Law Club Lecture Notes Draft 1

London Law Club: 24 November 2010 Sarah Worthington

The arguments surrounding the anti-deprivation rule

The anti-deprivation rule

The anti-deprivation rule broadly asserts 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, and be taken away from his creditors.’1

A contractual arrangement which infringes the rule is void. Avoidance ensures that the liquidator will have more assets for distribution to the unsecured creditors than would have been available if the agreement had taken effect according to its terms.2 Conversely, if the rule is not infringed, the parties’ agreement takes effect, and certain creditors are, legitimately, advantaged in the way intended by the contractual arrangement.3

The rule has been applied by courts since at least the 18th century.4 On its face looks to be a simple rule, yet the line between what is permitted and what is not remains surprisingly unclear. Lord Neuberger made this plain in both Perpetual Trustee and Money Markets.5 The only House of Lords authority is British Eagle International Airlines Ltd v Compagnie Nationale Air France.6 The fallout from the current financial crisis has meant that the issue is increasingly raised in court as liquidators seek to maximise returns to creditors. The decision in Perpetual Trustee goes on

1 Ex p Jay (1880) 14 Ch D 19, 26 (Cotton LJ), cited by Lord Neuberger in Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2009] EWCA Civ 1160, [2010] Ch 347 (CA) (‘Perpetual Trustee (CA)’), para. 1. This is subject to the statutory rules on protective trusts: Trustee Act 1925 s 33. The cases primarily relied on in Perpetual Trustee (CA) were Whitmore v Mason (1861) 2 J&H 204 (‘Whitmore’); Ex parte Mackay, re Jeavons (1873) LR 8 Ch App 643 (‘Mackay’); Ex parte Jay, re Harrison (1879) 14 Ch D 19 (‘Jay’); Ex parte Newitt, re Garrud (1880) 16 Ch D 522 (‘Newitt’); In re Detmold (1889) 40 Ch D 585 (‘Detmold’); Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 (‘Borland’); British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758 (HL) (‘British Eagle’); Carreras Rothmans Ltd v Freeman Mathews Treasure Ltd [1985] Ch 207 (ChD) (‘Carreras’); Money Markets International Stockbrokers Ltd (in liq) v London Sock Exchange [2002] 1 WLR 1150 (Neuberger J) (‘Money Markets’); Fraser v Oystertec plc [2003] EWHC 2787 (Ch) (‘Oystertec’); and International Air Transport Association v Ansett Australia Holdings Ltd [2008] HCA 3 (Aust HCt) (‘Ansett’). 2 The two most common illustrations of the operation of the rule are Ex parte Mackay, re Jeavons (1873) LR 8 Ch App 643 (‘Mackay’); and British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758 (HL) (‘British Eagle’); 3 Eg Perpetual Trustee (CA), n. 1 above. 4 See the cases cited in n. 1 above. 5 See Perpetual Trustee (CA), n. 1 above, paras. 32, 57, 93 (Lord Neuberger); and Money Markets, n. 1 above, paras. 87 and 117 (Neuberger J). Also see Oystertec, n. 1 above, paras 46-7. 6 n. 1 above.

1 appeal to the Supreme Court in March 2011.7 I have already written about the analysis in Perpetual Trustee (CA),8 but the issues merit wider discussion.

What follows is a survey of the common arguments which are advanced to cut down the application of the anti-deprivation rule, and brief comments on the strength of each of these arguments.

1. Preliminary issue: there are two distinct sub-rules which make up the ‘anti-deprivation rule’

Before addressing the different arguments, one comment on the anti-deprivation rule itself seems useful.

In Mackay, James LJ put the anti-deprivation rule this way: ‘…a man [the insolvent] is not allowed, by stipulation with a creditor, to provide for a different distribution of his effects in the event of bankruptcy from that which the law provides.’9

An insolvent might seek to achieve this end by two distinct means, and these – it seems to me – need to be separately recognised if the anti-deprivation rule is to be analysed satisfactorily.

First, as in Jay, the insolvent may attempt to provide for an insolvency-triggered deprivation of his property, so that there is less in the asset pool for the statutory insolvency distribution rules to bite on, to the detriment of the [non-contracting, non- consenting] third party unsecured creditors. As Cotton LJ said, ‘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, and be taken away from his creditors.’10

In this context, the anti-deprivation rule is not breached unless there is a deprivation/diminution of the debtor’s asset pool, and that deprivation is triggered by the debtor’s insolvency. Both aspects are crucial, even if they are not repeated at every relevant point in what follows.

Secondly, as in British Eagle, the insolvent may enter into an agreement that takes the debtor’s property as it is [and does not effect any deprivation triggered by insolvency], but attempts to contract out of the statutory insolvency regime by providing for distribution of the debtor’s asset pool on insolvency in a manner that is different from that provided for by the insolvency legislation. As Lord Cross for the majority11 in British Eagle put it, ‘[s]uch “contracting out” must, to my mind, be contrary to public policy.’12 13

7 And Peck J’s decision in the US Bankruptcy Court is also being appealed: ** 8 ‘ Insolvency Deprivation, Public Policy and Priority Flip Clauses’ (2010) International Corporate Rescue 28-39. 9 Mackay, n. 1 above, 647. 10 Jay, n. 1 above, 26. 11 Himself and Lords Diplock and Edmund-Davies. 12 [1975] 1 WLR 758, 780. 13 The minority did not disagree with this principle, but thought that the agreement had effectively deprived British Eagle of any claim against Air France [and this would not have offended the anti-

2 This second sub-rule is not breached unless the purported contractual arrangement delivers an insolvency distribution that is different from the statutory insolvency distribution, and which disadvantages the non-contracting unsecured creditors. The arrangement need not be triggered by the debtor’s insolvency; all that matters is the disadvantageous difference in the insolvency distribution.

In summary, the anti-deprivation rule embraces two distinct sub-rules: (i) the ‘no contracting out’ rule (ie no arrangements that take the debtor’s property as it is, but provide for its distribution in a manner that is different from that provided for by the IA 1986) and (ii) the ‘no insolvency-triggered deprivation of the debtor’s property’ rule (ie no arrangements that purport to reduce the assets available for distribution to the unsecured creditors on the debtor’s insolvency).

These two sub-rules are both motivated by the same public policy – that non- consenting unsecured creditors should not be deprived of their entitlements under the IA 1986. But failure to segregate the two sub-rules – which themselves simply reflect the two distinct routes open to the debtor in avoiding the statutory insolvency distribution scheme – is liable to escalate confusion in the relevant analysis.

For example, the British Eagle case is often described as illustrating an unacceptable deprivation: the netting-out arrangement ‘removed from British Eagle’s estate for the benefit of other member airlines a sum due from Air France which would otherwise have been an asset available to the general body of creditors of British Eagle’.14 But this is not strictly true (although we might all be guilty of expressing the point rather informally in much this way). At least it is not true in the sense that the British Eagle arrangement did not divest assets from British Eagle’s estate; it merely provided for their different distribution. Indeed, if the arrangement had divested assets from British Eagle’s estate, then the arrangement would have been effective on British Eagle’s insolvency – this is precisely the point that divided the majority of the HL from the minority and from all the other judges in the lower courts, and the point which ensured a different conclusion in the Ansett15 litigation.

Now it is possible to turn to the common arguments advanced to cut down the application of the anti-deprivation rule.

