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International Law

UK High Court Upholds Freedom of Contract Over Public Policy Invalidation of “Anti-deprivation” Clauses in Standard Credit Default Swap Contract

By Louis M. Solomon

Belmont Park Investments PTY Limited (Respondent) v. BNY Corporate Trustee Services Limited and Lehman Brothers Special Financing Inc (Appellant), 2011 UKSC 38 (Trinity Term July 2011), is a decision by the UK's Supreme Court of England and Wales that involves two important principles of international litigation practice.  The decision dismisses an appeal in the case of Perpetual Trustee Company Ltd v. BNY Corporate Trustee Services and provides an exhaustive analysis of the "anti-deprivation" rule.  The decision is comprised of several decisions, long, detailed, erudite, lucid, and well-written opinions that, in the end, appear unanimously to agree on a result. 

The anti-deprivation rule is aimed at attempts to withdraw an asset on bankruptcy or liquidation or administration, thereby reducing the value of the insolvent estate to the detriment of creditors.  Its application is one of a number of instances we have discussed in this blog concerning the limits of freedom of contract in the face of overarching public policy constraints (also see the same struggle in the state law context).  

As explained by the Court, the appeal concerned the effect of the security arrangements in a complex series of credit swap transactions under which, in effect, investors gave credit protection to Lehman by reference to the performance of a basket of underlying obligations.  A Lehman entity was a counterparty to a number of swap agreements made with a series of special purpose vehicles.  These SPVs in turn issued notes to investors and used the funds to buy securities.  There were priority provisions in the various instruments, the priority altered in the event of a default including insolvency, and the Court said that the "central issue" in the proceedings and the appeal is the validity of those provisions for alteration of priority.  Lehman's creditors argued that they were being deprived of assets otherwise available in the event of insolvency. Both the High Court and the Court of Appeal found that no deprivation had occurred.

The two principles of international practice reflected in the decision are:

First, procedurally, there is an interesting use of international communication, cooperation, and comity exhibited in the decision.  Litigation involving these issues was pending in many different forums, including in the UK and in the Bankruptcy Court in the Southern District of New York.  As the Court explains here:

"Following communications between the High Court in England and the Bankruptcy Court in New York, it was agreed that, in order to limit potential conflict between decisions in the two jurisdictions, relief would be limited to declaratory relief: Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2009] EWHC 2953 (Ch), [2010] 2 BCLC 237; Re Lehman Brothers Holdings Inc, 422 BR 407 (US Bankruptcy Court, SDNY, 2010) [enhanced version available to subscribers] ."

Interestingly as well on the procedural front, the UK decision observes that

"In January 2010 Judge Peck, sitting in the US Bankruptcy Court for the Southern District of New York, granted summary judgment in favour of LBSF on its application for a declaration that the provisions in the Perpetual documentation were ineffective because they were in breach of the US Bankruptcy Code: Re Lehman Brothers Holdings Inc, 422 BR 407 (US Bankruptcy Court, SDNY, 2010) [enhanced version available to subscribers]."

Second, substantively, the holding by the US court did not prevent the UK Court from essentially coming out the opposite way.  The Court explained initially that:

"the law is too clearly settled to admit of a shadow of doubt that 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"

Yet despite 200 years of applicability finding anti-deprivation provisions unenforceable, the Court here determines that the rule should not be applied invariably and unbendingly to complex and bona fide commercial transactions but rather should be applied with "common sense".  The Court determined that the intent to single out the case of bankruptcy was not evident in the standard form contracts.  Said the Court:

"As has been seen, commercial sense and absence of intention to evade insolvency laws have been highly relevant factors in the application of the antideprivation rule. Despite statutory inroads, party autonomy is at the heart of English commercial law. Plainly there are limits to party autonomy in the field with which this appeal is concerned, not least because the interests of third party creditors will be involved. But, as Lord Neuberger stressed [2010] Ch 347, para 58, it is desirable that, so far as possible, the courts give effect to contractual terms which parties have agreed. And there is a particularly strong case for autonomy in cases of complex financial instruments such as those involved in this appeal".

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