Whether a debtor is an individual or a sophisticated financial institution, a common issue that arises is whether its insolvency alters the rights of the parties with whom the debtor has entered into contracts. Several questions arise. Could the non-defaulting party to the contract, on the basis of the debtor\u2019s insolvency, terminate or amend the contract? Could there be a demand for accelerated payment? Many parties preserve contractual rights, through what are commonly known as ipso facto <\/em>clauses, to terminate and amend contracts or to demand an accelerated payment in the event that a counterparty to the contract becomes insolvent. Despite recent amendments to the Bankruptcy and Insolvency Act<\/em>[1]<\/a> and the Companies\u2019 Creditors Arrangement Act<\/em>,[2]<\/a> the validity of ipso facto <\/em>clauses, outside the context of derivatives contracts,[3]<\/a> is an issue that has only received limited attention in the Canadian literature.<\/p>\n This article will focus on the treatment of contracts in cases involving individual and corporate bankruptcies as well as proceedings under the BIA <\/em>and the CCAA<\/em>. Unlike both England and the United States, Canadian insolvency law is unique because both common law principles and statutory provisions could apply, depending on the nature of the debtor involved and the particular facts of each case. Whereas the common law principle, known as the \u201canti-deprivation rule\u201d or \u201cfraud upon the bankruptcy law rule,\u201d is over two hundred years old, statutory developments in this area have only materialized significantly in Canada over the last two decades. Thus, this article will explore to what extent these statutory developments have codified or displaced common law principles. The BIA <\/em>and the CCAA <\/em>have provided some welcomed clarity that ipso facto <\/em>clauses are generally void in cases involving Division I proposals, consumer proposals, proceedings under the CCAA<\/em>, and individual bankruptcies. The status of such clauses with respect to corporate bankrupts and receiverships is less clear, but recent jurisprudence suggests that the common law anti-deprivation rule is still very much a facet of Canadian law.<\/p>\n This article has been divided into three main parts. Part I begins with a brief overview of the insolvency regimes in both England and Canada. It then provides a foundation as to why the issue of the treatment of a debtor\u2019s contract in the event of its insolvency is important. Part II will trace the development of the anti-deprivation rule in England, and it will conclude with a categorization of cases where the rule has been found not to apply, with a particular focus on the changes to the scope of the rule as a result of the United Kingdom Supreme Court\u2019s decision in Belmont Park Investments PTY Ltd. v. BNY Corporate Trustee Services Ltd. and Lehman Brothers Special Financing Inc<\/em>.[4]<\/a><\/p>\n This article will then move on to the Canadian context in Part III and start with an overview of the anti-deprivation rule in Canadian jurisprudence. Then, using the concepts explored in Part II as a framework for discussion, this article will explore to what extent the recent amendments to the BIA <\/em>and the CCAA <\/em>have displaced the common law in Canada. Both the BIA <\/em>and the CCAA<\/em> have nullified ipso facto <\/em>clauses in some but not all situations, the most notable exceptions being cases involving corporate bankruptcies and receiverships. Part III will discuss the codified exceptions to the statutory principles and explore the issue of whether the Canadian jurisprudence might incorporate some of the modifications to the anti-deprivation rule introduced by Lord Collins in his seminal decision in Belmont<\/em>, before concluding.<\/p>\n I begin by briefly elucidating the various types of insolvency regimes available. In England, individuals, companies, and partnerships are largely governed by the Insolvency Act 1986<\/em>.[5]<\/a> Insolvent individuals can be subject to debt relief orders,[6]<\/a> voluntary arrangements, or bankruptcy orders. Under an individual voluntary arrangement (IVA), creditors can agree to a debtor\u2019s proposal in satisfaction of his or her debts; the process is supervised by a nominee.[7]<\/a> Alternatively, the individual or other parties, including creditors,[8]<\/a> can petition the individual debtor into bankruptcy provided that certain prerequisites are satisfied.[9]<\/a> In the case of such a bankruptcy order, all of the property belonging to the debtor at the commencement of the bankruptcy is vested in a trustee.[10]<\/a> The trustee then liquidates the assets and distributes them in accordance with various statutory rules.[11]<\/a><\/p>\n As for companies, there are a few possible outcomes. Upon the application of a petition to a court, a company can be wound up.[12]<\/a> As in cases involving personal bankruptcies, the liquidator obtains control of the company\u2019s assets and then realizes and disposes of them in accordance with the statutory scheme.[13]<\/a> Alternatively, with company voluntary arrangements (CVAs),[14]<\/a> administrations,[15]<\/a> and reorganizations,[16]<\/a> a company attempts to come to an arrangement with its creditors with the objective to survive as a going concern.[17]<\/a> If these efforts fail, however, the company will be dissolved and wound up.[18]<\/a> Finally, debenture holders can enforce their security by way of an administrative receivership although, nowadays, many would opt for an administration instead.