2. The IA 1986 is a code, and should not be subject to public policy additions made by judges [FALSE]

There was noticeable judicial hesitation in intervening in Perpetual Trustee,16 with concern expressed not to extend the rule any further.17 Similarly in the Australian deprivation rule, it not being a deprivation triggered by British Eagle’s insolvency]. This was indeed the basis for the favourable finding in Ansett, n. 1 above. 14 L Gullifer (ed), Goode on Legal Problems of Credit and Security (4th edn, 2009, Thomson/Sweet & Maxwell), p 292, para [7-30]. 15 See n. 1 above. 16 Perpetual Trustee (CA), n. 1 above, paras 54, 113, 123 and especially 171-2, all seemingly confining intervention to ‘contracting out’ provisions, although contrast paras 32 et seq and 152 et seq; also see para. 91. 17 Perpetual Trustee (CA), n. 1 above, para. 57.

3 High Court decision in the Ansett case, there was judicial reluctance on the part of the majority to reach a conclusion that would upset the commercially successful and internationally beneficial IATA clearing house scheme.18 Other modern cases are to similar effect.

If these arrangements are to be outlawed, however, it is the courts that must act. Perpetual Trustee recognised this.19 And a public policy motivated intervention that simply outlaws contractual evasion of the statutory insolvency distribution regime, and in particular a contractual evasion that purports to prefer the contracting parties and effect a deprivation on the non-contracting parties, is surely not an intervention that is especially controversial. The judges are hardly making new law; they are simply ensuring proper application of existing legislation.

Of course, the legislation can exclude the application of this public policy rule, as it now does with recognised investment exchanges or clearing houses.20

3. Contractual terms should be enforced according to their terms— especially when such terms have been agreed by sophisticated parties who have had legal advice, etc. [FALSE]

The tenor of this argument can be seen in Lord Neuberger’s judgment in Perpetual Trustee (CA):21 ‘58 … It is also desirable that, if possible, the courts give effect to contractual terms which parties have agreed. Indeed, there is a particularly strong case for party autonomy in cases of complex financial instruments such as those involved in the Perpetual appeal and in arrangements involving large corporate groups, such as those who signed the agreements in the Butters appeal; in such cases, the parties are likely to have been commercially sophisticated and expertly advised.’

The same idea is put by Professor Sir Roy Goode, commenting on British Eagle:22 ‘ … the decision of the majority is difficult to reconcile with the principle … that the liquidator stands in the shoes of the company in liquidation and takes each contract as he finds it, so that he cannot procure the company to enforce those provisions which are for its benefit without at the same time being bound by the contractual conditions qualifying the company's entitlement. In policy terms a multilateral netting arrangements should not be regarded as offensive to insolvency law if it is intended to operate in the same way outside and inside insolvency, so that it is not a device designed to improve the position of one party by reason of the insolvency of another.’

18 Ansett, n. 1 above, eg paras 76-79. In this respect, the hesitancy also relates to the notion that carefully negotiated contractual arrangements between sophisticated parties should be given their full effect. 19 n. 1 above, paras 32 et seq and 152 et seq. 20 Financial Markets and Insolvency (Settlement Finality) Regulations 1999, SI 1999/2979, reg 14 (iro payment and settlement systems) and Financial Collateral Arrangements (No 2) Regulations 2003, SI 2003/2336, reg 12(1), which applies to financial collateral arrangements. 21 See n. 1, para 58. Also see para 91. And see para 99 (Longmore LJ). 22 R Goode, Legal Problems of Credit and Security (3rd edn, 2003, Thomson/Sweet & Maxwell), p 253- 254, para 7-30.

4 By contrast, in Mayhew v King,23 where a promised indemnity terminated in the event that the indemnified party became insolvent/etc – Sir Edward Evans-Lome did not accept this ‘contract’ argument, holding instead that such a rule would allow avoidance of the anti-deprivation rule in almost every imaginable case, and would in any event be contrary to Moneymarkets, Perpetual Trustee, etc.

But even this does not put the case strongly enough. As with all disputes on insolvency, the real issue is not simply the pro-party interpretation of bilateral arrangements as they affect the rights of the contracting parties. These arrangements potentially affect the rights of non-contracting third party creditors, and – however much the contracting parties wished it – a bilateral arrangement cannot deprive these third parties of their legitimate statutory rights.24 It may be difficult is to determine what those legitimate third party rights are, but they are not necessarily the rights that the contracting parties deign to leave them.

4. A contractual deprivation does not offend the anti-deprivation rule if it takes place before the onset of the debtor’s insolvency – with this timing, it cannot be seen as either an improper contracting out of the insolvency regime, nor (of course, by definition) an improper insolvency-triggered deprivation [TRUE]

This outcome is evident on the face of the policy which the anti-deprivation rule seeks to implement, and is illustrated by all the cases: eg in British Eagle, the netting out arrangements which had been completed before BE went into liquidation were valid; and in Carreras Rothmans, the assets already received on trust were held that way through the liquidation, even though post-insolvency receipts could not be.25

Similarly, any deprivations triggered by some event other than insolvency are prima facie valid, although they may sometimes be unwound under claw-back provisions in the insolvency legislation itself26 or under specific statutory, common law or equitable rules27 (often unrelated to insolvency) that might enable the liquidator to enhance the size of the insolvent estate.

5. A deprivation is valid if the parties had no intention of avoiding the insolvency laws28 [FALSE]

23 [2010] EWHC 1121 (Sir Edward Evans-Lome) 24 See S Worthington, ICR, p xxx. The same issue arose in the Spectrum litigation where the HL declined to accede to the clear intention of the contracting parties in the face of the disadvantage wreaked on non-contracting to creditors protected by the IA 1986. 25 26 Insolvency Act 1986 (‘IA 1986’) ss 238 (transactions at an undervalue), 239 (preferences), and 245 (avoidance of certain floating charges). 27 Eg the equitable rule providing relief against forfeiture. See S Worthington, ‘What is Left of Equity’s Relief Against Forfeiture?’ in Elise Bant and Matthew Harding (eds), Exploring Private Law (2010, CUP) (forthcoming), where it is suggested that equitable relief is far more limited than traditionally conceived. 28 The assertion is noted in H Beale et al, The Law of Personal Property Security (2007, OUP), p 285, para [6.85] citing Money Markets [2001] 4 All ER 223, 255 and also the direct payment cases in building contracts. But also noting that this proposition is of doubtful authority because (it seems) the effect is to disadvantage third party creditors and advantage the party exercising the forfeiture right

5 This suggestion can be given short shrift. British Eagle now makes it abundantly clear that, for the purposes of the anti-deprivation principle, what matters is the effect of the relevant contractual provisions, not their purpose.29

Oditah reinforces this, noting that: ‘The Ex p. Mackay line of cases focused on the aim of the transaction whereas British Eagle looks at the effect.’30

6. A deprivation is valid if it is not effected by means of an insolvency trigger. [PARTLY TRUE]

British Eagle makes it clear that an insolvency trigger is not essential where the ‘contracting out’ rule is in play.

By contrast, the insolvency trigger is crucial where the ‘insolvency-triggered deprivation’ rule is relied on, and a deprivation that is not triggered by insolvency is not caught by the rule [and is therefore effective to reduce the pool of assets avail for distribution on the debtor’s insolvency].

