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The judgment in LB Holdings Intermediate 2 Ltd (in administration) contains a clear direction on the extent to which the courts will bless a transaction in an insolvency context, according to Euan Clarke, a partner in Linklater’s dispute resolution group in London. It also provides guidance on when it would be appropriate for insolvency practitioners to seek directions from the court with respect to a transaction.
LB Holdings Intermediate 2 Ltd (in administration)  EWHC 2032 (Ch), All ER (D) 44 (Aug)
In this rare and exceptional case, a proposal by joint administrators to appoint a director to a company already in administration (Lehman Brothers Europe Ltd), in order to distribute surplus funds to its sole member (Lehman Brothers Holdings plc), as opposed to a creditor, was held to be legally permissible, as well as pragmatic and beneficial.
What is the background to the case and what are the issues arising within it that are pertinent to insolvency practitioners?
The widely known administrations of various UK entities within the Lehman Brothers group (the group) have been ongoing since late 2008. Following a highly successful process of collecting and realising assets by its joint administrators, the group’s principal trading company in Europe, Lehman Brothers International (Europe) (LBIE), now holds a substantial surplus, estimated at between £7bn and £8bn.
Various high profile applications to the court, known as the ‘Waterfall’ applications, have been made for the purposes of determining issues between various stakeholders as to their respective entitlements in relation to that surplus, as well as related issues. These applications have already given rise to various High Court decisions (see Re Lehman Brothers International (Europe) (In Administration)  EWHC 2417 (Ch),  EWHC 2131 (Ch),  EWHC 2270 (Ch),  EWHC 2269 (Ch), and  EWHC 704 (Ch)), as well as appellate authority, both at the Court of Appeal and Supreme Court levels (see Re Lehman Brothers International (Europe) (In Administration)  EWCA Civ 485, and  UKSC 38).
The present decision was made in the context of a further such application known as the ‘Waterfall III’ application (the application), which was issued pursuant to paragraph 63 of Schedule B1 to the Insolvency Act 1986 (IA 1986) by the joint administrators of LBIE in early 2016. The purpose of the application had been to resolve a number of inter-company positions between various companies within the group. The Supreme Court’s decision in Re Lehman Brothers International (Europe) (In Administration)  UKSC 38, which was handed down on 17 May 2017, however, rendered it considerably less likely that the issues the application aimed to resolve would in fact arise. Consequently, the administrators of the various estates concerned negotiated a proposed settlement of the various inter-company positions, with a view to bringing the application to an end.
The administrators of the various estates concerned applied to the court for directions that they be at liberty, inter alia, to enter into and perform the transaction documents forming the proposed settlement agreement. A key driver for many of the estates involved was that the proposed settlement would allow for the payment of dividends to their creditors, which had otherwise been retained pending resolution of various proceedings making their way through the courts.
What were the main legal arguments raised?
The relevant legal test to be applied by Hildyard J in this case was recently summarised in Re Nortel Networks UK Ltd  EWHC 2769 (Ch). In short, while administrators are generally expected to exercise their own judgment in commercial matters, without fettering their discretion, where the decision is ‘momentous’, the court can be asked to give the administrators a direction permitting them to proceed with such a decision. In that event, the court needs to decide whether what is proposed is within the power of the administrator, whether the administrator genuinely holds the view that what he proposes will be for the benefit of the company and its creditors, and whether he is acting rationally and without being affected by a conflict of interest in reaching that view.
Hildyard J noted that ‘the court’s function is not to determine, and could not sensibly extend to determining, whether the settlement proposed is the best available, or might be improved in some way’ and that the court’s focus ‘is on the rationality and propriety of what is proposed, and on being satisfied that it is not infected by some conflict of interest affecting any of its proponents’.
What did the judge decide, and why?
Hildyard J noted that entry into settlement agreements and compromises is within the powers of administrators pursuant to IA 1986, Sch B1, para 60 and Sch 1, para 18, and that given the ‘unique nature of the Lehman Group administrations and the long-running and complicated disputes that they have given rise to’, he was in no doubt that the proposed settlement was a ‘momentous’ decision.
Granting the applications for directions sought, Hildyard J was satisfied that each administrator genuinely held the view that the settlement would be for the benefit of the relevant company and its creditors, that the view each had reached had not been infected by any conflict of interest and that the settlement was rational and not improper. He noted that it was ‘apparent that considerable thought has been put into developing the proposed settlement over a period of several months by professional administrators with the benefit of professional legal advice’.
In reaching that view, Hildyard J satisfied himself, after reviewing the witness evidence, that each of the administrators of the respective estates had considered the principal advantages and disadvantages of the proposed settlement, which he sets out in the judgment. In addition, Hildyard J was satisfied in respect of the steps taken to mitigate any potential conflicts of interest arising from the fact that a number of the joint administrators were administrators of other companies within the group. In this case, a single administrator in each estate (different from the single administrator authorised in each other estate) to be authorised to take primary responsibility for negotiation of the settlement and to determine whether it benefitted the creditors of that party separately.
Hildyard J also noted, when assessing the rationality of the decision to enter into the proposed settlement, that the creditors of each estate had been informed of the proposed settlement and had been provided with the opportunity to express their views.
What are the practical implications of this case for insolvency lawyers advising their clients?
Insolvency practitioners, as officers of the court, can in certain circumstances seek directions from the court when making decisions, which can provide an element of protection from subsequent challenge to such a decision. This case serves as a helpful reminder that, while the court may be prepared to give a direction, it will not intervene to assess the merits of a proposed transaction, and that the ultimate discretion to enter into commercial arrangements resides with the insolvency practitioner. It also serves as a high profile practical application of the process of more limited scrutiny outlined in Nortel (above).
To what extent is the judgment helpful in clarifying the law in this area?
The judgment contains a clear direction on the extent to which the courts will bless a transaction in an insolvency context and provides guidance on when it would be appropriate for insolvency practitioners to seek directions from the court with respect to a transaction. It reiterates that the courts will not consider whether a particular course of action is the best available—that discretion resides with the insolvency practitioner. Rather, the court’s focus will be on the ‘rationality and propriety of what is proposed’.
Euan is a specialist in insolvency and banking litigation. His practice covers contentious and advisory insolvency and restructuring, banking disputes and fraud and regulatory investigations. He has particular experience of advising banks, financial institutions, companies and insolvency practitioners in relation to contentious issues arising from complex finance transactions, as well as restructuring, insolvency and corporate distress situations, especially those with a cross-border element. In LB Holdings, Euan acted for LBIE.
Interviewed by Kate Beaumont. First published on Lexis PSL Restructuring & Insolvency
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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