December 14, 2011
The answer to this question lies in another question, namely does the termination infringe the anti-deprivation principle?
The anti-deprivation principle
The purpose of the anti-deprivation principle is simple, it is to ensure that upon the insolvency of a person his assets are available to his creditors for equal distribution, in accordance with the insolvency legislation.
The principle in its basic form was established 1861, when the Court considered a clause in a partnership deed which provided that in the event of a partner’s insolvency, his share in a mining lease forming part of the partnership property should pass to his partners. The clause was held void. The court held that no man can enter into a contract under the terms of which he reserves the ownership of property to himself, until the occurrence of insolvency, when it is to pass to another and not to his creditors.
Two recent court decisions, namely that of the Court of Appeal in the matter of Folgate London Market Ltd v Chaucer Insurance Plc and the High Court decision in the matter of Lomans and Others v JB Firth Rixon, Inc and Others have addressed the anti-deprivation principle.
The Lomans case makes clear that in certain circumstances a contracting party may validly terminate or adjust its contractual obligations with an insolvent counterparty, without infringing the anti-deprivation principle.
The Court distinguished between (1) situations in where the insolvent party still has to render a service or something still has to be supplied by the insolvent party under an ongoing contract and (2) situations in which the insolvent party has already rendered the service or made the delivery prior to the insolvency.
The Folgate case confirms that the anti-deprivation principle covers not only physical assets, but also rights enforceable by legal action such as the right to recover a debt or a contractual right to be paid under an indemnity. The case also makes clear that the Court will make an assessment of the commercial purpose of any termination provision.
The brief facts of the case were as follows. A lorry of M, a haulage company, was involved in accident and M was sued for personal injury by Mr Mayhew. M was insured, but the insurer refused to pay out, relying on an exception in the policy. M involved F, its broker in the proceedings, claiming that F had been negligent in arranging the policy.
M and F entered into a settlement agreement under the terms of which F would indemnify M in respect of sums payable in connection with the personal injury claim. The settlement contained a provision which stated that the obligation on F to indemnify M would cease if M entered into insolvency proceedings (“the Provision”). M went into administration.
The High Court Judge held that the Provision infringed the anti-deprivation principle. Whilst the Judge accepted the argument advanced by F that parties may contractually limit the period during which a legal right may be enforced, it held that such a time limit is void if it is linked to the insolvency of one of the parties. The Court of Appeal upheld this finding.
The Court of Appeal furthermore rejected the argument raised by F that there was commercial link between a provision in the settlement agreement which put upon M an obligation to provide assistance to F in defending the personal injury proceedings and the release of its payment obligation in the event of insolvency when M would no longer be able to provide the assistance.
The Court of Appeal found on the facts that the assistance obligation had been foreseen by the parties as being in practice of no or only limited value and therefore did not constitute a commercial link. The Court held that the commercial purpose of the Provision was a device to avoid the consequences of the insolvency legislation which makes the indemnity payment available to M’s creditors as a whole rather than for the sole benefit of Mr Mayhew.
Conclusion
Whilst it is possible to validly terminate contractual rights upon the insolvency of one of the parties, it is clear that this can only be achieved in limited circumstances. In assessing a termination provision the Court will have regard not only as to whether the insolvent party is subject ton ongoing contractual obligations, but also to the commercial purpose behind the termination clause
Great care should therefore be taken to clearly define and set out that the parties’ respective commercial interests and contractual obligations within the terms of any agreement reached.
For further advice on this subject or any other aspect of corporate insolvency and business recovery, please contact Petra Van Dijk on 01295 204159 or email her direct at pvandijk@se-law.co.uk.
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