up in the manner advocated. There will be an order dismissing the applicant’s application.
In the matter of Irish ISPAT Limited (in voluntary liquidation)
[2004] IEHC 278
Carroll J.
“Issue 2
In my opinion s. 290(1) cannot be construed so that property described as unsaleable does not have any further qualification. In my view the section must be read so that property is either unsaleable by reason of having to perform onerous acts or the payment of money, or not readily saleable for the same reasons. The purpose of the section is to allow disclaimer of onerous property. If the property is not subject to the performance of onerous acts or the payment of money there is no valid reason why a liquidator should seek or be allowed to disclaim.
Issue 3
Is the license property within the meaning of s. 290(1).
The nature of rights created by a licence has arisen in other cases. In Hempenstall v. Minister for Environment [1994] 2 I.R. 20 (dealing with taxi licences) Costello J. said at p. 28:
“Property rights arising in licences created by law (enacted or delegated) are subject to the conditions created by law and to an implied condition that the law may change those conditions. Changes brought about by law may enhance the value of those property rights (as the Regulations of 1978 enhanced the valuation of taxi plates by limiting the number to be issued and permitting their transfer) or they may diminish them (as the applicants say was the effect of the Regulations of 1992). But an amendment of the law which by changing conditions under which a licence is held reduces the commercial value of the licence cannot be regarded as an attack on the property right in the licence – it is a consequence of the implied condition which is an inherent part of the property right in the licence.”
In Maher v. Minister for Agriculture [2001] 2 IR 139, Keane C.J. left open the question of property rights in licences. He said at p. 186:
“It seems to me unnecessary in this context to consider whether rights in the nature of licences conferred by law in relation to particular property such as planning permission or licences for the sale of alcohol constitute property rights.”
In The State (Pheasantry) v. Donnelly [1982] I.L.R.M. 512 it was held that the holder of an intoxicating liquor licence does not have a property in the licence separate from the premises:
“The premises have an enhanced value as a result of the licence being attached thereto but the licence cannot be regarded as property capable of separation from the premises themselves.” (at p. 515)
This is not saying that the licence cannot be regarded as property.
I do not find the English cases Mineral Resources Ltd. [1999] 1 A.E.R. 746 or Celtic Extractions Ltd. [2001] Ch. 475 to be very helpful. The statutory scheme in the U.K. under the Environmental Protection Act, 1990 is materially different from the 1992 Act. The definition of property in s. 178 of the U.K. Insolvency Act, 1986 is materially different from s. 290 of the 1963 Act.
Also I am not convinced that in order to qualify as unsaleable/not readily saleable under s. 290, the property must be transferable by act of parties. Under the statutory regime instituted by the 1992 Act, s. 91(1), it is provided that the grant of the licence enures for the benefit of the activity and of all persons for the time being interested therein. Under sub-s. (2): where a licensee ceases to hold or transfers to another person his interest in the activity to which the licence relates he shall forthwith give his notice to that effect to the agency specifying in the case of a transfer of his interest the name of the person to whom his interest in the activity has been transferred. It follows that the transfer of rights under the licence is by operation of law.
If the licenced activity was potentially profitable, there was nothing to stop the Liquidator selling the business as a going concern, the value of which would be enhanced by the existence of the licence in the same way as a licensed premise derives a large part of its value from the existence of a liquor licence attached thereto. The sale of the business would also have to include the sale of the site to which the licence related. This would mean that the premises, the activity and the interest under the licence together were capable of constituting “saleable property”. In my opinion it is sufficient if it were capable of being saleable property even though the reality was that it was unsaleable because of onerous covenants and the payment of money. Therefore I am satisfied that taken together, the premises, the rights under the licence and the activity authorised by the licence constituted property within the meaning of s. 290.
The Liquidator did not transfer his interest in the activity or indeed in the premises. By operating the break clause in the lease the link between the premises where the activity had to be carried on and the licence was broken.
The EPA’s submission was that the licence was not unsaleable because of onerous covenants or the payment of money but rather that it was unsaleable because the licence had no existence independently of the activity.
That does not take account of the decision in Tempany v. Royal Liver [1984] I.L.R.M. 291 (Keane J.) which was cited in relation to the considerations to be taken into account by the court in an application for leave to disclaim. At p. 290 Keane J. considered the question of the date at which disclaimer should become operative in the case of a lease. He said the lessors were entitled to apportioned rent in full from the date of the appointment of the liquidator to the date on which they were given notice of the liquidator’s intention to disclaim. The order accordingly was that the disclaimer took effect from that date.
In this case, while the Liquidator was in correspondence about disclaiming the lease, the s. 290 application dated 27th June, 2002 claimed disclaimer of both the lease and the licence. So if the same principle applied, the latest date for the disclaimer to take effect would be that date or the date of service, if later. At this time the lease and the licence were together vested in the Company so that the licence did not suffer the infirmity of being separated from the premises. By analogy with the disclaimer of a lease, I am of opinion that the disclaimer of a licence, where allowed, would take place on the date notice was given. This predated the exercise of the break clause and accordingly the licence can be treated as property within the meaning of s. 290.
Issue 4
In considering whether the Liquidator should be permitted to disclaim the licence the court must take account of the interests of all parties interested in the liquidation. (Tempany v. Royal Liver [1984] I.L.R.M. 273) First of all, there are the creditors whose money this is and who would be most affected if there is no disclaimer of the licence.
Next there is the EPA, the grantor of the licence. I take into account (as has already been mentioned in connection with the s. 58 application) that the Company operated legally without conditions under the 1992 Act until the EPA granted an IPC licence after the Company had given up production and given notice to creditors. It is not clear to me why the EPA issued the licence in circumstances where it was clear it would never be operated. I consider that the completion of work in progress by the Liquidator was done in his capacity as Liquidator rather than taking over or adopting the licence for the benefit of the liquidation.
The State having failed in its application under s. 58, does not have an interest in the winding up.
In my opinion this is an appropriate case in which to allow disclaimer of the licence.
Boylan -v- Governor and Company of Bank of Ireland
2012 IEHC 386
Laffoy J.
“The law
17. The Court has had the benefit of written submissions from both sides, which were not only thorough and comprehensive, but also raised interesting points. Although I do not propose outlining the submissions in detail, I have had regard to them.
18. In relation to subs. (1) of s. 286, while it is more user-friendly than its predecessor, which necessitated applying s. 53 of the Bankruptcy (Ireland) Amendment Act 1872, which, as amended by the Act of 1963, was set out in the Eleventh Schedule to the Act of 1963, I am satisfied that there is no difference of substance between it and its predecessor. In relation to its application to the facts underlying this application, the principal ingredients of subs. (1) in its current form and their application are as follows:
(a) That a payment was made by the Company in favour of a creditor. That ingredient is present here because the relationship of debtor and creditor arose between the Company and the respondent because the current account was overdrawn at all material times.
(b) That the Company was unable to pay its debts as they became due, when the payment was made. As I have already indicated, I am assuming that from 8th April, 2010 onwards the Company was not able to pay its debts as they became due.
(c) That the payment was made with a view to giving the creditor, that is to say, the respondent, or any surety or guarantor of the debt due to the creditor, that is to say, Mr. Kerr, a preference over other creditors. That is the crucial ingredient in this case. It is well settled that the onus of proof of a dominant intention to prefer under subs. (1) lies on the liquidator, that is to say, in this case, on the applicant. The jurisprudence on establishing an intention to prefer is succinctly summarised in the following passage from the annotation on s. 286 in MacCann and Courtney Companies Act 1963 – 2009) (2010 E Book, Bloomsbury):
“In order to prove that a transaction is a preference, it is not sufficient to show that the effect of the transaction was to give a preference; rather the phrase ‘with a view to giving . . .’ has been interpreted as meaning that the transaction must have been entered into with a dominant intention to prefer. It is not enough to prove that there was actual preferment from which an intention to prefer can, with hindsight, be inferred. The liquidator must prove an intention to prefer at the time the payment is made. Where there is no direct evidence of intention, the court can draw an inference of an intention to prefer in a case where some other possible explanation is open. The method of ascertaining the state of mind of the payer is the ordinary method of evidence and inference, to be dealt with on the same principles which are commonly employed in drawing inferences of fact.”
(d) That the winding up of the Company must have commenced within six months of the making of the payment. That requirement is complied with in relation to all the payments made after 8th April, 2010.
(e) That at the commencement of the winding up the Company is unable to pay its debts. I am satisfied that that requirement is complied with.
19. In my view, as a matter of construction, subs. (3) of s. 286 has no application to the facts here. The expression “[a] transaction to which subs. (1) applies” in subs. (3) captures, inter alia, any payment made by the Company in favour of a creditor. If the creditor is a connected person within the meaning of subs. (5) then there is a presumption of preference within the two year period provided for in subs. (3). However, in this case, the transaction was in favour of the respondent, who is not a connected person, so there is no presumption of preference. Indeed, in the applicant’s solicitors’ preliminary letter dated 14th October, 2010 only subs. (1) of s. 286 was invoked.
20. As regards the crucial ingredient, the requirement that the applicant prove, on the balance of probabilities that the dominant intention, when the payments were made by the Company to the respondent was to prefer the respondent, and, indirectly, to prefer Mr. Kerr, the authorities which have been cited by the parties which, in my view, are of most relevance in determining whether the applicant has discharged that onus are the following: the decision of the Court of Appeal of England and Wales in Re M. Kushler Limited [1943] Ch. 248; and the decision of the High Court (Carroll J.) in Station Motors Ltd. v. AIB Ltd. [1985] I.R. 756. I propose considering each of those authorities, to which counsel for the applicant attached most weight, in detail.
21. A key feature of the legal submissions made on behalf of the applicant was reliance on the so called Rule in Clayton’s Case. The position adopted on behalf of the respondent is that the Rule is of no relevance to the issue before the Court. I will consider whether it is or is not of relevance later.
Re M. Kushler Limited
22. In the Kushler case, the company’s bankers, Lloyds Bank, granted the company a permitted overdraft of £800, secured by the guarantee of the majority shareholder and director, Morris Kushler, for the total amount of £900. The overdraft stood at varying amounts down to 10th May, 1941, when it stood at just over £609. On 12th May, 1941, the directors were advised that the company was insolvent and must be wound up. Between 12th May and 21st May, 1941, sums amounting to in excess of £730 were received by the company and paid into the company’s account at the bank, with the result that the overdraft was extinguished and Mr. Kushler was relieved of liability under his guarantee. The liquidator claimed that the payments to the bank constituted a fraudulent preference and relied on the following matters in support of that claim:
(a) that between 10th May and 31st May substantially no payments were made by the company to existing creditors;
(b) that a trade creditor had been pressing for payment of its February account of in excess of £88 since the beginning of April but at the request of Mr. Kushler had consented to wait if half the amount was paid by the end of April, but no part of it had been paid;
(c) that the bank never pressed for reduction of the overdraft and up to 23rd May would have allowed the company to operate up to the limit of their permitted overdraft;
(d) that, although on 14th May there was still an overdraft, no notice of the creditors’ meeting was sent to the bank; and
(e) that at the meeting of creditors, in answer to a creditors’ question, Mr. Kushler falsely stated that the guarantors were third parties.
The Court of Appeal held that, on the facts, fraudulent preference had been established.
23. In his judgment, Lord Greene M.R., having stated that the period to which attention must be drawn was between 10th May and 23rd May and that the question was what inference ought to be drawn from the evidence, stated (at p. 251):
“The weight of evidence of conduct in these cases may vary very much according to the type of case with which the court is concerned. In some cases the circumstances may be insufficient to justify an inference of an intent to prefer, but at the other end of the scale comes the type of case, which is extremely familiar nowadays, where the person (such as a director) who makes the payment on behalf of the debtor is himself going to obtain by means of it a direct and immediate benefit. These cases of guarantees of overdraft and securities deposited to cover overdrafts are very common, and where directors have given guarantees the circumstance of a strong element of private advantage resulting from payment of the debt may justify the court in attaching to the other facts much greater weight than would have been attached to similar facts in a case where that element did not exist.”
Lord Greene concluded that, taking the whole situation in that case, the proper inference to be drawn was that the payments made after 10th May were made with a view to giving to the bank a preference over the other creditors and so discharging the guarantee. Later, Lord Greene stated (at p. 252):
“The statute is directing the court to ascertain the state of mind of the payer in relation to a particular transaction. A state of mind is as much a fact as a state of digestion and the method of ascertaining it is by evidence and inference, and I can see nothing in the language of the section which justifies the view that the problem which the legislature sets the court is to be dealt with on any principles different from those commonly employed in drawing inferences of fact. It must, however, be remembered that the inference to be drawn is of something which has about it, at the least, a taint of dishonesty, and, in extreme cases, much more than a mere taint of dishonesty. The court is not in the habit of drawing inferences which involve dishonesty or something approaching dishonesty unless there are solid grounds for drawing them.”
That passage is the authority for the last sentence of the passage from MacCann and Courtney which has been quoted earlier.
24. The judgment of Goddard L.J. in the Kushler case is also cited frequently. He stated (at p. 255):
“The authorities establish that the mere fact that a preference is shown is not sufficient to enable the court to draw the inference that that preference was fraudulent. Before that inference can be drawn the court must be satisfied that the dominant motive of the debtor was to prefer the particular creditor. It would be dangerous to attempt to lay down any particular circumstance or set of circumstances from which the court was or was not justified in drawing that inference, except to say that the mere fact that a preference is shown is not sufficient. For the rest, the matter stands as it does in any matter relating to a state of mind. Where in any criminal or civil court the person on whom the onus lies proves no more than a state of facts equally consistent with guilt or innocence, it is impossible to draw the inference of guilt. To give a person the benefit of the doubt only means that the case against him is not proved beyond reasonable doubt, and, therefore, fails. . . . In my view, for the reasons given by the Master of the Rolls, the inference of an intention to prefer here is overwhelming . . ..”
Station Motors Limited v. AIB Ltd.
25. There were a number of issues in the Station Motors case. However, the facts relevant to the issue which bears on the application of s. 286(1) were that Station Motors Ltd. was effectively controlled by two directors, William Murphy and his wife. On 16th June, 1980, by joint and several guarantee, Mr. Murphy and his wife guaranteed the obligations of the company to the defendant bank on foot of its current account up to £75,000 with interest. The company went into liquidation on 3rd October, 1980, the company being insolvent, on foot of notice to convene an extraordinary general meeting which issued on 15th September, 1980. Between 15th September, 1980 a sum in excess of £23,278 was lodged to the company’s current account. During the same period six cheques totalling in excess of £8,057 were honoured by the bank, of which one was payable to Mr. Murphy in the sum of £2,730 and was drawn on 16th September, and the other five were drawn prior to 15th September. The bank’s evidence was that those cheques were paid following representations from Mr. Murphy. During the same period four cheques totalling £2,321 were presented but were not honoured.
26. Against those facts, the first issue the Court had to decide was whether the lodgments made after 15th September, 1980 constituted a fraudulent preference within the meaning of s. 286(1). In addressing that issue, Carroll J., having stated that there was no direct evidence by Mr. Murphy as to what his intention was, continued (at p. 761):
“Nevertheless the court is not precluded from drawing an inference of an intent to prefer. Re M. Kushler Limited . . . deals with the following points: –
1. The phrase “with a view to giving such creditor a preference’’ means that the intention to prefer must be the dominant intention which actuates the payment (per Lord Greene M.R. . . .).
2. It is not enough to prove that there was actual preferment from which an intention to prefer can, with hindsight, be inferred. The liquidator must prove an intention to prefer at the time the payment is made (per Goddard L.J. . . .).
3. Where there is no direct evidence of intention, there is no rule of law which precludes a court from drawing an inference of an intention to prefer, in a case where some other possible explanation is open (per Lord Greene M.R. . . ). . . .
4. The method of ascertaining the state of mind of the payer is the ordinary method of evidence and inference, to be dealt with on the same principles which are commonly employed in drawing inferences of fact (per Lord Greene M.R. . . ).”
27. Carroll J. stated that, having considered the established facts in the case before her, she was satisfied that the overwhelming inference to be drawn from those facts was that the lodgments made after 15th September, 1980 were made with the composite intention to prefer (a) the bank as a direct creditor and (b) the Murphys themselves as guarantors of the company’s overdraft. She then outlined the facts which supported that view as follows:
(a) The case was a guarantee case, and the guarantee which had been £30,000 in January 1980 had been increased to £70,000 in June 1980.
(b) Given that at a directors’ meeting of 15th September, 1980 it was resolved to convene the extraordinary general meeting and the creditors’ meeting for the purposes of a creditors’ voluntary winding up, the inference had to be drawn that, on and from 15th September, the directors knew that the company was insolvent.
(c) Only six cheques were paid out of the company’s account on and after 15th September and then only as a result of special representations made by Mr. Murphy. It had been argued by the bank that the account was being operated normally in the ordinary course of business because of the payment of those six cheques. However, Carroll J. found exactly the opposite; the necessity to make a special case for those cheques inferred that the account was not being operated normally. The fact that one of the cheques was drawn after 16th September by Mr. Murphy did not weaken the inference of an intention to prefer the bank, which was coupled with an intention to prefer the guarantors. The payment of the cheque for £2,730 to Mr. Murphy was a direct preferment of him rather than an indirect preferment by reducing the amount payable on foot of the guarantee.
