Belmont Park Investments Pty Ltd v (1) BNY Corporate Trustee Services Ltd (2) Lehman Brothers Special Financing Inc (2011)
The above case is a recent banking and finance case regarding the anti-deprivation principle which was heard by the High Court, Court of Appeal and the Supreme Court. The Supreme Court handed down judgment on 27 July 2011.
What is the anti-deprivation principle?
Under the Insolvency Act 1986 all assets of an insolvent organisation must be made available for distribution amongst its creditors.
Assets are not allowed to be taken out of the company if this will deprive creditors otherwise creditors will end up with nothing.
In the case of Harrison Ex p. Jay Re , Cotton L.J said:
"There cannot be a valid contract that a man’s property shall remain his until his bankruptcy, and on the happening of that event shall go over to someone else and be taken away from his creditors."
Summary of Belmont Park
The case concerned the validity of ‘flip clauses’ under English law.
Belmont Park (investors) signed a contract with the subsidiary of Lehman Brothers, Lehman Brothers Special Finance ("LBSF").
LBSF was a counterparty to a number of swap agreements made with a series of special purpose vehicles (each an issuer). Notes were issued by the issuer to investors (noteholders) and the funds were used to buy government bonds and other securities (collateral). The same collateral was also used to secure the issuer’s obligations to LBSF under a credit default swap.
The priority of security over the collateral was set out in a Trust Deed between LBSF, the issuer and a security trustee on behalf of the investors. This Trust Deed provided that LBSF had priority over the investors so long as no event of default (which included insolvency) was continuing in respect of LBSF. It was never entitled to that priority on an absolute basis. The agreement contained a flip clause meaning that after the occurrence of an event of default, the order of priority reversed, so that the investors had priority over LBSF. In effect, the order of priority ‘flips’.
Lehman Brothers later filed for bankruptcy in September 2008. As a result, the flip occurred and the noteholders looked to enforce their priority interest in the collateral. LBSF applied to the High Court for an order that the flip fell afoul of the anti-deprivation principle and was invalid as their creditors were being deprived of assets that they would otherwise have been entitled to on insolvency.
The High Court held that the flip did not fall foul of the rule. LBSF appealed to the Court of Appeal who upheld the decision of the High Court. The Court of Appeal held that the anti-deprivation principal did not apply in these circumstances because LBSF had only ever been entitled to priority while it was not in default and was therefore not deprived of any right as a result of its insolvency.
LBSF then appealed to the Supreme Court.
Decision of the Supreme Court
On 27 July 2011, the Supreme Court dismissed LBSF’s appeal and upheld the validity of the contractual provisions. Therefore, the enforceability of flip clauses under English law was confirmed.
The Supreme Court held that assets can be transferred, contrary to the anti-deprivation rule, as follows:
- If it makes commercial sense
- The contract was agreed in good faith
- The intention is not to avoid creditors/insolvency laws and the Courts are to take into account the contractual terms agreed between the parties
- Flawed assets can fall outside of the anti-deprivation rule. A flawed asset is a contractual right between parties which is contingent upon the completion of some precondition or is limited by reference to whether or not a particular state of affairs exist.
The Supreme Court found that not all creditors should be treated equally.
If a flip clause is drafted properly in a complex transaction, it will not be held to fall foul of the anti-deprivation principle and where possible, the contractual term will be effected.
The anti-deprivation rule will only apply where there is an intention to evade the insolvency laws.
What does this mean?
The anti-deprivation principle has been applied by courts since at least the 18th century.
Now, it would appear that a priority flip triggered by insolvency does not offend the anti-deprivation principle.
This means that if you are considering litigating a flip clause, careful consideration needs to be given to whether the conditions referred to above apply. If they do, you will be unlikely to successfully challenge the clause and priority can flip.
Jeremy Marshall, Partner, Commercial Litigation, London