The Supreme Court has given a further indication that the courts really do not want to intervene in cases involving complex financial instruments and are now seeking to emphasize party autonomy.

This case involved a complex credit swap transaction.  Investors’ money was used to acquire assets which were then charged in favour of a security trustee.  The “waterfall” provisions of the charge (which set out the priority of payment of enforcement proceeds) stated that the counterparty to the swap (a Lehman Brothers spv); was to be paid in priority to the noteholders, unless an event of default occurred.  If an event of default did occur the priority was to be “flipped”, so that the noteholders were to be paid in priority to the counterparty.  An event of default included the insolvency of the counterparty to the swap.  Unfortunately, this then occurred due to Lehman Brothers entering into Chapter 11 Bankruptcy in September 2008.  The counterparty argued before the Court that the “flip” clause infringed the anti-deprivation rule.  This is a common law rule which states that parties cannot contract out of insolvency legislation by attempting to withdraw an asset from an insolvent estate which would otherwise be available for distribution to the creditors of that estate.

However, the Supreme Court has ruled that the anti-deprivation principle should not be extended to strike down complex commercial transactions entered into in good faith where there is no intention to evade insolvency law.  The judgment has also clarified the operation of the anti-deprivation principle in commercial transactions following the decision of the House of Lords in British Eagle International Airlines Ltd v CIE Nationale Air France [1075] 1 WLR 758 which had caused confusion between the anti-deprivation principle and the pari passu principle (which prevents parties contracting to give a creditor more than a pro-rata distribution on insolvency).

Comment

The courts do seem to be stepping back from previous interventionist stances and are now leaving it up to well advised commercial parties to negotiate and agree their own positions.  If an insolvent company loses an asset as a result of documentation drafted in good faith and for commercial reasons, the Supreme Court does not believe the courts should intervene to alter an agreed position provided that there is no intention to evade insolvency law.

In theory the decision could have wide ranging consequences, certainly not confined to financial instruments, as the anti-deprivation principle applies to all forms of assets from claims to real property.  The UK Supreme Court has been sitting only since October 2009, but it is already making its weight felt in the commercial arena, and read alongside other recent Supreme Court decisions such as Rainy Sky SA (see our blog of 21 November 2011),  Belmont Park certainly helps to strike a blow for business common sense.

Whether this decision leads to renewed attempts by parties to push the boundaries of contracting out of the consequences of insolvency is less certain.  It is worth noting that the judgment in this case does not state that good faith and commercial justification will be good defences on all occasions, nor does it set out clear principles of law which can be applied definitively in all circumstances.

In short, watch this space for further developments!

For more information on this topic please contact James McNeil or Mike Pavitt