In its ruling on Wednesday 27 July in the matter of Belmont Park Investments PTY Ltd v BNY Corporate Trustee Services Lte & Anor  UKSC 38 the Supreme Court of the United Kingdom has dismissed the appeal by Lehman Brothers Special Finance Inc. ("LSF") relating to the validity of an alleged anti-deprivation provision known as a 'flip' provision which, has the effect of altering the payment priority order as a result of a bankruptcy of the relevant swap counterparty, in this case Lehman Brothers. The effect of the provision is to allow investors to move ahead of the swap counterparty in the distribution of the assets where the swap is in default by reason of a default by the swap counterparty (including by reason of the bankruptcy of that swap counterparty).
The basis of the LSF argument was that the agreement and outcome had breached the 'anti-deprivation principle' under which contractual terms purporting to determine the disposal of property on bankruptcy may be invalid or in breach of bankruptcy law.
In their unanimous dismissal of Lehman's appeal, the Supreme Court concluded that commercial sense and absence of intention to evade insolvency laws were highly relevant factors in determining the application of the anti-deprivation rule and that the rule does not apply to bona fide commercial transactions which do not have as their predominant purpose the deprivation of the property of one of the parties on bankruptcy. This decision reaffirms the position which had already been established by the lower courts of the UK but is in contrast to the U.S where the Bankruptcy Court has previously confirmed that flip clauses do violate U.S. bankruptcy law.
The result is helpful in removing doubts that arose in respect of applying flip clauses in priority of payments provisions under English law and is an endorsement of the approach adopted by English courts to give effect to the express terms of commercial contracts negotiated by sophisticated parties. The position between the UK and the US remains at odds however on this point and it will therefore remain a sensitive issue for US financial institutions executing swaps in structured transactions. Agreeing the form of legal opinion acceptable to rating agencies in structured transactions where a non US subsidiary of a US financial entity has in itself proved difficult in some circumstances. The position under English law is thankfully clarified but care will continue to be needed in certain cross border transactions.