(d) The payment of the five other cheques did not negative an intention to prefer the bank directly and the guarantors indirectly. In proportion to the lodgments, the amounts involved in the four cheques were very small.
(e) Once the directors had decided on 15th September to hold the meetings for a creditors’ voluntary winding up, there could not be normal trading, as the company at that stage must have been unable to pay its debts.
On the basis of the foregoing facts, Carroll J. found the inference overwhelming that the lodgments after 15th September were made to prefer the bank directly and the guarantors indirectly and that was the dominant purpose of the lodgments.”
Devey Enterprises Ltd [in voluntary liquidation] -v- Companies Acts
[2011] IEHC 340
Laffoy J.
“5. The Statutory Provisions Invoked
5.1 The distinction between fraudulent preferences and fraudulent dispositions and specifically the distinction between s. 286 of the Act of 1963 and s. 139 of the Act of 1990 is explained in Courtney on “The Law of Private Companies” (2nd Ed. 2002) at para. 27.096 as follows:-
“There is a distinction between fraudulent preferences and fraudulent dispositions, as Warner J. observed in Clasper Group Services Limited [[1989] B.C.L.C. 143 at 148] when he said:-
‘…there is a distinction between a payment to a creditor as such and a payment which, albeit made to a person who is a creditor, is a sheer misapplication of the company’s money.’
Section 139…does not apply to fraudulent preferences, which are addressed by…s. 286. Section 139 can be analysed by counter reference to the limits of s. 286… Accordingly, it is irrelevant for the purposes of s. 139 that the company was insolvent at the time of the disposition or that it was made to a creditor, or that the disposition was made within a certain time frame. There needs only to be a disposal where the effect is to perpetrate a fraud on the company, its creditors or its members.”
5.2 If I understand the case made by the liquidator correctly, it is that the company’s money was misapplied in that it was gifted to or used to discharge the personal debts of the respondents, who were the directors of the company. As I understand the case, it is not that, in relation to the money in issue, the respondents, as creditors, had an entitlement to the money and they were preferred over other creditors of the company at a time when the company was insolvent. In other words, the liquidator’s case is that the respondents had no entitlement whatsoever the money in issue, being sums either paid to them or to third parties at their direction. In the circumstances, it seems to me that s. 286 has no application.
5.3 Subsection (1) of s. 139, insofar as it is relevant for present purposes, provides as follows:-
“Where, on the application of a liquidator…of a company which is being wound up, it can be shown to the satisfaction of the court that –
(a) any property of the company of any kind whatsoever was disposed of either by way of conveyance, transfer, mortgage, security, loan, or in any way whatsoever whether by act or omission, direct or indirect, and
(b) the effect of such disposal was to perpetrate a fraud on the company…the court may, if it deems it just and equitable to do so, order any person who appears to have the use, control or possession of such property or the proceeds of the sale or development thereof to deliver it or pay a sum in respect of it to the liquidator on such terms or conditions as the court sees fit.”
5.4 Strangely, despite the fact that twenty years have elapsed since s. 139 was enacted, it has been the subject of very little judicial consideration. The annotation on s. 139 contained in MacCann & Courtney “Companies Acts 1963 – 2009” (2010 Ed.) at (p. 1302) sets out the current state of the jurisprudence on that provision as follows:-
“In some respects the provisions of s. 139 represent a statutory embodiment of the principles enunciated in Re Frederick Inns Limited [[1994] 1 ILRM 387]. In order to set aside a disposition of assets the liquidator does not have to prove that the company intended to defraud its creditors. Rather, he has the lower evidential burden of merely establishing that the effect of the disposition has been to defraud the creditors. However, in Re Comet Food Machinery Co. Ltd. [[1999] 1 ILRM 475] the Supreme Court observed, albeit obiter, that the section could be invoked if it were established that assets had been diverted with a view to frustrating a judgment against the company. This is hardly a controversial observation since, in such circumstances, the disposition would not only have had the effect of defrauding the creditors; rather, it would have been intended to defraud them. More recently, in Le Chatelaine Thudichum Ltd. v. Conway [[2008] IEHC 349] Murphy J. has held that the effect of a transaction is to perpetrate a fraud where the company, its creditors or members are deprived of something to which it is, or they are, lawfully entitled.”
5.5 In essence, what the liquidator’s review and analysis of the books and records of the company indicates is that the company’s money was gratuitously paid to or used to discharge the personal liabilities of the respondents. The only reasonable inference which can be drawn from the evidence is that this was done at the direction of the respondents. Further, to the extent that that happened, the respondents did not at any time reimburse the company. Therefore, in reality, the respondents procured a gratuitous disposition of the company’s money in their own favour. I am satisfied that the effect of the making of the payments identified by the liquidator, which were made by the company to the respondents or in discharge of the respondents’ liabilities, was to perpetrate a fraud on the company and its creditors. As I have noted earlier, according to the statement of affairs produced at the extraordinary general meeting of the company and at the creditors’ meeting on the 10th October, 2007, as of that date, the company’s deficit was €1,971,857.54. It seems to me that it is just and equitable that the respondents, who procured benefits from the depletion of the assets of the company to the extent assessed by the liquidator, should be directed to repay an equivalent sum to the liquidator on behalf of the company in liquidation.”
Le Chatelaine Thudicum Ltd (in voluntary liquidation) -v- Conway
[2008] IEHC 349
Murphy J.
“2. Fraudulent preference
So far as material, s. 286(1) of the Companies Act 1963, as amended by s. 135 of the Companies Act 1990, provides:
“Subject to the provisions of this section, any…delivery of goods, payment, execution or other act relating to property made or done by or against a company which is unable to pay its debts as they become due in favour of any creditor…with a view to giving such creditor…a preference over the other creditors, shall, if a winding-up of the company commences within 6 months of the making or doing the same and the company is at the time of the commencement of the winding-up unable to pay its debts (taking into account the contingent and prospective liabilities), be deemed a fraudulent preference of its creditors and be invalid accordingly.”
It is settled law that, to succeed in an application under this provision, the liquidator must prove that the transfer of property or funds was carried out with the dominant intention of preferring the recipient over the other creditors (Corran Construction Co. Ltd. v. Bank of Ireland Finance Ltd. [1976-77] ILRM 175 at 178; Station Motors Ltd v. AIB Ltd. [1985] I.R. 756 at 760). Where the court is faced with a member or director who has effective control over the affairs of the company, it may attribute his state of mind in this regard to the company (Corran Construction [1976-77] ILRM 175 at 178; Station Motors [1985] I.R. 756 at 761).
In Station Motors, Carroll J. accepted the principle laid down in Re M Kushler Ltd [1943] 1 Ch 248 that an intention to prefer cannot be inferred in hindsight merely from the fact that an actual preferment occurred. However, in the absence of direct evidence of intention it remains possible for the court to infer intention, even where an alternative explanation is open (Station Motors [1985] I.R. 756 at 761). Nevertheless, Carroll J. sounded a cautionary note, quoting the following passage from the judgment of Lord Greene MR in Kushler:
“It must, however, be remembered that the inference to be drawn is of something which has about it, at the least, a taint of dishonesty, and, in extreme cases, much more than a mere taint of dishonesty. The court is not in the habit of drawing inferences which involve dishonesty or something approaching dishonesty unless there are solid grounds for drawing them.” ([1943] 1 Ch 248 at 252).
3. Fraudulent disposition
Section 139(1) of the 1990 Act provides:
“Where, on the application of a liquidator, creditor or contributory of a company which is being wound up, it can be shown to the satisfaction of the court that—
( a ) any property of the company of any kind whatsoever was disposed of either by way of conveyance, transfer, mortgage, security, loan, or in any way whatsoever whether by act or omission, direct or indirect, and
( b ) the effect of such disposal was to perpetrate a fraud on the company, its creditors or members, the court may, if it deems it just and equitable to do so, order any person who appears to have the use, control or possession of such property or the proceeds of the sale or development thereof to deliver it or pay a sum in respect of it to the liquidator on such terms or conditions as the court sees fit.
(2) Subsection (1) shall not apply to any conveyance, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company to which section 286(1) of the Principal Act applies.
(3) In deciding whether it is just and equitable to make an order under this section, the court shall have regard to the rights of persons who have bona fide and for value acquired an interest in the property the subject of the application.”
It is apparent from the terms of this provision that, before it can make an order under s. 139, the court must be satisfied that all of the following criteria are met:
(i) there was a disposition
(ii) of company property
(iii) the effect of the disposition was to perpetrate a fraud either on the company, its creditors or its members.
Insofar as the meaning of the term disposition is concerned, the section is drafted in very broad terms apt to encompass almost any kind of transaction. For our purposes it is clear that the company, acting through Mr. Thudichum, gave the respondent possession of the stock and cash involved in the transaction. On the date of that transaction the company was insolvent and the respondent, with the co-operation of the applicant, resumed control of the premises together with all stock and cash thereon, and resumed trading in the ordinary course. This appears sufficient to come within the ambit of the section. The court must then consider and decide what the extent of the company’s stock was at the time of the transaction.”
Kennington (Official Liquidator) -v- McGinely
[2014] IEHC 356
Charleton J.
“In order to achieve an order under the section, a liquidator must establish that the dominant intention behind the disposition was to prefer the beneficiary; Corran Construction Company Limited v Bank of Ireland Finance Limited [1976, 1977] ILRM 175. At a remove of several years from the time of a transaction, and in the absence of direct evidence, intention may be impossible of direct proof. Instead, circumstantial evidence allows an inference of intention to be drawn in the appropriate circumstances; Station Motors Limited v Allied Irish Banks Limited [1985] IR 175. The latter authority, drawing on Re M Kushler Limited [1943] 2 All ER establishes four propositions as to the appropriate approach. These are that: firstly, dominant intention is required; secondly, hindsight may suggest such an intention but that is not enough since the circumstances seen in the light of what subsequently happened may mislead and instead an intention to prefer must be proven as of the time of the relevant disposition; thirdly, circumstantial evidence is to be assessed as to its probability, the fact that there might be another explanation for a payment is to be assessed as to the competing proofs and is not necessarily an answer; fourthly, since what is involved here is a fraudulent preference, solid grounds are needed since what is required is an inference of something which has the taint of dishonesty about it at the very least and which in extreme cases may be very much more than that. While in Re Patrick and Lyon Limited, Maugham J had doubted that moral blame was a necessary proof to make out a fraudulent preference, the later Kushler case establishes that the onus on a liquidator is not discharged where the state of facts established is consistent with both an unfavourable and a favourable inference; doubts as to the probable inference to be resolved against the party bearing the burden of proof. In both Re M Kushler Limited and Station Motors Limited v Allied Irish Banks Limited, the High Court was compelled to infer an intention to prefer because the purpose of the payments had been proven to be to reduce the amount of an overdraft on the bank accounts of both companies, which had been personally guaranteed in each instance by the directors. Thus the approach is to seek out the state of mind of the officer or officers of the company making the disposition judged from the circumstances as a whole and drawing such inferences as are appropriate; Re Clasper Group Services Limited [1989] BCLC 143.
Section 139 of the Companies Act 1990 provides as follows:
(1) Where, on the application of a liquidator, creditor or contributory of a company which is being wound up, it can be shown to the satisfaction of the court that—
(a) any property of the company of any kind whatsoever was disposed of either by way of conveyance, transfer, mortgage, security, loan, or in any way whatsoever whether by act or omission, direct or indirect, and
(b) the effect of such disposal was to perpetrate a fraud on the company, its creditors or members, the court may, if it deems it just and equitable to do so, order any person who appears to have the use, control or possession of such property or the proceeds of the sale or development thereof to deliver it or pay a sum in respect of it to the liquidator on such terms or conditions as the court sees fit.
(2) Subsection (1) shall not apply to any conveyance, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company to which section 286 (1) of the Principal Act applies.
(3) In deciding whether it is just and equitable to make an order under this section, the court shall have regard to the rights of persons who have bona fide and for value acquired an interest in the property the subject of the application.
Proof of intention, in contrast to section 286, is not required. What is required is that a liquidator show that any property of a company was disposed of and that the effect of that was to perpetrate a fraud on the company. In this section, unlike in section 286, a broad authority is vested in the court since an order for repayment should only be made against any person to repay money or restore property where it is just and equitable to do so. In making any such decision, a court is obliged to have regard to the rights of those who have acted in good faith and have for fair value accepted such a disposal of company property. Here, a court is concerned with effect and not with intent; Le Chatelaine Thudicum Limited (In Liquidation) v Conway [2010] IR 529.
Fundamental to both sections, however, is the nature of the duties that are cast on company directors once a company becomes insolvent. In such circumstances, once a company has to be wound up and its assets applied in discharge of its liabilities, the directors have a duty to the creditors to preserve the assets to enable this to be done or as least not to dissipate same; Re Frederick Inns Limited [1994] 1 ILRM 187. That duty applies once it becomes clear that a company is insolvent; McLaughlin v Lannen (Re Swanpool Limited) [2005] IEHC 341 at 3.1.”
Tucon Process Installations Ltd -v- Bank of Ireland
[2015] IEHC 312
Hunt J.
“s.139 of the 1990 Act
This section provides an addition to the provisions of the 1963 Act. It is described as a power of the court to order the return of assets which have been improperly transferred. s.139 effectively provides that where the court is satisfied on the application of a liquidator, creditor or contributory that company property was disposed of with the effect that such disposal perpetrated a fraud on the company or its creditors or members, it may make various orders in respect thereof on a “just and equitable” basis. It also provides that s.139 does not apply to transactions to which s.286 of the 1963 Act applies.
Consequently, the availability of relief under this section requires proof of a disposal of property accompanied by the effect of the perpetration of a fraud on the company, or its creditors or members. It does not require proof of an intention to defraud, merely that the impugned transaction has that effect.
The important distinction between fraudulent preferences and fraudulent dispositions was noted by Warner J. in Clasper Group Services Ltd. [1989] BCLC 143, when he said:-
“….There is a distinction between a payment to a creditor as such and a payment which, albeit made to a person who is a creditor, is the sheer misapplication of the company’s money”.
The courts in Ireland have held that the following behaviour has had the effect of constituting a fraudulent disposition for the purposes of s.139:-
1. Entry on to company premises and the taking of possession of a cash sum and the entire stock of an insolvent company in lieu of rent owed: Le Chatelaine Thudichum Ltd. v. Conway [2010] 1 IR 529.
2. Personal expenditure by company directors which had been recorded as business expenditure on behalf of the company: Devey Enterprises Ltd. v. Devey [2012] 1 IR 127.
3. Payment of the proceeds of company sales at a restaurant to a related company: Kirby (as liquidator of Citywest Hire Limited v. Petrolo Limited and Stokes [2014] IEHC 279.
4. The use of company funds to settle the private debts of a company director: Kirby (as official liquidator of MPS Global Limited) v. Muldowney [2014] IEHC 318.
The courts have equally held that where the company has received a benefit from a disposition, such as where sums were used to discharge the liabilities of the company to employees or suppliers, such sums do not fall to be repaid under the section, on the basis of the “just and equitable” provision therein. In Petrolo Limited Finlay Geoghegan J. stated as follows:-
“On the evidence before the court, I find…that the sum of €29,334.92 was paid out of the Petrolo account to the employees of Citywest for the period up to and including 9 June 2013, in which they were employed by and worked for the benefit of Citywest. It appears just and equitable that such sum should be excluded from any order for payment now to be made.
Similarly, on the facts before the court, I find, on the balance of probabilities that a sum of €12,664.31 was paid to suppliers of Citywest in the period up to 10 June 2013 for the purpose of the continued trading of Il Segreto restaurant. Again, it appears just and equitable that this sum be excluded from any order for payment against the respondents.”
The principles to be discerned in relation to s.139 from these cases are that improper dispositions or misapplications of company property will be caught by the section, but payments or dispositions in favour of creditors or employees for the benefit of the company concerned will not be included in an order made under the section. A simple payment made to an unsecured creditor when the company is insolvent will not, without more, trigger the operation of the section. It is not the case that every otherwise lawful payment made by an insolvent company to a legitimate unsecured creditor will automatically amount to a fraudulent disposition. The type of additional ingredient necessary to trigger the application of the section is illustrated by the features of the cases listed above. The additional ingredient must amount to an impropriety before the provisions of the section are engaged.
This point is further demonstrated by the observation of Laffoy J. in Devey that in some respects, the provisions of s.139 represent a statutory embodiment of the principles enunciated by the Supreme Court in Re Fredericks Inns Limited [1994] 1 I.L.R.M. 387. In that case, an arrangement was entered into by a group of insolvent companies with the Revenue to repay a total of IR£1.2 million in discharge of their respective liabilities to the Revenue Commissioners. However, the only element of the payments that was declared by the Supreme Court to be unlawful and therefore repayable by the Revenue Commissioners was the amount which each of the companies had paid out of their own assets to the Revenue Commissioners in respect of monies owed not by the individual companies concerned, but by other companies in the same group to the Revenue Commissioners.
