Understanding Debt Subordination and the Rule in Cherry v. Boultbee: Re SSSL Realisations

Abstract

A debt subordination may in general take two forms, viz., contractual subordination and turnover subordination. A contractual subordination occurs where, by agreement between a debtor and a creditor, debts owed to the creditor are to rank below other debts of the debtor. A turnover subordination (which may or may not involve a trust) requires the junior creditor, on the insolvency of the debtor, to turn over to the senior creditor all recoveries received by the junior creditor in respect of the junior debt. Where a trust is utilized, this technique is also called trust subordination. The English Court of Appeal decision in Re SSSL Realisations has confirmed that is valid, binding and enforceable. If necessary, the court would enforce it by injunction. Furthermore, a properly drafted trust subordination will not become a security interest. While championing the enforceability of contractual subordination especially in case of insolvency, the Court of Appeal made no mention of some age-old arguments that contractual subordination is of doubtful validity because it infringes the principle of pari passu distribution. In light of this decision, it is no longer credible to claim that the pari passu principle is fundamental in insolvency practice. This decision also confirms that a subordination agreement is unlikely to be liable to disclaimer by a liquidator of the subordinated creditor. The court also took the opportunity to restate how the rule in Cherry v. Boultbee interacts with corporate insolvency law. In brief, the rule in Cherry v. Boultbee holds that that a person cannot share in a fund in relation to which he is also a debtor without first contributing to the whole by paying his debt. While the court made a commendable effort to restate this equitable rule, some aspects of the restatement are dubious. In particular, it failed to consider the rule's compatibility with the contractual setting and failed to engage fully the very authorities it purportedly relied upon. Instead, it rolled out self-serving numbers to underscore its answer to a purportedly unprecedented question of principle.