May 2015
The treatment of a surplus in an
administration – the Court of Appeal
judgment in the Lehman “Waterfall I” appeal.
Introduction
The Court of Appeal has handed down its judgment in respect of various
disputes concerning the treatment of surplus assets, once the unsecured
creditors of Lehman Brothers International (Europe) (LBIE) have been repaid.
The complex judgment, which covered unprecedented legal issues, followed
appeals made by the administrators of LBIE and various other Lehman
entities in relation to aspects of the “formidable” first instance judgment given
by David Richards J in March 2014.
Priority ranking of subordinated debt
The first point under consideration related to the ranking in the administration
(and any subsequent liquidation) of subordinated debt owed by LBIE to its
shareholder, LB Holdings Intermediate 2 Limited (LBHI2), such debt having
formed part of LBIE’s regulatory capital. The issue between the parties was
whether this debt ranked immediately after unsecured provable debts or
further down the priority list, so that it ranked after provable debts, statutory
interest and even non-provable liabilities.
Contents
Introduction ....................... 1
Priority ranking of
subordinated debt ............. 1
Currency conversion claims
.......................................... 2
Post administration interest
.......................................... 2
Scope of the liability of
LBIE’s members, as
contributories .................... 3
Provability of a Section 74
claim ................................. 3
Contributory rule ............... 3
Summary .......................... 4
The Court of Appeal (Lewison LJ) held that the debt ranked after even nonprovable liabilities, given the breadth of the definition of “Liabilities” in the
relevant documents, which was wide enough to capture both statutory
interest and non-provable debts. In doing so, he rejected the argument that
statutory interest fell outside the contractual definition in question because the
relevant Insolvency Rule merely provided a direction to the administrator and
such direction did not technically result in an amount “payable or owing by the
Borrower”.
The Court of Appeal did, however, agree that the subordinated debt was
provable in LBIE’s administration as a contingent liability (the contingency
being the prior payment by LBIE of the statutory interest and non-provable
liabilities, as well as provable claims) as there was nothing in the documents
to prohibit the creditor from proving for the subordinated debt and the rules of
the Financial Services Authority (the then relevant regulator) did not appear to
prevent it from doing so.
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Currency conversion claims
Many of LBIE’s creditors were owed debts payable in foreign currencies. As
required, such claims were converted into sterling pursuant to Insolvency
Rule 2.86 when proving the debt. The issue for the Court of Appeal was
whether the conversion under Rule 2.86 was a “once and for all” conversion
or whether foreign currency creditors had a claim, should the total sterling
amount ultimately paid to them be less than the value of their contractual
claim in the foreign currency, as a result of currency fluctuations during the
administration.
Briggs and Moore-Bick LJJ held (with Lewison LJ dissenting), that foreign
currency creditors revert to their contractual rights once the process of
proving (and payment of statutory interest) have run their course. As a result,
they have a claim, payable out of any surplus funds (as a non-provable claim,
ranking after provable claims and statutory interest), in respect of any shortfall
in the sums paid to them when converted into the original contractual
currency.
Briggs LJ gave the principal judgment on this point, concluding that (i) the
mandatory Rule 2.86 conversion occurred only for the purpose of proving the
debt, placing emphasis on the opening words of this Rule and (ii) there was
nothing in the Insolvency Act or the Insolvency Rules which prevented a
foreign currency creditor from making such a claim, should there be a
surplus.
Post administration interest
The next question considered by the Court of Appeal was that of whether, if
there was a surplus, any right to statutory interest which had accrued during
the administration, but which remained unpaid, would be lost should the
company subsequently go into liquidation.
In the original decision, David Richards J had felt compelled to rule, based on
the drafting of the statute, that there was an unfortunate lacuna which meant
that creditors would not, in this scenario, receive any accrued, but unpaid,
interest in relation to the period from when the company went into
administration until the date on which it went into liquidation. The argument
was that any such entitlement would not technically be provable as a debt in
the liquidation, nor would it be payable as statutory interest under either
Insolvency Rule 2.88 or Section 189 of the Insolvency Act, although it would
rank as a non-provable claim.