The distinction made by the Supreme Court between payments made for the benefit of the company and payments made for the benefit of others is entirely consistent with the approach subsequently taken by the High Court in the case law pertaining to s.139. Two basic principles emerge from this collection of authorities. Firstly, the purpose of this section is to address and correct situations where company property has been diverted for improper purposes, to the detriment of the company, its members or creditors. Secondly, the “just and equitable” provision in the section prevents ordinary payments to creditors or suppliers which accrue to the benefit of the company, as opposed to any third party, from being regarded as being tantamount to a fraud on the company, its members or other creditors.
Application of these principles to the facts of this case suggest that the respondent should not be subject to a repayment order under s.139 unless receipt of the payments made to the company current account by third parties should be regarded as a wrongful diversion or misapplication of company funds, with an effect equivalent to fraud, because they had the incidental effect of reducing the applicant’s indebtedness to the respondent.
The fact that ordinary payments into an overdrawn bank account may subsequently have the effect of preferring the bank if they happen not to be followed by any withdrawals before the date of liquidation does not necessarily indicate action tantamount to fraud. When the matter is put in this way, it shows clearly that the section ought to have no application to circumstances where a bank operates a company current account in the ordinary course of business and in accordance with applicable contractual obligations prior to the operative date of a voluntary creditors winding up.
In such circumstances, the bank simply operates a current account by receiving or disbursing payments in accordance with the relevant mandate. Ordinary payments in and out of a company current account facilitate and benefit the operation of the company business. Absent proof of other circumstances, such payments cannot be regarded as being equivalent to a fraud upon the company, its members or other creditors.
Neither the company nor the bank had any particular input into the receipt of any of the three third party payments in question. The creditors’ voluntary winding up did not become operative until the necessary resolution was passed at the meeting on 4 May 2012. The mere fact that the respondent was on notice of the intention to hold this meeting did not of itself entitle it to amend the ordinary operation of the company current account. To hold otherwise would be to alter the clear provisions of the 1963 Act as they relate to such situations, and would import uncertainty into banking and business arrangements. Certainty is provided by fixing the date of assessment of the ultimate balance in the current account as the date of the passing of the resolution to wind up.
By acting to rule the account before the necessary resolution was passed at the creditors meeting, the respondent would be anticipating the outcome of that statutory meeting. Until the status of the customer is changed by operation of law, the respondent is obliged to continue to operate the current account in accordance with applicable contractual arrangements. In these circumstances, it is required to process ordinary payments in and out of the account by or for third parties until a liquidator is validly appointed. If it was obliged to refuse to accept payments in these circumstances, as contended by the applicant, presumably it would also be entitled to refuse to honour payments made by the applicant and received in good faith by third parties.
This cannot be the effect of a statutory provision designed solely to either prevent or correct dispositions of company property having an effect equivalent to a fraud, unless the words of the section plainly encompass this scenario. To have this character, the payments must feature something other than receipt or application of funds by the respondent in the ordinary course of a banking relationship. There is no evidence at all to suggest that the payments in issue here are tainted by any quality imparting to them an effect equivalent to fraud. If in some demonstrable way they were not made or received in the ordinary course of business, this could in other circumstances supply the essential additional element required to attract operation of the section in issue.
The balance in the current account as of the effective date of the winding up in this case was simply the product of the ordinary operation of the account, and might have been higher or lower depending on the unplanned or undirected actions of third parties or the company on or before that date. It did not depend in any way on particular dispositions made by either of the parties to the account, nor is there evidence that any of the transactions in question were implemented or managed with either the intention or the effect of improperly diverting or misapplying company property. The respondent may have been indirectly benefited by the reduction of the company overdraft consequent on the receipt of payments, but it might equally have been indirectly prejudiced by payments properly issued by the company to third parties out of the account in the period prior to winding up.
Some further or other ingredient must be present before the receipt or the making of payments on a current account could be regarded as the diversion of company property with an effect equivalent to a fraud on a relevant party. These items were payments simpliciter and did not amount in any sense to a “sheer misapplication” of company property. It would not be “just and equitable” or otherwise appropriate to make an order for repayment under s.139 in such circumstances. To hold otherwise would be to potentially invalidate all payments or receipts, on the sole basis that they are made against a background of insolvency. The remedy for improper trading whilst insolvent is to be found elsewhere in the relevant legislation.
It cannot be concluded that the bare fact that a banker has knowledge or information that a company is insolvent is sufficient in itself to outlaw or render fraudulent ordinary payments in or out of the company account pending the legal commencement of a subsequent liquidation. If that was the conclusion or outcome intended by the legislature in enacting s.139, it is not apparent from the plain meaning of the words actually used in enacting the section, and could have been achieved by a simple provision to that effect, without reference to the concept of fraud.
The application herein must be dismissed on the merits, as the applicant has not discharged the burden of proving that the receipt of third party payments by the respondent had an effect amounting to fraud, as well as by reason of lack of the requisite statutory standing on the part of the company. As a consequence, no other order or direction arises under the provisions of s.280 of the 1963 Act.
32. This may appear harsh insofar as the bank is concerned. However, that cannot be a valid reason for construing the Section in a way which banks might regard as more satisfactory from their own commercial point of view.
33. As Murphy J. pointed out in PMPA Coaches Limited (Judgment delivered on the 15th of June 1993):-
“…all payments made subsequent to the presentation of the petition are void unless and to the extent that the same are validated by an express order of the Court. The hardship which flows from this express statutory provision could not be of itself a ground for validating a payment. Such a principle would constitute an effective repeal of the statutory provision.”
34. To uphold the contention of the Bank would in my view effectively truncate the section.
35. However, the Court retains the important power of validation. This gives the Court a wide discretion to ameliorate and mitigate the rigours of Section 218.”
O’Connors Nenagh Shopping Centre [in liquidation] -v- Companies Acts
[2011] IEHC 508
Gilligan J.
“The Law
13. Carroll J. in Station Motors Limited v. AIB Ltd [1985] I.R. 756 at p. 760, very adroitly summarises the situation that arises herein:-
“It is common case that the onus is on the liquidator to establish a dominant intention to prefer one creditor over another see: Corran Construction Company Limited v. Bank of Ireland Finance Limited (Unreported, High Court, McWilliam J., 8th September, 1976). Since this is a Company managed and run by Mr. Murphy, it is Mr. Murphy’s intention which falls to be considered. There is no direct evidence here by Mr. Murphy as to what his intention was. Nevertheless the court is not precluded from drawing an inference of an intent to prefer. Re M. Kushler Limited [1943] 2 All E.R. 22 deals with the following points:—
1. The phrase “with a view to giving such creditor a preference” means that the intention to prefer must be the dominant intention which actuates the payment (per Lord Greene M.R. at page 24).
2. It is not enough to prove that there was actual preferment from which an intention to prefer can, with hindsight, be inferred. The liquidator must prove an intention to prefer at the time the payment is made (per Goddard L.J. at page 28).
3. Where there is no direct evidence of intention, there is no rule of law which precludes a court from drawing an inference of an intention to prefer, in a case where some other possible explanation is open (per Lord Greene M.R. at page 26).
Also in relation to the absence of direct evidence as to intention, Lord Greene M.R. says at p. 27:— “. . . it does not seem to me that he (i.e. Lord Tomlin in Peat v. Gresham Trust Limited [1934] A.C. 252) could have meant that in every case where there is no direct evidence you are bound to say the onus is not discharged on the grounds that there may have been another explanation. Of course, there may have been other explanations. One can scarcely imagine a case of circumstantial evidence where it would not be possible to say that there might be another explanation of the fact.”
4. The method of ascertaining the state of mind of the payer is the ordinary method of evidence and inference, to be dealt with on the same principles which are commonly employed in drawing inferences of fact (per Lord Greene M.R. at page 26). He goes on to say that the inference to be drawn in a case of fraudulent preference is an inference of something which has about it, at the very least, the taint of dishonesty, and, in extreme cases, very much more than a mere taint of dishonesty, and that being so, the court, on ordinary principles, is not in the habit of drawing inferences which involve dishonesty or something approaching dishonesty, unless there are solid grounds for drawing them.
As to the question of whether the taint of dishonesty is necessarily involved in a case of fraudulent preference, Maugham J. in Re Patrick and Lyon Limited [1933] 1 Ch. 786 at p. 790 expressed the view that a fraudulent preference within the meaning of the Companies Act, 1929, or the Bankruptcy Act, 1914, whether in the case of a Company or of an individual possibly may not involve moral blame at all.
However, in the Kushler case, the same point was dealt with by Goddard L.J. at p. 28:-
“. . . the matter stands as it does in any matter relating to a state of mind where any criminal or civil court, if the person upon whom the onus lies, proves no more than a state of facts which is equally consistent with guilt or innocence (using the expression ‘guilt’ for convenience, because, in bankruptcy, there is no question of crime or criminal intent). In such a case, the court is not entitled to draw the one unfavourable inference and find the payment was a guilty rather than an innocent preference, and, if any court is left in doubt as to the inference, then the trustee has not proved his case.””
14. In the earlier case of Corran Construction Company v. Bank of Ireland Finance Ltd [1976-7] ILRM 175, McWilliam J. in refusing the plaintiffs claim held as per the head note:-
(1) In order to establish a fraudulent preference a liquidator must prove that the dominant intention of the Company was to prefer the creditor in question.
(2) On the evidence the intention of the Company in creating the charge appeared to be that of keeping the Company going for as long as possible. This intention falls short of an intention to prefer the defendant over other creditors.
15. It is clear from the relevant legal authority that in order to prove that a transaction is a preference it is not sufficient to show that the effect of the transaction was to give a preference, as is the situation in this case. The transaction has to be entered into with the dominant intention to prefer, and that intention must have existed at the time of the transaction. Where there is no direct evidence of intention the court can draw an inference of an intention to prefer in a case where some other possible explanation is open. That is not the situation in this case because repeatedly the directors of the Company state that they were not under pressure from the bank and they believed that allowing the bank to register the charge was the only way to enable the Company to hold on and continue to trade, and it was much to their dismay that they did not succeed in achieving this objective.
16. Effectively, the facts of the present case before this court bear much the same rationale as the facts before McWilliam J. in Corran where the intention of the Company in creating the charge was that of keeping the Company going for as long as possible.
17. Essentially the liquidator on the one hand is alleging a fraudulent preference, and on the other, relying on the content of a letter from the solicitors for the directors wherein it is specifically stated that the directors were anxious to maintain the relationship with the bank and keep them on board as the business was failing and could only survive if they could succeed with their restructuring plan.
18. In my view there is direct evidence of intention which I accept that the charge, the subject matter of this application, was entered into by the directors of the Company in order to keep the business going and hopefully succeed with a restructuring plan.
19. I do not consider that there was any taint of dishonesty on the part of the directors and there is no evidence that their dominant intention in signing up to the charge which they had previously in any event agreed to do, was for the purpose of giving a preference to the Bank of Ireland.
20. In these circumstances the court declines to grant the declaration as sought.
Belmont Park Investments PTY Ltd v BNY Corporate Trustee Services Ltd & Anor
[2011] UKSC 38 (27 July 2011)
[2011] BCC 734, [2011] BPIR 1223, [2011] 3 WLR 521, [2011] Bus LR 1266, [2012] 1 All ER 505, [2011] UKSC 38, [2012] 1 AC 383, [2012] 1 BCLC 163LORD COLLINS
I Introduction: the anti-deprivation rule and the pari passu principle
The anti-deprivation rule and the rule that it is contrary to public policy to contract out of pari passu distribution are two sub-rules of the general principle that parties cannot contract out of the insolvency legislation. Although there is some overlap, they are aimed at different mischiefs: Goode “Perpetual Trustee and Flip Clauses in Swap Transactions” (2011) 127 LQR 1, 3-4. The anti-deprivation rule is aimed at attempts to withdraw an asset on bankruptcy or liquidation or administration, thereby reducing the value of the insolvent estate to the detriment of creditors. The pari passu rule reflects the principle that statutory provisions for pro rata distribution may not be excluded by a contract which gives one creditor more than its proper share.
The anti-deprivation rule
What is now described as the anti-deprivation principle dates from the 18th century, although the expression “deprivation” has been in use in this context only since the decision of Neuberger J in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150. In 1812 Lord Eldon LC confirmed that a term which is “adopted with the express object of taking the case out of reach of the Bankrupt Laws” is “a direct fraud upon the Bankrupt Laws” from which a party cannot benefit: Higinbotham v Holme (1812) 19 Ves Jun 88, 92.
Classic statements of the principle include these:
“… the law is too clearly settled to admit of a shadow of doubt that no person possessed of property can reserve that property to himself until he shall become bankrupt, and then provide that, in the event of his becoming bankrupt, it shall pass to another and not to his creditors.” (Whitmore v Mason (1861) 2 J & H 204, 212, per Sir William Page Wood V-C)
“… a simple stipulation that, upon a man’s becoming bankrupt, that which was his property up to the date of the bankruptcy should go over to some one else and be taken away from his creditors, is void as being a violation of the policy of the bankrupt law” (Ex p Jay; In re Harrison (1880) 14 Ch D 19, 25, per James LJ).
In the case of personal bankruptcy, section 306(1) of the Insolvency Act 1986 Act (“the 1986 Act”) provides that a bankrupt’s estate vests in the trustee in bankruptcy immediately upon his appointment and section 283(1) provides that a bankrupt’s estate comprises “all property belonging to or vested in the bankrupt at the commencement of the bankruptcy; and…any property which by virtue of any of the following provisions of this Part is comprised in that estate or is treated as falling within the preceding paragraph.”
In the case of corporate insolvency, the insolvent company continues to be owner of its property but holds it on trust for the creditors in accordance with the provisions of the 1986 Act: Ayerst v C & K (Construction) Ltd [1976] AC 167. For companies, section 436 defines “Property” so that it:
“includes money, goods, things in action, land and every description of property…and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property”
The pari passu principle
In the case of personal bankruptcy, by section 328 of the 1986 Act, subject to preferential payments, and with the exception of certain deferred debts, all other debts are to be paid equally. For companies, section 107 provides that, subject to the provisions relating to preferential payments, “the company’s property in a voluntary winding up [should] on the winding up be applied in satisfaction of the company’s liabilities pari passu”. By rule 4.181 of the Insolvency Rules 1986 (SI 1986/1925) similar provision is made for a winding up by the court. In such a winding up, the liquidator must “secure that the assets of the company are got in, realised and distributed to the company’s creditors” and, subject to that, he must “take into his custody or under his control all the property and things in action to which the company is … entitled” (sections 143 and 144 of the 1986 Act).
In British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 1 WLR 758 the House of Lords by a bare majority (reversing Templeman J and a unanimous Court of Appeal [1974] 1 Lloyd’s Rep 429, with Russell LJ delivering the judgment of the court) decided that a clearing house arrangement between a large number of airline companies relating to debts arising as between them was ineffective as against the liquidator of one of the companies, British Eagle. All members of the House upheld the principle that contracting out of the pari passu provisions of what was then section 302 of the Companies Act 1948 was contrary to public policy and void. The difference between the majority and minority related largely (but not exclusively) to the question whether the arrangement resulted in no debt being due. The conclusion of the majority in the House of Lords was that, insofar as the arrangement purported to apply to debts which existed when the members of the company passed the resolution to go into creditors’ voluntary liquidation, it would have amounted to contracting out of the statutory requirement that the assets owned by the company at the date of its liquidation should be available to its liquidator, who should use them to meet the company’s unsecured liabilities pari passu, under what is now section 107 of the 1986 Act.
The ratio of the decision was accurately stated by Peter Gibson J in Carreras Rothmans Ltd v Freeman Mathews Treasure Ltd [1985] Ch 207, 226, as being that “where the effect of a contract is that an asset which is actually owned by a company at the commencement of its liquidation would be dealt with in a way other than in accordance with [the statutory pari passu rule] … then to that extent the contract as a matter of public policy is avoided.”
The distinction between the two sub-rules is by no means clear-cut. Several decisions which are regarded as decisions on the anti-deprivation rule could also be characterised as cases in which the parties sought to disturb pari passu distribution. Ex p Mackay; Ex p Brown; In re Jeavons (1873) LR 8 Ch App 643 is usually regarded as an anti-deprivation case. It involved two transactions: the first was the sale of a patent for improvements in the manufacture of armour plates by Mr Jeavons to Brown & Co and Cammell & Co in consideration of the companies paying royalties; the second was a secured loan of £12,500 from the companies to Mr Jeavons. The parties agreed that (1) the companies would keep half the royalties towards satisfying the debt, and (2) in the event of Mr Jeavons’ bankruptcy, they could also keep the other half of the royalties until the debt had been fully paid. It was held that provision (1) was valid against Mr Jeavons’ trustee, but provision (2) was not.
