Belmont Park Investments PTY Limited v BNY Corporate Trustee Services Limited and Lehman Brothers Special Financing Inc

The anti-deprivation rule invalidates arrangements which remove property from an insolvent estate upon bankruptcy, liquidation or administration. It remains a distinct common law rule despite modern statutory avoidance provisions.

The rule should be applied according to substance and with commercial sensitivity. A bona fide commercial transaction falls outside it where deprivation of property on insolvency is neither its predominant purpose nor one of its main purposes. Neither drafting a divestment provision into the transaction from the outset nor describing the asset as inherently limited supplies the answer.

The source of the relevant asset may be important and sometimes decisive. A commercially justified priority arrangement over collateral funded in substance by the beneficiary of the priority can therefore remain valid and enforceable.

Investors subscribed for credit-linked notes issued by special purpose vehicles established under the Lehman Brothers Dante Programme. Subscription funds purchased collateral held by a trustee. The collateral secured obligations owed both to the noteholders and to Lehman Brothers Special Financing Inc (“LBSF”) under related swap agreements.

The documents ordinarily gave LBSF priority over the collateral. If an Event of Default occurred for which LBSF was the Defaulting Party, priority passed to the noteholders. Insolvency proceedings involving LBSF and its parent triggered the disputed provisions.

The Chancellor held that the provisions were valid under English law: [2009] EWHC 1912 (Ch). The Court of Appeal affirmed that decision: [2009] EWCA Civ 1160, [2010] Ch 347. The central issue before the Supreme Court was whether the change of priority unlawfully deprived LBSF’s insolvent estate of property contrary to the anti-deprivation rule.

1. Appeal dismissed unanimously. Lord Collins delivered the leading judgment. Lord Walker agreed with it, as did Lord Phillips, Lord Hope, Lady Hale and Lord Clarke. Lord Mance reached the same result by partly different reasoning.

2. The anti-deprivation rule and the prohibition on contracting out of pari passu distribution are distinct consequences of the principle that parties cannot contract out of insolvency legislation. The former prevents the withdrawal of an asset upon bankruptcy, liquidation or administration. The latter prevents a contractual distribution of an insolvent estate otherwise than according to the statutory scheme. Only the anti-deprivation rule was engaged here.

3. The anti-deprivation rule remains part of English law. The detailed avoidance provisions of the Insolvency Act 1986 cover different ground and were enacted against its background. The court could not discard two centuries of authority as a matter of judicial development.

4. Per Lord Collins, commercial sense and the absence of an intention to evade insolvency law are highly relevant. The rule should be applied in a commercially sensitive manner. It catches intentional or inevitable evasion, but not a bona fide commercial transaction whose predominant purpose, or one of whose main purposes, is not to deprive a party of property on insolvency. Subjective intention is unnecessary, and an evasive purpose may be inferred in an obvious case.

5. Substance prevails over drafting form outside established categories such as leases and licences. A provision is not necessarily valid merely because it existed from the transaction’s inception, because the right is expressed to terminate on bankruptcy, or because it is characterised as an inherently “flawed” asset. A general flawed-asset theory would deprive the rule of substantive content.

6. The source of the asset can nevertheless be important and sometimes decisive. The collateral was acquired using noteholders’ subscriptions and was, in commercial substance, provided by them. The priority terms regulated risks in a complex transaction designed and marketed by the Lehman group. They were not intended to evade insolvency law. The possibility that their operation benefited the noteholders and reduced LBSF’s effective security did not invalidate the bargain.

7. Lord Mance agreed that the appeal should be dismissed. He considered that LBSF had not acquired Swap Counterparty Priority before the event fixing priority occurred. Alternatively, the limitation served the legitimate commercial purpose of protecting future reciprocal performance and did not evade insolvency law. He did not adopt the majority’s reliance upon the source of the collateral.

8. The majority also held that the parent company’s earlier Chapter 11 filing was itself an Event of Default. The contractual priorities were fixed when that event occurred; no termination notice was required for that purpose. Lord Mance reserved his position on that issue.

1. United Kingdom Supreme Court: The appeal was dismissed unanimously. The Court affirmed that the priority provisions were valid and enforceable: [2011] UKSC 38.
2. Court of Appeal: The Chancellor’s decision was upheld: [2009] EWCA Civ 1160, [2010] Ch 347.
3. High Court, Chancery Division: Sir Andrew Morritt C held that the priority provisions did not offend the anti-deprivation rule. He also accepted an alternative ground based on the earlier insolvency filing of LBSF’s parent: [2009] EWHC 1912 (Ch), [2009] 2 BCLC 400.