In a unanimous judgment handed down today, 18 January 2006, the Court of Appeal have upheld the first instance decision on all points of the Liquidators of SSSL Realisations (2002) Ltd v AIG and the Liquidators of Save Group Plc v AIG (27 July 2004; [2004] EWHC Ch 1760; [2005] 1 BCLC 1).

At first instance, the validity of a subordination or "non-compete" clause in favour of AIG was confirmed. The clause was challenged as an offence against the pari passu principle, preventing, as it did, creditors of the companies in liquidation from submitting proofs of debt until AIG had been paid in full.

The use of subordination clauses remains a valid option for financiers, who find subordination clauses such as the one in this case can provide a necessary adjunct to their security position. The wording of the relevant clauses is provided for illustrative purposes below.

It is noteworthy that the court held the contract of which the subordination clause formed part could not be disclaimed by the liquidators as onerous property.

It is understood that the decision will not be appealed.

The wording of the subordination clause and declaration of trust:

8.2 Postponement of Indemnitors’ rights

Until all amounts which may be or become payable by the Indemnitors to the Surety under this deed have been irrevocably paid in full no Indemnitor shall after a claim is being made by the Surety hereunder or by virtue of any payment made by it under this deed:

  1. be subrogated to any rights, security, cash cover or other monies received on account of that Indemnitor’s liability hereunder;

  2. claim rank prove or vote as a creditor of any Indemnitor or its estates in competition with the Surety; or

  3. receive, claim or have the benefit of any payment distribution or security from or on account of any Indemnitor or exercise any right of set-off as against any Indemnitor.

8.3 Declaration of Trust:

Each Indemnitor shall hold on trust for and forthwith pay or transfer to the Surety:

  1. any payment distribution benefit or security received by it contrary to clause 8.2; and

  2. following any claim upon or payment by the Surety under or in respect of a Bond any payment or repayment received by it from the Commissioners or any other person in respect of the Charges or in respect of any overpayment or over-declaration of Value Added Tax."

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

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The original publication date for this article was 18/01/2006.