James LJ said (at p 647) that provision (1) represented “a good charge upon one moiety of the royalties, because they are part of the property and effects of the bankrupt”, but provision (2) “is a clear attempt to evade the operation of the bankruptcy laws” as it “provide[d] for a different distribution of his effects in the event of bankruptcy from that which the law provides”. Mellish LJ said (citing Higginbotham v Holme 19 Ves Jun 88, 92) that the case fell within the principle that:
“… a person cannot make it a part of his contract that, in the event of bankruptcy, he is then to get some additional advantage which prevents the property being distributed under the bankruptcy laws …” (p 648)
What James and Mellish LJJ said cannot be applied unconditionally, since “a different distribution” and “additional advantage” can be obtained by lawful charges between debtor and creditor and by subordination agreements between creditors, and the same applies to what Lord Cross of Chelsea said about “contracting out” generally. The reference, therefore, by James LJ to a “different distribution of his effects in the event of bankruptcy from that which the law provides” is an early expression of the pari passu principle. That is perhaps why the decision was the only prior relevant decision discussed in Lord Cross’ sole speech for the majority in British Eagle. He said (at 780):
“In Ex p Mackay 8 Ch App 643, the charge on [the] second half of the royalties was…an animal known to the law which on its face put the charge[e] in the position of a secured creditor. The court could only go behind it if it was satisfied – as was indeed obvious in that case – that it had been created deliberately in order to provide for a different distribution of the insolvent’s property on his bankruptcy from that prescribed by the law.”
Lord Morris of Borth-y-Gest, in his dissenting speech, agreed that Ex p Mackay was a case where the relevant provisions were “a clear attempt to evade the operation of the bankruptcy laws”, or “a device for defeating the bankruptcy laws” (p 770).
By the time that International Air Transport Association v Ansett Australia Holdings Ltd [2008] HCA 3, (2008) 234 CLR 151 was decided by the High Court of Australia the rules of the clearing house scheme had been modified following the British Eagle decision so as to exclude any liability or right of action for payment between member airlines. The High Court decided by a majority (Kirby J dissenting) that the rule changes were effective to make the IATA the sole creditor of Ansett, and that the revised system did not have the effect of administering debts due to an insolvent company otherwise than in accordance with the mandatory pari passu rule. In their joint judgment Gummow, Hayne, Heydon, Crennan and Kiefel JJ also referred to Ex p Mackay and suggested that Lord Cross’ speech in British Eagle was based in part on the anti-deprivation principle; and that there was no need for recourse to the rule that a contract which is contrary to public policy is void, because the statute was an overriding one which applied according to its terms: at paras 74 and 76. There is much to be said for the observation that recourse to public policy is unnecessary for the application of the mandatory statutory pari passu principle. There is little difference in practice between declaring a contractual provision invalid or ineffective because it is inconsistent with the statute and declaring it contrary to public policy for the same reason, but this is not the occasion for the decision in British Eagle to be reconsidered. Although it must be said that the decision of the minority and of the lower courts makes more sense commercially than that of the majority, there was no real disagreement on the applicable principles.
But it does not follow from the fact that it is difficult in some cases to draw the line between the two categories that there are no relevant differences. The anti-deprivation rule applies only if the deprivation is triggered by bankruptcy, and has the effect of depriving the debtor of property which would otherwise be available to creditors. The pari passu rule applies irrespective of whether bankruptcy or liquidation is the trigger. There is a question whether the bona fides of the parties is equally relevant to the application of the two principles. These points will be taken up below.
This is a case in which only the anti-deprivation principle is potentially applicable. The Noteholders are creditors of the Issuer. There is no question of disturbance of the pari passu rule as between the creditors of Lehman Brothers Special Financing Inc (“LBSF”). What is said, in effect, is that the parties have unlawfully extracted an asset belonging to LBSF, namely its first charge on the Collateral, and passed it to the Noteholders.
Anti-avoidance provisions
There are anti-avoidance provisions for personal and corporate insolvency. They are relevant on this appeal because of an argument that the anti-deprivation rule dates from a time when there were anti-avoidance provisions which, if they existed at all, were in their infancy, and that consequently the need for the rule needs to be re-visited in the light of legislative developments. For personal bankruptcies, section 284 of the 1986 Act provides that where a person is adjudged bankrupt, any disposition of property made by that person in the period from the day of the presentation of the petition for the bankruptcy order is void except to the extent that it is or was made with the consent of the court, or is or was ratified by the court. There are claw-back provisions dealing with the setting aside of transactions at an undervalue and preferences in sections 339-340 of the Act.
For companies, section 127 provides that “any disposition of the company’s property … made after the commencement of the winding up is, unless the court otherwise orders, void”. Sections 238 and 239 enable a liquidator to apply to the court for an order to restore the position where the company has entered into a transaction at an undervalue, or has done anything which, in the event of the company’s insolvent liquidation, would put a creditor (or guarantor) of the company in a better position than he would otherwise be in. By section 423 the court may set aside transactions entered into at an undervalue at any time if they were entered into “for the purpose … of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him, or … of otherwise prejudicing the interests of such a person in relation to the claim.”
II Background
Prior to the events which form the background to this appeal, the Lehman Brothers group was the fourth largest investment bank in the United States. On 15 September 2008, Lehman Brothers Holdings Inc (“LBHI”), the parent company of the Lehman Brothers group, applied to the US Bankruptcy Court for the Southern District of New York for protection under Chapter 11 of the United States Bankruptcy Code.
This appeal concerns the effect of the security arrangements in a complex series of credit swap transactions under which, in effect, investors gave credit protection to Lehman Brothers by reference to the performance of a basket of underlying obligations.
The Lehman Brothers vehicles used for what was called the “Dante Programme” (named after the first special purpose vehicle (“SPV”) used in the programme) were LBSF and SPVs incorporated in jurisdictions chosen for tax reasons. The programme was what was called a synthetic debt repackaged note issuance programme.
At the time of the Lehman Brothers collapse in September 2008 there were 19 SPVs being used as Note issuers in the programme with a total of about 180 series of Notes with an aggregate principal amount of $12.5 billion. LBSF filed for Chapter 11 protection in the United States Bankruptcy Court for the Sothern District of New York on 3 October 2008.
The documentation is complex, but, in broadest outline, the transactions in the representative example series before the court on this appeal were these:
(1) Lehman Brothers set up an SPV (“the Issuer”) in a suitable jurisdiction (in the representative example, Saphir Finance plc, incorporated in the Republic of Ireland).
(2) Investors (“the Noteholders”) subscribed for Notes issued by the Issuer. The Notes were floating rate medium-term Notes (with a seven year maturity) with a margin of 1.3% over Australian dollar denominated 3 month bills.
(3) The Issuer used the subscription moneys to purchase government bonds or other secure investments (in the representative, triple-A rated floating rate Rabo Australia Ltd Notes guaranteed by Rabobank Nederland) (“the Collateral”).
(4) The Collateral was vested in a Trustee (in the present case BNY Corporate Trustee Services Ltd) (“the Trustee”).
(5) LBSF entered into a credit default swap agreement with the Issuer under which LBSF would pay the Issuer the amounts due by the Issuer to the Noteholders in exchange for the payment by the Issuer to LBSF of sums equal to the interest received on the Collateral.
(6) The amount by which the sum payable under the swap agreement by LBSF exceeded the yield on the Collateral represented what has been described as the premium for credit protection insurance provided by the Noteholders.
(7) The amount payable by LBSF to the Issuer on the maturity of the Notes (or on early redemption or termination) was the initial principal amount subscribed by the Noteholders less amounts (if any) calculated by reference to the Credit Events occurring during a specified period by reference to one or more reference entities. In return, LBSF would receive the proceeds of the Collateral.
(8) The payment due from LBSF at maturity of the swap agreement (and also the outstanding principal amount of the Notes) could be reduced (in extreme circumstances to zero) during the term of the swap agreement (and the Notes) if Credit Events occurred and were notified in accordance with the terms of the swap agreement.
(9) Credit protection or insurance is a misnomer because there was no requirement for LBSF to have any direct exposure to the reference portfolio (substantially the same 260 reference entities in the two tranches before the Court on the appeal): it was expressly provided that the swap did not constitute a contract of insurance and that payments would be due in the event of Credit Events without proof of economic loss to LBSF.
(10) There was in effect an “excess” because the notified Credit Events would lead to a reduction only if they exceeded a stated “subordination amount.” In the representative example before the Court A$70m was the amount of the issue, the subordination amount was A$126m, and the Offering Circular indicated that the Notes would be reduced to zero when the cumulative losses on the reference portfolio reached A$196m.
(11) If Credit Events did not occur the Noteholders were due to receive the full amount of the Notes, and LBSF was to put the Issuer in funds to redeem the Notes.
(12) If Credit Events occurred, the amounts payable by LBSF and the principal amount due on the Notes were to be reduced from time to time as and when such Credit Events occurred and were notified.
(13) Consequently the performance of the Notes was linked to the performance of the obligations of the reference entities. In effect, LBSF was speculating that sufficient Credit Events would occur for it to be required to pay less than the Noteholders had invested and to net a substantial part of the Collateral; and the Noteholders were speculating that the credit reference portfolio was safe and that any Credit Events within it would not “burn through” the net amount of the subordination amount.
(14) The Collateral was charged by the Issuer in favour of the Trustee to secure its obligations to LBSF under the swap agreement and to the Noteholders under the terms and conditions of the Notes.
(15) The claims of LBSF and the Noteholders were limited to the Collateral and they had no right of recourse against the Issuer.
(16) The respective priorities of LBSF under the swap agreement and the Noteholders were described as “Swap Counterparty Priority” and “Noteholder Priority.”
(17) The respective priorities of LBSF and the Noteholders depended on whether there had been an Event of Default under the swap agreement, which included the institution by LBSF (or LBHI as LBSF’s “Credit Support Provider” under the swap agreement) of proceedings in insolvency or bankruptcy (such as filing for Chapter 11 protection).
(18) If there were no such Event of Default, then LBSF would have priority in relation to the Collateral, but if there were an Event of Default in respect of which LBSF (or LBHI) was the “Defaulting Party,” the Noteholders would have priority over LBSF.
The central issue in the proceedings and the appeal is the validity of those provisions for alteration of priority. The practical importance of the question is that under the terms of the swap, in the event of its early termination, it was to be unwound with certain “Unwind Costs” payable either to LBSF or to the Issuer. The Unwind Costs represented the market assessment of the amount either LBSF or the Issuer were expected to receive under the swap were it to run to maturity. The commercial purpose was to reflect the value of the swap in the market place as at the point of termination.
Since, following the financial crisis, many more Credit Events were expected to occur in the future, the Unwind Costs (representing a payment for the future losses) would be due to LBSF. If Swap Counterparty Priority subsists LBSF would be entitled to recourse to the Collateral towards satisfaction of its claims. But if the Noteholders have priority, the Collateral would be exhausted in repayment of the Notes where Credit Events did not occur before termination so as to reduce the amount due on the Notes and to make some of the Collateral available to LBSF.
III The litigation
The first 29 respondents (which will for convenience be called “the Belmont respondents” after the first respondent, Belmont Park Investments Pty Ltd, or “the Noteholders”, depending on the context) are Australian companies, institutions, authorities and charities who are Noteholders in ten series of Notes, nine of which are involved in this appeal. After 15 September 2008, periodic payments due to the Noteholders were not made. The same applied in respect of other Note series under the Dante Programme, including two series held by Perpetual Trustee Co Ltd (“Perpetual”).
The total outstanding under those nine series of Notes is approximately A$250.23m (approximately £155m) of which the Belmont respondents account for approximately A$91.1m. The contractual documentation differs between the various Belmont series, but the parties are content for the court to consider the Saphir 2004-4 Note documentation as, for relevant purposes, representative, and the documentation before the court has included the documents relating to two tranches. The facts set out below relate to those tranches. There are minor differences in relation to some other series, but they are immaterial for present purposes.
On 15 September 2008, LBHI filed for Chapter 11 protection under the US Bankruptcy Code, and on 3 October 2008, LBSF filed for Chapter 11 protection.
Later in 2008 or in March/April 2009, following directions by the Noteholders, the Trustee caused the Issuer to terminate the swap agreement. The swap termination notices served in respect of the Notes relied on the event of default constituted by LBSF’s Chapter 11 filing and reserved all rights, claims and defences in relation to all other Events of Default. On 6 May 2009, the Trustee issued Condition 10 notices declaring the Notes to be due and payable at their Early Redemption Amount.
LBSF’s position was that the effect of the provisions for a change in priority on default was unlawfully to deprive LBSF of property to which it is entitled in its bankruptcy, because they purported to modify the priority which was enjoyed over Collateral by LBSF in favour of the Noteholders after an insolvency event; and changed the allocation of Unwind Costs in favour of the Noteholders to exclude payment to LBSF.
In May and June 2009 respectively Perpetual and the Belmont respondents issued Part 8 Claims in England against the Trustee for orders designed to procure the realisation of the Collateral held by the Trustee in respect of each of the series of Notes held by them respectively and the application of the Collateral and its proceeds in favour of the Noteholders in priority to any claim of LBSF as Swap Counterparty in accordance with the contractual provisions. LBSF was subsequently joined as a party.
Proceedings were also commenced (but not by the Belmont respondents) against the Trustee by LBSF (and other Lehman entities) in the United States Bankruptcy Court for the Southern District of New York claiming a declaration that the provisions in the Note issues held by Perpetual modifying LBSF’s rights to a priority distribution solely as a result of a Chapter 11 filing were unenforceable because they were clauses which sought, in breach of the United States Bankruptcy Code, to modify contractual relationships due to a filing of a bankruptcy petition (“ipso facto clauses”).
On 28 July 2009 Sir Andrew Morritt C found that the contractual provisions were effective as a matter of English law and, in particular, did not offend the anti-deprivation rule; alternatively, if the provisions were capable of offending the anti-deprivation rule, the rule was not engaged because an alternative Event of Default (the Chapter 11 filing by LBHI) had occurred prior to the Chapter 11 filing by LBSF, and consequently the Chapter 11 filing did not deprive LBSF of any property: Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2009] EWHC 1912 (Ch), [2009] 2 BCLC 400. On 6 November 2009 Sir Andrew Morritt C’s judgment was upheld by the Court of Appeal ([2009] EWCA Civ 1160, [2010] Ch 347).
Following communications between the High Court in England and the Bankruptcy Court in New York, it was agreed that, in order to limit potential conflict between decisions in the two jurisdictions, relief would be limited to declaratory relief: Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2009] EWHC 2953 (Ch), [2010] 2 BCLC 237; Re Lehman Brothers Holdings Inc, 422 BR 407 (US Bankruptcy Court, SDNY, 2010).
In January 2010 Judge Peck, sitting in the US Bankruptcy Court for the Southern District of New York, granted summary judgment in favour of LBSF on its application for a declaration that the provisions in the Perpetual documentation were ineffective because they were in breach of the US Bankruptcy Code: Re Lehman Brothers Holdings Inc, 422 BR 407 (US Bankruptcy Court, SDNY, 2010).
Permission was granted by this court to LBSF to appeal from the decision of the Court of Appeal. The Trustee was given leave by the United States District Court to appeal from Judge Peck’s decision. But before the appeal to the United States District Court, or the appeal to this court, were heard, the proceedings in relation to the Notes held by Perpetual were settled and the appeals were withdrawn. This appeal consequently concerns the Notes held by the Belmont respondents only.
IV The contractual provisions
All of the documents are expressly governed by English law. The relevant provisions of the documentation are set out in an appendix to the judgments on this appeal, but for present purposes the following account of the crucial provisions should be sufficient.
The Notes are governed by: (1) a Principal Trust Deed (the “Principal Trust Deed”) between Dante Finance plc (“Dante”), the first issuer under the programme, and the Trustee under which the Dante Programme was established, which has effect in relation to any specific Note issue as amended by the Supplemental Trust Deed and Drawdown Agreement relating to that issue; (2) a Supplemental Trust Deed and Drawdown Agreement (“the Supplemental Trust Deed”) made between the Issuer, the Trustee (together with its associated custodian and paying agent), LBSF (described as the swap counterparty) and the Lehman company which arranged the Dante Programme, Lehman Brothers International (Europe); and (3) the Terms and Conditions of the Notes (“the Terms and Conditions”) which appeared in a schedule to the Principal Trust Deed and which were also supplemented or amended by additional terms were attached to the prospectus sent to potential investors.
The credit default swap agreement (“the Swap Agreement”) is constituted by: (1) an ISDA Master Agreement, including the Schedule (and Credit Support Annex) (“the ISDA Master Agreement”) between Dante and LBSF (to which the Issuer subsequently acceded); and (2) a Swap Confirmation between LBSF and the relevant Issuer.
The Principal Trust Deed
Clause 5.5 of the Principal Trust Deed provides that:
“… the security … shall become enforceable if (i) any amount due in respect of the Notes is not paid or delivered when due or (ii) a Swap Agreement terminates with sums due to the Swap Counterparty [ie, LBSF]….”
