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Pari Passu And Anti Deprivation Notes

BPTC Law Notes > Corporate Insolvency Notes

This is an extract of our Pari Passu And Anti Deprivation document, which we sell as part of our Corporate Insolvency Notes collection written by the top tier of City Law School students.

The following is a more accessble plain text extract of the PDF sample above, taken from our Corporate Insolvency Notes. Due to the challenges of extracting text from PDFs, it will have odd formatting:

The treatment of claims - pari passu and anti-deprivation principles Who can claim an interest in the assets the subject of the statutory trust?
Anyone with valid security or quasi-security interests as we have seen. This is a manifestation of the rule that the liquidator takes the company's assets as he finds them (i.e. 'warts and all'). But one exception to this general rule is that parties cannot 'contract out' of the provisions of the insolvency legislation. So the law of security sets against each other 2 fundamental principles of credit and insolvency law - Freedom of contract to bargain for priority vs. Postinsolvency pari passu distribution and not being able to contact out of this. Pre-Belmont Park decision, the 2 rules which epitomise this principle were treated as separate principles aimed at separate mischiefs:

1. Pari Passu rule - statutory provisions for pro rata distribution pari passu. This may not be excluded by a contract which gives 1 creditor more than its proper share (i.e. unsecured creditors 'proper' share is pro rata distribution of the prescribed part).

2. Anti-deprivation rule - Prohibits attempts to withdraw an asset on bankruptcy/liquidation/etc. and thus reduce the value of the insolvent estate to the detriment of creditors. But here Supreme Court said parties cannot contract out of insolvency legislation and the 2 above rules are merely sub-rules to this general principle (an argument advocated previously by Sarah Worthington). It probably isn't important per se whether they are separate rules or sub-species of the same, but note there can be considerable overlap between the application of the 2, and test of whether an agreement breaches one of them is different for each so its VIP to characterise the effect of any given agreement properly. Pari passu -the statutory scheme This essentially talks about pro rata distribution/equal abatement amongst equals (unsecured creditors all equal) and finds expression in 2 statutory provisions: S107 IA 1986 And r.4.181 Insolvency Rules 1986 The rule of pari passu distribution cannot be contracted out of. If the rule is breached, then that agreement is void. Limitations of the 'pure' pari passu principle The courts insist this is a mandatory rule of law, but many have argued that because there are so many limitations to the rule, it is arguably an exception, or rather a 'residual basis' of distribution that only applies after all the other bases of distribution have been exhausted: A rateable distribution among creditors is hardly ever achieved because: pari passu does not affect creditors with rights in rem e.g. secured creditors, retention of title, trusts e.g. Quistclose. Also some things which simply do not offend against the principle e.g. subordination agreements.

And also 'true exceptions' to the rule as laid down by Statute e.g. prescribed part and preferential debts. Also set-off. Mokal - In most proceedings nothing is distributed to general unsecured creditors Goode - Pari Passu is just a 'theory' of insolvency law Oditah - PP is 'shallow' Cork Committee - PP is rarely achieved anyway Keay and Walton - PP is nothing more and has little relevance, other than acting as a convenient default principle However, albeit residual, it is still a 'prevailing' rule since good faith doesn't matter like it now does to anti-deprivation (Belmont). The nevertheless mandatory nature of pari passu - 'contracting out' of the principle Re Jeavons, ex p Mackay -Further part of clause initially just on security went on to say if Mr J becomes bankrupt (insolvent by analogy) then company entitled to cease paying the other 50% of royalties to him. Held: The first part of clause was said to a security agreement, but the second part - about withholding other 50% if Mr J bankrupt was void, because cannot make own rules about insolvency when law provides for this - here this was 'contracting out' through 'fraud on the bankruptcy law'. Even though this is now widely accepted as representing the anti-deprivation rule, not the pari passu principle - Jeavons appears to involve the 'removal' of an asset (i.e., entitlement to royalties) from the insolvent's estate triggered by insolvency, and so seems to fall within the Belmont formulation regarding the anti-deprivation principle. British Eagle Airlines - Airlines carrying passengers for each other and so owing each other money turned to IATA - used a netting arrangement: So if in credit - IATA would pay you, if in debit you would pay IATA. This was obv entered into for legitimate reasons. But found to be invalid/void on insolvency of British Eagle liquidator went after Air France for the money it owed to BE, they said no claim because of the arrangement with IATA, so liquidator said this was a fraud on bankruptcy law - airlines which were creditors of British Eagle could avoid joining the ranks of unsecured creditors by going to IATA. And those who owed BE money (such as Air France) were effectively by virtue of the agreement here removing an asset from BE's estate. So Pari Passu and deprivation overlap here again. HOL: Unenforceable because it provided for a diff form of distribution to Insolvency Act. The 'contracting out' here said to contrary to public policy/a fraud. (Morris cogently dissented and said netting arrangement only defined BE's assets like security defines beneficial interests in assets. Also said intention of parties should be relevant). Note the broad scope of Pari Passu rule here - ANY contractual arrangement which has effect of disturbing rule is invalid and it doesn't matter if you entered agreement with intention of helping yourself re insolvency or not. So intentions of parties irrelevant here.

Should insolvency law redistribute? Is pari passu even a good rule?
Pari passu is said to be entrenched in law, but so too is idea that liquidator takes assets as he finds them. Pari passu does not prevent a company's assets becoming extensively encumbered by earlier contractual security and quasi-security agreements, so rather than promoting equality per se on a mandatory, widespread basis, it is probably more accurate to describe it as promoting equality among equals (i.e. unsecured creditors) on a residual basis. While British Eagle seems to promote the dominance of the pari passu rule, it doesn't explain the rationale for the rule, or why equality amongst equals is the dominant ideology. Indeed, it is arguable that insolvency law should not attempt to achieve equality per se, but rather achieve fairness - Many US scholars say pari passu is not the proper basis for insolvency distribution. Should devise scheme that allocates loss to those most able to bear it, and most vulnerable creditors should receive a larger portion of pie. Legislative redistributive regimes (arguably exceptions to pari passu): Besides, there are clearly re-distributive regimes prescribed by legislation (indeed they create certain rules allowing re-distribution and then apply pari passu internally so that those rules can't be avoided either). For instance legislative regimes designed to prevent floating charges from unfairly 'scooping the asset pool':
- E.g. Preferential debts S175 IA Preferential debts take priority over a floating charge and so in one sense are an exception to pari passu. These mainly include employee's claims now (Crown preference abolished).
- E.g. Prescribed part S176A Insolvency Act -- allocates proportion of floating charge realisations to unsecured creditors (rationale is explicitly re-distributive). While this seems to undermine pari passu, confusingly, the prescribed part is also abated rateably amongst unsecured creditors - paradox of both exception to and application of the rule internally. Plus Courts plc shows that although prescribed part seems to be an exception to pari passu, pari passu actually reinforces the natural construction of s176A precluding the court from dis-applying it in part, e.g. by excluding creditors with claims of less than a specified amount. Imagine you're under-secured as a creditor (shortfall re what creditor owed and what assets would realise). Can you then say that the part of your debt which is unsecured means you can share in the prescribed part as you're an unsecured creditor?
Airbase Services also says you cannot share in prescribed part if part of your debt is unsecured but partly secured. The charge holder could only claim a portion of the prescribed part if the unsecured debts were discharged in full. So pari passu cannot be invoked so as to entitle the holder of a floating charge to share in the prescribed part, since the general principle must give way to the express terms of s176A(2).

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