Supreme Court Overrules Sigma Finance Decision: A Return to Pari Passu?
November 13 2009
Facts
Supreme Court Decision
Comment
A Supreme Court decision on October 29 2009(1) overturned the previous Court of Appeal ruling in relation to Sigma Finance (in administrative receivership).(2) The Court of Appeal had held that Sigma's assets were to be distributed to certain creditors holding notes that matured within a 60-day realization period following an enforcement event, in priority to other secured creditors.
Facts
Sigma was a structured investment vehicle (SIV) which invested in asset-backed securities. It financed such investments by issuing short-term commercial paper and obtaining liquidity from other sources, including facilities and currency and interest-rate hedging. All of Sigma's assets were secured under the terms of a security trust deed dated March 27 2003 in favour of Sigma's secured creditors.
On October 6 2008 Sigma joined a list of other well-known SIV victims of the credit crunch - including Whistlejacket, Cheyne and Golden Key - when administrative receivers were appointed over its assets under the terms of the security trust deed.
The issue facing Sigma's receivers - as had been the case for other SIV receivers - was how they should distribute moneys coming into their hands when faced with secured creditors with debts with different maturity dates under the deed.
Previous casesWhere the language in a security trust deed is clear, previous decisions have shown that the courts will not generally let the pari passu principle of distribution (ie, treating creditors equally according to ranking) interfere with the parties' contractual intentions. In Cheyne(3) and Whistlejacket(4) the High Court interpreted the payment provision clauses in the relevant security trust deeds in such a way that the receivers were obliged to adopt a 'pay as you go' approach to distribution.
Most recently, in Golden Key(5) the Court of Appeal held that parties to a commercial agreement should be free to agree that assets should be distributed among them on a 'pay as you go' basis, rather than pari passu. The court considered that if it was not the commercial intention that the assets be distributed pari passu, the courts should not automatically impose distribution pari passu where the terms of the contractual agreement are ambiguous.
Sigma's realization periodThe occurrence of an enforcement event under the security trust deed started a 60-day realization period during which the security trustee was required to establish separate asset pools for creditors with short-term and long-term liabilities. In order to establish such asset pools, the security trustee was required to dispose of or otherwise deal with Sigma's assets as it deemed appropriate.
During the realization period, Clause 7.6 of the deed required the security trustee "so far as possible [to] discharge on the due dates therefor any short-term liabilities falling due for payment during such period, using cash or other realizable or maturing assets of the issuer".
Supreme Court Decision
The Court of Appeal had held that the assets should be distributed preferentially according to the dates when the relevant debts became due. It was clearly persuaded that the last sentence of Clause 7.6 should be given its natural meaning. The appeal to the Supreme Court was formulated on the basis that the assets should instead be distributed pari passu among all secured creditors, irrespective of the maturity date of their debt.
A Supreme Court majority considered that the Court of Appeal had given too much weight to the natural meaning of the words of the deed and too little weight to their overall context.
Lord Mance stated that when considering the meaning of the deed to a reasonable person with the relevant background, the key factor was "an understanding of [the deed's] overall scheme and a reading of its individual sentences and phrases which places them in the context of that overall scheme". He considered that as the definition of 'enforcement event' did not necessarily equate to insolvency or insufficiency of assets to meet all secured liabilities, the relevant clauses of the deed were drafted on the assumption that Sigma had enough assets to cover its liabilities to secured creditors. Therefore, Clause 7.6 appeared to be relevant only where the underlying assumption was that all secured liabilities can be covered and no issue of priority would arise. Applying the Court of Appeal's interpretation raised a number of other problems of consistency with the terms of the deed, including the practical ability to pay debts on their due date during the realization period and the conflicting duties on the security trustee to meet realization period debts as they fell due, but also to establish asset pools for the benefit of both short and long-term creditors. The Court of Appeal's construction would also result in no priority or protection for payment of the fees and expenses of the security trustee and receivers if the debts falling due in the realization period were paid as they fell due.
Comment
Many SIV cases have relied on the parties' contractual intentions when determining asset distribution, rather than the fundamental English law principle of pari passu distribution on insolvency. The Supreme Court's decision in Sigma marks a return to this fundamental principle, but only on a specific interpretation of the contractual provisions in question and where such provisions are insufficient to show that the parties intended certain creditors to be paid on a 'pay as you go' basis. Lord Collins considered that:
For further information on this topic please contact Kenneth Baird, Anne Sharp or Victoria Cromwell at Freshfields Bruckhaus Deringer LLP by telephone (+44 20 7936 4000), fax (+44 20 7832 7001) or email (ken.baird@freshfields.com, anne.sharp@freshfields.com or victoria.cromwell@freshfields.com).
Endnotes
(1) In re Sigma Finance Corporation (in administrative receivership) and In re The Insolvency Act 1986 [2009] UKSC 2.
(2) In the matter of Sigma Finance Corporation (in administrative receivership) [2008] EWCA Civ 1303.
(3) Kahn v Interested Party A (In re Whistlejacket Capital) [2008] EWCA Civ 575.
(4) Cheyne Finance plc, Re [2007] EWHC 2402_2 (Ch), September 12 2007.
(5) In the matter of Golden Key Limited (in receivership) [2009] EWHC 148 (Ch).
Supreme Court Decision
Comment
A Supreme Court decision on October 29 2009(1) overturned the previous Court of Appeal ruling in relation to Sigma Finance (in administrative receivership).(2) The Court of Appeal had held that Sigma's assets were to be distributed to certain creditors holding notes that matured within a 60-day realization period following an enforcement event, in priority to other secured creditors.