Clause 6.1 of the Principal Trust Deed provides that moneys received, otherwise than in connection with the realisation or enforcement of the security, are to be held by the Trustee, after payment of the Trustee’s costs, on trust to pay, first, the amounts due to LBSF, the Noteholders and others pari passu, and, secondly, the amounts due to the Issuer.
Clause 6.2 of the Principal Trust Deed directs the Trustee:
“… [to] apply all moneys received by it under the Principal Trust Deed and the relevant Supplemental Trust Deed in connection with the realisation or enforcement of the security … as follows”
and goes on to provide that “Swap Counterparty Priority” means that the claims of LBSF are payable in priority to the claims of the Noteholders, whereas “Noteholder Priority” means the converse, in each case after providing for payment of certain specified costs and charges. The priority which is to apply in any particular case is that specified in the Supplemental Trust Deed.
The Supplemental Trust Deed
Clause 5.2 contains a charge by the Issuer “as continuing security in favour of the Trustee” over the Collateral and other property representing it from time to time.
43. Clause 5.3 provides that such security is
“granted to the Trustee as trustee for itself and/or the holders of Notes and [LBSF] the Custodian and the Paying Agents as continuing security (i) for the payment of all sums due under the Trust Deed and the Notes, (ii) for the performance of the Issuer’s obligations (if any) under the Swap Agreement …”
44. Clause 5.5 provides that:
“The Trustee shall apply all moneys received by it under this Deed in connection with the realisation or enforcement of the Mortgaged Property as follows: Swap Counterparty Priority unless … an Event of Default (as defined in the Swap Agreement) occurs under the Swap Agreement and the Swap Counterparty is the Defaulting Party (as defined in the Swap Agreement) … in which case Noteholder Priority shall apply.”
45. Clause 8.3 provides:
“[LBSF] hereby agrees that, if an Event of Default (as defined in the ISDA Master Agreement) occurs under the Swap Agreement and [LBSF] is the Defaulting Party (as defined in the ISDA Master Agreement) … and Unwind Costs are payable by the Issuer to [LBSF], the Issuer shall apply the net proceeds from the sale or realisation of the Collateral (1) first in redeeming the Notes in an amount as set out in the Conditions and (2) thereafter, in payment of such Unwind Costs to [LBSF].”
Terms and Conditions
The second paragraph of Condition 44 (“Condition 44.2”) provides:
“… if an Event of Default (as defined in the ISDA Master Agreement …) occurs under the Swap Agreement and [LBSF] is the Defaulting Party (as defined in the ISDA Master Agreement) …”,
the Early Redemption Amount payable on each Note is to be equal to:
“(i) such Note’s pro rata share of the proceeds … from the sale or realisation of the Collateral … plus (ii) (but only if payable to the Issuer) the amount of any applicable Unwind Costs divided by the total number of Notes outstanding; provided that if the amount determined pursuant to sub-paragraphs (i) and (ii) above results in an Excess Amount (as defined above), such Excess Amount shall be payable by way of an additional payment of interest on each Note. In the event that Unwind Costs are payable by the Issuer to the Swap Counterparty, the Issuer shall apply the net proceeds from the sale or realisation of the Collateral as aforesaid (1) first in redeeming each Note in an amount equal to its Outstanding Principal Amount as of the Early Redemption Date plus the Accrued Early Redemption Interest Amount and (2) thereafter, in payment of such Unwind Costs to the Swap Counterparty.”
The ISDA Master Agreement
Section 5 of the ISDA Master Agreement defines an “Event of Default” as being: “[t]he occurrence [of certain specified events] at any time with respect to [LBSF], or if applicable, any Credit Support Provider” of LBSF. According to paragraph 9(iv) of the Swap Confirmation, the Credit Support Provider is LBHI, the ultimate parent of LBSF. The defined Events of Default include (i) failure to pay any sums due under the ISDA Master Agreement (if such failure is not remedied after three local business days’ notice of such failure), and (ii) the institution by LBSF or by LBHI of any proceedings “seeking a judgment of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights …”.
Section 6 of the ISDA Master Agreement deals with early termination and provides that:
“If at any time an Event of Default with respect to a party (the ‘Defaulting Party’) has occurred and is then continuing, the other party … may, by not more than 20 days notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions …”
V The decisions of Sir Andrew Morritt C and the Court of Appeal
LBSF’s position
LBSF’s position is, in summary, that the rights under the Swap Agreement and the rights created over the Collateral to secure them were property of LBSF within the meaning of the Insolvency Act 1986 and formed part of LBSF’s insolvent estate. At the time of its filing for bankruptcy on 3 October 2008 (and at the Early Termination Date), LBSF was “in the money” under each of the Swap Agreements. LBSF had existing contractual rights which, on final maturity or if the Issuer elected to terminate the Swap Agreement early, would result in a right to payment to LBSF from the Issuer. That was so whether or not LBSF was the Defaulting Party under the Swap Agreement. It was illegitimate to provide for the alteration of those rights in reliance on LBSF’s bankruptcy so as to deprive LBSF of the benefit of its first priority right of recourse to the Collateral.
When the Issuer elected to terminate the Swap Agreements it did so expressly in reliance upon LBSF having filed for bankruptcy on 3 October 2008. That termination gave rise to a debt payable by the Issuer to LBSF and which is charged on the Collateral. The effect of the disputed clauses was to deprive LBSF of property to which it was entitled in its bankruptcy: Clause 5.5 of the Supplemental Trust Deed removed the senior ranking rights which LBSF had to the proceeds of sale of the Collateral and instead LBSF was given second ranking rights which ranked behind the claims of the Noteholders in some instances, and even further behind the Portfolio Manager in other transactions; by Condition 44.2 of the Terms and Conditions of the Notes, the amount due to LBSF in respect of its claim under the terminated Swap Agreement was disregarded when determining what the Issuer should pay to Noteholders on early redemption of the Notes. The result of the offending provisions was that the Collateral was treated as being freed from the charge to secure the debt to LBSF and was simply divided up among the Noteholders in proportion to their original subscriptions.
The fundamental change brought about by the operation of these clauses depends upon the Issuer having elected to terminate the Swap Agreement in reliance on LBSF’s bankruptcy. The security for the obligations owed to LBSF under the Swap Agreement cannot validly be altered in reliance on LBSF’s bankruptcy, and offends against the anti-deprivation rule. Consequently, the provisions are void and unenforceable under English law.
On the Noteholders’ alternative case, that the Event of Default occurred on 15 September 2008, when LBHI filed for Chapter 11 protection, LBSF says that Clause 5.5 and the concepts of Swap Counterparty Priority and Noteholder Priority only have relevance in relation to events taking place after the Collateral has been sold. The parties could not have intended any permanent changes in the operation of Clause 5.5 and Condition 44.2 to have occurred unless and until the service of a notice by the Non-defaulting Party to terminate the Swap Agreement.
Sir Andrew Morritt C
Sir Andrew Morritt C decided that Clause 5.5 of the STD was not contrary to public policy. The Collateral was bought by the Issuer with the money subscribed by the Noteholders. It was not derived directly or indirectly from LBSF. The court should not be astute to interpret commercial transactions so as to invalidate them, particularly when doubt might be cast on other long-standing commercial arrangements. As long as the Swap Agreement was being performed it was appropriate for LBSF to have security for the obligations of the Issuer in priority to security in respect of the Issuer’s obligations to the Noteholders, but the intention of all parties was that the priority afforded to LBSF was conditional on LBSF continuing to perform the Swap Agreement. Such beneficial interest by way of security as LBSF had in the Collateral was, as to its priority, always limited and conditional, and could never have passed to a liquidator or trustee in bankruptcy free from those limitations and conditions as to its priority. Alternatively, LBSF was a Defaulting Party on 15 September 2008 when LBHI filed for Chapter 11 protection, and the anti-deprivation rule was not engaged if deprivation occurred on a ground other than bankruptcy of the entity alleged to be unlawfully deprived.
Court of Appeal
In the Court of Appeal [2009] EWCA Civ 1160, [2010] Ch 347 Lord Neuberger of Abbotsbury MR’s conclusion that the provisions were valid relied to a large extent on the fact that the Collateral was acquired with money provided by the Noteholders and that the change in priorities was included to ensure that the Noteholders were repaid out of those assets: at para 67. In particular he relied on these matters (at para 61 et seq): (a) so long as there was no risk of default, the Noteholders were prepared for LBSF to have priority when it came to unwinding the transaction; (b) the scheme provided, and was sold on the basis that, if LBSF or LBHI defaulted so that they could not, or did not, pay the interest and the capital on the Notes, then it would be the Noteholders who would have priority both in relation to repayment and in relation to the Unwind Costs; (c) the effect of the “flips” would not be to entitle the Noteholders to more than they had subscribed, and, if there was no shortfall, LBSF would not have been out of pocket as a result of the “flips”. The right granted to LBSF was a security right over assets purchased with the Noteholders’ money, and, from the very inception, the priority, and the extent of the benefits, enjoyed by LBSF in respect of the security were contingent upon there being no Event of Default.
He agreed with Sir Andrew Morritt C’s conclusion on the LBHI point. Longmore LJ agreed with Lord Neuberger MR.
Patten LJ thought that the anti-deprivation rule did not apply because (at paras 135-136):
“The reversal of the order of priority under clause 5.5 was always a facet of the security designed to regulate the competing interests over the collateral of LBSF and the noteholders. To say that its operation in the event of the company’s bankruptcy constitutes 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. LBSF retains the same asset as it had before its bankruptcy and is free to deal with any recoveries for the benefit of its general creditors in accordance with the applicable statutory regime. …
… Condition 44 is said to have the effect of increasing the amount payable to noteholders in the event of LBSF being the defaulting party under the swap agreement by diverting to the noteholders moneys which would otherwise have been payable to it in order to discharge the issuers’ liability for unwind costs. … Although the amount of the security available to meet LBSF’s claims is obviously reduced in the event of a shortfall in the value of the security over what it would have been had no event of default occurred, that is simply a function of the change in priority which was always a feature of the security which the company enjoyed.”
Lord Neuberger MR, while not disagreeing, had some reservations about this approach (paras 66-68), particularly because the authorities did not support the view that arrangements which were an original feature of the transaction were insulated from the anti-deprivation rule.
VI The principles
Lord Neuberger MR rightly pointed out in his judgment (at para 32) in these proceedings that it was not easy to identify the precise nature or limits of the anti-deprivation rule. He was echoing what he had said as Neuberger J in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, para 87, a decision which contained the first full judicial analysis of the principles: at paras 117-118.
The rule has existed for nearly 200 years, and it is therefore necessary to look at the development of the rule to see what its nature and limits are. All but one of the relevant cases prior to the decision of the House of Lords in British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 1 WLR 758 on the pari passu principle are cases of personal bankruptcy. The principal decisions are Whitmore v Mason (1861) 2 J & H 204 (Sir William Page Wood V-C); Ex p Mackay; Ex p Brown; In re Jeavons (1873) LR 8 Ch App 643 (CA); Ex p Jay; In re Harrison (1880) 14 Ch D 19 (CA); Ex p Newitt; In re Garrud (1881) 16 Ch D 522 (CA); Ex p Barter; Ex p Black; In re Walker (1884) 26 Ch D 510 (CA); In re Detmold; Detmold v Detmold (1889) 40 Ch D 585 (North J); Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 (Farwell J); In re Johns, Worrell v Johns [1928] Ch 737 (Tomlin J); Bombay Official Assignee v Shroff (1932) 48 TLR 443 (PC); and In re Apex Supply Co Ltd [1942] Ch 108 (Simonds J) (the sole liquidation case).
The anti-deprivation rule applied
The anti-deprivation rule was applied to invalidate contractual provisions in the following decisions. In none of them did it matter whether the provision was in a contract from the inception of the relationship. Whitmore v Mason 2 J & H 204 is a classic case of the application of the anti-deprivation rule. It was concerned with a provision in a partnership deed that, in the event of the “bankruptcy or insolvency” of a partner, an account was to be taken, and the bankrupt partner was to lose his interest in the partnership assets (mines in Portugal) at a market valuation (save that his interest in a mining lease was to be excluded from the valuation). Sir William Page Wood V-C accepted the assignee’s argument ( at p 207) that the exclusion of the lease was void because it was “an attempt to evade the rule in bankruptcy, which provides that, upon an act of bankruptcy being committed, all the property of the bankrupt vests in his assignees”, and held that, insofar as it related to the lease, the provision was void as being “in fraud of the bankrupt laws” (at p 213), because
“… the law is too clearly settled to admit of a shadow of doubt that no person possessed of property can reserve that property to himself until he shall become bankrupt, and then provide that, in the event of his becoming bankrupt, it shall pass to another and not to his creditors.” (p 212)
So also in Ex p Mackay LR 8 Ch App 643, 648, discussed above, the agreement that the lender could keep the royalties in the event of the borrower’s bankruptcy was an unlawful “additional advantage”. This, like several of the other decisions, is really about an unsuccessful attempt to create a charge. It was applied in Ex p Williams; In re Thompson (1877) LR 7 Ch D 138 (sham rent intended to give lender additional security of distraining on chattels).
In Ex p Jay 14 Ch D 19 a clause in an agreement for a lease between a landowner and a builder (under which the builder was to build 40 houses on land in Waltham Cross) provided that, until the lease had actually been granted, in the event that the builder was in default of any of his obligations or became bankrupt, any materials on the land should be forfeited to the landowner. A few weeks later the builder granted a charge over the materials, but it was not registered as a bill of sale. At a time before the builder had completed the development or any lease had been granted, and when the builder was not in default of any of his obligations, he was made bankrupt. A dispute arose between his trustee in bankruptcy and the landowner over a quantity of building materials which the builder had brought onto the land. The Court of Appeal held that the provisions of the agreement purporting to forfeit such building materials to the landowner were void as being a violation of the policy of the bankruptcy law, and that the building materials were the property of the trustee.
In Ex p Barter 26 Ch D 510 a shipbuilding contract provided that, if at any time the builder should cease working on the ship for 14 days, or should allow the time for completion and delivery of the ship to expire for one month without it having been completed and ready for delivery, or in the event of the bankruptcy or insolvency of the builder, the buyer could cause the ship to be completed, and could employ materials belonging to the builder as should be then on his premises. It was held that the clause was void as against the trustee in his bankruptcy as being an attempt to control the user after bankruptcy of property vested in the bankrupt at the date of the bankruptcy, and as depriving the trustee of the right to elect whether he would complete the ship or not as might seem most advantageous for the creditors under the bankruptcy. This decision is an application of a general principle that the bankrupt’s property vests in the trustee, and its user cannot be contractually controlled.
In re Johns, Worrell v Johns [1928] Ch 737, concerned an arrangement between mother and son, whereby the amount repayable by the son in respect of periodic loans made by the mother (which could not exceed £650, and might be as little as £10, in all) was to increase from £650 to £1,650 (plus interest) in the event of the son’s bankruptcy. Tomlin J said that the principle was that a “person cannot make it a part of his contract that, in the event of bankruptcy, he is then to get some additional advantage which prevents the property being distributed under the bankruptcy laws” (quoting Ex p Williams; In re Thompson 7 Ch D 138, 143) and described the agreement as “a deliberate device to secure that more money should come to the mother if the son went bankrupt, than would come to her if he did not; and, that being so, … the device is bad” (p 748). The agreement would also have offended the pari passu principle, because the claim of the mother’s estate in the insolvent estate would have increased.
The principle not infringed
The anti-deprivation principle did not apply in the following decisions. These decisions are particularly important for the light which they throw on the limits of the principle.
Ex p Newitt 16 Ch D 522 was decided by the same Court of Appeal which had decided Ex p Jay a year earlier. This was also a case of a bankrupt builder. The provision for forfeiture operated on breach and not on bankruptcy, and was held to be valid. The bankrupt builder had broken the terms of his agreement with the landowner and it was provided in the agreement that the chattels would be forfeited to the landowner “as and for liquidated damages”, whereas in Ex p Jay the builder was not in breach of contract, and the right to forfeit was expressed to be triggered, inter alia, on the builder becoming bankrupt. James LJ said (at p 531)
“Another point taken before us, which does not appear to have been really argued before the judge of the county court, was this – that the seizure was not made in sufficient time, that it was not made before the filing of the liquidation petition. To my mind it is immaterial at what particular moment the seizure was made. The broad general principle is that the trustee in a bankruptcy takes all the bankrupt’s property, but takes it subject to all the liabilities which affected it in the bankrupt’s hands, unless the property which he takes as the legal personal representative of the bankrupt is added to by some express provision of the bankrupt law. There is no such provision applicable to the present case. The building agreement provides, in effect, that in a certain event certain property of the builder may be taken by the landowner in full satisfaction of the agreement. It appears to me analogous to a sale of property with a power of repurchase in a certain event.”
The relevance of this decision lies in the effect of a provision for forfeiture on an event other than bankruptcy which takes place after bankruptcy, and it will be necessary to revert to it.