[19]<\/a><\/p>\n In the case of a court-initiated winding-up order, there is a statutory stay against the company during which no actions or proceedings can be commenced or continued without the court\u2019s permission.[20]<\/a> A similar form of protection, known as a moratorium, is available where there is either a CVA or an administration order.[21]<\/a> Parallel forms of protection are also available when the debtor is an individual. Once a bankruptcy order has been made, there is usually a stay against the debtor\u2019s creditors, with an exception made for its secured creditors.[22]<\/a> It is also an industry standard that IVAs provide for a stay against the debtor\u2019s creditors.[23]<\/a><\/p>\n Despite some differences in nomenclature, similar insolvency regimes and procedures exist in Canada. Under the BIA<\/em>, both natural persons and legal persons, including companies, can be petitioned voluntarily or involuntarily into bankruptcy.[24]<\/a> Once a bankruptcy order has been made, the debtor\u2019s property vests in the trustee, who then proceeds to liquidate and distribute the assets in accordance with the scheme laid out in the BIA<\/em>.[25]<\/a> Alternatively, both individuals and companies can file proposals under the BIA <\/em>in an attempt to gain their creditors\u2019 approval of an alternative plan to satisfy their debts.[26]<\/a> Companies with more than $5 million in debt, though, can also opt to restructure under the CCAA<\/em>, which is characterized by a higher degree of court involvement than proposals under the BIA<\/em>.[27]<\/a> The BIA<\/em> also governs receiverships.[28]<\/a> Like its English counterpart, Canadian insolvency legislation provides the debtor with a stay against its creditors. Whereas a stay under the BIA<\/em> is automatic,[29]<\/a> a stay under the CCAA<\/em> is usually derived from a court order.[30]<\/a><\/p>\n The principles discussed in this article, with some exceptions, are generally applicable in both the bankruptcy and reorganization proceedings described above. This article will focus on how these insolvency proceedings alter parties\u2019 contractual rights, with a particular emphasis on the Canadian context. There are two possible viewpoints. The first is the debtor\u2019s rights in relation to the contract\u2014that is, the right to disclaim, affirm, and assign contracts\u2014a topic that has been thoroughly scrutinized in the literature.[31]<\/a> The second, which will be explored in this article, is the counterparty\u2019s rights upon learning that the debtor has become insolvent. To ensure clarity, the term \u201cdebtor\u201d will denote the party, whether an individual, corporation, or a partner in a partnership agreement, that has entered into insolvency proceedings. The counterparty to the contract will be referred to as the \u201cnon-defaulting party\u201d. Although this article\u2019s focus is on Canadian law, it is useful to reference its American counterpart to better elucidate some of the concepts discussed.<\/p>\n Generally, bankruptcy itself neither terminates a contract nor does it constitute a breach of contract.[32]<\/a> Parties, however, can use ipso facto <\/em>clauses to preserve certain contractual rights in the event that one of the contracting parties has entered into bankruptcy or insolvency proceedings, including the right to terminate the contract.[33]<\/a> Ipso facto <\/em>clauses can also provide, upon one of the parties\u2019 insolvency, a right to amend or cancel an agreement, to demand the return of goods, or to make a liquidated damages claim.[34]<\/a> The term \u201cipso facto <\/em>clause\u201d stems from the American context, where they are largely prohibited; Title 11 of the United States Code<\/em>[35]<\/a> nullifies contractual clauses that prohibit debtors from using, selling, or leasing property as a result of an insolvency or filing under a Bankruptcy Code<\/em> provision.[36]<\/a> The Bankruptcy Code<\/em> also prohibits parties from contracting to prevent the debtor\u2019s property from forming part of its estate because of it entering into insolvency proceedings.[37]<\/a><\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0 Ipso facto<\/em> clauses, indeed, can be problematic. First, where such clauses reserve the right of a non-defaulting party to terminate a contract upon a debtor\u2019s insolvency, a debtor\u2019s ability to reorganize and survive as a going concern may be stymied if the non-defaulting party supplied goods and services vital to the debtor\u2019s business. Ipso facto <\/em>clauses may also prevent a trustee from affirming the contract unless the non-defaulting party consents.[38]<\/a> The term \u201cexecutory contract\u201d originates from the American context. Although its meaning has been disputed in both the literature and the jurisprudence, American courts have largely agreed that a situation would be characterized as an executory contract where both parties have outstanding obligations and a party\u2019s failure to perform would be a material breach.[39]<\/a><\/p>\n For example, a party agrees to sell 1,000 widgets for $1,000 to a debtor with delivery to be made in thirty days. On the date of the debtor\u2019s bankruptcy, neither side has performed its obligations, making the arrangement an executory contract. The debtor, or its trustee, has the option of affirming, disclaiming, or assigning the contract.