Way back in 2004 I first went to press about the iniquitous withholding of payment for 12 years by main contractors in the case of its subcontractor becoming insolvent.

That paper was nominated for an “International Business Journalist of the Year” award, but nothing was done about the practice itself. Since then the number of main contractors using such clauses has multiplied. This has become particularly evident following the wholesale re-drafting of construction contracts and sub-contracts following the passing into law of the Local Democracy Economic Development and Construction Act 2009, but I suspect is equally due to the main contractors lack of cash in these straightened times, and the temptation to make easy money.

It is my firmly held view that such causes are illegal as a matter of Public Policy, yet the main contractors are using them on a daily basis to avoid making payment to liquidators and the like for legitimately completed work, starving struggling creditors, legitimate charge-holders and other stake-holders of recovery.

My main point back in 2004 was that if this practice continued and became widespread, which it now has, sooner or later the banks would stop any funding of subcontractors as the prospect of ever getting its money back via a receivership or administration would be gone – at least for the foreseeable future.

To emphasise just how much of a cash cow this clause is, one of the biggest construction organisations in the country, a household name with assets of £500m, even had a clause in its contract that, in the event of insolvency, the subcontractor would receive no payment at all, ever. This is clearly illegal, and the organisation concerned did eventually pay, plus interest, but it leaves me wondering just how many times it has pulled this stunt, and how many times it has got away with it. The history of anti-avoidance is long, and has been consistent throughout the ages. Even before the “modern” Bankruptcy Acts came into law in the 19th century the law required that, upon insolvency, a person’s assets be distributed pari-passu to his creditors, and by nature, outlawed any arrangement which sought to circumvent this rule. This rule has become known as the “Anti-Deprivation Principle”

The earliest Bankruptcy Act is The Statute of Bankrupts or “An Acte againste suche persones as doo make Bankrupte”, 34 & 35 Henry VIII, c. 4, 1542. The Preamble to the Act state:

“Where divers and sundry persons craftily obtaining into their hands great substance of other men’s goods do suddenly flee to parts unknown or keep their houses, not minding to pay or restore to any their creditors their debts and duties, but at their own will and pleasure consume the substance obtained by credit of other men, for their own pleasure and delicate living, against all reason, equity and good conscience ...the Lord Chancellor ... shall have power and authority by virtue of this Act to take ... imprisonment of their bodies or otherwise, as also with their [real and personal property however held] and to make sale of said [real and personal property however held] for true satisfaction and payment of the said creditors, that is to say; to every of the said creditors a portion, rate and rate like, according to the quantity of their debt.

” In more modern times, the law has unflinchingly and repeatedly upheld the Principle both in Acts of Parliament and in the courts. The earliest modern case-law I have found is Higinbotham v Holme (1812) 19 Ves 88, 92, at LR 8 Ch App 643, 648 in which Mellish LJ stated:

"a person cannot make it part of his contract that, in the event of bankruptcy, he is then to get some additional advantage which prevents the property being distributed under the bankruptcy laws."

There was a rash of new insolvency statutes in the mid- 19th century with the enactment of the Bankruptcy and Liquidation Act 1858, the Bankruptcy and Liquidation Act 1859, The Bankruptcy Act 1861 and The Bankruptcy Act 1869 which, together reinforced the principle of pari-passu and the “Anti-Deprivation Principle”.

As early as Whitmore v Mason (1861) 2 J 8c H 204, Page Wood V-C (later Lord Hatherley) considered the law to be “clearly settled” as he stated:

"... I apprehend that the law is too clearly settled to admit of a shadow of doubt, that no person possessed of property can reserve that property to himself until he shall become bankrupt, and then provide, that, in the event of his becoming bankrupt, it shall pass to another, and not to his creditors.”

Similarly, in the Court of Appeal case in Ex p Jay; In A re Harrison (1880) 14 Ch D 19, the three Appeal Court Judges were unanimous:

"a simple stipulation that, upon a man's becoming bankrupt, that which was his property up to the date of the bankruptcy should go over to someone else and be taken away from his creditors, is void as being a violation of the policy of the bankrupt law ... I think we cannot escape from applying that principle to the present case."

