The Anti-Deprivation Principle: Contrasting Approaches to the Common Law Rule
Debby Lim (Dentons Rodyk & Davidson LLP) and Marcus Haywood (South Square)
Introduction
The anti-deprivation rule has existed for at least two hundred years. The rule is a rule of common law that is aimed at attempts to withdraw an asset on bankruptcy, liquidation or administration, thereby reducing the value of the insolvent estate to the detriment of creditors1. In this article we consider two contrasting approaches that have been taken to the rule.
Firstly, we review the approach adopted by the United Kingdom Supreme Court in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd [2012] 1 AC 383 (“Belmont”) which focuses on the intention of the parties. Secondly, the more recent approach adopted by the Supreme Court of Canada in Chandos Construction Ltd v Deloitte Restructuring 2020 SCC 25 (“Chandos”) which focuses on the effect of the relevant contractual provision, not whether the intention of the contracting parties was commercially reasonable. In light of these contrasting approaches, we reflect upon which of the two approaches might be adopted in other common law jurisdictions, in particular the Asian financial centres Singapore and Hong Kong.
Summary of the rule
The anti-deprivation rule operates to render void, as contrary to public policy, contractual provisions designed to remove assets from the estate of a bankrupt or an insolvent company on the commencement of the bankruptcy, winding up or administration.2 Classic statements of the principle include:3 “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”: Whitmore v Mason (1861) 2 J & H 204 at 212, per Sir William Page Wood V-C. "(....) a simple stipulation that, upon a man's becoming bankrupt, that which was his property up to the date of the bankruptcy should go over to someone else and be taken away from his creditors, is void as being a violation of the policy of the bankrupt law”: Ex p Jay (1880) 14 Ch D 19 at 25, per James LJ.
In short, the anti-deprivation rule operates to prevent an insolvent company or individual from being deprived of an asset which would otherwise be available for the benefit of its creditors. The rule seeks to prevent an arrangement whereby if a company or individual is the subject of insolvency proceedings certain assets which belong to that company or individual are no longer regarded as its assets or are transferred to some other party.
The pari passu principle
The anti-deprivation rule must be distinguished from the common law rule outlawing contractual provisions that undermine the principle of pari passu distribution. The anti-deprivation rule is designed to avoid a reduction in the net asset value of a company to the detriment of its creditors at the point of winding-up. It is not concerned with the order of distribution among creditors. By contrast the pari passu rule is aimed at provisions that would give a particular creditor an unfair advantage over other creditors by circumventing the rule against pro rata distribution.4 As Lord Collins put it in Belmont at [1]: “The anti-deprivation rule and the rule that it is contrary to public policy to contract out of pari passu distribution are two sub-rules of the general principle that parties cannot contract out of the insolvency legislation. Although there is some overlap, they are aimed at different mischiefs: … 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. The pari passu rule reflects the principle that statutory provisions for pro rata distribution may not be excluded by a contract which gives one creditor more than its proper share.”
There are important distinctions between the scope and application of the two rules. One such difference is that the pari passu rule is concerned with the effect of the arrangement in question, rather than its underlying purpose or commercial justification. Moreover, whereas the anti-deprivation rule is concerned with the preservation of assets in an insolvency, the pari passu rule is concerned with the distribution of those assets. Thus, although the rules may overlap in practice, their application is in principle different.
Belmont
The leading English case in relation to the application of the anti-deprivation rule is Belmont. The issue before the United Kingdom Supreme Court in Belmont was whether the lower courts had been right to conclude that the anti-deprivation rule did not operate to invalidate certain provisions of English law-governed agreements concerning the issue of credit-linked notes under a synthetic securitisation programme established by a Lehman Brothers entity.
The structure was widely used in the financial markets, such that the case was regarded as having important implications. The Supreme Court held that the anti-deprivation rule did not apply to invalidate the relevant provisions, yet for quite different reasons to those given by the lower courts. These differences reflect the way in which the anti-deprivation rule was formulated by Lord Collins (who gave the leading judgment in the Supreme Court in Belmont), and the decision to limit the scope of the rule not primarily by reference to considerations of contractual form but by reference to the intention of the parties.