In In re Detmold 40 Ch D 585 a marriage settlement provided that income on the property in the settlement (originating from the husband) should pass to the wife for life in the event of an alienation by, or the bankruptcy of, the husband. The provision was held valid against the husband’s trustee in bankruptcy, on the ground that it had been triggered by the alienation effected as the result of the appointment of a judgment creditor as receiver (by way of equitable execution) of the income on the property in the settlement, prior to the commencement of the bankruptcy two months later. In re Detmold is an illustration of a provision held valid because, though it worked a deprivation, it did so prior to the onset of bankruptcy even though it was also expressed to operate on bankruptcy.
In Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 Mr Borland was a shareholder in Steel Brothers & Co Ltd. Its articles of association contained pre-emption rights, the effect of which was that on a shareholder becoming bankrupt, he had, on receiving a transfer notice from the directors, to transfer his shares to a manager or assistant at a fair value calculated in accordance with the articles. Mr. Borland’s trustee in bankruptcy claimed that the transfer articles were void because, among other reasons, the articles constituted a fraud upon the bankruptcy laws, and could not prevail when bankruptcy had supervened, since the effect was that the trustee in bankruptcy was forced to part with the shares at something less than their true value, with the result that the asset was not fully available for creditors.
The argument was rejected. Farwell J started with the principle that “a simple stipulation that upon a man’s becoming bankrupt that which was his property up to the date of the bankruptcy should go over to some one else and be taken away from his creditors, is void as being a violation of the policy of the bankrupt law” (at p 290, quoting Ex p Jay 14 Ch D 19, 25). The basis of the decision was that there was a commercial arrangement. The provisions were inserted bona fide and constituted a fair agreement for the purposes of the business of the company and were binding equally upon all persons who came in as shareholders. There was no suggestion of fraudulent preference of one over another. There was nothing obnoxious to the bankruptcy law in a clause which provided that if a man became bankrupt he should sell his shares. The price was a fixed sum for all persons alike, and no difference in price arose in the case of bankruptcy. The purpose was that there should be in the company, if it were so desired, none but managers and workers in Burma. There was nothing repugnant in the way in which the value of the shares was to be ascertained. It would have been different if there were any provision in the articles compelling persons to sell their shares in the event of bankruptcy at something less than the price that they would have otherwise obtained, since such a provision would be repugnant to the bankruptcy law (p 291).
In Bombay Official Assignee v Shroff 48 TLR 443 the bankrupt had been a registered broker in the Bombay Broker’s Hall, an unincorporated association. The rules of that association permitted only those “holding … a card” to enter the hall and conduct business. The rules also allowed the directors to declare a member a defaulter. Following the bankrupt’s failure to pay funds owing to other members, he was declared a defaulter, his card and right of membership was forfeited. About a week later, he was declared bankrupt. The official assignee contended (relying on Whitmore v Mason 2 J & H 204 and In re Borland’s Trustee [1901] 1 Ch 279) that his card and/or right of membership of the association or the value thereof vested in him as the assignee in the insolvency, because among other reasons, “if the effect of the rules be that the proceeds of sale of the insolvent’s card do not enure for the benefit of the general body of his creditors the rules are contrary to the law of insolvency.” Lord Blanesburgh, speaking for the Board, said (at p 446):
“It being agreed … that the rules of this association are entirely innocent of any design to evade the law of insolvency, it may be that even these cases, although cases of a company and a partnership, are more favourable to the [association] than to the [official assignee] … [T]he real answer to this contention of the [official assignee] [is] in the nature and character of the association as they have described it whereby in the case of a defaulting member who is expelled from the association no interest in his card remains in himself, and none can pass to his assignee, whether his expulsion does or does not take place before the commencement of his insolvency.”
The decision of the Privy Council was applied by Neuberger J in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150. The claimant was a member of the stock exchange and defaulted on its obligations. Under provisions in the articles of association of the stock exchange its share was transferred away and the claimant lost its membership. Neuberger J held the anti-deprivation rule did not apply because the share was incapable of uncontrolled transfer and was closely connected with a right in respect of which a deprivation provision was effective, viz membership of the exchange.
In In re Apex Supply Co Ltd [1942] Ch 108 a hire purchase agreement provided that if the hirer should go into liquidation, and the owner should retake possession, the hirer would pay a sum by way of compensation for depreciation. Applying Ex p Mackay and In re Johns, Simonds J held that the provision for the payment of compensation was not a fraud on the bankruptcy laws as giving the owner company an undue advantage in the event of the hirer company going into liquidation. The provision was not a deliberate device to secure that more money went to the creditor: “it would be extravagant … to suggest that this clause is aimed at defeating the bankruptcy laws or at providing for a distribution differing from that which the bankruptcy laws permit” (at p 114).
The limits of the anti-deprivation rule
Good faith and commercial arrangements
The first question is whether absence of good faith, or an intention to obtain an advantage over creditors in the bankruptcy, is an essential element for application of the principle.
From the earliest days of the rule, it has been based on the notion of a fraud, or “a direct fraud” (Lord Eldon LC in Higinbotham v Holme 19 Ves Jun 88, 92), on the bankruptcy laws, and that decision was taken to be authority for the proposition that where a person settles property in such a way that his interest determines on his bankruptcy “that is evidence of an intention to defraud his creditors”: In re Stephenson; Ex p Brown [1897] 1 QB 638, 640, per Vaughan Williams J. The overall effect of the authorities is that, where the anti-deprivation rule has applied, it has been an almost invariably expressed element that the party seeking to take advantage of the deprivation was intending to evade the bankruptcy rules; but that where it has not applied, the good faith or the commercial sense of the transaction has been a substantial factor. By contrast, in the leading pari passu principle case, British Eagle [1975] 1 WLR 758, it was held by the majority that it did not matter that the clearing transaction was a sensible commercial arrangement not intended to circumvent the pari passu principle. Although Lord Morris of Borth-y-Gest (at p 763) placed weight in his dissenting speech on the fact that there was “no trace in the scheme of any plan to divert money in the event of a liquidation” his conclusion was not based on the absence of bad faith. The basis of his reasoning was that transactions had taken place and services had been rendered on the basis that clearance would follow; it was not open to the liquidator to seek to alter ex post facto the contractual arrangements pursuant to which the airlines had supplied services to British Eagle; and the effect of the clearing was that no sum was due: p 763-764.
To take first the cases in which the anti-deprivation rule was held to apply: in Whitmore v Mason 2 J & H 204 the exclusion of the lease on bankruptcy of the partner was void and Sir William Page Wood V-C said that “no one can be allowed to derive benefit from a contract that is in fraud of the bankrupt laws” (p 213). In Ex p Mackay LR 8 Ch App 643, 647, James LJ said that the provision was an ineffective charge and was “a clear attempt to evade the operation of the bankruptcy laws” as it “provide[d] for a different distribution of his effects in the event of bankruptcy from that which the law provides”. As Lord Cross of Chelsea said of Ex p Mackay in British Eagle [1975] 1 WLR 758, 780: “The court could only go behind [the transaction] if it was satisfied – as was indeed obvious in that case – that it had been created deliberately in order to provide for a different distribution of the insolvent’s property on his bankruptcy from that prescribed by the law;” and Lord Morris agreed that Ex p Mackay was a case where the relevant provisions were “a clear attempt to evade the operation of the bankruptcy laws”, or “a device for defeating the bankruptcy laws” (p 770). In Ex p Jay 14 Ch D 19, the case of the housebuilder’s materials, there was no mention of evasive intent, but that was probably because it was obvious that the intention was to ensure that the property did not go to the trustee. In In re Johns, Worrell v Johns (the case of the increase of the debt on bankruptcy) the agreement was described [1928] Ch 737, 748) as “a deliberate device to secure that more money should come to the mother, if the son went bankrupt, than would come to her if he did not…”
By contrast, where the anti-deprivation rule was held not to apply, good faith and the commercial sense of the transaction have been important factors. In Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 (the case of pre-emption rights on bankruptcy) Farwell J relied specifically on the fact that the provisions were inserted bona fide and constituted a fair agreement for the purposes of the business of the company, and that there was no suggestion of fraudulent preference. So also in Bombay Official Assignee v Shroff 48 TLR 443 (forfeiture of membership of the Bombay Broker’s Hall) Lord Blanesburgh (at p 446) referred to the fact that it had been agreed that the rules of the association were “entirely innocent of any design to evade the law of insolvency…” Again, in In re Apex Supply Co Ltd [1942] Ch 108 (the hire purchase case) Simonds J accepted that the provision was not a deliberate device to secure that more money went to the creditor and that “it would be extravagant … to suggest that this clause is aimed at defeating the bankruptcy laws or at providing for a distribution differing from that which the bankruptcy laws permit.” (p 114).
Thus there is an impressive body of opinion from some of the most distinguished judges that, in the case of the anti-deprivation rule, a deliberate intention to evade the insolvency laws is required. That conclusion is not affected by the decision in British Eagle [1975] 1 WLR 758. The pari passu rule is clear. Parties cannot contract out of it. That is why, by contrast with the anti-deprivation cases, Lord Cross was able to accept (p 772) that the clearing house was a commercial arrangement which was for the mutual advantage of the airlines, but that the power to go behind agreements, the result of which were repugnant to the insolvency legislation, was not confined to cases in which the dominant purpose was to evade its operation. It was irrelevant that the airlines had “good business reasons for entering” into the arrangements and “did not direct their minds to the question how the arrangements might be affected by the insolvency of one or more of [them]” (p 780).
That does not mean, of course, that a subjective intention is required, or that there will not be cases so obvious that an intention can be inferred, as in Ex p Jay. But it does suggest that in borderline cases a commercially sensible transaction entered into in good faith should not be held to infringe the anti-deprivation rule. Although he did not accept that absence of good faith was a necessary element, Neuberger J suggested in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, para 103 that if a deprivation provision, which might otherwise be held to be valid, could be shown to have been entered into by the parties with the intention of depriving creditors of their rights on an insolvency, then that might be sufficient to justify holding invalid the provision when it would not otherwise have been held invalid.
Anti-deprivation rule does not apply if the deprivation takes place for reasons other than bankruptcy
By contrast with the pari passu principle, it is well established that if the deprivation takes place for reasons other than bankruptcy, the anti-deprivation rule does not apply. In British Eagle [1975] 1 WLR 758 the clearing house system was ineffective to avoid the pari passu principle, even though it applied throughout irrespective of whether the airlines went into liquidation. But the position is different with regard to the anti-deprivation rule, which is intended to operate only where provision is made for deprivation on bankruptcy. Thus in Ex parte Jay 14 Ch D 19 (the case of the builder’s materials) both Brett and Cotton LJJ accepted (p 26) that if forfeiture had taken place on the builder’s breach (as the provision envisaged) then it would have been valid: “It appears that there was no default on the debtor’s part up to the filing of the petition, and the [owner] cannot, therefore, succeed except by virtue of the provision for forfeiture on bankruptcy, and according to the authorities such a stipulation is void” (Brett LJ) and “One of the two events is not hit by the decided cases”(Cotton LJ). In Ex p Barter 26 Ch D 510 (shipbuilding materials) the contract provided for events other than bankruptcy in which the property could be seized, but it was held that it was the bankruptcy which was the basis of the powers of control exercised by the buyers: p 519.
So also in In re Detmold 40 Ch D 585 (marriage settlement providing that income on the property in the settlement, originating from the husband, should pass to the wife for life in the event of an alienation by, or the bankruptcy of, the husband) the provision was held valid against the husband’s trustee in bankruptcy, on the ground that it had been triggered by the alienation effected as the result of the appointment of a judgment creditor as receiver (by way of equitable execution) of the income on the property in the settlement:
“… [T]he limitation of the life interest to the settlor was validly determined by the fact that, in consequence of the order appointing the receiver, he ceased to be entitled to receive the income. This took place before the commencement of the bankruptcy, and, therefore, the forfeiture is valid as against the trustee in the bankruptcy” (p 588 per North J).
In Ex p Newitt 16 Ch D 522 (as has been seen, like Ex p Jay, a case of a bankrupt builder) the provision for forfeiture was on breach and not on bankruptcy and was held to be valid. The controversial point in the case is that the forfeiture took place after bankruptcy, but it is not clear when the breach occurred. In the present case the Court of Appeal expressed the view (obiter) that the anti-deprivation rule would apply in such circumstances and that once bankruptcy commences, deprivation on any grounds would be impermissible: paras 93-94 and 161-163 per Lord Neuberger MR and Patten LJ. They considered (echoing what Neuberger J had said in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, para 105) that the decision in Ex p Newitt 16 Ch D 522 could not survive British Eagle.
Whether Ex p Newitt was correctly decided does not arise for decision on this appeal. It was cited, with apparent approval, by Harman J in Jennings’ Trustee v King [1952] Ch 899, 911. It was not mentioned in any of the phases of the litigation in British Eagle [1975] 1 WLR 758 other than in the dissenting speech of Lord Morris (at p 771), who used it in support of the proposition that a right in a contract is not defeated by the commission of an act of bankruptcy before the contractual right is exercised. The view of the majority was that the netting-off in the clearing house which occurred after the liquidation was ineffective, and consequently the majority must be taken to have rejected the proposition. But it does not follow that the principle identified by Lord Morris is no longer good law in the context of the anti-deprivation rule. On the facts of Ex p Newitt, however, the pari passu principle as well as the anti-deprivation principle may have been engaged, and it may be that the right to forfeiture after bankruptcy or liquidation was not the type of equity to which a trustee or liquidator would take subject. In either of those cases, the forfeiture would not have been effective.
Determinable and defeasible interests and “flawed assets”
The law reporter, Mr Clement Swanston, summarised some of the early cases in a note to his report of the decision of Lord Eldon LC in Wilson v Greenwood (1818) 1 Swans 471, 485, and his summary was quoted with approval in Whitmore v Mason 2 J & H 204, 209-210 by Sir William Page Wood V-C, by the Court of Appeal in Ex p Barter 26 Ch D 510, 519, and by Stirling J in Mackintosh v Pogose [1895] 1 Ch 505, 511. Mr Swanston said:
“The general distinction seems to be, that the owner of property may, on alienation, qualify the interest of his alienee, by a condition to take effect on bankruptcy; but cannot, by contract or otherwise, qualify his own interest by a like condition, determining or controlling it in the event of his own bankruptcy, to the disappointment or delay of his creditors …”
In Whitmore v Mason 2 J & H 204, 212 Sir William Page Wood V-C distinguished the exclusion of the lease on the partnership account to be taken on bankruptcy from “the ordinary condition in a demise of land, that in the event of the tenant becoming bankrupt the land shall revert to the landlord.” This reflected the old rule that a provision for forfeiture of a lease on winding up did not contravene the principle since it was merely a qualification of the lessee’s estate: Roe d Hunter v Galliers (1787) 2 Term Rep 133. A provision of this kind is common form in most leases and is recognised by sections 146(7), (9) and (10) of the Law of Property Act 1925. By providing for limited relief against the operation of such clauses, the legislation implicitly endorses the validity of such provisions at common law. The lease cases show that such a provision is regarded by the law as effective to bring the lease to an end whether the lease is expressed (a) to run “until bankruptcy” or (b) as a lease with “a proviso for forfeiture” in that event. The result has not depended upon linguistic differences of expression, and section 146(7) of the 1925 Act proceeds on the basis that no difference is to be drawn between the two situations.
So also licences of intellectual property expressed to determine (or to be determinable on notice) on bankruptcy of the licensee are valid; and interests under protective trusts granted by the settlor to a beneficiary until the beneficiary’s bankruptcy: Lewin on Trusts, 18th ed (2008), para 5-135; and section 33 of the Trustee Act 1925.
The distinction for the purposes of insolvency law is between an interest determinable on bankruptcy/liquidation and an absolute interest which is made defeasible on bankruptcy/liquidation by a condition subsequent. A determinable interest is an interest the quantum of which is limited by the stipulated event, so that the occurrence of that event marks the end of the duration of the interest, whereas a defeasible interest is one which is granted outright and then forfeited. As Professor Sir Roy Goode points out in his comment (2011) 127 LQR 1, 8 on the decision of the Court of Appeal in this case, the difference between a determinable interest, limited to last until bankruptcy, and an interest forfeitable on bankruptcy as a condition subsequent, turning as it does on fine verbal distinctions, has been categorised as “little short of disgraceful to our jurisprudence” when applied to a “rule professedly founded on considerations of public policy” (quoting In re King’s Trust (1892) 29 LR Ir 401, 410, per Porter MR, a case on the rule against repugnancy, which is offended by forfeiture but not by termination).
Professor Sir Roy Goode rightly accepts (ibid) that the principle that a determination clause is not an attempt to remove an asset from the company but simply a delineation of the quantum of the asset or the duration of the transferee’s entitlement is too well established to be dislodged otherwise than by legislation. That is particularly so for these reasons. It would go far beyond the judicial function to hold that the distinction is indefensible. To hold that both types of determination are contrary to the anti-deprivation principle would be thoroughly destructive of commercial expectations in many areas. So also to say that both types of determination are valid would at a stroke do away with a 200 year old principle, which could only be justified if the mischief which the anti-deprivation rule seeks to remedy were adequately covered by statute. No doubt to some extent the anti-avoidance provisions go some way to dealing with the mischief, but they cover different ground and contain time limitations which do not constrain the common law rule.
