Has the Football League set a dangerous precedent in the 15-point deduction it imposed on Leeds United? Nikki Singla and David Phillips explore the implications the decision holds for smaller football clubs

There is every indication that tough times lie ahead for lower league football clubs. Luton have started the season with a massive 30 points deducted for breaching insolvency rules, while Bournemouth and Rotherham have both had 17 point handicaps imposed as a result of failing to meet terms for exiting administration. These penalties stem from the decision of the Football League to deduct 15 points from Leeds United last year.

Some football fans and pundits believe that the Leeds United penalty set a very damaging precedent which could cripple many more clubs in the future. Others congratulated the Football League for taking a firm stand against a club that could not emerge from insolvency with a creditors' voluntary arrangement (CVA).

In April this year, a three-man panel of arbitrators (Sir Philip Otton, Peter Leaver QC and Peter Cadman) heard Leeds United's challenge to the 15-point deduction. In May, the arbitrators dismissed the club's claim. Now the dust is beginning to settle on the controversy, what lessons, if any, will be learned from the arbitrators' decision? Unlike most arbitration awards, which are confidential, this award contains the reasons given by the arbitrators for their decision – available to the public on the Football League's website: football-league.co.uk.

For those not familiar with the background to the case, Leeds United became heavily insolvent just six years after reaching the semi-finals of the UEFA Champions League. The club went into administration in May 2007. In line with Football League rules, this triggered an automatic deduction of 10 points from Leeds United's total that season, dooming them to relegation from the Championship.

Then, for the first time in its history, the Football League went on to impose a further 15-point penalty on the club for the following season. Why?

The story begins with the fact that the Football League insists that a club that becomes insolvent should conclude a CVA with its creditors – unless there are "exceptional circumstances". KPMG was appointed administrators of Leeds United and attempted to conclude a CVA and sell Leeds' assets to a third-party purchaser. Several potential buyers expressed an interest and KPMG sold the club to the highest bidder. Once the purchase had been concluded, the purchaser sought agreement from the Football League that the club could compete in the league during the coming season.

However, the CVA did not go ahead. In the words of the arbitrators, the Football League "faced a novel situation"; namely, how to protect the interests of the unsecured creditors in the absence of a CVA?

The Football League retains a discretion to permit a club to continue competing in the League without a CVA, but this discretion would be exercised only in "exceptional circumstances". The purchaser could have applied to the Football League for permission to join the League afresh by starting in the lowest applicable League competition (Coca-Cola Football League Two). But, understandably, this is not what they wanted, attempting instead to get the Football League's permission to compete in Coca-Cola League One, the same level of competition it would have enjoyed had a CVA been concluded successfully.

Shortly before the 2007-08 season began, the Football League decided to permit Leeds United to compete in League One. However, in exercising its discretion to waive the requirement of the CVA under the "exceptional circumstances" proviso, it would only allow this on the condition that the club accepted a 15-point penalty. The purchaser reluctantly accepted and signed an agreement (the Compromise Agreement) with the Football League, releasing all rights to complain against the Football League, save for a right of appeal. The Football League arranged for the appeal to be heard by a special meeting of all the 72 Football League clubs. By a very substantial majority the clubs found in favour of the Football League. Unhappy with this outcome, Leeds United went to arbitration.

The arbitrators did not accept Leeds United's arguments, but in any event, their view was that the case "begins and ends" with the Compromise Agreement and therefore failed in limine. The arbitrators said that the release of rights clause in the Compromise Agreement was not an ouster clause, but was a legitimate release and waiver provision in a commercial agreement. Thus the challenge was dismissed.

Lord Mawhinney, the chairman of the Football League, welcomed the decision. Leeds United stated that: "If what football achieves out of this is clarity for clubs in the future, then that can mitigate some of our disappointment as we want all clubs to survive through what are very difficult times."

But is the football world any clearer? At the very end of the award, the arbitrators added a postscript which makes interesting reading for clubs facing financial difficulties.

First, the arbitrators thought the Football League should review its insolvency policy and the guidance issued to each member club detailing the treatment it can expect from the Football League in the event of future insolvency. The arbitrators were told that there are several more current or anticipated insolvencies and, in many cases, "it will prove impossible to exit administration via a CVA."

The arbitrators noted that during the arbitration the Football League itself recognised the need to amend its insolvency policy to make new specific provisions which would apply where a club could not conclude a CVA. In the words of the arbitrators, the clubs "should be entitled to clear guidelines, objectives and procedures."

Secondly, the arbitrators were concerned that the 15-point deduction was described as a "penalty". It went on to state that the Football League should not automatically sanction a club in the future with 15 points if it is unable to conclude a CVA. Rather it should consider all the circumstances relevant to the club in question and the events leading up to the insolvency.

Lastly, the arbitrators stated that they considered an appeal to members of the League to be unsatisfactory. "Some clubs in the League," it said, "may not readily agree to reduce a points sanction in the understandable self-interest of their clubs." A recommendation was made that the Football League makes provision for an appeal to an independent tribunal.

The sentiments expressed by the arbitrators in the postscript to the award are to be welcomed. The Football League would do well to heed them, especially given the financial predicament of many of its member clubs. A modern insolvency policy is required which is alive to reality: the financial prospects of lower league clubs are in a different world to those of teams in the Premiership. It will be no credit to football if the outcome of a season is determined as much off the pitch as on it.

Nikki Singla and David Phillips QC, both of Wilberforce Chambers, represented Leeds United in the arbitration against the Football League.