British Eagle International Air Lines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758

The House of Lords held (3:2) that a contractual clearing house arrangement between airlines, which purported to settle mutual indebtedness through a multilateral netting system operated by IATA, could not displace the statutory requirement that an insolvent company’s assets be distributed pari passu amongst unsecured creditors. Such “contracting out” of the statutory insolvency scheme was held to be contrary to public policy. The case remains the leading authority on the anti-deprivation principle, though its scope has since been clarified by the courts.

Facts

British Eagle International Air Lines Ltd (“British Eagle”) and Compagnie Nationale Air France (“Air France”) were both members of the International Air Transport Association (IATA). IATA operated a clearing house system under which member airlines rendered services to one another (known as “interline services”) and settled the resulting mutual indebtedness not directly between themselves, but through the clearing house.

Under the clearing house regulations, the participating airlines agreed that:

• They would not claim directly from one another in respect of interline services performed;
• Each airline could only claim from IATA the net balance due to it on a monthly basis under the clearing scheme;
• Balances became payable to the airlines five days after “closure”, which took place a month after the end of the accounting month.

In November 1968, British Eagle went into liquidation. At that point, taking a simple bilateral account of the credits and debits as between British Eagle and Air France alone, Air France owed British Eagle £7,925 1s. 3d. However, if the full IATA multilateral clearing arrangement was applied across all member airlines, British Eagle was in a net debtor position overall.

The liquidator of British Eagle sought to recover the sum due from Air France on a bilateral basis, arguing that this debt formed part of British Eagle’s property available for distribution to its general body of creditors. Air France resisted, relying on the IATA clearing house arrangements, under which any sums owed by Air France to British Eagle fell to be accounted for only within the multilateral settlement involving all other participating airlines.

Issues

The case raised three interrelated issues:

1. Whether the sums owed by Air France to British Eagle (on a bilateral accounting) constituted an asset of British Eagle available for distribution under the statutory scheme;
2. Alternatively, whether, as a matter of contract, British Eagle’s only asset was the net claim due to it through the clearing house system (with no direct debt owed by Air France at all); and
3. Whether the clearing house arrangement amounted to an impermissible attempt to contract out of the statutory distribution regime under section 302 of the Companies Act 1948, which provided:

“Subject to the provisions of this Act and to preferential payments, the property of a company shall, on its winding up, be applied in satisfaction of its liabilities pari passu …”

Judgment

The House of Lords divided 3:2, with the majority (Lords Cross of Chelsea, Diplock and Edmund-Davies) finding for the liquidator, and the minority (Lords Morris of Borth-y-Gest and Simon of Glaisdale) dissenting on the construction of the contractual arrangements.

The Majority

The leading speech was given by Lord Cross of Chelsea, with whom Lords Diplock and Edmund-Davies agreed. Lord Cross characterised the IATA arrangements as a “simple contractual clearing house”, explaining that the documents (at 780C-D):

“…set up by simple contract a method of settling each other’s mutual indebtedness at monthly intervals.”

Having so characterised the arrangement, Lord Cross held that it offended public policy because it diverted sums that would otherwise fall into the general pool of the company’s assets on liquidation (at 780G-H):

“[W]hat [Air France] are saying here is that the parties to the ‘clearing house’ arrangements by agreeing that simple contract debts are to be satisfied in a particular way have succeeded in ‘contracting out’ of the provisions contained in section 302 for the payment of unsecured debts ‘pari passu‘ …. Such ‘contracting out’ must, to my mind, be contrary to public policy.”

The consequence of the majority’s reasoning (at 781A-B) was that, on British Eagle’s liquidation, the company became entitled to recover from the other airlines the net sums due to it on a bilateral account, and conversely those airlines to whom British Eagle owed money (on a bilateral account) were entitled to prove in the liquidation as ordinary unsecured creditors and share pari passu in the assets of the company. Their Lordships followed and applied the earlier authorities of Ex parte Mackay (1873) 8 Ch App 643 and National Westminster Bank v Halesowen Presswork & Assemblies Ltd [1972] AC 785.

The Dissent

Lords Morris and Simon dissented, but – importantly – the dissent was confined to the contractual characterisation of the arrangement, and not to the underlying principle that one cannot contract out of the statutory scheme. Both dissenting Lords accepted that principle.

Lord Morris framed the critical question as follows (at 761C-D):

“If [Air France] owed £7,925 1s. 3d. to [British Eagle] then clearly the right to receive that sum was part of the property of [British Eagle] and would be receivable for the benefit of all creditors generally. If, on the other hand, the contract made between the two companies did not result in any sum or sums becoming payable or being payable then the property of [British Eagle] did not include any right to receive that or any other sum from [Air France].”

