Enforcement of finance transactions – slice and dice approach to illegality 

England and Wales

Illegality committed by some noteholders does not prevent recovery on behalf of innocent noteholders under an English law note instrument. In Madison Pacific Trust Limited v (1) Shakoor Capital Company Limited and (2) Joint-Stock Company Commercial Bank Privatbank [2020] EWHC 610 (Ch) the English High Court has approved a security trustee making a payment to innocent noteholders who invested in good faith in an English law note instrument despite the fact that the notes were tainted by the fraud of some noteholders.


UK SPV Credit Finance Plc (the “Issuer”) had issued two series of notes: one in 2010 and the other in 2013.  The funds raised from the notes were used to advance loans by the Issuer to Joint Stock Company Commercial Bank PrivatBank (“PrivatBank”). The Issuer had charged and assigned by way of security all of its interest under the loan agreements in favour of Madison Pacific Trust Limited (the “Trustee”) as trustee of the two series of notes.

Payment under the notes was dependent on the recoveries made under the loan agreements. In November 2017 the Trustee commenced arbitral proceedings under the loan agreements to seek recovery of the sums due. One of the defences raised by PrivatBank was that the loan agreements were unenforceable for illegality perpetrated by two former owners of PrivatBank (the “Former Owners”).  That illegality also infected the notes because some notes had been acquired by the Former Owners or entities under their control.

The illegality conundrum

In partial awards published in the arbitration relating to each loan agreement the arbitral tribunal concluded that (subject to the other defences, the determination of which had been postponed) PrivatBank would be required to pay only certain amounts due under the loan agreements.  The difficulty the arbitral tribunal faced was that as between the Issuer and the Trustee (on the one hand) and PrivatBank (on the other) illegality would appear to operate as a binary defence: each loan agreement was either enforceable as a whole, or not at all.  The arbitral tribunal considered whether there were other ways of ensuring that innocent noteholders could recover, while preventing those involved in the illegality (the Former Owners and their associated entities) from recovering.  In order to do so the arbitral tribunal made an award that, in effect, PrivatBank had no liability in relation to the value of the notes that were held for the benefit of the Former Owners or entities owned or controlled by them but PrivatBank did have to pay in relation to notes held by others. 

The issue this created was whether the Trustee would incur liability under the Trust Deed or otherwise as a result of making the payments envisaged by the arbitral tribunal.  Any sums received by the Trustee from PrivatBank represented “moneys received by [the Trustee] … in connection with the enforcement or realisation of the Security Interests” within the meaning of clause 8.1 of the Trust Deed.  Accordingly, they had to be applied pursuant to the payment waterfall set out in clause 8.1, as follows:

8.1.1 first, in payment or satisfaction of the costs, charges, expenses and liabilities incurred by the Trustee in or about the preparation, execution and performance of the trusts of this Trust Deed (including remuneration of the Trustee and of any Appointee appointed hereunder) and incurred by the Trustee or a Receiver (and any Appointee) in the realisation or enforcement of the Security Interests;

8.1.2 secondly, in or towards payment pari passu and rateably of all arrears of amounts corresponding to principal and interest remaining unpaid in respect of the Notes; and

8.1.3 thirdly, the balance (if any) in payment to the Issuer …”.

In considering the above terms, there was a risk that all noteholders (including the wrongdoers) could argue that they were entitled to receive an equal payment from the Trustee under clause 8.1.2.  If the Trustee paid only some noteholders, the Trustee could be exposed to potential claims by the noteholders who did not receive a payment.  In order to address the above problem, the Trustee made an application to the English Court for directions.

The English High Court confirmed that the Trustee would not be acting in breach of trust if it accepted the payments from PrivatBank under the arbitral awards and made the payments in accordance with the payment mechanism set out in the arbitral awards.  In doing so, the Court considered the interpretation of the payment waterfall in clause 8.1 of the Trust Deed and the Trustee’s powers and duties in connection with enforcement of the security. 

Interpretation of the payment waterfall

The Court concluded that payments received by the Trustee were payable to the noteholders under clause 8.1.1 of the payment waterfall.  This was on the basis that the payments under the arbitral awards were subject to the condition that the Trustee would distribute those payments to a certain group of noteholders only.  As such the Trustee would be subject to a liability, falling within clause 8.1.1 of the Trust Deed, once the proceeds of enforcement were in its hands.  

Trustee’s powers and duties

The Court recognised that as per the terms of the Trust Deed the Trustee had an unfettered discretion as to the way in which it enforced the security but had to exercise that discretion subject to its overarching obligation to act in the interests of all the noteholders. 

The Court concluded that in the special circumstances of this case the Trustee’s duty to act in the interests of all noteholders did not preclude it from accepting the payments under the arbitral awards that would benefit only some noteholders.  The inability of certain noteholders to recover (and the Trustee’s inability to recover on their behalf) was not due to any action (or inaction) of the Trustee but was due to the decision of the arbitral tribunal.


The English law approach to illegality in the context of a civil claim has been evolving to reflect the modern realities of business. 

In the nine-judge panel decision of Patel v Mirza [2016] UKSC 42, the Supreme Court had ruled that illegality will not always be a defence to a civil claim. This was a landmark decision because it changed a well-established principle of English law, i.e. the Court will not enforce an illegal bargain.

In that decision the English Supreme Court held that just because a party had provided funds to another for committing an illegal act, this did not mean that the paying party was not entitled to recover its funds in circumstances where they had not been used for the illegal act.

The Supreme Court decision set out a framework approach in relation to the illegality defence as follows:

  1. the underlying purpose of the law which has been breached by the conduct, and whether that purpose is enhanced by denying the civil claim;
  2. the impact on public policy if the claim is denied; and
  3. whether denying the claim is a proportionate response to the illegality, bearing in mind that punishment remains the reserve of the criminal courts.

Please click here to read our analysis of Patel v Mirza.

The decision in Madison Specific Trust is a good example of the fact that the existence of some form of illegality in a civil claim context will not always be a bar to the relief being sought and the English Court is willing to take a flexible approach to achieve a just outcome by reference to the facts of each case.  This is particularly important in the context of finance transactions that have multiple parties and some who may have no connection to the illegality.