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The Court of Appeal’s approach in Burlington v Lomas (part of the Lehman Waterfall litigation) to the entitlement to surplus and calculating the statutory interest due to creditors on the debts of a company in administration is examined by Robert Amey, of South Square.
Burlington Loan Management Ltd and others v Lomas and others  EWCA Civ 1462
The Court of Appeal dismissed the appeals of the representative creditors of Lehman Brothers International Europe (LBIE) on various issues regarding the amount of statutory interest they should receive on what LBIE had owed them when it went into administration.
When LBIE entered administration on 15 September 2008, it was thought to be insolvent by nearly all concerned. As it turned out, after paying all debts and administration expenses in full, there remained a surplus estimated at around £7.39bn.
The administrators of LBIE therefore applied to the court for directions as to how to distribute the surplus, and a number of representative creditors were joined to the proceedings to present the arguments in favour of their class receiving the greatest possible share. These proceedings were known as the Waterfall proceedings, since they concerned the appropriate payment waterfall out of the estate.
The first of these applications, known as Waterfall I, was determined by the Supreme Court in May 2017 (see The Joint Administrators of LB Holdings Intermediate 2 Ltd v The Joint Administrators of Lehman Brothers International (Europe)  UKSC 38,  All ER (D) 102 (May)). The second application, known as Waterfall II, was divided into three tranches (A, B and C). The latest judgment contains the Court of Appeal’s conclusions on parts A and B of Waterfall II (as well as a single issue which had previously been determined within part C, but which more naturally fell to be considered along with part A).
(There was also a Waterfall III application, which has now been settled, along with various other pieces of LBIE surplus-related litigation).
Following the Supreme Court’s judgment in Waterfall I (which considerably narrowed the issues remaining in Waterfall II), the six outstanding issues for the Court of Appeal in the latest judgment all concerned the quantum of statutory interest payable under what was then rule 2.88 of the Insolvency Rules 1986, SI 1986/1925 (now rule 14.23 of the Insolvency (England and Wales) Rules 2016, SI 2016/1024).
The Court of Appeal upheld the judgments of Richards J below. In short:
On item one (Bower v Marris)
The court held that the legislation contained ‘a complete and clear code for the award of statutory interest’ and ‘contains all you need to know’, namely, interest could only be paid after the proved debts had been paid in full. The judge-made law in cases such as Bower v Marris (which provided for dividends to discharge interest before principal) was no longer relevant now that the legislation provided an express rule for the payment of interest.
On item two (compound interest)
The court looked again at the exact language of the legislation, and reasoned that, since interest could only be paid on principal, and since principal had to be paid off before interest, there was no room for compound interest to continue to accrue once dividends equal to the proved debts had been paid.
On item four (late payment of interest)
The court noted that there was no particular date by which administrators were required to pay dividends or interest. Accordingly, no compensation could be payable for a failure to pay interest by a particular date.
On item five (contingent debts)
The court noted that interest accrued on future debts prior to the debt falling due for payment, and held that there was no reason to treat contingent debts any differently. More fundamentally, statutory interest was compensation for dividends on account of provable debts having to be paid after the date of administration. Since it was possible to prove for (and be paid in respect of) contingent debts which had not yet fallen due, there was no reason for those debts not to bear interest from the date of administration.
On item 11 (foreign judgment rates)
The court held that the payment of statutory interest, like the proof and payment of debts, needed to be regulated by reference to a single date, namely, the date of administration. If a creditor had not actually obtained a foreign judgment (carrying interest at the foreign judgments rate) by that date, then it could not claim the foreign judgments rate in the administration.
On item 12 (contingent right to interest)
The court noted that a floating rate of interest was capable of being a ‘rate applicable to the debt apart from the administration’. That being so, there was no reason why a contingent right to interest, which was triggered on some action having been taken by the creditor, could not also be a ‘rate applicable to the debt apart from the administration’.
The Waterfall II judgment provides the first judicial guidance on how to construe the interest provisions in the Insolvency Rules 1986, and how to calculate the appropriate interest due to each creditor.
Interest has always been payable under the Insolvency Rules 1986 wherever a surplus arises in liquidation, bankruptcy or a distributing administration, but normally when surpluses arise, they are so small that it is not worth litigating the point (surpluses arise most frequently in low-value bankruptcies, where unsophisticated individuals go bankrupt for failure to pay a comparatively small debt, despite having sufficient equity in their home to discharge all their debts in full). For the first time in more than 30 years, insolvency practitioners will be able to calculate interest with certainty as to the applicable legal principles.
The underlying theme of the senior creditors’ submissions was that, in corporate insolvency, senior creditors should receive their full entitlement before subordinated creditors and shareholders receive anything (a similar argument can be made in relation to bankruptcy, that bankrupts should not receive anything out of the estate until their creditors have been paid in full). The senior creditors simply invited the court to calculate interest under the legislation in the same way that commercial parties calculate interest outside of any insolvency context. The Court of Appeal accepted that this argument had ‘real force’, but nonetheless concluded that it was inconsistent with the clear language of the legislation.
Accordingly, interest awarded to a creditor under the insolvency legislation will often be less than the interest which would have been payable outside of insolvency proceedings. Although the Court of Appeal has decided that this is what a literal reading of the legislation requires, it has the potential to operate harshly against creditors.
Robert Amey appeared with Tom Smith QC for the fifth appellant in this case.
Interviewed by Robert Matthews.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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Lehmans waterfall I case
Waterfall of payments in administration—the position under the Insolvency (England and Wales) Rules 2016
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