7. An arrangement which, on its face, appears to be an improper ‘contracting out’31 may be recharacterised as a valid agreement which simply defines the debtor’s assets themselves. [TRUE]

This choice of characterisation [improper contracting out or proper defining of the debtor’s asset] is precisely what divided the majority in the House of Lords in British Eagle from the minority and from all the judges in the lower courts. The majority in the HL (Lord Cross delivering the judgment) held that British Eagle had a claim against Air France, and that the IATA netting arrangements simply purported to effect an illegitimate contracting out of the insolvency regime; all the other judges held that the agreement between the airlines and IATA was such that no claim by British Eagle against Air France survived, and the only asset that British Eagle had was a net claim through IATA, which claim would then be dealt with as required by the statutory insolvency rules.

This same characterisation question was again in issue in the Ansett litigation, where the validity of the revised IATA contracts was again called into question on the insolvency of Ansett. The Australian High Court held that the revised terms were effective to define the assets held by Ansett, ensuring that its only claim was a net claim through IATA (although see the powerful dissent by Kirby J).32

These cases have led some to suggest – wrongly it seems – that ‘the principle in British Eagle is relatively easily overcome by drafting’.33 (ibid). 29 British Eagle, n. 1, p 780. 30 From F Oditah, ‘Assets and the treatment of claims in insolvency’ (1992) 108 LQR 459, 466 (footnotes omitted). 31 Being an arrangement which does not also include an insolvency-triggered deprivation clause. 32 ** 33 L Gullifer, supra, p 294 at para [7-30].

6 8. The impugned arrangement may be properly characterised not as an improper contracting out, but as a proper and effective security or subordination agreement. [TRUE, BUT ONLY RARELY]

Effective security arrangements fall outside the anti-deprivation rule. This is not the place to address the requirements of an effective security agreement, although it is worth recalling the difficulties that do arise (ROT, fixed/floating charges, etc). The arrangement that is functionally most like a deprivation, yet counts as a legitimate security, is a floating charge, since this form of security enables the debtor to use the secured assets at will in the ordinary course of business until the charge crystallises (at a time defined by the debenture agreement or, by implied agreement, on the debtor’s insolvency). Recall that the US common law courts denied traders the right to create a floating charge, regarding it as a fraud on the creditors.34 The UCC now provides an equivalent security—a floating lien—to meet the commercial demands of traders.35

Effective subordination agreements also fall outside the anti-deprivation rule. But note that it is the debtor’s creditors—whether secured or unsecured—who are free to agree as between themselves that their combined statutory insolvency entitlements (whether as secured or unsecured creditors) will be distributed as between themselves in any fashion they choose. This does not deprive non-consenting creditors of anything they might otherwise be entitled to. This route to achieving a different insolvency distribution is commonly used—see all the forms of subordination agreements that are upheld by the courts – eg arrangements that work via turnover subordination,36 or via the junior creditor agreeing to hold any dividends or distributions for the senior creditor (either expressly on trust, or via a contractual agreement which likely gives rise to a constructive trust), or by expressing the subordinated debt as a contingent obligation,37 or even via a subordination agreement that prohibits the junior unsecured creditor from proving in the liquidation until the senior creditor has received 100 pence in the pound;38 indeed, sometimes such agreements are implied in order to ensure fair distribution of pooled assets.39

Of course, if the junior creditor is insolvent, an agreement that gives the senior creditor priority over the junior creditor’s other unsecured creditors in relation to the distributions from the third party creditor will be void—unless the agreement creates a security interest in the senior creditor.40

What creditors cannot agree is that non-consenting parties will be affected by any agreement between the consenting parties. The only exception to this, it seems (and

34 35 36 Indirectly confirmed in Re British and Commonwealth Holdings plc (No 3) [1992] 1 WLR 672; Re SSSL Realisations (2002) Ltd, Manning v AIG Europe (UK) Ltd [2004] EWHC 1760 (Ch), [25] (Lloyd J). 37 See below. 38 Home v Chester & Fein Property Developments Pty Ltd (1987) 11 ACLR 485 (Southwell J); Re Maxwell Communications Corp plc (No 2) [1994] 1 BCLC 1 (Vinelott J); Re SSSL Realisations (2002) Ltd, Manning v AIG Europe (UK) Ltd [2004] EWHC 1760 (Ch), confirmed on appeal sub nom Squires v AIG Europe (UK) Ltd [2006] EWCA Civ 7, [2006] 2 WLR 1369. 39 This is one possible interpretation of Barlow Clowes v Vaughan [1992] 4 All ER 22 (CA). 40 It would offend the principle in British Eagle, n. 1.

7 even this was controversial for a time41), is where the agreed arrangement is to the advantage of the non-consenting parties. This is the case, eg, with a subordination agreement where the junior creditor does not simply agree to turnover provisions (which leave the other unsecured creditors unaffected), but agrees instead not to prove in the liquidation until the senior creditor has been paid in full: a creditor is not obliged to prove in the debtor’s insolvency, of course, and this denial/waiver/deferral of the junior creditor’s rights to prove means that the debtor’s liabilities are temporarily reduced, to the advantage of all the unsecured creditors proving against them.

9. The agreement does not effect an improper insolvency-triggered deprivation because the deprivation is matched by a repayment to the debtor of fair value for the asset subtracted from the insolvency pool. [TRUE]

This idea that deprivations are assessed pragmatically is supported by both Borland42 and Butters (CA),43 where the price payable for shares on their insolvency-triggered deprivation was deemed, respectively, ‘fair’ or ‘market’ value.

10. The agreement for an insolvency-triggered deprivation does not effect an illegitimate forfeiture of the debtor’s assets upon insolvency (which is void,44 unless fair value is received45), but a legitimate determination of the interest on insolvency46.47 [TRUE, SOMETIMES, BUT THE DIVIDING LINE IS CONTROVERSIAL]

This characterisation harks back to the common consensus that it is perfectly proper, and common, to provide that a lease or licence in favour of A will determine on A’s insolvency.48 These recognised exceptions make it plain that not all insolvency- triggered deprivations of the debtor’s assets are illegitimate, and the difficult issue is then to decide which of the debtor’s assets are like rights to royalties (Mackay), where insolvency-triggered deprivations are illegitimate, and which are like leases and licences, where insolvency-triggered deprivations (‘limitations’/’determinations’) may be allowed.

The argument that an interest falls on one side of the line or the other can be put in different, and often attractive, ways, as was done by Robin Knowles QC in Mayhew v

41 See above, n. 29. 42 See n. 1. 43 See Perpetual Trustee (CA), which involved a determination of this case too. 44 Citing Whitmore v Mason (1861) 2 J&H 204; Re Harrison, ex p Jay (1880) 14 Ch D 19; Re Walker, ex p Barter (1884) 26 Ch D 510 (CA), and noting Neuberger J in Money Markets doubting whether the contrary decision in Re Garrud, ex p Newitt (1881) 16 Ch D 522 can now be sustained—but see below. 45 Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279. 46 Citing Money Markets [2001] 4 All ER 223, 237-8, 247, and 255 (Neuberger J). 47 H Beale et al, The Law of Personal Property Security (2007, OUP), p 284, para [6.85]. 48 Perpetual Trustee (CA), n. 1 above, para. 64 (extracted above). Also see paras 81, 143-6. By contrast, other similarly worded deprivation arrangements are void: Whitmore (partnership property), Borland (shares), Money Markets (shares), and Oystertec (patents) all illustrate potentially void insolvency-triggered deprivation provisions that had always been part of the parties’ agreement: see n. 1 above.

