Harneys Corporate Recovery Services Guides to The Insolvency Act 2003 - Part 3

GUIDE 5: SET-OFF, NETTING & MARKET CONTRACTS

5.1 Introduction

The provisions dealing with set-off and market contracts in liquidation may rightly be†regarded as one of the show-cases of the BVI Insolvency Act, for they contain an†important innovation: they exempt market contracts and netting agreements from†insolvency set-off (and other provisions of the Insolvency Act), and are governed instead†by sections 434 and 435 of the Act which in effect validate such netting arrangements†through insolvency. The provisions are based on the ISDA Model Netting Act. All other†debts are subject to the insolvency set-off regime in sections 149 - 154 which, although†based on Rule 4.90 of the English Insolvency Rules, contain a number of clarifying†provisions which will bring much greater certainty to this vital, but difficult, area.

5.2 Insolvency set-off

The regime for insolvency set-off does not represent a conceptual change from existing†BVI law and, while based on Rule 4.90 of the English Insolvency Rules, represents an†improvement on both English law and current BVI law by introducing a number of†clarifying provisions. The set-off applies all liquidations however commenced and also†applies to the liquidation of foreign companies in the BVI. It also applies to†administration252 (but not to administrative receivership or voluntary arrangements).

Section 150(1) provides that where before the "relevant time" there have been mutual†credits, mutual debts or other mutual dealings between a company and a creditor claiming†or intending to claim in its liquidation, then:

(a) an account shall be taken of what is due from each party to the†other in respect of those mutual credits, mutual debts or other†mutual dealings, as at the relevant time;

(b) the sum due from one party shall be set-off against the sums due†from the other party; and

(c) only the balance of the account, if any, may be claimed in the†liquidation or is payable to the company.

The "relevant time" is the time of the commencement of the liquidation253 which is the†time when a liquidator is appointed254.

English case law confirms that insolvency set-off, where it applies, is mandatory255 and†there is no discretion to dispense with it256 even though it may result in a breach of the†pari passu principle in that a creditor may effectively receive payment in full of his debt.†What makes the BVI legislation particularly attractive is that many of the uncertainties†which surrounded the previous BVI law (and indeed English law) have been removed.

Thus, netting arrangements in market contracts are specifically exempt from insolvency†set-off. A creditor can validly waive or contract-out of the benefit of the set-off†provisions before liquidation, and such waiver or contract will be effective257. Debt†subordination agreements and acknowledgments are also effective.

There are detailed provisions dealing with the quantification of contingent claims or†claims where the amount is uncertain258, and debts that are payable in the future will be†discounted in accordance with the Rules259. Where rent or payments of a periodical†nature are involved, the Act provides that the claim may include any amount due and†unpaid, and where a payment was accruing due at the commencement of liquidation, it†can be treated as if it had been accruing from date to day and that amount claimed260.†There are also detailed provisions dealing when interest can be included in a claim and†the amount of such interest261.

5.3 Exception: notice of insolvency

However, set-off does not apply to claims by a creditor where he has actual notice that†the company was insolvent at the time when he gave credit to the company or he acquired†a claim against it262. Insolvency in this context has a restricted meaning and does not†include balance sheet insolvency but is essentially confined to the cash flow basis263. The†creditor must have actual knowledge of the company's insolvency.

5.4 Netting and market contracts

This innovative feature of the Insolvency Act is based on the ISDA Model Act and its†purpose is to preserve the sanctity of netting arrangements in market contracts even when†the company goes into liquidation.

The scheme of the legislation is straightforward: the provisions relating to set-off are†made subject to section 434264 which, together with section 435 deal with netting†agreements between two parties in relation to "financial contracts". "Financial contracts"will be defined in the Insolvency Rules265 (to maintain flexibility and will cover a†multitude of market contracts) but it is our belief that it will be broad enough to†encompass all standard derivatives and market contracts.

Section 435(1) provides that "Notwithstanding anything contained in this Act or the Rules†or in any rule of law relating to insolvencyÖ" the provisions relating to netting in†relation to financial contracts contained in netting agreements remain legally enforceable.†The same applies to credit support agreements, the set-off of money provided by way of†security, the enforcement of a guarantee, the enforcement and realisation of collateral266,†and the set-off of proceeds contained in netting agreements, and master netting†agreements are also included267. Section 435 is widely drafted so as to exempt such†arrangements from all insolvency provisions such as voidable transactions, stays or†moratoria in administration.

We have already provided opinions on the scope of this provision and the enforceability†of netting arrangements in the liquidation of BVI companies.

The provisions are, however, confined to financial contracts between two parties, and do†not include multi-party arrangements268. A party is not confined to a company and could†include an individual, and could include a person acting in his own capacity or as a†trustee or nominee.

Also, the exemption from the effects of the Insolvency Act does not apply if there is†fraud or misrepresentation269, nor does the section confer validity on the netting etc if any†provision in the agreement between the two parties was void for fraud or†misrepresentation270.

GUIDE 6: CROSS-BORDER INSOLVENCY

6.1 Introduction

In this guide we discuss some of the more common cross-border issues that could arise in†international insolvencies. This is a topic of considerable importance to BVI companies†incorporated under the International Business Companies legislation (IBCs) whose†international dimensions - their management and business is almost invariably carried on†outside the BVI - mean that cross-border issues will be thrown up in the event of their†insolvency.

This guide is not a comprehensive survey of all possible cross-border issues, nor does it†cover litigation and tactical issues, that could arise in insolvency as we would advise on†those on a case-by-case basis. The purpose of this guide is to highlight common issues†and how the law of the BVI has been affected by the Insolvency Act 2003, and they will†be discussed under the following headings:

(a) Insolvency regimes that can be initiated in the BVI

(b) Effect of a liquidation in the BVI; and

(c) Foreign liquidations and BVI and foreign companies.

6.2 Insolvency regimes that can be initiated in the BVI

Under this heading we examine the jurisdiction of the BVI in respect of foreign†companies in insolvency matters.

(a) Companies incorporated in the BVI

BVI corporations can be the subject of all the insolvency regimes provided in the†Insolvency Act and discussed in more detail in the other guides i.e. Liquidation,†Administration, Administrative Receivership, and Creditors' Arrangement, and there is†no requirement that they must have carried on business in the BVI or indeed have any†connection with the BVI other than their incorporation. The regimes in the Act apply†simply because of their incorporation in the BVI.

(b) Foreign companies: liquidation

The position with foreign companies, i.e. companies incorporated outside the BVI271, is†different. They can enter into Liquidation (through a Court appointed Liquidator)†provided that they have a "connection" with the BVI272. Connection for these purposes†has a statutory definition and means the presence of assets in the BVI, the carrying on of†business here; or a reasonable prospect that the appointment of a Liquidator here will†benefit the creditors of the company273. Even if such connection is established, the BVI†Court retains a discretion whether or not to appoint a liquidator. This is discussed in†more detail in Guide 1 on Liquidation.

(c) Administrative Receivership

Administrative Receivership under the Insolvency Act is also open to foreign companies†for there is nothing in the Act restricting this procedure to BVI companies. However, for†a foreign company to take advantage of this procedure, two requirements would have to†be fulfilled: (a) the creditor is the holder of a valid floating charge274; and (b) the†appointment of a licensed insolvency practitioner i.e. an individual resident in the BVI†who holds an appropriate licence from the Financial Services Commission275.

With regard to a valid floating charge, the effect of a charge not governed by BVI law is†open to some debate. In our view...