In a case that provides an increasingly common example of a capital market structure unravelling, the Supreme Court has handed down its judgment in Re Kaupthing Singer and Friedlander Limited (in administration) [2011] UKSC 48. The appeal concerned a long-standing principle of insolvency law known as the rule against double proof.
In a case that provides an increasingly common example of a capital market structure unravelling, the Supreme Court has handed down its judgment in Re Kaupthing Singer and Friedlander Limited (in administration) [2011] UKSC 48. The appeal concerned a long-standing principle of insolvency law known as the rule against double proof (see box "Two rules").
The facts of this case were typical in the context of a capital markets transaction. Kaupthing Singer & Friedlander Limited (KSF) formed a wholly-owned subsidiary, Kaupthing & Singer Funding plc (Funding), which it used to raise finance for its operations.
Funding issued £250 million of bonds to noteholders. KSF guaranteed the notes and, in turn, Funding gave KSF an indemnity for its obligations under the guarantee. These arrangements were governed by a trust deed. Funding used the proceeds of the notes to make an unsecured upstream loan to KSF (see box "Guarantee structure").
When KSF went into administration, it owed Funding approximately £242 million. When Funding went into administration, £240 million was due on the bonds, and the obligations of Funding (as principal debtor) and KSF (as guarantor) came into immediate effect.
The bondholder trustee proved in the administrations of KSF (for the guarantee) and Funding (for the notes) for £248 million. Funding proved in the administration of KSF for £242 million in respect of the unsecured loan.
KSF's administrators applied to the court for directions as to how to apply distributions in the administration.
At first instance, the focus was on whether certain terms in the trust deed between KSF and Funding operated to exclude the rule in Cherry v Boultbee (1839) 4 My & Cr 442 (see box "Two rules") (www.practicallaw.com/5-501-5193). This is a technique for netting-off reciprocal monetary obligations, even where there is no room for set-off.
KSF owed Funding repayment on the original upstream loan, but KSF had an indemnity claim against Funding under the trust deed. However, the trust deed contained a non-competition clause which provided that: KSF could not exercise any rights of subrogation or contribution or remedy or claim any payment from Funding (including in its liquidation); and, in the event that (despite these non-competition provisions) payments or distributions were made to KSF, those payments were to be held on trust for the bondholders.
If the rule in Cherry v Boultbee applied, KSF could use its indemnity claim to prevent a claim under the upstream loan; that is, it could claim that equity prevented Funding claiming from a fund to which it owed a contribution (via the indemnity).
The High Court held that, following a binding Court of Appeal decision in Re SSSL Realisations (2002) Ltd [2006] Ch 610, the rule in Cherry v Boultbee was not excluded by the non-competition clause in the trust deed. This meant that KSF's administrators were able to rely on the rule and refuse payment on Funding's claim in KSF's administration unless and until KSF's right of indemnity (as a surety) had been satisfied in full. (For more information on the decision in SSSL Realisations, see News brief "Subordination clauses: saved by the bell", www.practicallaw.com/6-201-9047).
So, although the bondholders could claim against both Funding and KSF, Funding would have no funds to pay the claim of the bondholders unless and until Funding had satisfied KSF's indemnity claim in full. As a result, the bondholders would be prevented from an effective "double dip": once under the guarantee, and once under the original bonds via Funding's indemnity claim against KSF, and so would not receive the full amount due under the notes.
As it was recognised that the case concerned a point of law which was of general public significance, it was allowed to leapfrog the Court of Appeal and go straight to the Supreme Court.
Interestingly, the Supreme Court did not need to consider whether the non-competition clause contained within the trust deed excluded the rule in Cherry v Boultbee because it held that the rule was simply a form of equitable set-off and, as such, was displaced in this case by the rule of double proof. The court effectively overruled the Court of Appeal's decision on this point in SSSL, bringing the application of the rule of double proof in line with statutory set-off.
This meant that KSF was prevented from seeking to use the indemnity claim under the guarantee to block Funding's claim under the original upstream loan. As a result, Funding could claim in full from KSF, and the bondholders could benefit from:
Assets coming into the Funding estate as a result of that claim (because, apart from a very small HM Revenue and Customs claim, the bondholders were the major creditor of Funding).
Their direct claim against KSF under the guarantee.
In other words, the bondholders now had a double dip, and could submit proofs of debt to both Funding as principal debtor and KSF as guarantor. Therefore, the bondholders now had the likelihood of a full recovery rather than a partial recovery.
The judgment is good news for the bondholders and provides a good example of how claims arising between co-obligors of the same debt, such as guarantors' rights of contribution and indemnity, operate in an insolvency. It clarifies the primacy of the rule against double proof over the application of the rule in Cherry v Boultbee in these types of situation.
It is likely that the practice of including non-competition clauses in guarantees will continue as part of the general contractual protections. In addition, many draftsmen may be minded to include an express provision that excludes the rule in Cherry v Boultbee, so that the point is beyond doubt in future cases.
Philip Hertz and Adrian Cohen are partners at Clifford Chance LLP.
The rule against double proof prevents a paying guarantor from proving a claim in relation to his right of indemnity against the principal debtor in the liquidation of the principal debtor when the beneficiary of the guarantee is also proving for its primary claim. This is because it would lead to the payment of a double dividend out of one estate in relation to the same debt. The rule is extended to administration proceedings where the administrators elect to make a distribution.
The rule in Cherry v Boultbee is an equitable rule that a person cannot share in a fund if he is also a debtor of that fund without first contributing to the fund by paying the debt he owes to the fund ((1839) 4 My & Cr 442).
