'Pay As You Go' In Complex Insolvencies

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...

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