8 King,49 where a promised indemnity terminated in the event that the indemnified party became insolvent/etc: ‘In substance the case is concerned with the duration of a negotiated contractual promise, not the relinquishment of an asset.’ This argument was not accepted by Sir Edward Evans-Lome, however, who held it would be contrary to ex parte Mackay, and would allow avoidance of the rule in almost every imaginable case. This criticism also applies to the equally broad approach suggested by some commentators.50

In Perpetual Trustee (CA), Lord Neuberger tentatively opted for a charge being more like a lease or licence, and so legitimately able to be determined by a provision which took effect on insolvency.51

Before addressing the difficult distinction in play here, note that the question will only arise if the debtor received the asset subject to the insolvency-triggered limitation. If the debtor initially acquired the asset without such a limitation, then a subsequent agreement to subject it to such an insolvency-triggered limitation will be void – it will offend the insolvency-triggered deprivation rule, even if the underlying asset is a lease or a licence. This is because if the insolvent has an asset, and arranges that it – or any part of it – will ‘remain his until his bankruptcy, and on the happening of that event shall go over to someone else, and be taken away from his creditors’,52 then that offends the insolvency-deprivation rule and the arrangement is void: see Mackay (royalties), Jay (builder’s chattels), Detmold (marriage settlement), Oystertec (patents).53 From this follows the well-recognised rule that parties cannot set up protective trusts of their own property in favour of themselves.54

If, on the other hand, the arrangement is such that the debtor receives and only ever holds the asset subject to an insolvency-triggered deprivation limitation, then the deprivation question is considerably more difficult. Cases and commentary often suggest that the divide tracks the distinction between impermissible conditional interests (‘but if’ the person becomes insolvent), and permissible determinable interests (‘until’ the person becomes insolvent). Moreover, the line between these two categories is said to turn primarily on the language used, or on the form rather than the substance of the arrangement.55 If breach of the insolvency-deprivation rule hangs on the form of words used, so that ‘but if’ offends public policy whilst ‘until’ does not, even though both might relate to the same underlying asset and impose the same

49 [2010] EWHC 1121 (Sir Edward Evans-Lome) 50 R Calnan, Proprietary Rights and Insolvency (2010, OUP), p 9. 51 Perpetual Trustee (CA), n. 1 above, para. 64. Also see para. 62: a charge given up or flipped is not a divestiture. Similarly, Patten LJ at para. 137: a priority flip is not a disposition of the company’s property. These latter comments seem to misplace their focus, and relate to the chargor (the Issuer), not the chargee (LBSF). 52 Jay, n. 1 above, p. 26. 53 All cases cited at n. 1 above. This conclusion on patents is not, it seems, touched by Lord Neuberger’s suggestion in Perpetual Trustee that parts of the Oystertec decision must be deemed overruled: n. 1 above, para. 74. 54 Re Brewer’s Settlement [1896] 2 Ch 503. This is so even though protective trusts (of income) are allowed under the Trustee Act 1925 s 33, and that provision does not explicitly deny a settlor the ability to do this with his own property; s 33(3) merely preserves the general law rules in respect of invalidity. On the other hand, an insolvent can of course be the beneficiary of a protective trust (of income) which has been set up by others over property that they then owned. 55 G Moffatt, Trusts Law: Text and Materials (4th edn, CUP, Cambridge, 2005), pp 257-8.

9 insolvency limitation, then there is certainly something seriously wrong with the law.56 But the crucial distinction, it seems, is not rooted simply in language. For instance, it has never been suggested that the validity of insolvency-triggered limitations in leases and licences turns on such niceties of language.

In my paper in International Corporate Rescue,57 I suggested that this commonly cited distinction between conditional and determinable interests is not the underlying discriminator in deciding whether an arrangement delivers an unacceptable insolvency-triggered deprivation. Rather, the distinction is between proprietary interests which can only and necessarily be defined in a time-limited way, and all other cases where interests need not be so defined. In the former category, the time limitation can be defined in any way the parties choose, including by reference to the insolvency of the interest-holder; in the latter category, any insolvency-triggered time- limitation will offend the insolvency-deprivation rule, and the arrangement will be void. This is true even if the limitation was imposed from the outset.

Leases, licences, rights to interest payments and dividend payments, rights to income and annuities all fall into the former category. Within this category, the debtor can agree to receive (by gift or by contract) such assets in a way that is time limited from the outset, including a time limitation that determines on the party’s insolvency.58 Only in these cases is it true to say that the limitation marks the bounds of the right, so the right terminates, or is determined, on the insolvency trigger, and the insolvent’s estate is not illegitimately deprived of an asset it would otherwise have for distribution.

By contrast, with all other proprietary rights, the insertion of a time limitation effects a forfeiture; it does not simply define the term of the interest. In this category are houses, shares, patents, debts, royalties, and so on. In this category, if a time limitation is inserted, and if it is triggered by the right-holder’s insolvency, then the limitation is void.59 It will be regarded as designed to ensure that the asset – or some

56 See the discussion in R Calnan, Proprietary Rights and Insolvency (2010, OUP), p 8-9: Calnan decries a distinction based on conditional and determinable word formulations, and goes on to suggest that there is no difference between an agreement to grant a lease/pay £5 a month for the next five years which terminates/determines on bankruptcy/insolvency [a formulation intended to illustrate the illegitimate determination of the interest] and an agreement to grant a lease/pay £5 a month which ends on the earlier to occur of bankruptcy/insolvency and five years from today's date [a formulation intended to illustrate the legitimate limitation of the interest]. He is right. There is no difference between the two formulations. He is also right that neither of these particular formulations effects an improper deprivation. But this is because of a fortuitous choice of illustrations, not because it is generally true that ‘it is open to the parties to establish the extent of the debtor's rights under the contract in any way they wish -- including by reference to the insolvency of either or both of the parties’. His chosen illustrations are both necessarily and inherently time-limited interests, and it is roundly conceded that it is open to the parties to limit these interests in any way they see fit, including by reference to the debtor’s insolvency. This is precisely the lease/licence exception so commonly cited. 57 ** , at p ** 58 Recall, however, that the debtor cannot set up such an arrangement over assets that are already his – see above. 59 Eg, many assets can be made subject to contractual forfeiture provisions, or can be held under trusts in ways that define different parties’ interests along a time line. These arrangements can sometimes be overturned outside insolvency (see, eg, the rules on forfeiture), but will invariably be held void if the forfeiture or deprivation trigger is the right-holder’s insolvency.

10 part of it – will ‘remain [the insolvent’s] until his bankruptcy, and on the happening of that event shall go over to someone else, and be taken away from his creditors.’60

It may be instructive to note one inherent difference between these different insolvency-triggered deprivation/determination clauses. Where the asset is not one that is necessarily and inherently time limited, any insolvency-triggered deprivation provision will need to specify, even if only implicitly, in whose favour the debtor’s interest is forfeited. By contrast, where the asset is inherently time-limited, this specification is unnecessary.

11. The agreement does not effect an illegitimate insolvency-triggered deprivation but simply defines the debtor’s asset as a limited or flawed asset, being one which has a value which is rather less on the trigger operating on the debtor’s insolvency than when the debtor is solvent. [FALSE, IF THE DEBTOR’S INSOLVENCY TRIGGERS A DEPRIVATION ]

This argument is seductively simple, and therefore attractive, but on examination it seems to carry no weight at all.

