Mark my words

Re Sigma Finance Corporation (in administrative receivership) [2009] UKSC 2 was decided by the Supreme Court on 29 October 2009. The Supreme Court (Lord Walker dissenting) departed from the judgments of both Sales J at first instance and a majority of the Court of Appeal (Lord Neuberger dissenting) and held that on their true construction the documents governing the rights of a number of secured creditors required liabilities to be paid as they fell due during a 'realisation period' (referred to as 'pay as you go') rather than pari passu.

Sigma was a structured investment vehicle (SIV). Its business model involved investing in asset-backed securities, primarily using monies raised by issuing medium term notes (MTNs). The holders of the MTNs were secured creditors and all of Sigma's assets were secured in favour of them (and others) under a security trust deed (STD).

The MTNs issued by Sigma matured at different dates. While Sigma was trading, they were paid on a 'pay as you go' basis. However, upon the occurrence of an 'enforcement event', the STD obliged the security trustee to allocate Sigma's assets within a 60-day realisation period so as to establish a short-term pool to meet short-term liabilities and a long-term pool to meet long-term liabilities.

At the end of the clause requiring the security trustee to create the pools, the following words appeared: 'During the realisation period the security trustee shall so far as possible discharge on the due dates therefore any short-term liabilities falling due for payment during such period, using cash or other realisable or maturing assets of the issuer.' These were the words in issue in the case.

Both Sales J and the majority of the Court of Appeal considered that they obliged the security trustee to continue paying holders of MTNs which became due for payment in the realisation period in full as and when their MTNs matured.

Meaning behind the words

In reaching this decision, the courts below considered that the words 'discharge on the due date' were clear in their meaning. Although they acknowledged that this conferred a possibly unfair advantage on those whose notes happened to mature in the realisation period, both Sales J and the majority of the Court of Appeal considered that this was a consequence of the parties having agreed a regime which was designed to replace the statutory insolvency scheme.

In the Supreme Court, Lord Mance (with whom all bar Lord Walker agreed) took a different view. Lord Mance considered that the courts below had attached 'too much weight to what the court perceived as the natural meaning of the words' and 'too little weight to the context in which that sentence appears and to the scheme of the security trust deed as a whole'.

A feature Lord Mance considered had been overlooked was that the words in issue were contained in a part of the STD which contemplated Sigma having sufficient assets to at least meet all of its obligations to secured creditors in full, whereas later parts of the STD dealt with an insolvency situation and required the pools to be reduced proportionately to reflect the extent to which liabilities exceeded assets.

Lord Mance considered that requiring a 'fire sale' of assets to meet liabilities maturing in the realisation period would confer an unwarranted priority on such liabilities and interfere with the ability of the security trustee to establish the pools. As a result, he reached the conclusion that 'the parties to the [STD] cannot have contemplated the approach adopted by the courts below, even in a less extreme situation of insolvencythan the present such as they might have foreseen'.

The solution, according to Lord Mance, was to return to the words 'as far as possible': although drafted to deal with minor discrepancies between the funds available and the need to meet obligations in a solvency situation, they could be transposed to an insolvency situation because they 'are apposite to enable the trustee to determine that no further payments can appropriately be made, having regard to the overall aim of achieving equitable pools and an equitable allocation of assets between the two (or main) pools'.

It is crucial to bear in mind that in Sigma the Supreme Court did not reject the 'pay as you go' construction because it found the disapplication of pari passu to be unfair. Instead, it was based on the need to give effect to the regime established by the STD.

This is particularly significant from an insolvency lawyer's perspective: the fact that 'pay as you go' was not upheld in Sigma on the construction of the particular wording used in the Sigma STD does not mean that clear wording requiring accrued liabilities to be paid in full will not be upheld, as it was in the recent Court of Appeal decision in Re Golden Key Ltd (in Receivership) [2009] EWCA Civ 636, especially per Arden LJ at 61-62 (see also Re Cheyne Finance Plc (in receivership) [2007] EWHC 2116 (Ch)).

However, Sigma demonstrates the willingness of the courts to depart from the ordinary and natural meaning of the words used when it appears from the background that 'something has gone wrong with the language' (per Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896).

This only serves to emphasise the need for practitioners to take special care when drafting clauses which alter rights that parties would normally enjoy in an insolvency context.