[40]<\/a> The trustee would prefer to affirm the contract if its completion would benefit the debtor\u2019s estate because, in this case, the non-defaulting party would need to deliver the widgets. The trustee would then be obligated to pay the purchase price. An ipso facto <\/em>clause, which allows the non-defaulting party to terminate the contract immediately upon learning the debtor has become insolvent, would in turn prevent the trustee from exercising its option to affirm the contract later on\u2014a reason why the Bankruptcy Code<\/em> in the United States also nullifies ipso facto <\/em>clauses in cases involving executory contracts.[41]<\/a> Ipso facto <\/em>clauses, however, are enforceable in certain types of agreements such as securities contracts, as well as commodities and forward contracts.[42]<\/a> As will be seen in Part III, Canadian insolvency legislation provides a similar exemption for these types of agreements.<\/p>\n Second, ipso facto <\/em>clauses may compel the debtor to transfer a portion of its assets or to make an accelerated payment to the non-defaulting party. In both situations, the value of the debtor\u2019s estate is reduced, which is contrary to the general objective of insolvency legislation to maximize the value of assets available to be paid out to the debtor\u2019s creditors.[43]<\/a> Finally, ipso facto <\/em>clauses provide a mechanism by which a non-defaulting party could circumvent the statutory scheme of distribution. That is, such clauses would compel the debtor to pay the non-defaulting party even if it would not otherwise have had a valid claim under the relevant insolvency statute.<\/p>\n In England, the treatment of a debtor\u2019s contracts upon its insolvency has largely been crafted by the common law in the form of the \u201cfraud upon the bankruptcy law principle\u201d or the \u201canti-deprivation rule\u201d. Briefly, the purpose of the rule is to prevent contractual arrangements designed to remove assets at the commencement of the bankruptcy or winding-up process, that are held by the debtor, on the ground that such arrangements are contrary to public policy.[44]<\/a> As seen in Part I.C., the term \u201cipso facto <\/em>clause\u201d is an American one. Since that term is largely absent in the English jurisprudence, it will not be employed in this section on English law. This Part will first explain the differences between the anti-deprivation rule and two similar but distinct concepts\u2014the pari passu <\/em>rule and statutory anti-avoidance provisions. Then, drawing guidance from Belmont<\/em>, it will highlight situations where the anti-deprivation rule has been applied and conclude with comments on the implications of Lord Collins\u2019 judgment in Belmont<\/em>.<\/p>\n Despite being two distinct concepts, the pari passu<\/em> principle and the anti-deprivation rule are often discussed collectively in English jurisprudence.[45]<\/sup><\/a> It is a long-standing principle that debts are to be paid equally\u2014that is, a debtor\u2019s liabilities should be satisfied pari passu<\/em>, subject only to secured creditors\u2019 claims and priorities given by statute.[46]<\/sup><\/a> Provisions that attempt to contract out of the pari passu <\/em>principle are void as being contrary to public policy, which is known as the common law pari passu <\/em>rule.[47]<\/sup><\/a><\/p>\n To distinguish between the two principles, Goode suggests that the pari passu <\/em>rule could be characterized as preventing a creditor from jumping ahead of the other creditors for a slice of the pie. Satisfying this creditor\u2019s liabilities results in a corresponding diminution in the debtor\u2019s liabilities on its balance sheet. Thus, the size of the pie\u2014that is the debtor\u2019s net asset value\u2014remains unchanged. In Goode\u2019s view, though, the anti-deprivation rule only applies where the party that benefits from the deprivation is not a creditor, so the debtor\u2019s liabilities remain untouched. That is, the improper removal of an asset from the debtor\u2019s estate would reduce the debtor\u2019s overall net asset value, which would in turn reduce the size of the pie.[48]<\/sup><\/a> Although Goode\u2019s analogy is helpful in illustrating the conceptual differences between the two principles, it causes some problems in the Canadian context since, as will be seen in Part III, the provisions in the BIA <\/em>and the CCAA<\/em>, which nullify ipso facto <\/em>clauses, do not distinguish creditors from non-creditors.<\/p>\n As Goode explains, both the anti-deprivation rule and the pari passu <\/em>principle could fall under the umbrella of avoidance transactions, which also encompasses transactions at an undervalue, preferences, and dispositions made without the court\u2019s permission.[49]<\/a> The anti-deprivation rule, however, is seen to be distinct from the statutory anti-avoidance provisions. Agreeing with this viewpoint in Belmont<\/em>, Lord Collins recognized that in early cases where the anti-deprivation rule had been applied, little statutory protection existed against avoidance transactions.[50]<\/a> Despite legislative developments aimed at prohibiting avoidance transactions, Lord Collins found the anti-deprivation rule still to be useful since it is not subject to the time limitations inherent in the statutory anti-avoidance provisions.[51]<\/a> Neither Lord Collins nor the literature has thoroughly compared the anti-deprivation principle with the statutory anti-avoidance provisions. The following discussion will focus on those anti-avoidance provisions with Canadian counterparts: transactions at an undervalue and preferences.