This argument, put at its best, would explain the outcome in Perpetual Trustee (CA) as follows: ‘the reason in short being that the interests conferred on LBSF in the collateral were from the outset limited in extent in such a way that they would terminate on the happening of an event of default. LBSF never had any larger interest which was purportedly cut down on its insolvency.’61 Or, put another way, the flip clause effected a permissible reduction in value rather than an impermissible deprivation of property,62 or, in a similar vein, effected a mere change in priorities relating to the (otherwise unchanged) right.63

The question then is, when does this flawed asset characterisation accurately describe the agreement between the parties, and when is their agreement more accurately seen as involving an illegitimate insolvency-triggered deprivation?

By way of preliminaries, note yet again that this characterisation question is only material if the debtor received/acquired the asset subject to the insolvency-triggered limitation – ie if the limitation ‘was always a term of the contract’. If the debtor initially acquired the asset without such a limitation, then any subsequent agreement

60 Jay, n.1 above, at p. 26 (Cotton LJ). 61 Perpetual Trustee [2009] EWHC 2953 (Ch), para [7] (Henderson J) [This the judgment re sending a letter to the US Bankruptcy Court Judge, Peck J.] Also see how the point was put by Gabriel Moss QC in Perpetual Trustee (CA) [2010] Ch 347, 356-7: ‘To constitute a fraud on the bankruptcy laws there must be property of the bankrupt which the contract purports to take away: … It is therefore critical to identify the property: the second defendant has a beneficial interest under an English law-governed trust deed in the proceeds of the enforcement of the security over the collateral which has higher priority than another secured creditor in some events and lower priority in others. The contractual provisions do not remove any asset which the second defendant had at the start of the insolvency proceedings. There is no sum unconditionally due to the second defendant, and no removal of an unconditional asset vested in the company at the commencement of the winding up …’. 62 Perpetual Trustee (CA), n. 1 above, para. 152. 63 Perpetual Trustee (CA), n. 1, para 64 (Lord Neuberger) and para 99 (Longmore LJ).

11 to subject it to an insolvency-triggered limitation will be void – it will offend the insolvency-triggered anti-deprivation rule.64

When can it be said that the debtor never receives more than a limited interest? Rather sweepingly, but attractively simply, Richard Calnan suggests: 65 ‘… but insolvency law does not generally interfere with the contractual and proprietary arrangements made by the debtor before his insolvency. It takes the debtor as it finds him. It should follow, therefore, that the principle being discussed [the anti-deprivation principle] does not apply where the debtor's proprietary interest is itself limited in scope. If the debtor has been granted a proprietary interest in an asset which is limited in such a way that it falls away on his insolvency, the arrangement should be entirely effective. This is not a case of a contract purporting to remove a proprietary interest from the debtor on his insolvency, but, rather, a contract defining the scope of the debtor's proprietary interest in the asset. It is, in the vernacular, a “flawed asset”.’ (emphasis added)

This approach would mean that the line between ‘flawed asset’ and ‘illegitimate deprivation’ is drawn where the arrangement was ‘always was a term of the contract’. An arrangement is void if it imposes an insolvency-triggered deprivation or limitation on the debtor’s assets after their initial receipt by the debtor. But it is valid if the limitation was always a term of the contract. This approach was favoured by Patten LJ in Perpetual Trustee,66 and is conceded to have the merits of simplicity,67 but was rejected by Lord Neuberger,68 and has not been accepted by a majority in any case as the rationale for the decision.

In Money Markets, Neuberger J rejected this approach because it would represent an easy way to avoid the application of the principle (Calnan’s answer to this seems to be that the IA 1986 does not prevent parties from bargaining in disadvantageous ways, but merely provides for distribution of whatever assets remain in the debtor's hands69), it would be inconsistent with the distinction between a limited interest and a determinable interest (Calnan says this is a distinction without a difference70), and it would be inconsistent with some of the authorities (Calnan says the only authority which makes it difficult to accept the idea of a flawed asset is British Eagle, and that authority is itself ameliorated by the decision in Ansett71--but this is not the tenor of either decision: both these cases were concerned with defining the debtor’s asset, and that definition had no element of insolvency-triggered limitation or determination in it. By contrast, there are a good number of cases where the insolvency-triggered deprivation or limitation has been held void notwithstanding that it had always been a term of the contract.72 What the Australian High Court did concede was that the parties could enter in transactions which left the debtor with fewer assets to distribute on its insolvency, and the court would not then intervene to treat the debtor as if it had

64 See above. 65 R Calnan, Proprietary Rights and Insolvency (2010, OUP), p 8; also see p 9, and generally pp 6-13. 66 ** 67 Neuberger J in Money Markets, [92]; Lord Neuberger in Perpetual Trustee, ** 68 Neuberger J in Money Markets, ** ; Lord Neuberger in Perpetual Trustee, 69 Calnan, P 10 70 Calnan, P 10, and also see pp 7-9. 71 Calnan, P 10-11. 72 See all the cases cited in section XX above.

12 entered into different arrangements from those which it had entered into, being arrangements which would have left it with greater resources than distribution on its insolvency73).

In practical terms, if this approach were adopted, then the insolvency-triggered anti- deprivation principle would never bite on arrangements that ‘were always a term of the contract’. Every such arrangement could be interpreted as the grant of a proprietary interest ‘limited in such a way that it falls away on … insolvency’. By contrast, the cases indicate that these arrangements do fall foul of the anti-deprivation rule, and the difficulty is to draw the line between illegitimate deprivations and legitimately limited assets.74

But the real reply to this proposed approach is as simple as the approach itself. The logic of the preceding argument is all premised on the view that the debtor has been granted only a limited interest in an asset, and the debtor’s assets cannot pass to the liquidator except subject to that limitation or agreed contractual deprivation.75 But this ignores the whole point of the anti-deprivation rule. The function of the insolvency-deprivation rule is precisely to determine whether the agreed condition or limitation is void or effective. If the condition is effective, then – but only then – is it true that the debtor’s asset can only pass to the liquidator subject to that deprivation condition. So the preceding analysis will not work. It simply eliminates the very question which has to be answered (or at least assumes that the answers are all one way). The real question remains: does the specific condition effect an unacceptable deprivation or an acceptable limitation of the debtor’s rights? Does the limiting condition offend the anti-deprivation rule?

12. The agreement in Perpetual Trustee (CA) did not effect [an insolvency- triggered] deprivation, but merely changed the order of priority of access to the security. [FALSE]

This argument is neatly summarised in the Perpetual Trustee (CA) headnote: ‘The effect of the switch from swap counterparty priority, meaning that the claims of L were payable in priority to the claims of the noteholders, to noteholder priority, was not to divest L of property vested in it or even of the benefit of the security rights granted to it. It was merely to change the order of priorities in which the rights were to be exercised in relation to the proceeds of sale of the collateral in the event of a default.’

This makes it sound as though the only parties affected are those who have agreed to be affected, and that the insolvency consequences for unsecured creditors are unaffected. This would be the case if the Issuer were insolvent, and the question was the distribution of the secured assets as between PT and LBSF. It would even be the case if these two parties had an agreed unsecured subordination agreement. But this is not the issue. The issue is what should happen when LBSF is insolvent – can it legitimately agree to an insolvency-triggered provision that it will no longer have a first secured claim against the Issuer, but will only have a second claim, and a non-

73 Eg Ansett, [28] per Gleeson J. 74 See the previous section. 75 Perpetual Trustee (HCt), n. 1 above, para. 45.

13 recourse one at that? Is such a security priority flip an arrangement that has the effect of depriving LBSF of assets that would otherwise have been available for distribution to LBSF’s unsecured creditors? The answer must be yes, and unequivocally so—this is precisely why the liquidator of LBSF is pursuing the claim so assiduously.76

13. The anti-deprivation rule may not apply if it would prevent parties who have paid for assets from recovering those assets from the debtor in priority to the other unsecured creditors on the debtor’s insolvency. [FALSE]

In Perpetual Trustee (CA), Lord Neuberger, (with whom Longmore LJ agreed77) explained this as follows: 64. …. Secondly, there is authority for the principle that the rule may have no application to the extent that the person in whose favour the deprivation of the asset takes effect can show that the asset, or the insolvent person's interest in the asset, was acquired with his money … In this case, the collateral was effectively purchased exclusively with the Noteholders' money.