The Court of Appeal overturned this decision, concluding that Insolvency Rule
2.88(7) contained a statutory instruction to apply any surplus, following
payment in full of all provable debts, in paying statutory interest and that this
instruction burdened any surplus which passed from an administrator to a
subsequent liquidator. If, therefore, LBIE were to go into liquidation,
entitlements to statutory interest that had accrued during the administration
would be payable from the surplus in the liquidator’s hands.
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Scope of the liability of LBIE’s members, as contributories
As LBIE is an unlimited company, its shareholders, Lehman Brothers Limited
(LBL) and LBHI2, are liable pursuant to Section 74 of the Insolvency Act to
contribute sufficient funds to pay LBIE’s “debts and liabilities.” The question
arose as to whether this wording included statutory interest on those debts
and non-provable liabilities.
The Court of Appeal agreed with David Richards J, with Briggs LJ giving the
leading judgment on this point, that debts and liabilities “extends to all the
liabilities of the company at all stages of the waterfall”, including statutory
interest and non-provable debts. In reaching this view, Briggs LJ rejected the
appellants’ submissions that (i) the Section 74 liability should be confined to
the payment of provable debts and (ii) while the payment of statutory interest
is part of the statutory scheme, it is not a liability of the company and
therefore falls outside the ambit of Section 74.
Provability of a Section 74 claim
The next, related, issue was that of whether LBIE’s administrators were
entitled to prove in the liquidation or distributing administration of its
shareholders, LBL and LBHI2, in respect of their liability to make payment
under Section 74 of the Insolvency Act. This question arose because the
power to make calls on an unlimited company’s members pursuant to Section
74 is given to the liquidator, rather than to an administrator.
Briggs LJ gave the principal judgment on this issue, which both he and
Lewison LJ described as “difficult”. Ultimately, the Court of Appeal agreed
with David Richards J that LBIE, acting by its administrators, should be
entitled to lodge a proof in respect of Section 74(1) liabilities in a distributing
administration or a liquidation of LBL or LBHI2. This decision was based on
the conclusion that the right to benefit from the liability to contribute was
properly viewed as an asset of the company and that LBIE itself therefore had
a contingent claim.
The Court of Appeal considered the various consequences, raised by the
appellants, of the LBIE administrators being able to prove but concluded that
these were ultimately factors that fed into the valuation of the contingent claim
rather than points of principle which prevented the contingent claim from
existing.
Contributory rule
Finally, the Court of Appeal upheld David Richards J’s decision that the
contributory rule (which prevents a contributory from proving for a debt in a
liquidation until it has discharged in full any liability which it has to the
company as a contributory) has no application in an administration.
LBIE argued that extending this rule to distributing administrations was
necessary in order to prevent unfair results, but the Court of Appeal
concluded that the practical remedy to any potential injustice would be for
LBIE to go into liquidation. There was, therefore, no compelling reason for the
The Lehman “Waterfall 1” appeal
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Court of Appeal to make what it considered would be a radical extension to the
contributory rule.
An administrator cannot therefore refuse to admit a member’s proof of debt, or
refuse to pay dividends on such proof, on the grounds that, if the company
went into liquidation, the member would or might become liable to calls under
Section 74(1) of the Insolvency Act.
The one caveat to this point is that, if the contingent Section 74 liability is
provable by a subsidiary in the liquidation or distributing administration of its
contributories, it will be subject to statutory set off against the contributories’
claims in the administration or liquidation of their subsidiary.
Contacts
For further information
please contact:
Tony Bugg
Partner, Global Head,
Restructuring & Insolvency
Group
(+44) 207 456 4470
[email protected]
Summary
Euan Clarke
Partner, Dispute Resolution
The Court of Appeal held that the order of payment of surplus assets should
be:
(+44) 207 456 4267
[email protected]
Provable debts
Statutory interest
Non-provable debts
(incl. currency conversion claims)
Subordinated debt
Authors: Jo Windsor, Tony Bugg, Euan Clarke
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