There is something positively Dickensian when looking at the anti-deprivation rule (the "rule") and images come up of scribes working in dark and dismal rooms scratching their quills by dim candle light. Indeed, the rule dates back to the nineteenth century and many lawyers would be hard-pressed to explain it even if they are able to grasp the contradictions and fine distinctions thrown up by the old cases. In essence, the rule provides that a contractual provision is void if it provides for the transfer of an asset from the owner to a third party upon the insolvency of the owner. However, over time various courts have considered the rule and given judgments about it, some of which have been difficult, if not impossible, to reconcile. The position under current law has therefore been uncertain. The Court of Appeal has recently considered two quite different cases which both rested on the anti-deprivation principle (Perpetual Trustee Company Ltd and others vs Lehman Brothers Special Financing Inc and others and Butters and others vs BBC Worldwide ). The timing of the cases is pure coincidence as they are not related but for expediency and to assist with providing some clarity on this difficult issue, the Court of Appeal heard and gave judgment on both together.
This article will consider the judgment in the Perpetual Trustee case in a practical setting.
Our Case Study
Company A and Company B enter into a joint venture agreement, each owning 50% of the shares in their joint venture vehicle, JV. In situation (1), the joint venture agreement provides that if either Company A or Company B goes into an insolvency procedure, then that Company must give its shares in the JV to the other solvent party; in situation (2), the joint venture agreement states that the insolvent company must sell the shares to the other party at "fair market value" and in situation (3) the agreement provides that the shares must be sold to the solvent company at par.
The anti-deprivation rule explained
At first sight, any of these provisions (or similar ones in the articles of association of the JV) seem entirely reasonable. Why should a solvent joint venture partner be, in effect, penalised twice; once when its partner becomes insolvent and secondly if the liquidator or administrator sells the shares to a third party leaving the solvent joint venture company in business with a new, and potentially unknown, party? It is at this point that we need to consider the anti-deprivation principle.
The rule was first articulated in Ex p Jay; In re Harrison [2] as a common law principle that:
"There cannot be a valid contract that a man's property shall remain his until his bankruptcy and on the happening of that event shall go over to someone else [for no consideration] and be taken away from his creditors."
The rule has also been seen as one founded on grounds of public policy to protect the interests of creditors. More modern authorities have refined the rule and one judge summed it up in Perpetual Trustee as being "essentially based on the proposition that one cannot contract out of the provisions of the insolvency legislation which govern the way in which assets are dealt with in a liquidation".
The Insolvency Act governs how an officeholder must distribute the estate of an insolvent company, namely that subject to any secured or other claims having a priority status, the property in the estate must be applied rateably (or pari passu) between the creditors. The issue then becomes what property falls within the estate to be distributed.
It is worth noting that the rule only applies in relation to asset transfers taking place on or after the commencement of the insolvency. Any dispositions before insolvency fall to be dealt with under the so-called "claw-back" provisions of the Insolvency Act (i.e. transactions at an undervalue, preferences and void floating charges). However, it is striking that the court in Perpetual (as discussed below) placed much emphasis on the primacy of the statutory claw-back provisions over any "public policy argument" in favour of the rule. In particular, the court was reluctant to extend the rule beyond the present limits established in the Insolvency Act, since the Act contained detailed provisions on pre-insolvency disposals and came into force after many of the cases which dealt with the rule.
Some examples of the rule in operation are clear. It has long been accepted that it is legitimate for a landlord to terminate a lease when a tenant becomes insolvent; the tenant's right under the lease is purely a limited interest which is not part of a company's estate. Likewise, in Johns [3] the sum a son was to repay his mother for a series of small loans amounting to no more than £650 (and was possibly a great deal less), was expressed to rise from £650 in total to £1650 (plus interest) if the son went bankrupt. The court held the arrangement to be a sham and an attempt by the mother to obtain more money from her son's bankruptcy than was her entitlement.
A key case in defining the scope of the rule is Mackay [4]. This case involved two transactions: (i) A sold a patent to B in return for B paying royalties and (ii) a loan of £12,500 from B to A. It was agreed that (a) B would keep half of the royalties towards satisfying the loan and (b) if A went bankrupt, B could keep the other half of the royalties. It was held that (a) was a valid provision but (b) was not. The latter was described as a "clear attempt to evade the operation of the bankruptcy laws", since a person cannot "make it part of his contract that, in the event of bankruptcy, he is then to get some additional advantage which prevents the property being distributed under the bankruptcy law".
