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English Supreme Court upholds flip clause; noteholder priority does not offend against anti-deprivation principle



United Kingdom

On 27 July 2011 the English Supreme Court delivered its judgment in Belmont Park Investments PTY Limited v BNY Corporate Trustee Services Limited and Lehman Brothers Special Financing Inc ("LBSF").

Upholding the decision of the Court of Appeal, the Supreme Court held that a "flip" clause in a CDO did not offend against the anti-deprivation principle. The anti-deprivation principle provides, in effect, that it is wrong for parties to contract on terms that remove assets from a party that enters into insolvency proceedings.

In Belmont, LBSF was the credit default swap provider in the CDO.  The "flip" clause provided that, if an event of default occurred in relation to LBSF, priority to the collateral within the CDO changed from LBSF to the noteholders. LBSF argued, unsuccessfully, that the "flip" did wrongfully deprive its creditors. The Supreme Court said it was necessary to look at the underlying substance of the transaction, which was entered into in good faith and not with the intention of depriving LBSF's creditors: the collateral claimed by LBSF was provided by the noteholders in the first place.

The majority of the Supreme Court relied on the fact that it was LBHI's insolvency which triggered the operation of the flip clause (as LBHI was the credit support provider of LBSF) and this occurred before LBSF's bankruptcy commenced. It was not therefore LBSF's bankruptcy that triggered the effect of the provision.

The English ruling contrasts with the ruling of Judge Peck of the New York Bankruptcy Court in the U.S. in the Perpetual case, which found in favour of LBSF on this issue.