As explained in my ICR paper, it is irrelevant that the ‘preferred’ (non-insolvent) party effectively paid for the disputed benefit. On insolvency, disappointed creditors are perhaps doubly disappointed when they can readily identify ‘their’ assets in the pool of assets to be distributed on insolvency, but, notwithstanding this, they can have priority of access only if their agreement includes effective security over the assets in question. This can be provided relatively easily – eg retention of title, mortgages, charges, Quistclose trusts – but, unless it is done, the benefits cannot be claimed. This was precisely the predicament of the disappointed creditors in the corporate collapses of Goldcorp78 and London Wine.79 Noteholders are in no better position unless their security arrangements are effective. Importantly, their arrangements are only effective if they comply with all the usual rules relating to effective security and do not offend either of the anti-deprivation rules described above. In Perpetual Trustee, any assertion of a proprietary interest in favour of the Noteholders over either their purchase monies or the purchased collateral is likely to be overridden by contractual provisions which allowed the Issuer to use the monies and collateral as its own, including assigning the disputed property and issuing security over it to others.

14. By contrast, clauses that do work to remove assets from the insolvency pool….

The anti-deprivation rule does not catch arrangements which prevent property ever reaching the insolvent’s hands, as happens with effective retention of title agreements, Quistclose trusts,80 or purchase money security interests.81 Equally, deprivations caused by some other event – any other event – are not touched by this rule. In particular, deprivations caused by pre-insolvency disposal of assets,82 or by

76 This aspect is dealt with in more detail in my ICR piece. 77 Perpetual Trustee (CA), n. 1 above, para. 99. 78 Re Goldcorp Exchange Ltd (in rec) [1995] 1 AC 74 (PC). 79 Re London Wine Company (Shippers) Ltd [1986] PCC 121. Also see Re Wait [1927] 1 Ch 606. 80 Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567 (HL). 81 This must be the explanation of the dicta in Whitmore, n. 1 above, pp 212, 214-5 (Page Wood V-C). 82 Including encumbering assets by granting effective security over them.

14 deprivation or forfeiture clauses that are not triggered by the party’s own insolvency, are all untouched by the ‘insolvency-deprivation’ rule.83 This is illustrated by the effective deprivations in cases such as Newitt (deprivation triggered by default)84 and Detmold (deprivation triggered by alienation).85

Conclusion … I simply repeat what I said in my ICR piece:

“…the conclusions reached in Perpetual Trustee are correct, although the reasoning is far from being sufficiently clear to enable delivery of robustly predictable outcomes in other circumstances. Any future analysis might be assisted if the relevant principles and policies in play could be articulated more rigorously.

To that end, it is argued here that there are two distinct and distinctive rules in play, not one. There is a ‘contracting out’ rule. This prohibits arrangements which provide for a distribution of the insolvent’s assets that differs from the distribution that would be delivered by the IA 1986. There is also an ‘insolvency-deprivation’ rule. This is a public policy rule which prohibits insolvency-triggered arrangements that deprive the insolvent of assets available for distribution on insolvency.

In assessing whether particular arrangements offend either of these rules, it is completely irrelevant that party autonomy may be overridden, that there was no intention to offend insolvency rules, that the arrangements between the parties were always subject to the provisions in question, or that the preferred parties effectively paid for the preferential benefits delivered by the provisions. In addition, in relation to the ‘contracting out’ rule, it is also irrelevant that there is no insolvency trigger (and maybe no trigger at all).

Finally, in relation to the ‘insolvency-deprivation’ rule, the commonly cited distinction between conditional and determinable interests is not the underlying discriminator in deciding whether an arrangement delivers an unacceptable deprivation. Rather, the distinction is between proprietary interests which can only and necessarily be defined in a time-limited way, and all other cases where interests need not be so defined. In the former category, the time limitation can be defined in any way the parties choose, including by reference to the insolvency of the interest- holder; in the latter category, any insolvency-triggered time-limitation will offend the insolvency-deprivation rule and the arrangement will be void.”

83 This does not mean that the deprivation cannot be overturned, just that the means of overturning it is not this public policy insolvency-deprivation rule. Instead, the arrangement can be overturned – and the assets available to the unsecured creditors enhanced – using all the IA 1986 claw back provisions or other common law, equitable or statutory remedies. 84 n. 1 above. Now, however, such a clause needs to be construed a little more carefully. Forfeiture enabling the landowner to use the chattels to complete the work may be acceptable, but a forfeiture that entitles the landowner to keep the chattels as liquidated damages may be held to be a penalty (see Worthington, n. 19 above), and one that entitles the landowner to sell the chattels and retain an appropriate sum as damages may be held to be a floating charge (likely to be invalid as unregistered): see Re Cosslett (Contractors) Ltd [1998] Ch 459 (CA). 85 n. 1 above.

15 Appendix: Outline of relevant cases

Money Markets International Stockbrokers v London Stock Exchange86 MM was a member of the LSE (set up as a mutual company). Each member was allocated a B share in the LSE, and the articles of association provided for the B share to be taken away if a shareholder ceased to be a member firm of the LSE. MM ceased to be a member firm on its insolvency, and the LSE took away the B share. Shortly after MM had transferred its B share back to the exchange, LSE had demutualised. As a result, the B share would have had a value of nearly GBP 3 million. MM claimed the provision in the articles of association was unenforceable because it breached the anti-deprivation principle. The LSE argued that MM’s right as a shareholder was inherently limited by reference to its insolvency, and therefore that the contractual provision was valid. Held—provision valid because MM's acquisition of the B share had been merely incidental to membership of LSE, not in the nature of a free-standing asset, and the relevant clause had been implemented before LSE's decision to demutualise, and only at this point did the share became independent of membership.

Lord Neuberger: [92]. This [ie ‘where it is an inherent feature of an asset from the inception of its grant that it can be taken away from the grantee (whether in the event of his insolvency or otherwise), the law will recognise and give effect to such a provision’ from [91]] has the merit of being a simple and readily comprehensible proposition, and one which is easy to apply. However, it does not seem to me to be correct. First, it would represent such an easy way of avoiding the application of the principle that it would be left with little value. In other words, it seems to me that, if I accepted Mr Mann's simple proposition, the effect would be to emasculate the principle which, at least to Professor Goode, is one which should be more widely, rather than more narrowly, applied. In his book (p 150) he not only described ‘ [t]he distinction between recapture of an [interest] transferred outright and termination of a limited interest’ as ‘ redolent of [a] highly artificial distinction’ . He went on to describe as ‘ sound’ s541(c) (i) of the US Bankruptcy Code which he said, ‘ roundly declares ipso facto termination clauses ineffective, however they are formulated’ . Professor Goode also suggested that this ‘ is a sound rule and one which English courts could sensibly follow’ . I appreciate that there is a real argument to support the contrary view, namely that the principle should be abrogated on the basis that it is not for the courts but for the legislature to override contractual terms. This argument could be said to have particular force in light of the sophisticated and detailed legislative apparatus enshrined in the Insolvency Act 1986 , and Insolvency Rules 1986 . However, that is not an approach open to me in view of the authorities to which I have referred.

Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd87 Court of Appeal was asked to strike down a priority flip clause which switched the priority enjoyed over collateral away from a Lehman Brothers credit default swaps counterparty and in favour of third party noteholders (including Perpetual Trustee Co Ltd) in defined circumstances, to the potential detriment of the now insolvent Lehman Brothers counterparty.88

86 [2001] 1 WLR 1150. 87 [2009] EWCA Civ 1160 (CA) (‘Perpetual Trustee (CA)’), on appeal from [2009] EWHC 1912 (Ch) (‘Perpetual Trustee (HCt)’). 88 The court also addressed the treatment of ‘unwind costs’ between these parties, and determined the outcome of a related appeal which raised the anti-deprivation rule (Butters v BBC Worldwide Ltd). This article focuses exclusively on the anti-deprivation rule as raised by the facts of the priority flip

16 Held: no deprivation, and in any event any deprivation was not triggered by the relevant party’s insolvency, but was triggered earlier.

Butters v BBC Worldwide (CA)89 [Determined by CA at same time as Perpetual Trustee appeal.] Joint venture between a Woolworths subsidiary (M) and a BBC subsidiary (W). When Woolworths went into administration, W gave notice in accordance with the terms of the joint venture agreement requiring M to sell its shares in the joint venture company to W and thereby terminating a licensing agreement in accordance with its terms. Held—not a deprivation because (i) wrt the licence, licences could be legitimately limited in a way defined by the relevant party’s insolvency; and (ii) wrt shares, not a deprivation if market value paid for the deprived share. And, in any event, the deprivations were triggered earlier by the insolvency of the holding company.

Mayhew v King90 A load slipped off one of Milbank’s (M’s) trucks, struck Mayhew’s car and caused severe personal injuries to Mayhew. M’s insurer refused to pay. M sued his insurance broker (Towergate—T). Settlement agreement whereby T agreed to indemnify M, with M’s right to indemnity to cease ‘in the event’ that M went into administration/insolvency/etc. Held—was invalid deprivation.

And the older cases, as described by Lord Neuberger in Perpetual Trustee [2010] Ch 347, at paras [33]-[49]:

“33 The majority of reported cases on the extent and application of the rule to which we were referred were decided between 1860 and 1930. They were Whitmore v Mason (1861) 2 J & H 204 ; Ex p Mackay; Ex p Brown ; In re Jeavons (1873) LR 8 Ch App 643 ; Ex p Williams ; In re Thompson (1877) 7 Ch D 138 ; Ex p Jay 14 Ch D 19 ; Ex p Newitt ; In re Garrud (1881) 16 Ch D 522 ; Ex p Barter ; Ex p Black ; In re Walker (1884) 26 Ch D 510 ; In re Detmold ; Detmold v Detmold (1889) 40 Ch D 585 ; Borland's Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 and In re Johns ; Worrell v Johns [1928] Ch 737 .

34 Whitmore's case 2 J & H 204 concerned a provision in a partnership deed which stated that, in the event of the “bankruptcy or insolvency” of a partner, an account was to be taken, and the bankrupt partner was to lose his interest in the partnership assets at a market valuation (save that his interest in a mining lease was to be excluded from the valuation). Page Wood V-C held that, only in so far as it related to the lease, the provision was void. At p 212, he identified the rule as being “no person possessed of property can reserve that property to himself until he shall become bankrupt, and then provide that, in the event of his becoming bankrupt, it shall pass to another and not to his creditors”. He also made it clear that his decision would have been different if the other partners had provided the £500 which the bankrupt partner in that case had paid for his interest in the lease: see p 212 and pp 214–215 (and per Giffard QC in argument at p 210). He also made it clear that the rule did not extend to invalidate a provision *371 for the determination of a lease on insolvency-on the basis of the maxim cuius est dare eius est disponere: see pp 212–213. Page Wood V- C also held that the fact that the triggering event was Smith's insolvency rather than his bankruptcy, and therefore preceded his bankruptcy, did not enable the rule to be

in the Perpetual Trustee appeal. 89 [2009] EWCA Civ 1160 (CA). 90 [2010] EWHC 1121 (Sir Edward Evans-Lome)

17 avoided: to hold otherwise, he considered, would mean that “the bankrupt laws might, in all cases, be defeated”: p 215.

35 Ex p Mackay LR 8 Ch App 643 involved two transactions: the first was the sale of a patent by A to B in return for B paying royalties; the second was a loan of £12,500 from B to A. The two transactions were connected, in that the parties agreed that (i) B would keep half the royalties towards satisfying the debt, and (ii) in the event of A's bankruptcy, B could also keep the other half of the royalties. It was held that, while (i) was valid against A's trustee, (ii) was not. As explained by James LJ at p 647, (i) represented “a good charge upon one moiety of the royalties”, but (ii) “is a clear attempt to evade the operation of the bankruptcy laws” as it “provide[d] for a different distribution of [A's] effects in the event of bankruptcy from that which the law provides”. At p 648, Mellish LJ put it this way: “a person cannot make it a 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 laws.”

36 The decision in Ex p Williams 7 Ch D 138 was, as I see it, simply based on the fact that the clause in question “was a mere sham, a mere contrivance and device” the purpose of which was to give a particular creditor additional security on bankruptcy or liquidation, and therefore preference against other creditors, only in the event of the debtor's bankruptcy—per James LJ at p 143 (and similar language was used by Baggallay and Thesiger LJJ at pp 138, 143 and 144).

37 In Ex p Jay 14 Ch D 19 , the provision under consideration was a clause which entitled a landowner, who had granted a builder possession of her land, to retake possession and to forfeit any of the builder's chattels which were on the land, in the event of the latter's bankruptcy. There was no challenge to the right of re-entry onto the land, but the right to forfeit the chattels was held to offend the rule. The fact that the landowner had had no interest in the chattels until the builder became bankrupt seems to have been an essential feature, as is clear from the judgment of Cotton LJ at p 26, where he distinguished two earlier cases where the rule was held not to apply, so that the forfeiture provisions were valid. His ground for distinction was that, in those two cases, “the court considered the effect of the contract was to give the landlord from the very time when the contract was entered into an equitable interest in the chattels”.

38 The facts in Ex p Newitt 16 Ch D 522 were very similar to those in Ex p Jay 14 Ch D 19 , but the provision was held to be valid. The difference between the two cases was that, in Ex p Newitt 16 Ch D 522 , the bankrupt builder had breached the terms of his agreement with the landowner and it was provided in the agreement that the chattels would be forfeited to the landowner “as and for liquidated damages”, whereas in Ex p Jay 14 Ch D 19 , the builder was not in breach of contract, and the right to forfeit was not expressed to be in respect of any money claim. At 16 Ch D 522, 530, James LJ said that the court had “no power to add to the [Bills of Sale] Act [1854] for the purpose of making this security for the performance of the contract, which was bona fide taken by the landowner, bad by reason of the *372 bankruptcy of the builder”. On the following page, he made the point that the “broad general principle is that the trustee in a bankruptcy takes all the bankrupt's property, but takes it subject to all the liabilities which affected it in the bankrupt's hands, unless … added to by some express provision of the bankrupt law”.