Specifically, the United Kingdom Supreme Court held that the anti-deprivation rule should be applied in a commercially sensitive manner, so as to uphold bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy or winding up. Lord Collins explained the types of factors the court should consider in deciding whether to apply the principle as follows at [103] to [106]: “[103] As has been seen, commercial sense and absence of intention to evade insolvency laws have been highly relevant factors in the application of the anti-deprivation 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 (....) it is desirable that, so far as possible, the courts give effect to contractual terms which parties have agreed. [104] No doubt this is why, except in the case of a blatant attempt to deprive a party of property in the event of liquidation (...) the modern tendency has been to uphold commercially justifiable contractual provisions which have been said to offend the anti-deprivation rule (...). The policy behind the anti-deprivation rule is clear, that the parties cannot, on bankruptcy, deprive the bankrupt of property which would otherwise be available for creditors. It is possible to give that policy a common sense application which prevents its application to bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy (...) [105] [I]t is the substance rather than the form which should be determinant (...) [106] (...) the anti-deprivation is essentially directed to intentional or inevitable evasion of the principle that the debtor’s property is part of the insolvent estate, and is applied in a commercially sensitive manner, taking into account the policy of party autonomy and the upholding of proper commercial bargains.”
As Lord Collins stressed,5 this does not mean that a subjective intention is required, or that there will not be cases so obvious that an intention can be inferred. However, in borderline cases a commercially sensible transaction entered into in good faith will not be held to infringe the anti-deprivation rule.
The role of the court, the United Kingdom Supreme Court held, was to look at the substance of the agreement rather than its form and ask whether the purpose and effect of the relevant provision amounted to an illegitimate intent to evade the insolvency laws or had a legitimate commercial basis.
Developments in England since Belmont
Since Belmont, the English courts have had a number of opportunities to consider how the Supreme Court’s focus on good faith and intention operates in a commercial context.6
Accordingly, in Lomas v JFB Firth Rixson [2013] 1 BCLC 27 the Court of Appeal rejected a contention that a provision within an ISDA Master Agreement which, on its true construction, suspended a non-defaulting party’s payment obligation (rather than extinguished it) offended the anti-deprivation rule. At [87] to [88] Longmore LJ said as follows: “[87] … The suspension of the payment obligations of the Non-defaulting Party for the duration of the insolvency does no more than to prevent [the Non-defaulting party] from having to make payments under a hedging arrangement with a bankrupt counterparty. There is no suggestion that it was formulated in order to avoid the effect of any insolvency law or to give the Non-defaulting Party a greater or disproportionate return as a creditor of the bankrupt estate (....). The commerciality of the arrangements has to be judged by considering the operation of Section 2(a)(iii) throughout the life of the contract and not solely by reference to the point in time when it comes to operate. [88] Looked at in this way it cannot be said that the suspensory effect of Section 2(a)(iii) engages the anti-deprivation principle.”
Similarly, in HMRC v The Football League Ltd [2013] B.C.C. 60, David Richards J considered whether provisions in the articles of association of the English Football League fell foul of the anti-deprivation rule, or the pari passu rule. In so far as the anti-deprivation rule was concerned, the court held that the rule applied to the administration of a company, just as it did to a company in liquidation. The purpose of the anti-deprivation rule was to prevent insolvency proceedings from being undermined by dispositions of assets designed to avoid the effects of the proceedings. However, in the present case, the predominant purpose of the Football League’s articles of association was to implement a commercial response to an insolvent club, rather than to deprive an insolvent club of an asset.
By contrast, in Mayhew v King [2012] 1 BCLC 550 the Court of Appeal held that a clause in a settlement agreement between an insurance broker and an insured which provided for payment of various sums to the insured to terminate in the event that the insured should enter into administration did offend the anti-deprivation principle. Rimer LJ said of the relevant clause in that case as follows at [22]: “What was the commercial objective of cl.11? … As it seems to me, it was apparently a naked attempt to provide that, whilst Milbank’s right to payment and Folgate’s obligation to pay were to survive so long as the payment would accrue exclusively to the benefit of Mr Mayhew, they were to be extinguished if such payment would instead be available for Milbank’s creditors generally in the event of its insolvency. This is not a commercial purpose so much as a collateral device to avoid the consequences of the insolvency legislation.”
The approach of the Supreme Court of Canada: Chandos
The approach of United Kingdom Supreme Court to the anti-deprivation rule stands in stark contrast to that adopted by the Supreme Court of Canada in Chandos.
Chandos concerned a construction contract between Chandos Construction Ltd. (“Chandos”), and Capital Steel Inc. (“Capital Steel”). The contract contained a clause which provided that Capital Steel would pay Chandos 10 percent of the contract price as a fee for the inconvenience of completing the work using alternative means and/or for monitoring the work during the warranty period in the event of Capital Steel’s bankruptcy. When Capital Steel went into bankruptcy prior to completing the contract, Chandos argued it was entitled to set off the costs it had incurred to complete Capital Steel’s work and to set off 10 percent of the contract price, as provided by the relevant clause. Capital Steel’s trustee in bankruptcy applied for directions as to whether the clause contravened the anti-deprivation rule.