But it does not follow that any proprietary right which is expressed to determine or change on bankruptcy is outside the anti-deprivation rule, still less that a deprivation which has been provided for in the transaction from the outset is valid. If it were so, then the anti-deprivation rule would have virtually no content. This is the “flawed asset” theory, the idea that, where it is an inherent feature of an asset from the inception of its grant that it can be taken away from the grantee (whether in the event of his insolvency or otherwise), the law will recognise and give effect to such a provision. If that theory were generally applicable, it would represent such an easy way of avoiding the application of the principle, that the principle would be left with little value: Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, at paras 91-92, per Neuberger J.
The theory is also inconsistent with most of the cases in which the principle has been applied: see especially Whitmore v Mason 2 J & H 204; Ex p Mackay LR 8 Ch App 643; Ex p Jay 14 Ch D 19; Ex p Barter 26 Ch D 510. To the extent that this idea underpins Patten LJ’s judgment in the present case (which is by no means certain), it should not be accepted because it would empty the basic rule of any substantive content.
For the same reason the answer cannot be found by characterising or describing the right as limited by the condition. If it were possible to characterise LBSF’s right as “a right to be repaid in priority to the Noteholders when there was not at the date of termination an Event of Default in relation to which it was the Defaulting Party” then it would have been possible so to characterise the rights in cases in which the rule has been applied: eg an interest in the partnership mine if not bankrupt (Whitmore v Mason); or a right to royalties if not bankrupt (Ex p Mackay).
Acquisition of property with own assets
In Whitmore v Mason 2 J & H 204, 214-215 Sir William Page Wood V-C said:
“If his co-partners had advanced a definite sum of money on account of his share, then the property might have been considered to the extent of the money so advanced by them, as identically their money; but this has not been done.”
Sir William Page Wood V-C’s statement was based on a marriage settlement case, Lester v Garland (1832) 5 Sim 205, which confirmed a long line of cases which had established that the wife’s portion would be protected in the event of the husband’s bankruptcy:
“A variety of cases, beginning with the case of Lockyer v. Savage [(1732) 2 Str 947], which was decided about 100 years ago, have established that, though there cannot be a settlement of the husband’s own estates so as to make his life interest cease in the event of his becoming a bankrupt, in order that the benefit of the estate might be given to the wife or children of the marriage, yet the wife’s estate may be so settled.” (p 222)
As Stirling J put it in Mackintosh v Pogose [1895] 1 Ch 505, 511:
“… it has long been established that if husband and wife both bring property into such a settlement [viz, a marriage settlement], a trust of the income of the wife’s property in favour of the husband until his bankruptcy is good, while a similar trust of the income of the husband’s property is bad ..”
The basis of the rule was that
“the courts treated the property of the husband as being in substance the property of the wife … [and] as the identical property brought by her into settlement” (at 514-515).
In Higinbotham v Holme 19 Ves Jun 88, 92-93, Lord Eldon LC distinguished the case of the settlement by the bankrupt husband on himself of a life interest, from, firstly,
“the case of the wife’s property limited until the bankruptcy of her husband; that is, where she reserves a power over her own property”,
and, secondly,
“the case of a lease made determinable by the bankruptcy of the lessee: that is a reservation by the owner of the property of a power over it.”
The marriage settlement cases are not far removed from the category of determinable and defeasible interests or “flawed assets,” but they do suggest that the source of the assets is an important element in determining whether there has been a fraud on the bankruptcy laws. Lord Neuberger MR’s conclusion [2010] Ch 347, para 64 was that Whitmore v Mason is authority for the view that the anti-deprivation rule 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.
That conclusion is supported by the very frequent formulation of the anti-deprivation rule in terms of the bankrupt’s “own property.” Thus in Holmes v Penney (1863) 3 K & J 90, 102, Sir William Page Wood V-C stated the general principle as being that
“a trader cannot, even for valuable consideration, settle his own property in such a manner as that he should take an interest in it until his bankruptcy, and afterwards, it should be held in trust for his wife and children.” (emphasis added)
and there are many similar references in the older cases to the settlement or disposition of the bankrupt’s own property: eg In re Detmold 40 Ch D 585, 588 per North J; In re Stephenson [1897] 1 QB 638, 640 per Vaughan Williams J; In re Halstead, Ex P Richardson [1917] 1 KB 695, 709 per Warrington LJ.
The anti-deprivation rule of course only applies where the bankrupt’s own property is in issue, and these dicta do not show that the rule has no application where the source of the bankrupt’s asset is the person to whom it is to go on bankruptcy. Nor would it be right for there to be a general and universally applicable exception to the general rule based simply on the source of the assets. But if the source of the assets is the person to whom they are to go on bankruptcy that may well be an important, and sometimes decisive, factor in a conclusion that the transaction was a commercial one entered into in good faith and outside the scope of the anti-deprivation rule.
Provision operating on insolvency (as distinct from bankruptcy/liquidation)
This point does not arise for decision on this appeal. The only potentially relevant Events of Default are the Chapter 11 filings by LBSF and LBHI. The point was considered in Whitmore v Mason 2 J & H 204, where it was held that it did not matter that under the partnership deed the account was to be taken in the event of bankruptcy or insolvency, and insolvency had occurred before any act of bankruptcy:
“A bankrupt is usually insolvent before he commits an act of bankruptcy. First he becomes insolvent, and then bankrupt; and if that construction were to prevail the bankrupt laws might, in all cases, be defeated.” (p 215)
Executory contracts
It is a very common provision in commercial contracts that performance may be withheld in the case of the other party’s bankruptcy or liquidation. In Lomas v JFB Firth Rixson Inc [2010] EWHC 3372 (Ch) interest swap counterparties withheld payments due to Lehman Brothers International (Europe) in reliance on a provision of the ISDA Master Agreement that a party’s payment obligations were subject to the condition precedent that there was no continuing Event of Default with respect to the other party. On the question whether the anti-deprivation principle applied, Briggs J considered that the authorities justified a distinction between (a) cases where the asset of the insolvent company was a chose in action representing the quid pro quo for something already done, sold or delivered before the onset of insolvency; and (b) cases where the right in question consists of the quid pro quo (in whole or in part) for services yet to be to be rendered or something still to be supplied by the insolvent company in an ongoing contract. He held that in the former situation the court would more readily hold that the anti-deprivation rule applied. This decision was distinguished in Folgate London Market Ltd v Chaucer Insurance plc [2011] EWCA Civ 328, where there was a contractual provision for a right of indemnity to be terminated in the event of liquidation: it was a naked attempt to provide that the obligation to pay was to be extinguished if payment would be available for creditors generally in the event of insolvency: para 22.
The Swap Agreement in the present case is subject to the same provision, but its effect is not in issue in these proceedings. Accordingly the important and difficult question of the extent to which payment obligations in executory contracts are affected by the anti-deprivation rule does not arise on this appeal, and since it is a live issue in other proceedings it is best not to express a view on it, except to say that accrued property rights such as debts must be at least capable of being caught by the rule.
VII Conclusions
It would go well beyond the proper province of the judicial function to discard 200 years of authority, and to attempt to re-write the case law in the light of modern statutory developments. The anti-deprivation rule is too well-established to be discarded despite the detailed provisions set out in modern insolvency legislation, all of which must be taken to have been enacted against the background of the rule.
As has been seen, commercial sense and absence of intention to evade insolvency laws have been highly relevant factors in the application of the anti-deprivation rule. Despite statutory inroads, party autonomy is at the heart of English commercial law. Plainly there are limits to party autonomy in the field with which this appeal is concerned, not least because the interests of third party creditors will be involved. But, as Lord Neuberger stressed [2010] Ch 347, para 58, it is desirable that, so far as possible, the courts give effect to contractual terms which parties have agreed. And there is a particularly strong case for autonomy in cases of complex financial instruments such as those involved in this appeal.
No doubt that is why, except in the case of a blatant attempt to deprive a party of property in the event of liquidation (Folgate London Market Ltd v Chaucer Insurance plc [2011] EWCA Civ 328), the modern tendency has been to uphold commercially justifiable contractual provisions which have been said to offend the anti-deprivation rule: Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150; Lomas v JFB Firth Rixson Inc [2010] EWHC 3372 (Ch); and the judgments of Sir Andrew Morritt C and the Court of Appeal in these proceedings. The policy behind the anti-deprivation rule is clear, that the parties cannot, on bankruptcy, deprive the bankrupt of property which would otherwise be available for creditors. It is possible to give that policy a common sense application which prevents its application to bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy.
Except in the case of well-established categories such as leases and licences, it is the substance rather than the form which should be determinant. Nor does the fact that the provision for divestment has been in the documentation from the beginning give the answer, nor that the rights in property in question terminate on bankruptcy, as opposed to being divested. Nor can the answer be found in categorising or characterising the property as “property subject to divestment on bankruptcy.”
If the anti-deprivation principle is essentially directed to intentional or inevitable evasion of the principle that the debtor’s property is part of the insolvent estate, and is applied in a commercially sensitive manner, taking into account the policy of party autonomy and the upholding of proper commercial bargains, these conclusions on the present appeal follow.
The answer is not to be found in the Noteholders’ argument that (a) LBSF’s property was a beneficial interest under a trust, of which it was one of a number of beneficiaries (Clause 5.3 of the STD) and that (b) LBSF retains its beneficial interest under the trust to this day. The fact that the security interests were held by the Trustee is not determinative. The court has to look to the substance of the matter, which is that LBSF had a security interest, the content and extent of which altered when it filed for Chapter 11 protection. Nor is it to be found in the fact that the potential for change in priority was in the documentation from the beginning, nor in the “flawed asset” argument or variant of it, that the security interest, or the right under the trust to have the trust property administered in accordance with Swap Counterparty Priority, was inherently qualified or limited, because it applied only for so long as there had been no Event of Default under the Swap Agreement for which the Swap Counterparty was the Defaulting Party.
The answer is to be found in the fact that this was a complex commercial transaction entered into in good faith. Although, as a matter of law, the security was provided by the Issuer out of funds raised from the Noteholders, the substance of the matter is that the security was provided by the Noteholders and subject to a potential change in priorities.
The security was in commercial reality provided by the Noteholders to secure what was in substance their own liability, but subject to terms, including the provisions for Noteholder Priority and Swap Counterparty Priority, in a complex commercial transaction entered into in good faith. There has never been any suggestion that those provisions were deliberately intended to evade insolvency law. That is obvious in any event from the wide range of non-insolvency circumstances capable of constituting an Event of Default under the Swap Agreement.
The Offering Circular Supplement emphasised that, in addition to the Notes being credit-linked to the reference portfolio, Noteholders would also have exposure to the Collateral, and impairment of the Collateral might result in a negative rating action on the Notes. The document went on:
“Purchasers of Notes should conduct such independent investigation and analysis regarding the Issuer, the security arrangements and the Notes as they deem appropriate to evaluate the merits and risks of an investment in the Notes. In particular, purchasers should note that the credit risk of the Notes includes that of the Collateral, the Swap Counterparty and the Reference Entities and that the Notes allow a purchaser to obtain the stated coupon in exchange for assuming such credit risk. The coupon and Initial Principal Amount may be at risk if one or more Credit Events occur and in certain circumstances the Notes may redeem at zero.”
There were three main risks for Noteholders: (1) Credit Event risk, that is, the risk that Credit Events might occur and be notified under the Swap Agreement, reducing the amount payable by the Issuer; (2) Collateral risk, being the risk that the Collateral might default or decline in value (a more likely eventuality in modern conditions than it might have seemed in 2004); and (3) LBSF risk, being the risk that LBSF might not be in a position to provide sufficient funds to the Issuer for it to pay the Noteholders interest or principal. The documents were intended to regulate the delicate relationship between Noteholders’ risk and LBSF’s risk.
The Noteholder Priority provisions were intended to deal with LBSF risk. The fact that, in certain circumstances, the change in priority would lead to a (possibly unanticipated) benefit to the Noteholders and to the loss of LBSF’s security rights in the Collateral in respect of Unwind Costs does not unravel this highly complex transaction.
These transactions were designed, arranged and marketed by the Lehman group. The investors who bought the Notes were in the main not banks. In the case of the Belmont Noteholders they were Australian local authorities, pension funds, private investment companies and private individuals. There was evidence that the fact that the Noteholders would have priority over the Collateral in the event of LBSF’s insolvency was a very material factor in obtaining Triple A credit ratings which enabled Lehman to market the Notes.
For these reasons Sir Andrew Morritt C and the Court of Appeal were right to find that the key provisions were valid and enforceable.
Lord Mance
An anti-deprivation principle?
I am satisfied that there are, and ought to be, two principles in this area. One is the principle applied in British Eagle, which precludes a bankrupt from agreeing to distribute his, her or its property other than pari passu in bankruptcy (although it does not preclude creditors from agreeing inter se on the distribution inter se of their pari passu shares: In re Maxwell Communications Corpn plc [1993] 1 WLR 1402). The other is a concurrent principle, whereby dispositions of property on bankruptcy may be invalidated as being in fraud or an evasion of the bankruptcy laws. The only challenge to the former principle has been in written submissions made by The Premier League as interveners (closely related to pending proceedings brought against it by Her Majesty’s Revenue and Customs). I see no basis for any fundamental challenge to the principle, and I shall in view of the pending proceedings say nothing about particular issues which may arise there about the scope of the principle or its application to direct payment clauses such as those discussed in paragraph 6-11 of Professor Sir Roy Goode’s Principles of Corporate Insolvency Law, 3rd ed (2005). It is the latter principle which is in issue on this appeal. This, an anti-deprivation principle, was examined and applied by Lord Eldon in Higinbotham v Holme (1812) 19 Ves Jun 88, and in a series of later cases, such as Lester v Garland (1832) 5 Sim 205, Whitmore v Mason (1861) 2 J & H 204, Ex p Mackay; Ex p Brown; In re Jeavons (1873) LR 8 Ch App 643 (CA), Ex p Jay; In re Harrison (1880) 14 Ch D 19 (CA), Ex p Barter; Ex p Black; In re Walker (1884) LR 26 Ch D 510 (CA) and In re Johns; Worrell v Johns [1928] Ch 737 and, more recently, Mayhew v King [2010] EWHC 1121 (Ch). It was recognised and considered, without adverse comment, by the Privy Council in Bombay Official Assignee v Shroff (1932) 48 TLR 443 and by the House of Lords in British Eagle [1975] 1 WLR 758. Section 33(1)(ii) of the Trustee Act 1925 also assumes the existence of such a principle.
While the two principles are conceptually distinct, they are quite closely allied. British Eagle addresses what happens in bankruptcy. An anti-deprivation principle addresses what happens on bankruptcy. If contracting out of the statutory rule requiring pari passu distribution in bankruptcy is impermissible, it would be surprising if there were no concurrent principle capable of invalidating certain dispositions which, by removing property from the bankrupt on bankruptcy, had the same ultimate effect. The general principle of pari passu distribution in bankruptcy would otherwise easily be evaded, as the court observed in Ex p Mackay LR 8 Ch App 643. It is also unsurprising that the facts of some of the authorities (eg Whitmore v Mason 2 J & H 204 and Ex p Mackay) might plausibly have been analysed as falling within either principle. Further, it is clear that there is no conceptual difference between removing specific property from the bankrupt estate for no consideration (Whitmore v Mason), increasing the security given to a particular creditor (Ex p Mackay) and increasing the bankrupt estate’s liability to a particular creditor (In re Johns [1928] Ch 737). All these fall within the anti-deprivation principle.
The existence in the Insolvency Act 1986 of other provisions protecting the interests of creditors in bankruptcy does not supersede or make redundant an anti-deprivation principle. First, the 1986 Act must have been enacted against the background of the case law establishing that certain deprivations on bankruptcy are impermissible and void. Second, the statutory provisions cover different ground. Section 127 concerns dispositions after the commencement of the winding up, section 238 transactions at an undervalue and section 239 preferences. Sections 238 and 239 only avoid transactions within specified periods ending with the onset of insolvency (from six months to two years). Section 423 requires proof of both a transaction at an undervalue and a specific intent to put assets beyond the reach of or prejudice a potential claimant. These provisions have their own historical antecedents, dating back to the Fraudulent Conveyances Act 1571 (13 Eliz 1, c 5) and the doctrine of fraudulent preference formulated by Lord Mansfield in 1768 (see Alderson v Temple (1768) 4 Burr 2235 and later incorporated in statutory form in the Companies Act 1862 (25 & 26 Vict, c 89)).