39 Ex p Barter 26 Ch D 510 is another example of the application of the rule. A prospective buyer of a ship had the right to take possession of the ship and use the shipbuilder's premises and chattels to complete the building work, in the event of the

18 builder not proceeding with the shipbuilding or going bankrupt. The Court of Appeal applied the following proposition in Whitmore's case 2 J & H 204 , 210:

“ [T]he owner of property may, on alienation, qualify the interest of his alienee by a condition to take effect on bankruptcy; but cannot by contract or otherwise qualify his own interest by a like condition, determining or controlling it in the event of his own bankruptcy, to the disappointment or delay of his creditors. The jus disponendi, which for the first purpose is absolute, being, in the latter instance, subject to the disposition previously prescribed by law.”

40 In In re Detmold 40 Ch D 585 the provision under consideration stated that the property in a marriage settlement (originating from the husband) should pass to the wife for life in the event of an alienation by, or the bankruptcy of, the husband. The provision was held valid against the husband's trustee in bankruptcy, on the ground that it had been triggered, prior to the commencement of the bankruptcy, by the alienation effected as the result of the appointment of a receiver of the property in the settlement.

41 In Borland's case [1901] 1 Ch 279 , a provision in a company's articles of association, providing for the transfer of a shareholder's shares to the other shareholders in the event of his bankruptcy, would have been held to infringe the rule (consistently with the decision in Whitmore's case 2 J & H 204 ), but for the fact that, viewed in the context of the provisions of the articles governing the compulsory transfer of shares in other circumstances, the provision was “fair”, as explained [1901] 1 Ch 279 , 291. In particular, although the provision limited the price payable for the shares to their par value, it did not “[compel] … persons to sell their shares in the event of bankruptcy at something less than the price that they would otherwise obtain”; had it done so, the provision would have been “repugnant to the bankruptcy law”.

42 As for In re Johns [1928] Ch 737 , it concerned an artificial, transparent arrangement between mother and son, whereby the amount repayable by the son in respect of periodic loans made by the mother (which could not exceed £650, and might be as little as £10, in all) was to increase from £650 to £1,650 (plus interest) in the event of the son's bankruptcy. Unsurprisingly, the judge described it at p 748 as “a deliberate device to secure that more money should come to the mother, if the son went bankrupt, than would come to her if he did not; and, that being so … the device is bad”.

The House of Lords' decision in the British Eagle case

43 All these decisions (save, it would seem, Ex p Williams 7 Ch D 138 , which may have applied on a liquidation) related to bankruptcy. It is *373 common ground, at least at this level, that the rule exists and applies equally to liquidations, not least in the light of the decision of the House of Lords in British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 1 WLR 758 . It is also common ground that the rule also applies where the company concerned goes into administration (at least where, as in the Butters case, the administration is effectively for the purpose of maximising the return on the insolvency and will lead to a winding up order) or where the company concerned files for Chapter 11 protection in the United States (as in the Perpetual case) at least where the filing is for the purpose of maximising the return on the insolvency and cessation of business.

19 44 In the British Eagle case [1975] 1 WLR 758 , reversing Templeman J [1973] 1 Lloyd's Rep 414 and a unanimous Court of Appeal [1974] 1 Lloyd's Rep 429, the House of Lords , by a bare majority, decided that a clearing house arrangement between a large number of airline companies relating to debts arising as between them was ineffective as against the liquidator of one of the companies, British Eagle, which had gone into liquidation. As explained by Lord Cross of Chelsea (with whom Lord Diplock and Lord Edmund-Davies agreed), this conclusion was reached on the ground that, in so far as the arrangement purported to apply to debts which existed when the members of the company passed the resolution to go into creditors' voluntary liquidation, it would have amounted to contracting out of the statutory requirement that the assets owned by the company at the date of its liquidation should be available to its liquidator, who should use them to meet the company's unsecured liabilities pari passu, under section 302 of the Companies Act 1948 (now effectively re-enacted as section 107 of the Insolvency Act 1986 ).

45 British Eagle had gone into creditors' liquidation as a result of a members' resolution passed on 8 November 1968, having ceased carrying on business two days earlier [1975] 1 WLR 758 , 775 h , 776 d , and, at p 778 c , Lord Cross said that the contention of the respondents “with regard to the September clearance must succeed” as “Clearance in respect of business done in September was ‘completed’ … on 4 November, before the winding up resolution was passed”. In other words, he concluded that debts which had effectively ceased to exist by the date of the winding up resolution (8 November 1968), because they had already passed into the clearing house arrangement, were not caught by the rule, which only bit on debts which existed on or after the date of the winding up.

46 At p 780 a , there is reference to Ex p Mackay LR 8 Ch App 643 , and to the respondents' argument that it “was a very different case from this”, as “the provision which was impugned effected a change on bankruptcy”, whereas in the case before the House, “there was no change whatever on the winding up: the same ‘clearing house’ provisions applied”. However, Lord Cross rejected that argument, and, at p 780 f-g , he relied on the decision in Ex p Mackay , in which, he said, the court “could only [have] go[ne] behind [the charge on the second half of the royalties] if it was satisfied—as was indeed obvious in that case—that it had been created deliberately in order to provide for a different distribution of the insolvent's property on his bankruptcy from that prescribed by the law”, on the basis that it was “irrelevant that the parties to the ‘clearing house’ arrangements had good business reasons for entering into them and did not direct their minds to the question how the arrangements might be affected by the insolvency of one or *374 more of the parties”. Lord Cross said, at p 780 h : “Such a ‘contracting out’ must, to my mind, be contrary to public policy.”

47 The main dissenting speech was given by Lord Morris of Borth-y-Gest, with whom Lord Simon of Glaisdale agreed. Lord Morris also cited Ex p Mackay LR 8 Ch App 643 , and referred to In re Johns [1928] Ch 737 , distinguishing them as cases where the relevant provisions were “a clear attempt to evade the operation of”, or “a device for defeating”, “the bankruptcy laws”: see [1975] 1 WLR 758 , 770 a-e .

48 The British Eagle case [1975] 1 WLR 758 was applied in Carreras Rothmans Ltd v Freeman Mathews Treasure Ltd [1985] Ch 207 . Peter Gibson J said, at p 226 e - f , that the principle that he extracted from it was that

“where the effect of a contract is that an asset which is actually owned by a company at the commencement of its liquidation would be dealt with in a

20 way other than in accordance with section 302 … then to that extent the contract as a matter of public policy is avoided.”

He held that the rule did not apply to moneys due to the company, but paid, with its agreement because of its financial difficulties, into an account for the benefit of third parties. But he went on to hold that the rule did apply to other sums.

49 The decision of the High Court of Australia in International Air Transport Association v Ansett Australia Holdings Ltd [2008] BPIR 57 , where the British Eagle case was discussed and distinguished, should also be mentioned. The agreement creating the clearing house arrangement, as considered by the House of Lords, was redrafted so as to circumvent the rule. The majority of the High Court concluded that the document achieved its aim. At para 76, Gummow, Hayne, Heydon, Crennan and Kiefel JJ suggested that the basis of the House of Lords' decision was simply that one could not contract out of section 302 . In the following paragraph, they referred to the contention that: “in insolvency law, the whole of the debtor's estate should be available for distribution to all his creditors, and that no one creditor or group of creditors can lawfully contract in such a manner as to defeat other creditors not parties to the contract.” At para 79, the justices said that whether this contention was correct “depend[s] entirely upon what the relevant statute provides”. They then rejected the suggestion inherent in the contention “that the public policy achieves what the statute otherwise does not achieve”.”