[52]<\/a><\/p>\n First, as Part II.D. will explain, the anti-deprivation rule is applied to void a contractual provision for being contrary to public policy. That is, the parties contractually arranged ex ante what would happen should one of them become insolvent. In contrast, the application of statutory anti-avoidance provisions hinges on the transaction having taken place, rather than the parties\u2019 contractual arrangements. For instance, a gift from the debtor could qualify as a transaction at an undervalue whereas it would not fall under the anti-deprivation rule since the recipient of the gift was not in a contractual relationship with the debtor.[53]<\/a> A second difference, and one that Lord Collins briefly alluded to,[54]<\/a> is that the statutory anti-avoidance provisions define relevant time periods, such as in the two years leading up to the insolvency, where the transfer had to have taken place.[55]<\/a> This time element, however, is not a characteristic of the anti-deprivation rule; its focus is on whether a contractual provision should be found void on public policy grounds.<\/p>\n A third dissimilarity relates to the procedural elements of an application. With both transactions at an undervalue and preferences, there are strict conditions that must be satisfied for the onus of proof to be met, such as when the transaction was made and the nature of the transaction.[56]<\/a> In contrast, as will be seen in Part II.D., the requirements for the application of the anti-deprivation rule have varied from case to case, but it is not necessary for the transfer to have taken place. Under the anti-deprivation rule, the remedy being sought is a finding that a contractual provision is void for public policy. The desired remedy in cases involving statutory anti-avoidance provisions, however, would be that the transfer was void and that it should be reversed.[57]<\/a> Although the transfer of an asset may be reversed in an anti-deprivation case, the court could limit its remedy to declaratory relief that a contractual provision is void.[58]<\/a><\/p>\n Finally, the statutory anti-avoidance provisions and the anti-deprivation rule differ in their views on the role of good faith. The defence of good faith is generally unavailable to defendants in transactions at an undervalue and preferences cases, except in the case of bona fide purchasers.[59]<\/a> In contrast, after Belmont<\/em>, the presence of good faith is one of the factors considered when deciding whether the anti-deprivation rule should apply\u2014a point further discussed in Part II.E.3.[60]<\/a><\/p>\n The remainder of this Part traces the development of the anti-deprivation rule, which will help put the Canadian application of this principle, discussed in Part III, into context. The anti-deprivation rule first appeared in personal bankruptcy cases. As explained in Part I.A., in a personal bankruptcy, all of the property belonging to the debtor on the date of its bankruptcy vests in its trustee. After liquidating the assets, the trustee distributes the proceeds to creditors in accordance with the statutory scheme of distribution. Thus, contractual provisions that seek to prevent certain assets from being vested in the trustee, which in turn reduce the amount of assets available for liquidation and distribution, could trigger the application of the anti-deprivation rule.<\/p>\n From the eighteenth century until very recently, the anti-deprivation rule was largely known as \u201cthe fraud upon the bankruptcy law principle.\u201d The term \u201cdeprivation\u201d was not adopted in England in this context until 2002 in Money Markets International Stockbrokers Ltd. v. London Stock Exchange Ltd<\/em>.[61]<\/a> In fact, as seen in Part III, Canadian jurisprudence similarly refers to the rule as \u201cthe fraud upon the bankruptcy law principle;\u201d the term, \u201cthe anti-deprivation rule\u201d, seems to have only first appeared in Canada in the dissenting judgment of a 2012 Alberta Court of Appeal decision.[62]<\/a> Nevertheless, for consistency purposes, this article will refer to the principle as the anti-deprivation rule.<\/p>\n As Lord Collins observed in Belmont<\/em>, referring to the seminal decision in Higinbotham v. Holme<\/em>,[63]<\/a> the anti-deprivation rule is premised on the idea that there had been some sort of a fraud upon the bankruptcy laws.[64]<\/a> Higinbotham <\/em>involved a provision in a marriage settlement that reserved for the wife a life interest in her husband\u2019s property, in the form of an annuity, should he become bankrupt.[65]<\/a> Lord Eldon held the provision to be void as it was \u201ca direct fraud on the bankruptcy laws.\u201d[66]<\/a> The anti-deprivation rule has since been applied in a wide variety of cases, making its precise scope difficult to define\u2014a challenge recognized by Lord Collins in Belmont<\/em>.[67]<\/a> Nevertheless, highlighting some of the most relevant cases will provide a useful backdrop to the discussion in Part III on the anti-deprivation rule in Canada.<\/p>\n The anti-deprivation rule is often applied to void contractual provisions that provide for the divestment of ownership in an asset on a debtor\u2019s bankruptcy.[68]<\/sup><\/a> A classic example mentioned by Lord Collins is Ex parte Jay<\/em>,[69]<\/a> which involved a landowner who contracted a builder to construct houses on his property.[70]<\/a> They agreed that if the builder, prior to the completion of the homes, became bankrupt, the landowner could take possession of the materials on his property.[71]<\/a> The Court of Appeal held that the contractual provisions that purported to forfeit the building materials to the landlord on the builder\u2019s bankruptcy were void.