In particular, the question for the Supreme Court of Canada was the relevance of the intention of the parties and the commercial purpose of the clause.
In an 8 to 1 majority decision, the Supreme Court of Canada held that the anti deprivation rule had existed in Canadian common law since before federal bankruptcy legislation existed and had not been eliminated by any decision of the court or by statute. However, it rejected the approach adopted by the English Supreme Court in Belmont and instead adopted a two-part “effects-based” test to the application of the anti-deprivation rule. Firstly, that the relevant clause is triggered by an event of insolvency or bankruptcy. Secondly, that the effect of the clause is to remove value from the insolvent’s estate.
What was to be considered by the court is whether the effect of the contractual provision was to deprive the estate of assets upon bankruptcy, not whether the intention of the contracting parties was commercially reasonable. Adopting a purpose‑based test (like that adopted in Belmont), the Supreme Court of Canada held, would create new and greater difficulties. It would require courts to determine the intention of contracting parties long after the fact, detract from the efficient administration of corporate bankruptcies, and encourage parties who can plausibly pretend to have bona fide intentions to create a preference over other creditors by inserting such clauses.
In contrast to the approach taken by the United Kingdom Supreme Court in Belmont, Justice Rowe (who gave the judgment of the majority of the Supreme Court of Canada in Chandos) held at [35]: “The effects-based rule, as it stands, is clear. Courts (and commercial parties) do not need to look to anything other than the trigger for the clause and its effect. The effect of a clause can be far more readily determined in the event of bankruptcy than the intention of contracting parties. An effects-based approach also provides parties with the confidence that contractual agreements, absent a provision providing for the withdrawal of assets upon bankruptcy or insolvency, will generally be upheld.”
Applying this test to the facts of the case, the Supreme Court of Canada held that the effect of the relevant provision in the contract was to create a debt from Capital to Chandos in the event of insolvency. In these circumstances, Justice Rowe held “one can hardly imagine a more direct and blatant violation of the anti-deprivation rule.” The Supreme Court of Canada rejected the United Kingdom’s purposive interpretation of the anti-deprivation rule and endorsed the policy underlying the anti-ipso facto clause provisions in the United States Bankruptcy Code.7
Approaches in other common law jurisdictions
Belmont was consistent with the trend then adopted by the House of Lords and subsequently the Supreme Court (for example, Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38) towards taking a purposive interpretation of contracts9 in order to uphold the parties’ intentions as far as possible.8 Subsequently, there was a retreat from this trend, in favour of a reassertion of some traditional orthodoxies from earlier cases including the primacy of language in the interpretation of contracts. Notwithstanding this, recent case law indicates that the anti-deprivation rule is unlikely to be the subject of reconsideration in England (at least in the short term).10
The question then arises whether, in the light of the contrasting approaches adopted by the English and Canadian Supreme Courts in Belmont and Chandos what approach might be followed in other common law jurisdictions.
We first consider the approach that has been taken to the anti-deprivation rule in Hong Kong. We then consider which approach - that adopted in Belmont or Chandos - is likely to find favour in Singapore were the issue required to be decided in the future.
The approach in Hong Kong
The Hong Kong Court of Appeal in Hsin Chong Construction Co Ltd (In Provisional Liquidation) v Build King Construction Ltd [2019] HKCA 1305; [2020] 1 HKLRD 316 (“Hsin Chong”) applied Belmont and held that it was necessary to look at the substance of the agreement and consider whether the provision amounted to an illegitimate attempt to evade insolvency law or had some legitimate commercial basis.
In Hsin Chong, only one of the five events specified in the exclusion clause in question concerned insolvency. The remaining four events of default concerned breaches of contract. This evinced an absence of intention of the parties to seek to evade insolvency law. Also, it was clearly sensible and in the interests of the parties to provide for the contingency that had occurred, namely, the insolvency of one of the parties. This was a commercial bargain entered into freely by the parties.
It was also commercially fair that the company had to bear its share of post-exclusion losses until the completion of the project, given that in large construction projects, claims for latent defects tend to only emerge upon completion of the project.
