1. Collyer Bristow 13 February 2015 Securitisations: Operations Raymond Cox QC Fountain Court Chambers

2. Overview (1) Anti-deprivation rule (1) “Insolvency” test wording (3) Reinvest or pay out? The Napier Park case

3. (1) Anti-deprivation rule “There cannot be a valid contract that a man’s property shall remain his until his bankruptcy, and on the happening of that event shall go over to someone else, and be taken away from his creditors.” Ex parte Jay; Re Harrison (1880) 14 Ch D 19, at 26 (per Cotton LJ): Compare the pari passu rule: “[The two rules] are two sub-rules of the general principle that parties cannot contract out of the insolvency legislation. Although there is some overlap, they are aimed at different mischiefs… The anti-deprivation rule is aimed at attempts to withdraw an asset on bankruptcy or liquidation or administration, thereby reducing the value of the insolvent estate to the detriment of creditors. The pari passu rule reflects the principle that statutory provisions for pro rate distribution may not be excluded by a contract which gives one creditor more than its proper share.” (Lord Collins, in Belmont Park Investments Pty Ltd v BNY Corporate Trustees Services Ltd [2012] 1 AC 383, 396H, per Lord Collins)

4. Belmont Park Investments Pty Ltd v BNY Corporate Trustees Services Ltd [2012] 1 AC 383: o The supplemental trust deed dictated the priority ranking that would apply between the noteholders and LBSF in relation to realisation of the collateral. o A clause provided that LBSF would have priority unless there were an Event of Default in respect of which LBSF or Lehman Brothers Holdings Inc. (“LBHI”) were the Defaulting Party (as defined in the swap agreement), in which case the noteholders would have priority. Supreme Court o The clause was valid. Emphasised the restrictive scope of the ADR in complex commercial arrangements. “If the anti-deprivation principle is essentially directed to intentional or inevitable evasion of the principle that the debtor’s property is part of the insolvent estate, and is applied in a commercially sensitive manner, taking into account the policy of party autonomy and the upholding of proper commercial bargains, these conclusions on the present appeal follow.” per Lord Collins, at p.421G; emphasis added.

5. Contrast with US The “flip” clause was invalid under s. 365(e) of the Bankruptcy Code 1978 (i.e. on statutory basis), which invalidates “ipso facto” termination clauses. In re Lehman Bros Holdings Inc 422 BR 407.

6. (2) “Insolvency” test wording Insolvency: o Either the company is “unable to pay its debts as they fall due” (“cash-flow” insolvent) (IA 1986 s.123(2)); o Or the “value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities” (“balance sheet” insolvent) (IA 1986 s.123(1)(e)). BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL Plc [2013] 1 WLR 1408 o “Essentially, s 123(2) requires the court to make a judgment whether it has been established that, looking at the company’s assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities” (1426E-G). o Lord Walker (p.1424E-H) also approved the “future-looking” test of “cash-flow”

7. Effects: o The “future-looking” test of cash-flow insolvency and the “reasonable expectation” test of balance sheet insolvency approved, see - Briggs J in Re Cheyne Finance Plc [2008] 2 All ER 987 - Touslon LJ in the Court of Appeal in Eurosail o Little precise guidance as to when and how future and contingent liabilities should be taken into consideration. o How far into the future one can look for the purposes of establishing cash-flow insolvency? Once one moves beyond the reasonably near future any attempt to employ the cash-flow test is completely speculative: Lord Walker (p.1424E-H).

8. (3) Reinvest or pay out: the Napier Park case Napier Park European Credit Opportunities Fund Ltd v Harbourmaster Pro – Rata CLO 2 BV [2014] EWCA Civ 984. o Senior Notes had been rated AAA, then downgraded to AA for 2 years 9 months, and then upgraded back to AAA. o The “Reinvestment Criteria” in the CMA in the CLO structure included a condition that if “the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings”, then certain sums repaid early by borrowers under the underlying loan obligations would be used to redeem Senior Notes rather than be used for reinvestment by acquiring more loan obligations.

9. High Court: The Notes would be considered to have been downgraded, any payments received into the structure as unscheduled principal proceeds (UPP) had to be used to redeem the Notes, by paying Senior Notes according to the payment waterfall. Court of Appeal: The Notes were not considered as downgraded, then the UPP had to be used for reinvestment by the collateral manager according to specific criteria. Effect: o the Court is prepared to consider the commercial purpose of rating upgrades/ downgrades in the construction of contractual terms which are conditioned on these. o This is likely (depending on the wording of the provision) to work in favour of a rated entity which is downgraded and then upgraded before the issue reaches the Court.

10. For more information contact: Raymond Cox QC Fountain Court Chambers rc@fountaincourt.co.uk 020 7353 0329