[72]<\/a><\/p>\n There are numerous variations on the above example. Another well-known case discussed by Lord Collins is Ex parte Mackay<\/em>,[73]<\/a> where Jeavons entered into a series of linked agreements with Brown & Co. and Cammell & Co. In the first agreement, Jeavons sold a patent to Brown in exchange for royalties. In the second agreement, Jeavons granted Brown a security interest in a lease in exchange for a loan. In the third, Brown agreed to retain half of the royalties in satisfaction of Jeavons\u2019 debt. If Jeavons became insolvent or bankrupt, Brown could retain all of the royalties. It was this aspect of the third agreement that was challenged before the court.[74]<\/a><\/p>\n The court held that Jeavons could validly create a charge in favour of Brown for half of the royalties in order to repay his loan, but that the creation of a charge in Brown\u2019s favour for the other half of the royalties was an attempt to evade the insolvency laws.[75]<\/a> That is, Jeavons could not contractually arrange to prevent his property from being distributed in accordance with the bankruptcy laws.[76]<\/a> The court concluded that, had Brown been allowed to keep the royalties, it would have created an unlawful \u201cadditional advantage\u201d.[77]<\/a><\/p>\n Lord Collins characterized Ex parte Mackay <\/em>as belonging to a category of cases where there was an \u201cunsuccessful attempt to create a charge.\u201d[78]<\/a> Ex parte Jay <\/em>would also fall under this category.[79]<\/a> Alternatively, the situation in Ex parte Mackay <\/em>could be viewed as one where the impugned contractual provision amended the agreement by increasing the security given to a creditor or by triggering the obligation to make accelerated payments. In the event of Brown\u2019s insolvency, Jeavons could keep all the royalties rather than just half of them. As Lord Mance, who wrote the minority judgment in Belmont<\/em>, observed:<\/p>\n [T]here is no conceptual difference between removing specific property from the bankrupt estate for no consideration (Whitmore v Mason<\/em>), increasing the security given to a particular creditor (Ex p Mackay<\/em>) and increasing the bankrupt estate\u2019s liability to a particular creditor (In re Johns<\/em> [1928] Ch 737). All these fall within the anti-deprivation principle.[80]<\/a><\/p>\n In In re Johns<\/em>, under a loan agreement, the son, in the event he became bankrupt, had to increase the payments made to his mother.[81]<\/a> The agreement was considered void as it was designed to secure more money to the mother on her son\u2019s bankruptcy than what would have been available had he remained solvent.[82]<\/a> Although Lord Mance\u2019s observation was not pivotal in Belmont<\/em>, it can help elucidate some of the concepts underlying the Canadian statutory response to the anti-deprivation principle (see Part III.C.).<\/p>\n Having reviewed some English cases where the anti-deprivation rule has been applied,[83]<\/a> it will also be useful to examine judgments where the principle has been found not to apply. Lord Collins\u2019 holding in Belmont<\/em>, however, has further narrowed the scope of the anti-deprivation rule, and in doing so, has attracted its share of both support and criticism.<\/p>\n English law distinguishes between absolute and limited interests. A party who transfers to a debtor an absolute interest in an asset and gives itself a right to recapture the asset would fall afoul of the anti-deprivation rule.[84]<\/a> This result occurs because the non-defaulting party is attempting to remove an asset from the debtor\u2019s estate, in turn depriving the asset from the debtor\u2019s creditors.[85]<\/a> The examples discussed in Part II.D. would fall under this first category. As Lord Collins characterized it, an absolute interest is defeasible on bankruptcy or liquidation by a condition subsequent[86]<\/a>\u2014that being the party\u2019s insolvency. In contrast, a contractual right to terminate a limited interest in an asset conferred on another party would not infringe the anti-deprivation rule; bankruptcy is simply an event that terminates the limited interest.[87]<\/a> As Gabriel Moss points out, here, the debtor\u2019s proprietary interest in the asset could be seen as being subject to a condition precedent.[88]<\/a><\/p>\n The distinction between absolute and limited interests has been criticized because it often turns on the wording of the provision, prompting Goode, quoting from an Irish decision, to describe the distinction as \u201clittle short of disgraceful to our jurisprudence\u201d when it is applied to \u201ca rule professedly founded on considerations of public policy.\u201d[89]<\/a> Moss is more forgiving in his analysis, suggesting that, from the perspective of property law, the differing treatment of conditions subsequent and conditions precedent makes sense. He does, however, agree that to use this distinction to determine whether a contractual provision was subject to the anti-deprivation rule is difficult to reconcile with the rule\u2019s objective as being one based upon public policy.[90]<\/a> Lord Collins, though, pointed out that the distinction is one that is \u201ctoo well established to be dislodged otherwise than by legislation.\u201d[91]<\/a><\/p>\n Some common examples of limited interests that are terminable on the debtor\u2019s insolvency\u2014that is, where the anti-deprivation rule would not apply\u2014include provisions for the forfeiture of a lease upon winding up[92]<\/a> and the termination of intellectual property licenses.[93]<\/a> Although at face value there does not seem to be an outright deprivation of the debtor\u2019s estate, Goode brings up the valid concern that a debtor\u2019s lease is likely to be one of its most valuable assets.