As such, the Court of Appeal upheld the High Court’s ruling that there was no infringement of the anti-deprivation rule as the exclusion clause did not amount to an illegitimate attempt to evade insolvency law and had some legitimate commercial basis. Notably, the Court of Appeal rejected the argument that the anti-deprivation rule should focus on the effect of the provision on the unsecured creditors to be protected, rather than the intention of the parties or the bona fide or otherwise of the provision itself, which the creditors have no control of or involvement in.11
The anti-deprivation rule has yet to be decided on in Singapore
Unlike in Hong Kong, the anti-deprivation rule has not been the subject of any detailed consideration by the Singapore courts. In so far as the pari passu principle is concerned, the Singapore High Court in Joo Yee Construction Pte Ltd (in liquidation) v Diethelm Industries Pte Ltd and others [1990] 1 SLR(R) 171 (“Joo Yee”) at [21] held that a direct payment clause in a contract between a developer and the main contractor could be struck down in the liquidation of the main contractor as being contrary to public policy, as it fell afoul of the pari passu principle. The Court in Joo Yee followed British Eagle International Airlines v Compagnie Nationale Air France [1975] 1 WLR 758.
Subsequently, the Singapore High Court in Encus International Pte Ltd (in compulsory liquidation) v Tenacious Investment Pte Ltd and others [2016] 2 SLR 1178 (“Encus”) correctly noted at [79] that the anti-deprivation rule has not been applied in any Singapore judgment, although its cousin, the pari passu principle, has. The Plaintiff in Encus had argued that because the anti-deprivation rule was well established in English law prior to 12 November 1993, it was received into Singapore law pursuant to Section 31 of the Application of English Law Act (Cap 7A, 1994 Rev Ed).
The Court in Encus was of the view that since the Plaintiff was entitled to succeed on the basis of the statutory avoidance provisions, there was no need in that case to consider the applicability of the anti-deprivation rule, its extent, or the defences available when it is raised.
Very recently, the Singapore Court of Appeal in Denka Advantech Pte Ltd and another v Seraya Energy Pte Ltd and another and other appeals [2020] SGCA 119 at [141] to [142] referred to Chandos but in respect of the law relating to contractual penalties and not in the context of the anti-deprivation rule.
It, therefore, remains an open question as to how the Singapore courts might approach the anti-deprivation rule.
How might the Singapore courts approach the anti-deprivation rule?
In determining which approach to adopt, the Singapore courts will have to grapple with the theoretical underpinnings of the anti-deprivation rules and how the policies underlying collective winding up proceedings are to be balanced with freedom of contract and the need for commercial certainty.
The Singapore courts approach to contractual interpretation may shed some light on which of the differing approaches in Belmont or Chandos will be followed in Singapore. In Singapore, contracts are interpreted using the contextual approach rather than the textual approach. The Court of Appeal summarised the contextual approach in Yap Son On v Ding Pei Zhen [2017] 1 SLR 219 (“Yap Son On”) at [30] as follows: (...) the purpose of interpretation is to give effect to the objectively ascertained expressed intentions of the contracting parties as it emerges from the contextual meaning of the relevant contractual language. Embedded within this statement are certain key principles: (a) first, in general both the text and context must be considered; (b) second, it is the objectively ascertained intentions of the parties that is relevant, not their subjective intentions; and (c) third, the object of interpretation is the verbal expressions used by the parties and so, the text of their agreement is of first importance (...)
To elaborate further on this contextual approach, essentially the courts will first consider the plain language of the contract and the admissible extrinsic material that is objective evidence of its context: Zurich Insurance (Singapore) Pte Ltd v B-Gold Interior Design & Construction Pte Ltd [2008] 3 SLR(R) 1029 (“Zurich”) at [130]. In fact, Zurich “cautiously suggested that prior negotiations and even subsequent conduct may be admissible for the purpose of interpretation”.12
The contextual approach is not without limits. In Y.E.S. F&B Group Pte Ltd v Soup Restaurant Singapore Pte Ltd (formerly known as Soup Restaurant (Causeway Point) Pte Ltd) [2015] 5 SLR 1187 (“Soup Restaurant”), the court held that “although the relevant context is also important, the text ought always to be the first port of call for the court”13 . Further, however absurd and uncommercial the result, it remains the case that “the context cannot be used as a pretext to rewrite the text”: Oxley Consortium Pte Ltd v Geetex Enterprises Singapore (Pte) Ltd [2020] SGHC 235 at [43]. This is because the court is not free to disregard the parties’ intention as ascertained from the objective evidence and to rewrite the contract for them based on the court’s subjective view of what is just and fair.14
Unlike the retreat in England, the Singapore courts appear to have consistently adopted the contextual approach to contractual interpretation. It is therefore likely that the Singapore court will take a purposive approach to examining whether a transaction falls foul of the anti-deprivation rule. Further, it could be argued the anti-deprivation rule goes beyond contractual interpretation and actually engages public policy considerations. The Singapore courts are used to making subjective good faith assessments in other areas of insolvency, be it in the context of undervalue transactions, preferences, transactions defrauding creditors or wrongful trading.15
The Singapore courts are certainly not averse to considering the subjective intentions of the parties in respect of voidable transactions. For example in determining whether there was a “desire to prefer” the recipient, the Singapore courts will undertake a subjective assessment of the debtor’s intentions at the relevant time of the transaction. In fact, Singapore declined to follow the objective approach taken in the Australia Corporations Act16 . As such, it seems likely the Singapore courts will likely Belmont’s focus on good faith and intention and eschew Chandos’s effects-based approach.