The more difficult question concerns the character of transaction and the state of mind which will attract the operation of the anti-deprivation principle. In my opinion, the court has to make an objective assessment of the purpose and effect of the relevant transaction or provision in bankruptcy, when considering whether it amounts to an illegimate evasion of the bankruptcy law or has a legitimate commercial basis in other considerations. The references in the cases to “fraud” of the bankruptcy law are not to fraud in a strict sense or even to conduct which is morally opprobrious. Equity took a broader approach to “fraud”: Snell’s Equity, 32nd ed (2010), para 8-001; and see eg the cases on fraudulent concealment preventing the running of a limitation period: Kitchen v Royal Air Force Association [1958] 1 WLR 563; Tito v Waddell (No 2) [1977] Ch 106, 245B-C. Counsel for the unsuccessful wife in Higinbotham v Holme 19 Ves Jun 88 made the distinction between actual and other fraud clear when he said, at p 90, that the settlement “being free from objection for want of consideration or upon actual fraud” could only be represented as a fraud upon the bankruptcy law in one of two ways, either on the basis of (the then existing, but in that case irrelevant and since the Insolvency Act 1985 finally abolished) doctrine of reputed ownership “or by considering it as a subtraction from the creditors of his estate, which he enjoys and possesses for every other purpose”.
In a number of the old authorities, a conclusion that the anti-deprivation principle applied was expressed in terms referring to an express or deliberate object of evading the bankruptcy law. Lord Eldon LC in Higinbotham v Holme and the Court of Appeal in Ex p Mackay LR 8 Ch App 643 based themselves on an analysis of the transaction which led them to conclude that the “express object” was to take the case out of the reach of the bankruptcy laws. The palpably artificial scheme in In re Johns [1928] Ch 737 was described as “a deliberate device to secure that more money should come to the mother, if the son went bankrupt, than would come to her if he did not” (p 748). In dicta in British Eagle [1975] 1 WLR 758, 780, Lord Cross of Chelsea said that existences of a charge in Ex p Mackay meant that “The court could only go behind it if it was satisfied – as was indeed obvious in that case – that it had been created deliberately in order to provide for a different distribution of the insolvent’s property on his bankruptcy from that prescribed by the law”.
Other cases have however stated an anti-deprivation principle in terms focusing on the character of the transaction or provision, identified objectively. In a note to Wilson v Greenwood (1818) 1 Swans 471 (another decision of Lord Eldon) which was subsequently quoted by Lord Hatherley LC in argument in Whitmore v Mason 2 J & H 204, 209-210 and by Fry LJ in Ex p Barter LR 26 Ch D 510, 519-520, Mr Swanston stated simply that “the owner of property may, on alienation, qualify the interest of his alienee by a condition to take effect on bankruptcy; but cannot by contract or otherwise qualify his own interest by a like condition, determining or controlling it in the event of his own bankruptcy, to the disappointment or delay of his creditors”. That is an objective test. In Ex p Jay 14 Ch D 19 a building owner demised land to a builder for 99 years, with detailed covenants to build thereon within certain times and subject to a power of distress and entry in case of either default in performance or bankruptcy or insolvency on the part of the builder, in either of which cases all the builder’s improvements, plant and chattels on site were to be forfeited to the building owner. There was a commercial advantage behind the forfeiture provision, and Bacon CJ in fact said at first instance that “There was no fraud, but a transaction perfectly consistent with the speculation into which both parties had entered, that the materials brought upon the land were to be used in constructing the buildings” (p 23). But the Court of Appeal held that (there having been, prior to the bankruptcy, no default which could by itself have triggered the forfeiture) the forfeiture was void in the event that happened, of its being triggered by the builder’s bankruptcy.
In Ex p Barter 26 Ch D 510, a similar point arose under a shipbuilding contract, which entitled the owners, in various events including the builders’ cessation of work for 14 days or bankruptcy or insolvency, to take possession of the vessel and complete it using such of the builders’ materials as were on their premises intended for use in completion. The builders went bankrupt and the owners claimed the right to use their materials. In justification, they argued strenuously the question was “whether at the time when the contract was entered into the parties intended to defeat the bankruptcy law; – whether it was an honest or a dishonest contract” (p 515), and the clause was for the builders’ benefit since completion of the ship would reduce their bankrupt estate’s liability. The Court of Appeal noted that the latter argument was fallacious, since the effect of the clause was to transfer to the owner the trustee’s right to elect whether or not to complete. The court went on to reject the owner’s case without reference to any state of mind, on the simple basis of the rule stated by Mr Swanston. To similar effect is, as Neuberger J noted in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, para 102, a passage in the judgment of Farwell J in Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279, 291. In the Borland’s case, Farwell J, while accepting that the second principle did not apply to provisions compelling sale of shares on bankruptcy at their fair value, added that a provision compelling their sale at something less than the price they would otherwise obtain “would be repugnant to the bankruptcy law”. The reasoning of Lord Blanesburgh in Bombay Official Assignee v Shroff 48 TLR 443, 446, to which Neuberger J also referred is, as I see it, equivocal and the judgment went off on another point.
An objective approach is also consistent with authorities which show that what matters is whether the deprivation was triggered by bankruptcy, and that, if it is, it is irrelevant that there was also events other than bankruptcy, which if they had occurred would have triggered deprivation, but which did not in fact occur. In Higinbotham v Holme 19 Ves Jun 88 there was a settlement by a prospective husband of moneys on trust for the husband unless and until he should, during his wife’s lifetime, die or become bankrupt in which case she should receive an annuity. The annuity in favour of the wife was held void as regards the period between the husband’s bankruptcy and death, but Lord Eldon made clear that it would still be payable as and from the date when her husband later died. In Ex p Jay 14 Ch D 19 and Ex p Barter 26 Ch D 510 the relevant clauses authorised forfeiture of the builder’s materials on certain defaults in performance as well as on bankruptcy, but no such other events had occurred prior to the builders’ bankruptcy, upon which the clauses were actually operated. In re Detmold; Detmold v Detmold (1889) 40 Ch D 585, a settlor made a marriage settlement settling income on himself for life or until “he shall become bankrupt, or shall assign, charge, or incumber the said income, or shall do or suffer something whereby the same … would through his act, default, or by operation or process of law … become vested in or payable to some other person …”. A judgment creditor obtained the appointment of a receiver over the income on 19 July 1888 and on 29 July 1888 the settler was adjudicated bankrupt. The wife’s interest vested on the appointment of the receiver and was held valid as against the creditors.
In Whitmore v Mason 2 J & H 204, the fact that the trigger for the anti-deprivation principle is bankruptcy was ingeniously invoked in an argument that, since the clause purportedly removing property from the bankrupt partner’s estate was expressed to take effect in the event of “bankruptcy or insolvency”, it therefore “took effect in this case immediately the partner was unable to pay his debts, and consequently before any act of bankruptcy under which his assignees could claim”; but Page Wood V-C gave the argument short shrift, saying that a bankrupt is usually insolvent before he commits an act of bankruptcy and “if that construction were to prevail, the bankrupt laws might, in all cases, be defeated” (p 215). In contrast, in Ex p Newitt; In re Garrud (1881) 16 Ch D 522 the clause in a building lease entitled the building owner to re-enter, and provided for forfeiture on re-entry of the builder’s materials by way of liquidated damages, if the builder defaulted in fulfilling the agreement. The builder defaulted but, on one view of the facts, there was no re-entry and forfeiture prior to bankruptcy. The Court of Appeal held that, since the trustee in bankruptcy took possession subject to any pre-existing rights, the right to re-enter and forfeit could be exercised even after the bankruptcy. In the present case, Lord Neuberger MR and Patten LJ [2010] Ch 347, paras 93, 163 thought that the decision in In re Newitt cannot survive British Eagle [1975] 1 WLR 758, in so far as it held that a right to forfeit could be exercised after bankruptcy. But it is unnecessary in this case to consider whether that is correct.
A further point is that it may be possible to sever a transaction or provision which infringes the anti-deprivation principle, avoiding it only to the extent that it has this character. This is indicated by Lester v Garland 5 Sim 205 (where a husband’s provision that moneys settled on himself should on his bankruptcy go to his wife and children was held valid as to 15 sixty-sixths, on the basis that so much of the moneys derived from her father and could be treated as coming from her, and void as to the rest). Lord Eldon’s indication in Higinbotham v Holme 19 Ves Jun 88 that it was only in the period between the settlor’s bankruptcy and death that the creditors would take priority over the wife is in the same sense.
Mr Swanston’s note to Wilson v Greenwood 1 Swans 471 covers two categories of situation: first, the owner of property may, on alienation, qualify the interest of his alienee by a condition to take effect on bankruptcy; the anti-deprivation principle does not prevent that; but, secondly, he cannot by contract or otherwise qualify his own interest by a condition, determining or controlling it in the event of his own bankruptcy. A straightforward instance of the first situation is provided by the protective trust, within the meaning of section 33 of the Trustee Act 1925, created by a third party: Money Markets International Stockbrokers Ltd [2002] 1 WLR 1150, paras 47-49, and Sir Roy Goode, “Perpetual Trustee and Flip Clauses in Swap Transactions” [2011] LQR 1, 8. Provisions for the forfeiture of leases on a tenant’s bankruptcy were seen as falling within the same category (Whitmore v Mason, 2 J & H 204, 212-213). This was despite their mutual aspect (perhaps because it was assumed that landlords could dictate their own terms). Such provisions are now recognised as valid in section 146(9) of the Law of Property Act 1925. A straightforward instance of the second situation is the settlement by a person of his own property on terms depriving him (and so his creditors) of it upon his bankruptcy. Early examples are Higinbotham v Holme 19 Ves Jun 88 and Lester v Garland 5 Sim 205.
Contractual situations present more difficulty. As Mr Swanston’s note makes clear, the fact that two contracting parties have agreed a provision does not make it valid. The autonomy of contracting parties cannot axiomatically prevail over the interests of third party creditors in bankruptcy. By the same token, it can be no answer to a suggestion of evasion of the bankruptcy law that the provision for deprivation was in the contractual arrangements from the outset. That will commonly be the case (and was so in many of the cases, eg Whitmore v Mason 2 J & H 204, Ex p Mackay LR 8 Ch App 643, Ex p Jay 14 Ch D 19 and Ex p Barter LR 26 Ch D 510). However, it is reasonably clear that Mr Swanston’s note was focusing on contracts affecting a pre-existing property interest. Even in that connection, the note would, read literally and generally, go too far, as the position regarding leases shows.
Where the property interest arises out of or in close connection with the relevant contract providing for its determination on bankruptcy, it may be easier to suggest a real commercial or other basis for the deprivation provision, and correspondingly more difficult to invoke the anti-deprivation principle. Thus, in Borland’s Trustee [1901] 1 Ch 279 the purpose of the requirement, that any holder of the company’s shares who became bankrupt should sell them at a specified price, was that the company should remain under the control of its managers and workers in Burma. There was, Farwell LJ said, at p 291, “nothing repugnant to any bankruptcy law in such a provision as that”. Turning to the price, he said that there was also nothing repugnant in that, since it was a fair value, although there would have been, had the obligation been to sell the shares at a lesser price (p 291). In the Money Markets International Stockbrokers Ltd case [2002] 1 WLR 1150, Neuberger J identified deprivation provisions operating on bankruptcy in relation to valueless assets or to assets ownership of which depends upon the personal characteristics of their owner as likely also to fall outside the second principle. He noted that it was presumably on this basis that the loss of membership of the relevant stock exchange on bankruptcy had not been challenged in Bombay Official Assignee v Schroff 48 TLR 443 or in Money Markets. In the former case, Lord Blanesburgh said, at p 445, that “if such an organisation is to attain its ends membership must plainly be a personal thing, incapable of uncontrolled transfer: expulsion from membership must normally follow default or misconduct: upon expulsion all interest of the defaulting member in the property of the organisation must cease”. In Money Markets, Neuberger J extended this approach to an ancillary asset in the form of a share in the London Stock Exchange which was liable to rescission for no consideration on bankruptcy. It is unnecessary to engage with the detail of the case or its outcome, but the conclusion that assets which are ancillary to a personal right may be forfeited on bankruptcy is understandable, although I believe that the terms of forfeiture might require particular consideration if there was nothing personal about the assets themselves and they were detachable and separately alienable.
The existence of a contractual scheme, which is said to create the relevant property interest, but at the same time to include provisions providing for its illegitimate deprivation on bankruptcy, raises several questions: First, how far did the scheme confer any property interest on the subsequently bankrupt party? Second, how far did it deprive him of any such property on bankruptcy? Third, in so far as it did deprive him of any such property on bankruptcy, did this amount to an illegitimate evasion of the anti-deprivation principle? The first question is exemplified by the difference between the majority and minority in British Eagle as to whether the International Air Transport Association (“IATA”) arrangements then in force had given rise to any indebtedness between IATA members, and by the conclusion of the majority of the High Court of Australia in International Air Transport Association v Ansett Australia Holdings Ltd [2008] HCA 3, (2008) 234 CLR 151 that the modified IATA arrangements did not do so.
The parallel issue in the present case is whether the swap between Saphir and LBSF gave LBSF any property in the form of either or both of a contractual right to priority in respect of Unwind Costs and a proprietary interest in the collateral to secure such Unwind Costs. In answering that question, it is necessary to examine the terms and effect of the contractual arrangements, summarised above. There can be a fine distinction between arrangements conferring a limited or determinable benefit and arrangements conferring a larger benefit but making it forfeitable in circumstances including bankruptcy. Such a distinction has also been examined in the context of the common law rule of repugnancy which prevents a condition subsequent from being attached to an outright gift. The court was invited to sweep away any such distinction, at least in the present context. Mr Snowden made the invitation on the basis that limited or determinable interests should be assimilated with conditions subsequent, rendering the termination potentially invalid in all cases; Mr Salter and Mr Howard made it on the opposite basis that conditions subsequent should be assimilated with limited or determinable interests, and party autonomy given effect in all such situations.
In the context of the rule against repugnancy, the distinction between limited or determinable interests and conditions subsequent has been regularly criticised – although, one notes, with few positive suggestions as to what might replace it. Porter MR In re King’s Trust (1892) 29 LR Ir 401, 410 thought it “little short of disgraceful to our jurisprudence” that in reference to a rule professedly founded on public policy there should be a distinction between a gift of an annuity for life coupled with a proviso for cessation if the donee married (treated as giving a life interest) and a gift until he marries (treated as giving an interest only until marriage). Porter MR’s criticism appealed, in similar contexts, to Pennycuick V-C In re Sharp’s Settlement Trusts [1973] Ch 331, 340G and to Rattee J In re Scientific Investment Pension Plan Trusts [1999] Ch 53, 59F-G, as well as to Professor Sir Roy Goode (Principles of Corporate Insolvency Law, 3rd ed, pp 186-187 and (2011) 127 LQR 1, 8. However, all of these authorities have taken the distinction as well-established and one which has to be accepted, and either of the extremes embraced by Mr Snowden on the one hand and Mr Salter and Mr Howard on the other could have far-reaching implications. But I think that there is some scope for looking at the substance, rather than the form, when considering whether an agreement confers a limited or determinable interest or amounts to a condition subsequent depriving the bankrupt of property on bankruptcy. This would be consistent with the first instance decision in Mayhew v King [2010] EWHC 1121 (Ch), which no-one challenged before the Supreme Court, and which was upheld by the Court of Appeal after the hearing before the Supreme Court, sub nom Folgate London Market Ltd (formerly Towergate Stafford Knight Co Ltd) v Chaucer Insurance plc [2011] EWCA Civ 328. The broker’s undertaking by the settlement agreement in that case to indemnify the lorry owners (Millbank Trucks Ltd) against their liability to Mr Mayhew – as to 85% up to £1 m, and as to 100% above £1 m – clearly reflected effective acceptance of a pre-existing exposure to the lorry owners in negligence, and the clause limiting or terminating that agreement upon the lorry owners’ bankruptcy can have had no commercial or other object, except to prevent the lorry owners continuing to have the benefit of the indemnity to meet the claims of Mr Mayhew and/or their other creditors in whatever way would ordinarily follow in the event of such a bankruptcy. (In fact the lorry owners’ administrators had assigned the benefit of the indemnity to the lorry owners’ insurance company which had had under section 151 of the Road Traffic Act 1988 to meet Mr Mayhew’s claim against the lorry owners.)
Professor Worthington in “Insolvency Deprivation, Public Policy and Priority Flip Clauses” (2010) 7 International Corporate Rescue 28, 36 also criticises a distinction which hangs on the form of words or “wafer-thin differences in language”, but herself advances a more substantive distinction between necessarily time-limited interests (like leases) and others. I do not accept that distinction, which would have its own incongruities: a 999-year lease is to all practical intents a permanent interest, and it is hard to see, in its potential termination in say 900 years, any relevance to the question whether its termination on the tenant’s bankruptcy should be permissible; a distinction between such a lease and a permanent licence is equally unconvincing.
In Ansett (2008) 234 CLR 151, paras 151 to 179 Kirby J (dissenting) was, if necessary, prepared to look behind or through the parties’ actual contractual arrangements, in order to identify a deprivation of property in a contractual scheme which as a matter of law eliminated any indebtedness between IATA members at any time. That must, I think, also go too far and appears to me inconsistent with the assumption of both the majority and the minority in British Eagle. Courts cannot rewrite or review contractual arrangements to give them an effect contrary to the substance of what the parties have agreed, even though this means that the bankrupt has less property than would otherwise be the case before and when he becomes bankrupt.