Perhaps the best known case on the rule is British Eagle International Air Lines Ltd v Compagnie Nationale Air France [5]. In that case a group of airlines ran a clearing house arrangement relating to the debts between them. The House of Lords, by a bare majority and overturning both the first instance and the Court of Appeal, decided that such arrangements, as they related to debts which had not yet passed into the clearing system at the date of the winding up, were ineffective as against the liquidator of British Eagle. Lord Cross concluded the arrangements did create a different distribution of assets than would be prescribed by insolvency law. The fact that the parties had good business reasons to create the system as they did and the fact that none of them seemed to have considered the effect of insolvency of one of the parties on the system was "irrelevant". The main dissenting speech also considered the mindset of the parties and sought to distinguish British Eagle from cases like Johns where there was a deliberate attempt to defeat the bankruptcy laws, as opposed to an inadvertent one.
Perpetual Trustee
The Court of Appeal hearing of Perpetual Trustee was, as mentioned above, a hearing of two unrelated cases which had in common the question of the scope and operation of the anti-deprivation principle. The Lehman Brothers side of the case was a dispute between the noteholders under a series of bonds issued by a Lehman Brothers special purpose vehicle (the "Noteholders") and Lehman Brothers Special Financing ("LBSF") as swap counterparty. A trust deed provided that the issuer was obliged to pay LBSF before paying the Noteholders, unless an event of default occurred, in which case the priority would "flip" and the Noteholders would take priority. The first instance court upheld the "flip" provision because the provision merely regulated the order of priority and did not deprive LSBF of an asset otherwise available to it.
The BBC Worldwide matter involved a joint venture agreement between BBC Worldwide ("BBCW"), Woolworths and 2e, the joint venture company owned by the two of them. 2e in turn had a wholly owned subsidiary, V, which held a licence to produce DVDs for BBCW. The joint venture agreement contained a term that if Woolworths went into an insolvency procedure, BBCW could compel Woolworths to transfer its shares in 2e to BBCW for the prevailing "market price" for the shares. The licence granted to V was expressed to terminate on the insolvency of Woolworths. As is well-known, Woolworths went into administration. The licence was terminated and BBCW gave notice that it wished to acquire the shares in 2e. BBCW argued that "market price" should reflect the fact that the licence had been terminated. The administrators of Woolworths sought directions from the court on the question. The first instance court held that although the termination provisions themselves were not objectionable or illegal, the commercial effect, along with the share transfer provisions, was to deprive Woolworths' creditors of the value of the licence and so offended the rule.
The Court of Appeal upheld the Lehman Brothers decision and reversed the BBCW's first instance decision, so that in both cases the provisions as drafted were held not to fall foul of the anti-deprivation rule. With regard to the BBCW decision, two of the judges based their decisions on the fact that the estate of Woolworths was not diminished since BBCW had to pay "fair value" for the shares, albeit that the value was now reduced following the termination of the licence. However, the court was more divided on the reasoning for the Lehman case. One line of reasoning given was that since the contract had contained the "flip" provision from the outset and could be operated on other grounds before the commencement of any insolvency procedure, then the rule should not apply. Other views were also expressed: the decision in Mackay meant that (1) a right to re-coup money under a "flip" is "every bit as much of an asset as the right to monies (in the form of royalties) arising in the future", and so potentially offended the anti-deprivation rule, (2) sale transactions should not be "dressed up" in such a way to circumvent the rule and (3) the court is keen to provide as much certainty as to the law as possible and also have regard to the parties' autonomy to agree their own contracts, as far as possible, so cases should be considered on a case by case basis. For one judge, the crucial factor in Lehman was that the collateral which was sold to reimburse the parties was bought with money provided by the Noteholders. The Noteholders permitted LBSF to have priority of repayment in certain circumstances but it was agreed ab initio that the Noteholders could re-claim priority over the assets bought with their money in the event of a default, thus distinguishing this case from Mackay.
Conclusion
So, following the two court decisions, where does that leave the parties in our case study? It would seem that some careful structural planning and thoughtful drafting could prevent a great deal of uncertainty later. It is clearly important to establish any potential rights over assets from the outset, and possibly extend the circumstances in which one can claim the asset in question to more than situations triggered on insolvency. Additionally, any transfers of properties which occur before an insolvency procedure begins will not be subject to the anti-deprivation rule, although they may be challenged under the claw-back laws. However, the crucial point may be, following BBCW, that the value of the estate must not be lessened by the contractual asset transfer provisions agreed to by the parties; so where an asset is subject to a pre-emption right arising after insolvency but where the grantee must pay "fair value" if it exercises its right, it appears the rule will not be contravened. The fact that the value of the asset may be been diminished by the insolvency itself seems to be irrelevant, provided that an appropriate value at the time of the insolvency is achieved.
In our case study, the first example clearly offends the rule but the second should not. The result with the third example is unclear. In some circumstances, purchasing shares at par will be a fair (or even generous) sum, in others, it will be insufficient; it looks likely that a case on those facts will have to be decided on its own facts.
