Background
The anti-deprivation principle is a long established rule of common law based on the proposition that one cannot contract out of the provisions of the insolvency legislation. The anti-deprivation principle therefore supplements the Insolvency Act 1986 ("IA86") by invalidating attempts to avoid its objectives.
Pari Passu
The anti-deprivation principle protects the pari passu distribution of assets – or the rule that all property owned by a company or an individual as at the commencement of the relevant insolvency process should (subject to prior payment of legally recognised secured or preferential liabilities and expenses) be applied rateably in satisfaction of liabilities.
Infringement of the principle
The infringement of the anti-deprivation principle can be most commonly found in the following two examples:
Contracting out of pari passu distribution: in the landmark case of British Eagle International Limited v Compagnie Nationale Air France (1975), the House of Lordsdecided that the process of distribution to certain creditors under the International AirTransport Association ("IATA") clearing house system infringed the pari passu principleas the IATA creditors were to receive more than their proportionate share of thecompany's assets. So a contract that elevates a creditor or a group of creditors abovethe others on insolvency is therefore not permitted. However, creditors can relegatetheir own interests beneath the others without infringing the anti deprivation principle,by for instance, entering into subordination agreements that prevent a creditor orcreditors from proving until the others have been paid in full.
Contracts removing assets from the insolvent estate: the anti-deprivation principle also prevents the enforcement of a contract under which property is removed from the estate on insolvency for no or minimal consideration. So for example, the Court recently refused to enforce an arrangement where agreed payments in full settlement of a damages claim were to terminate on the insolvency of the recipient.
Alternatively, a contractual mechanism requiring the sale of shares or other assets of a company to a third party on insolvency would be enforceable, subject to the contract containing provision for market value to be calculated and paid. Contracts where the rights and obligations of the parties accrue over time do not tend to infringe the anti-deprivation principle, as consideration is supplied incrementally. For instance, it is common for leases and licences to terminate or be terminable on the insolvency of the tenant or licensee.
The consequences
Whilst the application of the anti-deprivation principle cannot be defined with absolute certainty, case law confirms that the Courts will uphold commercially justifiable contractual provisions. The principle has been applied sparingly to date and only to transactions which have as their predominant purpose the elevation of a creditor or creditors over the others in breach of pari passu and/or the removal of assets from an insolvent estate for insufficient consideration.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