[94]<\/a> Goode believes that allowing the non-defaulting party to terminate the debtor\u2019s lease is equivalent to removing an asset from the debtor\u2019s estate, which leads Goode to suggest that England should follow the American practice of banning such clauses altogether.[95]<\/a> England, however, has not taken steps in this direction.<\/p>\n The term \u201cflawed assets\u201d, which is often used interchangeably with the term \u201climited interests\u201d, further adds to the confusion. Flawed assets originally described mechanisms used in financing arrangements to manage the risk of owning assets denominated in foreign currency.[96]<\/a> These arrangements were not considered to have contravened the anti-deprivation rule.[97]<\/a> As Cleary explains, flawed assets simply allowed a party to \u201climit the negative consequences of a counterparty failing to perform its reciprocal obligations under the contract.\u201d[98]<\/a><\/p>\n Lord Collins\u2019 decision in Belmont<\/em>, however, provides welcomed clarity. Lord Collins explained that the \u201c\u2018flawed asset\u2019 theory\u201d meant that if \u201cit is an inherent feature of an asset from the inception of its grant that it can be taken away from the grantee (whether in the event of his insolvency or otherwise), the law will recognize and give effect to such a provision.\u201d[99]<\/a> As Lord Collins observed, if the flawed asset theory were always applied, the anti-deprivation rule would be of little use.[100]<\/a> It is easy to see why Lord Collins is worried; parties would draft their contractual provisions just to confer flawed assets as a means of evading the application of the anti-deprivation rule.[101]<\/a> Concluding that the flawed asset theory is not always applicable, Lord Collins sidestepped the problem of distinguishing between absolute and limited interests as well as flawed assets. As Worthington observes, Lord Collins finds that the termination of leases and licenses is legitimate, while agreements that end all other limited interests on bankruptcy are upheld unless they were made in bad faith and with the attempt to defeat the insolvency laws.[102]<\/a><\/p>\n In a sense, the court is moving toward a substance over form approach by sidestepping the absolute and limited interest distinction, which often, as rightly pointed out by Goode, turns on fine verbal distinctions.[103]<\/a> Furthermore, by incorporating the element of good faith, Lord Collins has simplified the conditions for the application of the anti-deprivation rule to cases involving flawed asset arrangements, with the exception of leases and licensing agreements. Worthington, however, observes that the effectiveness of the anti-deprivation rule has been stymied since it would be difficult to ascertain ex post whether the parties had been acting in bad faith.[104]<\/a><\/p>\n Lord Collins, though, was likely cognizant of the prominent role that flawed assets play in ISDA master agreements, which govern over-the-counter swaps and other derivative contracts, and that these agreements are usually governed by English law.[105]<\/a> Although writing before the release of the Belmont<\/em>, Moller, Noland, and Goldwasser believe that judicial recognition of flawed asset arrangements would encourage the use of that jurisdiction as the governing law for international financial transactions.[106]<\/a> Though Lord Collins did not explicitly endorse the use of flawed assets, his decision sends a clear message that these financing agreements would likely fall outside the scope of the anti-deprivation rule since it would be difficult to prove ex post that the arrangement was made in bad faith and with the view to defeating creditors.<\/p>\n As Lord Collins observed in Belmont<\/em>, the anti-deprivation rule is inapplicable if the deprivation occurred for reasons other than the debtor\u2019s bankruptcy, such as the debtor breaching another provision in the contract.[107]<\/a> A difficulty can arise, however, if the order of the events is unclear. Lord Collins used the example of Ex parte Newitt<\/em>,[108]<\/a> which has facts similar to Ex parte Jay<\/em>, where the provision for forfeiture was triggered by a contractual breach. The problem was that it was unclear when the breach occurred.[109]<\/a> Unfortunately, Lord Collins provides little commentary on this issue, but Goode suggests that this is now a moot point. After Belmont<\/em>, the anti-deprivation rule only applies if there has been bad faith and a deliberate intention to evade the insolvency laws. Goode concludes that if the deprivation took place to avoid the application of insolvency laws and after bankruptcy had occurred, then the conditions for the application of the anti-deprivation rule are satisfied.[110]<\/a><\/p>\n Perhaps the most influential aspect of Lord Collins\u2019 decision is his move to introduce a new a categorical exemption to the anti-deprivation rule. Concluding that \u201ccommercial sense and absence of intention to evade insolvency laws have been highly relevant factors in the application of the anti-deprivation rule,\u201d[111]<\/a> Lord Collins observed that the policy could be given \u201ca common sense application which prevents its application to bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy.\u201d [112]<\/a><\/p>\n Lord Collins believed that what mattered were the parties\u2019 objective intentions, and in borderline cases, where the parties entered into a commercially sensible transaction in good faith, the anti-deprivation rule would not be offended.