There is a host of later and current case law which hold these principles fast, in particular National Westminster Bank plc v Halesowen Pressworks Ltd [1972] AC 785 and British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758. Perhaps the most significant summary of the principle is contained within the extensive judgement of Neuberger J (now Lord Neuberger) in Money Markets International Stockbrokers Ltd (in liquidation) v London Stock Exchange Ltd and another [2002] 1 WLR. For completeness, I set out the entirety of Neuberger’s conclusions regarding the principle under discussion here:

“I am here concerned with a claim to rely on "the principle", i e that a provision that a person's property shall pass to another or be confiscated is regarded by the court as void where the person concerned is insolvent. Having considered a number authorities concerned with the application of the principle, and the analysis of those authorities, it seems to me that the position may be summarised as follows.

117 First, there is no doubt that the principle exists: it has been applied or approved in a number of cases, and fairly recently in the House of Lords. Secondly, the principle is essentially based on a common law rule of public policy, which is itself based on the long-established approach of the English law to the treatment of assets and creditors on insolvency. Thirdly, there are circumstances in which the principle does not apply. Fourthly, it is not D possible to discern a coherent rule, or even an entirely coherent set of rules, to enable one to assess in any particular case whether such a provision (a "deprivation provision") falls foul of the principle. Fifthly, and perhaps not surprisingly, it is not entirely easy to reconcile the conclusions, and indeed the reasoning, in some of the cases. Sixthly, there are some rules, of a somewhat "piecemeal" nature which can be derived from the cases.

118 It seems to me that one can extract the following rather limited propositions from the cases: (i) a person cannot validly arrange his affairs so that what is already his own property becomes subject to being taken away in the event of his insolvency; (ii) subject to the first proposition, the transfer of an asset for an interest coming to an end on the transferee's insolvency (or on some other event) is apparently effective even if the transferee is insolvent; (iii) subject to the following propositions, the transfer of an asset on the condition that the asset will revest in the transferor in the event of the transferee's insolvency is generally invalid; (iv) a proviso in a lease for determination, i e for forfeiture or re-entry, even in the event of the lessee becoming insolvent, is enforceable where the lessee is insolvent; (v) in deciding whether a deprivation provision, exercisable other than on insolvency, offends against the principle, one is primarily concerned with the effect of the provision and not with the intention of the parties, but it may be that, if the deprivation provision is exercisable for reasons which are not concerned with the owner's insolvency, default or breach, then its operation will not be within the principle; (vi) however, if the intention of the parties when agreeing the deprivation provision was to evade the insolvency rules, then that may invalidate a provision which would otherwise have been valid, and if the intention of the parties was not to evade the insolvency laws, the court will be more ready to uphold the deprivation provision if it provides for compensation for the deprivation; (vii) the court will scrutinise with particular care a deprivation provision which would have the effect of preferring the person to whom the asset reverts or passes as against other unsecured creditors of the insolvent person whose estate is deprived of the asset pursuant to the provision; (viii) where the deprivation provision relates to an asset which has no value, or which is incapable of transfer, or which depends on the character or status of the owner, then it will normally be enforceable on insolvency; (ix) a deprivation provision which might otherwise be invalid in light of the principle may be held to be valid if the asset concerned is closely connected with or, more probably, subsidiary to a right or other benefit in respect of which a deprivation provision is valid; (x) if the deprivation provision does not offend against the principle, then (subject to there being no other objection to it) it will be enforceable against a trustee in bankruptcy or on a liquidation just as much as it would have been enforceable in the absence of an insolvency.”

Coming right up to date, the latest case to re-state the principle is the Supreme Court judgement in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services ltd [2011] UKSC 38 (SC).

So, the essential purpose of the anti-deprivation principle is to counteract contract terms such as a clause, whose intentional or inevitable effect is the evasion of the fundamental principle of insolvency law that a debtor’s property remains with the debtor’s estate for distribution in accordance with insolvency law.

Whilst the clauses in question do not expressly state that their intention is to deprive the Company of the payment which is otherwise due, masquerading as a mere twelve year wait, interest free, the effect is the same. In that regard, Lord Collins in Investments Pty Ltd clarified that “it is the substance rather than the form which is the determinant”. There is no reasonable likelihood that a subcontractor company, having gone into a formal insolvency procedure during the course of the Works, would remain un-dissolved for the limitation period of twelve years from the date of Practical Completion of the main contractors Works, particularly when the Practical Completion date may itself be a year or two after the now insolvent subcontractor completed its part..

Accordingly, the clauses in question which seek to permanently deprive the insolvent subcontractor of a payment which would otherwise be due but for its insolvency are, in my firmly held view, void. If they are not void, they should be, but try telling that to the cash-strapped main contractors who are having a field day with the free money this particular scheme of avoidance provides. It would be interesting to know what portion of their profits was down to unpaid monies for work carried out by their subcontractors, rather than honestly earned.

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