In Re Sigma Finance Corporation (in administrative receivership) and In Re The Insolvency Act 1986

The Supreme Court considered the construction of clause 7.6 of a Security Trust Deed governing the distribution of the secured assets of Sigma Finance Corporation after an Enforcement Event and during a 60-day Realisation Period. Applying established principles of contractual interpretation (including the approach in Investors Compensation Scheme and related authorities) the Court held that the final sentence of clause 7.6 is an ancillary provision to facilitate the establishment of matching Short Term and Long Term Pools and does not, in circumstances where clause 7.9 applies (an overall shortfall of assets), command that receivers must use cash or realizable or maturing assets to pay Short Term Liabilities falling due during the Realisation Period to the exclusion or priority of other Short or Long Term Liabilities.

The decision emphasised the Deed's overall scheme: the trustee's broad discretions (clauses 17.3 and 17.5), the obligation to establish pools under clauses 7.6–7.9 and the special mechanism for pro rata reductions under clause 7.9 in the event of a deficit. On that basis the Court allowed the appeals of interested parties C and D and dismissed the appeal of interested party B, declaring that Short Term Liabilities falling due during the Realisation Period are to be treated as part of the Short Term Pool (and not separately preferred simply because they fell due during the Realisation Period).

Background and parties: Sigma was a structured investment vehicle whose assets were secured pursuant to a Security Trust Deed dated 27 March 2003. After margin calls in September 2008 Sigma resolved it could not continue in business and an Enforcement Event occurred. The Security Trustee appointed receivers and invoked the Deed’s Realisation Period. Sigma’s remaining assets were far short of secured liabilities.

Nature of the application: The issue was how remaining assets were to be distributed under the Security Trust Deed. Four interested creditor groups (A, B, C and D) advanced competing constructions. A and B argued for priority or special treatment of liabilities falling due during the Realisation Period (disagreeing between themselves as to timing or pari passu treatment). C and D argued for an equitable allocation between Short and Long Term Liabilities with Short Term Liabilities (including those falling due in the Realisation Period) treated together and distributed under the Pool regime, possibly with on-account payments.

Procedural history: Sales J (High Court) and a majority of the Court of Appeal accepted the construction advanced for interested party A; Lord Neuberger dissented in the Court of Appeal. The matter came to the Supreme Court with permission.

Issues framed:

• Whether the final sentence of clause 7.6 obliged the Security Trustee/receivers, during the Realisation Period, to discharge Short Term Liabilities as they fell due using cash or other realisable or maturing assets, even where clause 7.9 (dealing with an overall shortfall) applied; and
• If not, how Short Term Liabilities falling due during the Realisation Period should be treated in the distribution scheme of the Deed.

Reasoning and conclusions: The Court applied ordinary principles of contractual interpretation, emphasising that isolated phrases must be read in the landscape of the whole instrument. The Deed was drafted on the assumption that secured liabilities could be met and created a scheme for establishing Short and Long Term Pools (clauses 7.6–7.9) and for proportional reduction if Assets are insufficient (clause 7.9). The final sentence of clause 7.6, properly read in context, was an ancillary, interim measure to facilitate the creation of the Pools and to address limited timing mismatches during the Realisation Period; it was not intended to confer fortuitous priority on liabilities merely because they fell due within the Realisation Period and thereby defeat the pool mechanism and the pro rata adjustments of clause 7.9. The trustee’s broad discretions (clauses 17.3 and 17.5) and the absence of express protection for trustee/receiver fees under a pay-as-you-go regime supported that construction. The Supreme Court therefore allowed the appeals of interested parties C and D, dismissed B’s appeal, and declared that Short Term Liabilities due in the Realisation Period are to be treated as part of the Short Term Pool and distributed in accordance with clauses 7.6–7.12 and, where applicable, clause 7.9.

Wider context: The Court noted that the deed had been drafted for situations of solvency and that it was improbable the parties intended the fortuitous and potentially arbitrary priority that the lower courts’ construction would produce in insolvency. Lord Walker dissented, preferring the lower courts’ literal approach.

Appeals of interested parties C and D allowed; appeal of interested party B dismissed. The Court held that clause 7.6’s final sentence is an ancillary provision read in the context of the Deed’s scheme and does not require receivers, in circumstances where clause 7.9 applies (overall asset shortfall), to prioritise payment of Short Term Liabilities falling due during the Realisation Period; such liabilities remain part of the Short Term Pool and are to be treated under the Pool mechanism (including pro rata reduction under clause 7.9). The rationale rests on contractual interpretation principles, the Deed’s overall scheme and the trustee’s broad discretions.

First instance in the High Court (Sales J). On appeal the Court of Appeal ([2008] EWCA Civ 1303) by majority affirmed Sales J’s approach; Lord Neuberger dissented. Permission to appeal to the House of Lords (now Supreme Court) was granted and the Supreme Court ([2009] UKSC 2) allowed the appeals of parties C and D and dismissed B’s appeal.