[113]<\/a> Despite Lord Collins\u2019 thorough discussion on the anti-deprivation rule, the result in Belmont <\/em>simply turned on whether the impugned agreement was a bona fide commercial transaction.<\/p>\n The complex facts of Belmont <\/em>are largely irrelevant given how Lord Collins came to his conclusion. Briefly, Lehman Brothers set up special purpose vehicles (\u201cthe Issuer\u201d), which in turn issued Notes to investors (\u201cthe Noteholders\u201d), including the respondents. The Issuer used the Notes\u2019 proceeds to purchase secure investments (\u201cCollateral\u201d) while simultaneously entering into a credit default swap agreement with Lehman Brothers Special Financing (LBSF). LBSF agreed to pay the Issuer premiums in exchange for the latter\u2019s credit protection on loans owned by Lehman Brothers. The premiums the Issuer received from LBSF were then paid to the Noteholders. The agreements were governed by English law.[114]<\/a><\/p>\n On the basis that Lehman Brother Holdings and LBSF\u2019s Chapter 11 filings in 2008 were Events of Default as outlined in the contract, the Noteholders directed the Trustee to terminate the swap agreements. The Collateral, which was held by the Trustee, provided security for the Issuer\u2019s obligations to the Noteholders and LBSF. Although the latter had priority to the Collateral, the contract contained a provision, commonly referred to as a \u201cflip clause\u201d, that would reverse the priorities in favour of the Noteholders if an Event of Default, as defined under the agreement, occurred.[115]<\/a> LBSF argued the flip clause was invalid for two reasons. First, it deprived LBSF of property that it would have been otherwise entitled to in its bankruptcy. Second, the clause offended the anti-deprivation rule by reversing LBSF\u2019s and the Noteholders\u2019 respective priorities on the basis of LBSF\u2019s bankruptcy.[116]<\/a><\/p>\n Writing the leading judgment for the United Kingdom Supreme Court, Lord Collins upheld the flip clause on the basis that it was \u201ca complex commercial transaction entered into in good faith\u201d[117]<\/a> and that the impugned provisions were not used deliberately to evade the application of insolvency law.[118]<\/a> On this basis, Lord Collins dismissed the appeal and found in favour of the Noteholders.[119]<\/a> Lord Collins, however, did not indicate that his comments on the application of the anti-deprivation rule were confined to cases involving swap agreements, suggesting that they could be applied in cases of personal and corporate insolvency.<\/p>\n Lord Collins\u2019 decision has been both criticized and commended. Windsor and Sidle, for instance, believe that the scope of the anti-deprivation rule could have been expanded in accordance with the public policy objective of preserving the debtor\u2019s estate or narrowed to ensure greater commercial certainty.[120]<\/a> They conclude that Lord Collins was wise to opt for the latter.[121]<\/a> In contrast, Calnan questions the sudden relevance of whether the parties intended to evade insolvency law. He finds this approach difficult to justify since the intention of the parties is irrelevant in determining whether the pari passu <\/em>rule applies.[122]<\/a> Furthermore, both Worthington and Goode question the degree to which Lord Collins\u2019 holding is supported by the jurisprudence\u2014a point that the remainder of this section will focus on.<\/p>\n For instance, Lord Collins cited Borland\u2019s Trustee v. Steel Bros & Co Ltd<\/em>.[123]<\/a> as an example of where the anti-deprivation rule was not applied due to the parties\u2019 good faith and the commercial sense of the transaction.[124]<\/a> At issue was a clause in a company\u2019s articles of association that provided that a shareholder, on his bankruptcy, must transfer his shares to either a manager or assistant at a fair value, as determined in accordance with the company\u2019s articles.[125]<\/a> The trustee of Mr. Borland, a bankrupt shareholder, argued that the clause was a fraud upon the bankruptcy law as it forced the trustee \u201cto part with the shares at something less than their true value, and the result is that the asset is not fully available for the creditors.\u201d[126]<\/a> In summarizing Justice Farwell\u2019s decision to uphold the clause, Lord Collins focused on a few points: there was a fixed sum for the shares; the event of bankruptcy did not change the share price; and the clause would have been void had it required a transfer price that was less than what would have been otherwise obtained.[127]<\/a><\/p>\n Worthington, however, suggests that what underpinned Justice Farwell\u2019s decision in Borland\u2019s Trustee <\/em>was that the trustee received a fair value for the shares, so this was not a case of deprivation at all.[128]<\/a> She observes that the anti-deprivation rule was not applied in six out of the eleven precedents cited by Lord Collins.[129]<\/a> Worthington concludes that, in these six cases, the court was moved not by the parties\u2019 good faith but by the fact that there had not been a deprivation, or if there was one, it was not triggered by the debtor\u2019s insolvency.[130]<\/a><\/p>\n Worthington\u2019s criticism might be too harsh. Returning to Borland\u2019s Trustee<\/em>, which was also instrumental in the development of the anti-deprivation rule in Canadian jurisprudence, it is important to examine the basis on which the transfer price was found to be fair. A point that Worthington overlooks and that Lord Collins fails to highlight is that Justice Farwell concluded that he was \u201cdealing with a company whose assets are really in a sense incapable of valuation, but in which the parties have agreed on a basis of valuation which seems to [him] to be fair.