His Lordship concluded that there was “no trace in the scheme of any plan to divert money in the event of a liquidation” (at 763C-D), because the property of British Eagle never included any direct claim against Air France — it included only “the contractual right to have a clearance in respect of all services which had been rendered on the contractual terms and the right to receive payment from IATA if on clearance a credit in favour of [British Eagle] resulted” (at 765A-C).

Crucially, however, Lord Morris expressly accepted the majority’s public-policy principle (at 761E-G):

“… if [Air France] had owed money to [British Eagle] but if there was a direction to [Air France] which required them in the event of a liquidation to pay the money to some particular persons rather than for the benefit of all the creditors the liquidator could prevent what would be an invasion of law (see Ex parte Mackay (1873) 8 Ch App 643).”

Lord Simon reasoned similarly, holding that “British Eagle had long since deprived itself of the right to claim from Air France payment for the interline services British Eagle had performed for Air France” (at 771F-G), and that the “property” of British Eagle for the purposes of section 302 “did not include any direct claim against Air France … but merely the right to have the value of such services brought into the monthly settlement account” (at 772A-B). Nonetheless, on the point of principle Lord Simon agreed (at 771H):

“I agree that Halesowen Presswork & Assemblies Ltd v National Westminster Bank Ltd [1972] AC 785 applies by analogy to section 302 of the Companies Act 1948, so that one cannot contract out of its terms.”

On the question of whether parties may contract out of the statutory scheme, therefore, the House of Lords was unanimous.

Implications

British Eagle is the leading authority for what has come to be known as the “anti-deprivation principle” – a common law rule of public policy, not a creature of statute, which operates to render ineffective contractual arrangements that purport to remove or divert assets from the insolvent estate upon the onset of insolvency, so as to defeat the statutory pari passu distribution among unsecured creditors. The principle applies both to winding up under section 302 of the Companies Act 1948 (now reflected in the corresponding insolvency legislation) and, by analogy, to administration under rule 14.12 of the Insolvency (England and Wales) Rules 2016, which contains materially the same pari passu requirement.

The decision has become the cornerstone of a substantial line of authority. It was treated as the “leading case in the line of authority” on the anti-deprivation principle in Chaucer Insurance v Towergate (the Mayhew litigation), and has been subjected to extensive judicial analysis and attempted clarification, notably by Neuberger J. in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150. As Armour has observed, the precise scope of the rule remains “notoriously uncertain” – a reflection of the difficulty courts have had in distinguishing between legitimate commercial arrangements that happen to reduce the insolvent estate and impermissible devices that amount to contracting out of the mandatory statutory scheme.

Subsequent authority has, however, drawn an important distinction that limits the reach of the principle. In Re Maxwell Communications Corp plc (No 2) [1994] 1 BCLC 1, Vinelott J held that neither the rule making insolvency set-off mandatory nor the pari passu rule invalidated a contractual subordination provision, reasoning that a creditor must be entitled to waive his debt, and if he can waive it altogether there is no reason he cannot waive it in part by agreeing to rank behind other unsecured creditors (at 11c-e). This was followed by Lloyd J in Re SSSL Realisations Ltd [2004] EWHC 1760 (Ch), who held that British Eagle and the related authorities did not force the conclusion that a contract subordinating a creditor’s debt in an insolvent winding-up is void; on the contrary, such an agreement could be valid and, if necessary, enforced by injunction. The critical distinction is thus between an agreement that purports to alter the operation of the statutory scheme (void on public policy grounds) and an agreement by which a creditor alters his own personal rights to his detriment in relation to his claim against the company (permissible and enforceable).

This distinction was subsequently endorsed at the highest level by Lord Neuberger in the Supreme Court in The Joint Administrators of LBHI2 v the Joint Administrators of LBIE [2017] UKSC 38 (“Waterfall I“). At [66] his Lordship accepted James LJ’s dictum in Ex parte Mackay as correct, but subject to two qualifications:

1. The principle does not apply where the “different distribution” involves the contracting creditor ranking lower in the waterfall than the law would otherwise provide (i.e. contractual subordination of one’s own claim is permissible); and
2. Even where the “different distribution” involves the creditor ranking higher than he otherwise would, the principle does not apply if all those who are detrimentally affected by the promotion have agreed to it (unless there is some independent public policy reason to refuse effect to the arrangement).

The modern position that emerges from British Eagle, as refined by Maxwell, SSSL and Waterfall I, is therefore that the anti-deprivation principle strikes down contractual devices that redistribute the insolvent estate contrary to the mandatory pari passu scheme, but does not prevent a creditor from validly agreeing to subordinate, waive or otherwise diminish his own claim — whether before or after the onset of insolvency.