Facts
Sigma was a structured investment vehicle (SIV) which invested in asset-backed securities. It financed such investments by issuing short-term commercial paper and obtaining liquidity from other sources, including facilities and currency and interest-rate hedging. All of Sigma's assets were secured under the terms of a security trust deed dated March 27 2003 in favour of Sigma's secured creditors.
On October 6 2008 Sigma joined a list of other well-known SIV victims of the credit crunch - including Whistlejacket, Cheyne and Golden Key - when administrative receivers were appointed over its assets under the terms of the security trust deed.
The issue facing Sigma's receivers - as had been the case for other SIV receivers - was how they should distribute moneys coming into their hands when faced with secured creditors with debts with different maturity dates under the deed.
Previous casesWhere the language in a security trust deed is clear, previous decisions have shown that the courts will not generally let the pari passu principle of distribution (ie, treating creditors equally according to ranking) interfere with the parties' contractual intentions. In Cheyne(3) and Whistlejacket(4) the High Court interpreted the payment provision clauses in the relevant security trust deeds in such a way that the receivers were obliged to adopt a 'pay as you go' approach to distribution.
Most recently, in Golden Key(5) the Court of Appeal held that parties to a commercial agreement should be free to agree that assets should be distributed among them on a 'pay as you go' basis, rather than pari passu. The court considered that if it was not the commercial intention that the assets be distributed pari passu, the courts should not automatically impose distribution pari passu where the terms of the contractual agreement are ambiguous.
Sigma's realization periodThe occurrence of an enforcement event under the security trust deed started a 60-day realization period during which the security trustee was required to establish separate asset pools for creditors with short-term and long-term liabilities. In order to establish such asset pools, the security trustee was required to dispose of or otherwise deal with Sigma's assets as it deemed appropriate.
During the realization period, Clause 7.6 of the deed required the security trustee "so far as possible [to] discharge on the due dates therefor any short-term liabilities falling due for payment during such period, using cash or other realizable or maturing assets of the issuer".
Supreme Court Decision
The Court of Appeal had held that the assets should be distributed preferentially according to the dates when the relevant debts became due. It was clearly persuaded that the last sentence of Clause 7.6 should be given its natural meaning. The appeal to the Supreme Court was formulated on the basis that the assets should instead be distributed pari passu among all secured creditors, irrespective of the maturity date of their debt.
A Supreme Court majority considered that the Court of Appeal had given too much weight to the natural meaning of the words of the deed and too little weight to their overall context.
Lord Mance stated that when considering the meaning of the deed to a reasonable person with the relevant background, the key factor was "an understanding of [the deed's] overall scheme and a reading of its individual sentences and phrases which places them in the context of that overall scheme". He considered that as the definition of 'enforcement event' did not necessarily equate to insolvency or insufficiency of assets to meet all secured liabilities, the relevant clauses of the deed were drafted on the assumption that Sigma had enough assets to cover its liabilities to secured creditors. Therefore, Clause 7.6 appeared to be relevant only where the underlying assumption was that all secured liabilities can be covered and no issue of priority would arise. Applying the Court of Appeal's interpretation raised a number of other problems of consistency with the terms of the deed, including the practical ability to pay debts on their due date during the realization period and the conflicting duties on the security trustee to meet realization period debts as they fell due, but also to establish asset pools for the benefit of both short and long-term creditors. The Court of Appeal's construction would also result in no priority or protection for payment of the fees and expenses of the security trustee and receivers if the debts falling due in the realization period were paid as they fell due.
Comment
Many SIV cases have relied on the parties' contractual intentions when determining asset distribution, rather than the fundamental English law principle of pari passu distribution on insolvency. The Supreme Court's decision in Sigma marks a return to this fundamental principle, but only on a specific interpretation of the contractual provisions in question and where such provisions are insufficient to show that the parties intended certain creditors to be paid on a 'pay as you go' basis. Lord Collins considered that:
"[o]nce Clause 7.6 of [the deed] is seen in context, the conclusion that the receivers were not obliged to give priority to the first maturing short-term liabilities is consistent with the wording of the clause in the context of [the deed] as a whole and with the commercial purpose of the instrument."As several judges have noted, the facts of SIV cases vary greatly, which makes it difficult to interpret any judgment as an indication of how the courts might approach future cases. However, the decision provides some certainty as to how the courts are likely to respond if required to interpret conflicting contractual provisions, unless the drafting of such clauses is clear and unambiguous. As Collins put it: "Detailed semantic analysis must give way to business common sense."
For further information on this topic please contact Kenneth Baird, Anne Sharp or Victoria Cromwell at Freshfields Bruckhaus Deringer LLP by telephone (+44 20 7936 4000), fax (+44 20 7832 7001) or email (ken.baird@freshfields.com, anne.sharp@freshfields.com or victoria.cromwell@freshfields.com).
Endnotes
(1) In re Sigma Finance Corporation (in administrative receivership) and In re The Insolvency Act 1986 [2009] UKSC 2.
(2) In the matter of Sigma Finance Corporation (in administrative receivership) [2008] EWCA Civ 1303.
(3) Kahn v Interested Party A (In re Whistlejacket Capital) [2008] EWCA Civ 575.
(4) Cheyne Finance plc, Re [2007] EWHC 2402_2 (Ch), September 12 2007.
(5) In the matter of Golden Key Limited (in receivership) [2009] EWHC 148 (Ch).
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