The kaupthing singer and friedlander decision, the rule against double proof and the rule in Cherry v Boultbee

In its recent decision in Re Kaupthing Singer and Friedlander[1],the Supreme Court clarifies the interrelationship between the rule against double proof and the rule in Cherry v Boultbee. The Court considered in particular whether the rule in Cherry v Boultbee is (1) compatible with the principle against double proof, and (2) limited to seeking an indemnity in respect of sums actually paid.

Background

The common law rule against double proof (which supplements the provisions of the Insolvency Act 1986 and Rules) means that an insolvent estate can only accept one claim for each debt that it owes.

The rule in Cherry v Boultbee has also been applied to insolvent estates.  This rule is essentially a form of equitable set-off which provides that a party can pay its claimant net of any obligation that the claimant has to that party.

The interrelationship of the above rules is particularly relevant in the case of sureties.  For example, if an insolvent guarantor (G) also owes debts to an insolvent principal obligor (O), then pursuant to Cherry v Boultbee, O can set off any debts owed to it by G from the amount G claims.  However, G has then been given value for an obligation which the lender (as creditor) can also claim in breach of the rule against double proof.

A similar factual scenario was considered in the case of Re SSSL Realisations (2002) Ltd[2] where it was held that the rule against double proof prevented G from exercising set off, however it was held that this did not prevent Cherry v Boultbee applying and so when paying O’s dividends from G’s liquidation, G could withhold the amount it was entitled to receive from O’s liquidation.

In practical terms, it is therefore common for a guarantee to include a non- competition clause to restrict G from proving in O’s bankruptcy until the lender has been repaid in full.

Facts

Kaupthing Singer and Friedlander (KSF) had a subsidiary, Singer and Friedlander Funding (F) who raised funds for KSF and other group companies.  F issued loan notes to investors, who were represented by HSBC Trustee CI Ltd (the Trustee).  F lent the loan note proceeds of £249.5 million to KSF.  KSF and F subsequently went into administration, with the Trustee giving notice that an event of default had occurred and that the notes had become immediately due and payable.  The Trustee subsequently claimed in both administrations.KSF and F’s administrators sought directions from the Court as to how to deal with the Trustee’s claims against both entities.  The question therefore arose as to whether KSF could reduce the amount payable to F (by way of its right to indemnity, arising from its partial settlement of the Trustee’s claim against F) and whether the express provisions of the trust deed prevented KSF from doing the same.

At first instance, the High Court held that it was bound by the decision of Re SSSL and that KSF could reduce the amount payable to F (invoking Cherry v Boultbee).  It was also held that whilst the use of clear wording in a guarantee could exclude this rule; the wording had not done so in this particular case.  Given the far reaching effects of this decision, the Trustee was given permission to appeal straight to the Supreme Court.

The decision

The Supreme Court allowed the Trustee’s appeal, holding inter alia that:

– The rule in Cherry v Boultbee was excluded by the rule against double proof.  (In those circumstances the Court had no need to consider the effect of the particular non competition clause (referred to above) in the trust deed).

– The reasoning in Re SSSL was incorrect as it would be “technical, artificial and wrong to treat the rule against double proof as trumping (other forms of) set off, as it undoubtedly does, but as not trumping the equitable rule” (i.e. the rule in Cherry v Boultbee).

–  KSF could not therefore reduce the amount it owed to F, until the Trustee had been paid in full.

What effect does this case have?

The case clarifies and simplifies the potential outcomes for creditors who have competing claims.  A guarantor cannot reduce the amount it owes to a principal obligor and set off against its indemnity until the guaranteed obligation is discharged completely.Where both a guarantor and principal obligor are insolvent, a lender will no longer need to rely upon a non competition clause (as explained above), as the Cherry v Boultbee rule will be automatically excluded by the rule against double proof.

[1] The Supreme Court decision in Re Kaupthing Singer and Friedlander Ltd [2011] UKSC 48 is available at http://lgl.kn/5e440.
[2] The Court of Appeal decision in Re SSSL Realisations (2002) Ltd [2006] EWCA Civ 7 is available at http://lgl.kn/79175.

Emma Croxfor
Edward Starling