Conclusion
The divergence in approach between the United Kingdom Supreme Court in Belmont and the Canadian Supreme Court in Chandos reflects a conflict between the pro-commerce model of freedom of contract, on the hand, and the collectivist public policy model of insolvency law, on the other.
While Canada’s effects-based interpretation of the anti-deprivation rule protects creditors’ interests and promotes certainty in commercial transactions, the United Kingdom’s purposive approach shows a greater degree of respect for party autonomy and commercial expectations.
The debate as to which of these approaches should be adopted by other common law jurisdictions as and when relevant cases come before their courts is likely to be hotly contested.
(*) This article was first published in a special edition of the South Square Digest in collaboration with INSOL International.
1 Belmont at [1] per Lord Collins.
2 The rule has no application to deprivations triggered by a non-insolvency event, at least where the event occurs prior to the commencement of insolvency proceedings: see Belmont at [14] and [115] per Lord Collins.
3 Cited by Lord Collins in Belmont at [3].
4 The leading English case on the application of the pari passu rule is British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 758.
5 Belmont at [79].
6 There have also been recent statutory developments in England. Section 14 of the Corporate Insolvency and Governance Act 2020 introduced a new section 233B into the Insolvency Act which restricts the ability of a supplier of goods or services to a company in a formal rescue or insolvency procedure to terminate the supply contract (i.e. limiting the effect of so called “ipso facto” clause). For a detailed review of these reforms see Felicity Toube QC and Georgina Peters, Ipso Facto Reform: Why now, and does it go too far (or not far enough)?, South Square Digest, June 2020.
7 As to the approach adopted in the United States, which is largely based on statute, by way of comparison to that adopted in England in Belmont) see Gabriel Moss QC, Anti-deprivation, flip clauses, ipso facto rules and the Dante inferno Lehman Brothers Holdings Inc v Bank of American National Association Judge Chapman 28 June 2016, Insolvency Intelligence (2017) 30(2), 24-27.
8 Oliver Gayner, Case Comment: Belmont Park Investments v BNY Corporate Trustee and Lehman Brothers Special Financing [2011] UKSC 38". UKSC Blog. (24 August 2011).
9 Lord Sumption, A Question of Taste: The Supreme Court and the Interpretation of Contracts, Harris Society Annual Lecture, Keble College, Oxford, (8 May 2017).
10 Whilst the approach of the United Kingdom Supreme Court to the anti-deprivation rule has not been without its criticism (see, for example, Worthington, Good Faith, Flawed Assets and Emasculation of the UK Anti-Deprivation Rule (2012) 75(1) MLR 78-121, which was cited with approval by Rowe J in Chandos at [33]) in Fibria Celulose S/A v Pan Ocean Co Ltd [2014] EWHC 2124 (Ch) Morgan J (at [113]) preferred the policy choice made by the United Kingdom Supreme Court in Belmont over the contrasting approaches to ipso facto clauses adopted by the United States, Canada and Korea.
11 This argument was put forward based on an earlier decision of the Hong Kong Court of Appeal in Peregrine Investments Holdings Ltd & Anr v Asian Infrastructure Fund Management Co Ltd LDC & Ors [2004] 1 HKLRD 598. See [37] to [41] of Hsin Chong.
12 VK Rajah JA, “Redrawing Boundaries of Contractual Interpretation: From Text to Context to Pre-text and Beyond” (2010) 22 SAcLJ at 520
13 Soup Restaurant at [32]
14 Ibid
15 Michael Schillig, “Corporate Insolvency Law in the 21st Century: State-Imposed or Market-Based?”, Journal of Corporate Law Studies, Vol. 14, No. 1, 2015, p. 1-38.
16 Insolvency Law Review Committee, Report of the Insolvency Law Review Committee (2013) (Chairman: Lee Eng Beng SC), p172 to 175.