\u201d[131]<\/a> Given that the agreement was \u201ccome to between the parties after discussion and discontent on the part of some of them,\u201d Farwell J held that it would strain the fraud upon the bankruptcy law principle to use it to overturn the parties\u2019 joint decision.[132]<\/a><\/p>\n By focusing on how the parties must have negotiated the terms of transfer since the company\u2019s shares could not be valued by ordinary means, Justice Farwell seems to be persuaded by the fact that the arrangement was a bona fide commercial agreement. These points, rather than the ones Lord Collins cited, would likely better substantiate his argument that Justice Farwell\u2019s decision turned on the parties\u2019 good faith and the commercial nature of the transaction.<\/p>\n Lord Collins discussed two additional cases that involved organizations whose interests cannot be divorced from their membership in a body, such as when only member firms of a particular stock exchange are able to hold shares in the exchange.[133]<\/sup><\/a> For instance, in Money Markets<\/em>, a clause requiring members of a stock exchange to lose their membership\u2014that is their share in the exchange\u2014if they defaulted on their obligations was challenged in court. In that case, Justice Neuberger emphasized the importance of examining the rationale underlying the impugned provision, agreeing that it is reasonable to expel members who have not honored their commitments.[134]<\/a> Again, the commercial nature of the agreements seemed to have played an important part. Although Justice Neuberger held that freedom of contract was not sufficient to uphold the validity of the clause,[135]<\/a> Lord Collins\u2019 test solves this problem by incorporating an additional factor\u2014that being whether the parties were deliberately attempting to deprive one of the parties of its property on its bankruptcy. Thus, Lord Collins\u2019 approach could be regarded as only an incremental change in the law.<\/p>\n Nevertheless, both Goode and Worthington are rightly concerned over the difficulty in applying Lord Collins\u2019 formulation of the anti-deprivation rule. For instance, it is unclear as to what constitutes a \u201cborderline case\u201d\u2014a situation where Lord Collins held the anti-deprivation rule would not apply.[136]<\/a> Goode suggests that Lord Collins intended that parties should be given the benefit of the doubt when it comes to questions of good faith.[137]<\/a> Worthington, in contrast, believes that Lord Collins intended the decisive factor to be proof of deprivation.[138]<\/a> Furthermore, as observed in Part II.E.1., there is also the difficulty of determining ex post whether there has indeed been bad faith.[139]<\/a> On the facts of Belmont<\/em>, Lord Collins likely felt some pressure to give deference to the parties\u2019 contractual rights; after all, as explained in Part II.E.1., flawed assets have long played a prominent role in international financing agreements.<\/p>\n Finally, as will be further explored in Part III.C.6., an anti-deprivation rule that applies in a range of cases, though providing consistency, may not always be ideal. Whereas the anti-deprivation rule was first developed in cases of personal bankruptcies, the decisions Lord Collins relied on mostly involved large, sophisticated financial institutions. Different considerations apply in each of those situations. Although consistency across insolvency regimes is important, as will be seen, Canada\u2019s differing approaches to individual and corporate bankruptcies as well as to situations involving eligible financial contracts may be preferable.<\/p>\n Much like England, Canada also has its own statutory provisions relating to fraudulent transactions and preferences.[140]<\/a> The differences between them and the anti-deprivation rule are similar to the ones explored in Part II.C., so they will not be repeated here. Writing the minority judgment in Belmont<\/em>, Lord Mance remarked that \u201cany general rule invalidating ipso facto termination clauses ought to be a matter for legislative attention, rather than novel common law development.\u201d[141]<\/a> Unfortunately for Lord Mance, England\u2019s approach to ipso facto <\/em>clauses has stemmed from the common law. Rather, Lord Mance\u2019s view more aptly describes the situation in the United States, where the Bankruptcy Code <\/em>has declared ipso facto <\/em>clauses with respect to executory contracts and unexpired leases to be unenforceable.[142]<\/a><\/p>\n<\/a>I.\u00a0\u00a0 Overview of Insolvency Law Regimes<\/h1>\n
A.<\/a>\u00a0 England<\/h2>\n
<\/a>B.\u00a0 Canada<\/h2>\n
<\/a>C.\u00a0 The Effect of Bankruptcy and Insolvency Proceedings on the Debtor\u2019s Contracts<\/h2>\n
<\/a>II. The Anti-Deprivation Rule in England<\/h1>\n
<\/a>A.\u00a0 Introduction<\/h2>\n
<\/a>B.\u00a0 The Pari Passu Principle<\/h2>\n
<\/a>C.\u00a0 Statutory Anti-Avoidance Provisions<\/h2>\n
<\/a>D.\u00a0 Early Applications of the Anti-Deprivation Rule<\/h2>\n
<\/a>E.\u00a0 Where the Anti-Deprivation Rule Has Not Been Applied<\/h2>\n
<\/a>1.\u00a0\u00a0 Limited and Absolute Interests<\/h3>\n
<\/a>2.\u00a0\u00a0 Deprivation Took Place for Reasons Other than Bankruptcy<\/h3>\n
<\/a>3.\u00a0\u00a0 Good Faith and the Parties\u2019 Intentions<\/h3>\n
<\/a>III. The Treatment of Ipso Facto<\/em> Clauses in Canada<\/h1>\n
<\/a>A.\u00a0 Introduction<\/h2>\n