The Court of Appeal has held in Sigma Finance Corporation (in Administrative Receivership) ([2008] EWCA Civ 1303) that under the terms of a Security Trust Deed, in the initial period following the onset of insolvency secured creditors were to be paid as and when their debts became due, rather than on a pari passu basis. This resulted in one creditor being repaid in full, at the expense of all other senior secured creditors within the same class.
Sigma Finance Corporation ("Sigma") was a structured investment vehicle ("SIV") which became insolvent following the recent market turmoil. Sigma's creditors were all parties to a complex suite of documents which effectively replaced the statutory insolvency regime by allowing for the appointment of Administrative Receivers and setting out a detailed wind-down procedure for the application of Sigma's assets upon the occurrence of an event of default.
Upon such an occurrence, there was to be an initial Realisation Period, during which the following provision applied: "the Security Trustee shall so far as possible discharge on the due dates... any Short Term Liabilities falling due for payment during the period...". After the Realisation Period, the wind-down procedure would repay creditors pari passu within classes.
When Sigma became insolvent, its assets were insufficient to repay all the Short Term Liabilities (being senior secured liabilities) falling due within the Realisation Period. The Receivers applied to the Court for directions asking how they should apply Sigma's assets. Interested creditors appeared before the Court arguing for different interpretations of the above provision:
- Party A, a creditor whose debts fell due in the first days of the Realisation Period, contended that during that period Sigma's debts were to be repaid in full as they fell due, this being the 'pay as you go' argument. It would result in Party A being repaid in full, at the expense of creditors such as Party B, who would not be repaid at all.
- Party B, a creditor owed Short Term Liabilities falling due towards the end of the Realisation Period, contended that during that period Sigma's debts were to be repaid pari passu. Accordingly, all creditors with Short Term Liabilities falling due within the Realisation Period would be repaid in part (on a pro rata basis) but senior secured lenders owed debts falling due after the Realisation Period would receive nothing.
- Other creditors who were owed debts which did not fall due within the Realisation Period contended that payments should be made pro rata to the entire class of creditors, regardless of when debts fell due; or alternatively that payments should only be made in the Realisation Period if the Security Trustee could be sure that the relevant creditor would recover such sums during Sigma's wind-down after the Realisation Period, so that any payment during the Realisation Period was simply an interim payment. This would have resulted in creditors whose debts fell due within the Realisation Period having only a marginal advantage over creditors in the same class holding longer term debt.
Both the Judge at first instance and the Court of Appeal analysed numerous provisions of the Security Trust Deed in great depth so as to construe its proper meaning, concluding in both cases that Party A's interpretation was correct (with Lord Neuberger dissenting in the Court of Appeal). Rimer LJ acknowledged that the idea of pari passu repayment of creditors within the same class is so entrenched in English insolvency law that the idea of a 'pay as you go' regime may seem unfair, but concluded that this was the bargain the parties had reached. This is not the first time that the Courts have come to such a conclusion: in Re Cheyne Finance plc (in Receivership) (No 1) ([2008] 1 BCLC 732), regarding another SIV, the Court held that the underlying documents had also intended to apply a 'pay as you go' regime in the initial period following the appointment of receivers, despite the seemingly unfair results this might produce.
Practical implications
Where sophisticated parties have agreed to arrangements that contractually override the statutory insolvency regime, the Courts will give effect to this and will not strain the meaning of agreements so as to apply the pari passu principle at all costs. If the Courts find that the parties intended the debtor to proceed on a 'pay as you go' basis, even after the onset of insolvency, creditors within the same class may be exposed to very different risks. Indeed, the date on which a debtor breaches the terms of its financing agreements may affect which creditors are repaid. This case highlights the importance of giving careful consideration to these provisions at both the drafting and enforcement stages.
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