Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd

The Supreme Court considered whether contractual "flip" provisions that change priority over collateral on the insolvency of a swap counterparty offend the common law anti-deprivation principle. The Court restated that the anti-deprivation rule and the pari passu principle are distinct: the anti-deprivation rule prevents arrangements that withdraw assets from an insolvent estate on bankruptcy, while the pari passu rule disallows contractual departures from statutory pari passu distribution.

The Court held that the anti-deprivation rule is not to be applied to defeat bona fide, commercially sensible arrangements unless those arrangements have the dominant purpose (or one of their main purposes) of evading insolvency law. On the facts the documentation constituted a complex commercial transaction entered into in good faith, the collateral was provided out of investors’ money, and there was no suggestion the provisions were designed to fraudulently defeat the insolvency regime. Consequently the priority "flip" provisions and associated clauses (including Condition 44 and clause 5.5/8.3 of the Supplemental Trust Deed and related ISDA provisions) were valid and enforceable.

This litigation arose from the collapse of Lehman Brothers and concerned a synthetic note issuance programme (the Dante Programme) in which special purpose issuers purchased highly rated collateral with investors’ subscription money and entered into credit default swap arrangements with Lehman Brothers Special Financing Inc (LBSF). The documentation provided for a change of priority (a "flip") over the collateral so that, on certain Events of Default (including insolvency of the swap counterparty) the Noteholders would have priority over the swap counterparty in realisation of the collateral and payment of Unwind Costs.

Nature of the claim: Noteholders (including Belmont) sought declarations and orders to realise collateral and to apply proceeds in accordance with the contractual priority provisions; LBSF contended the provisions were void as offending the anti-deprivation rule by depriving LBSF of property on its bankruptcy.

Procedural history: The Chancellor (Sir Andrew Morritt C) held the provisions valid ([2009] EWHC 1912 (Ch)); the Court of Appeal upheld that decision ([2009] EWCA Civ 1160; [2010] Ch 347). LBSF obtained permission to appeal to the Supreme Court; parallel US proceedings produced a contrary decision at first instance in the US Bankruptcy Court (Re Lehman Brothers Holdings Inc, 422 BR 407 (SDNY)).

Issues framed by the Court:

• Whether the anti-deprivation rule invalidated the contractual change of priority which operated on an Event of Default triggered by bankruptcy;
• Whether the law requires a finding of an intention to evade insolvency law for the anti-deprivation rule to apply or whether an objective inconsistency with the insolvency scheme suffices;
• Whether the timing of related Events of Default (notably LBHI’s earlier Chapter 11 filing) meant that any deprivation was not caused by LBSF’s bankruptcy.

Reasoning and conclusions: The Court reviewed nearly two centuries of authority and concluded that the anti-deprivation rule remains good law but should be applied with commercial common sense. Where a provision is part of a bona fide commercial arrangement and not principally aimed at evading insolvency legislation, it will generally be upheld. The Court emphasised the distinction between determinable interests and outright defeasible interests, and rejected a broad "flawed asset" theory that would neuter the rule. The Court accepted that the collateral had been provided with investors’ money, the documentation was honest and commercially coherent, and there was no deliberate device to defeat insolvency law. The Court therefore dismissed the appeal and upheld the validity of the flip and related provisions. The Court also accepted the Court of Appeal’s reasoning on the LBHI point (that an earlier Event of Default affecting LBHI could operate to change priority before LBSF’s bankruptcy), so that deprivation was not necessarily occasioned by LBSF’s own insolvency.

Appeal dismissed. The Supreme Court held that the anti-deprivation rule remains a live common-law principle but should be applied so as not to defeat bona fide commercial arrangements; on the facts the priority-flip clauses formed part of a legitimate, commercially sensible transaction entered into in good faith and were not void as depriving LBSF of property on bankruptcy. The Court also accepted that the earlier LBHI Event of Default could mean the flip was triggered by reasons other than LBSF’s bankruptcy.

First instance: Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2009] EWHC 1912 (Ch) (Sir Andrew Morritt C). Court of Appeal: Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2009] EWCA Civ 1160; [2010] Ch 347 (upholding first instance). US parallel first-instance decision: Re Lehman Brothers Holdings Inc, 422 BR 407 (US Bankruptcy Court SDNY, 2010) (summary judgment for LBSF on related Perpetual documentation). Permission to appeal to the Supreme Court was granted and the appeal was dismissed by the Supreme Court [2011] UKSC 38.