Does the Lugano Convention permit a stay of English proceedings for relief under a derivative agreement?

Does the Lugano Convention permit a stay of English proceedings for relief under a derivative agreement?

Can English proceedings be stayed under the Lugano Convention or under the court's inherent jurisdiction on case management grounds? The case of Fondazione Enasarco v Lehman Brothers Finance SA [2014] EWHC 34 (Ch)[2014] All ER (D) 90 (Jan) looked at this. In the case Lehman Brothers Finance SA's (LBF) application for a stay of English proceedings in respect of a claim brought by the claimant (Enasarco) for relief under a derivative agreement was refused where there were strong grounds for such refusal and where the English court was the natural court to consider the issues raised because they raised contractual questions governed by English law.

What did the court decide?

Mr Justice Richards decided that:

  1. the Swiss proceedings (relating to construction of the derivative agreement and whether the claim should be included in LBF's schedule of claims) were derived directly from LBF's liquidation and closely connected to it
  2. the Swiss proceedings fell within the exception to the Lugano Convention
  3. the request to stay the English proceedings should be rejected, whether under the Lugano Convention or under the court's case management powers (under the SCA 1981, s 49(3))

How did the problem arise?

Enasarco invested in notes marketed by the Lehman group. ARIC was the special purpose vehicle for the notes programme. The principal amount of the notes was protected by a derivative agreement between LBF and ARIC. The agreement was governed by English law and contained an exclusive jurisdiction clause, as regards states which are parties to the Lugano Convention, in favour of the English courts.

In 2008, LBF's holding company filed for protection under Ch 11 of the US Bankruptcy Code, which constituted an event of default under the derivative agreement and resulted in its automatic early termination, with LBF as the defaulting party. LBF subsequently entered bankruptcy proceedings in Switzerland. In 2009, the English court recognised the Swiss bankruptcy proceedings of LBF as foreign main proceedings under the Cross-Border Insolvency Regulations 2006, SI 2006/1030 (the CBIR).

ARIC filed a claim in the Swiss bankruptcy of LBF for the loss under the derivative agreement. LBF rejected ARIC's calculation of loss and contended that ARIC in fact owed it money under the derivative agreement. ARIC's claim under the derivative agreement was assigned to Enasarco, which sought to resolve the loss calculation in the English courts.

The effect of the recognition of the Swiss bankruptcy proceedings as foreign main proceedings was the imposition of an automatic stay of all proceedings in England against LBF (under the CBIR, Sch 1 art 20). Enasarco obtained an order lifting the stay to permit proceedings to resolve issues regarding the derivative agreement, but the court did not determine liability. The liquidators of LBF subsequently rejected ARIC's claim.

In April 2013, Enasarco filed a claim with the Swiss court, challenging the liquidators' rejection of its claim and seeking an order for inclusion of its claim in the schedule of creditors.

In August 2013, Enasarco issued the current proceedings in the English courts seeking recovery of the sums due under the derivative agreement and a declaration that no sums were payable by Enasarco or ARIC to LBF.

Does the Lugano Convention apply?

The purpose of the Lugano Convention is to extend the principles laid down in the Council Regulation (EC) 44/2001 ( the Judgments Regulation) to the parties to the convention. It is accepted that judgments of the Court of Justice of the European Union (CJEU) on the Brussels Convention and the Judgments Regulation provide authoritative guidance on the interpretation of the Lugano Convention.

Insolvency proceedings are excluded from the ambit of the Lugano Convention under art 1(2)(b) because of the special nature of certain matters and of the profound differences between the laws of the contracting states (seeGourdain v Nadler). In addition, work was proceeding on a separate convention for insolvency. This gap has been filled by the Regulation on Insolvency Proceedings (EC) 1346/2000. Professor Peter Schlosser stated that the Brussels Convention and the intended Bankruptcy Convention were 'intended to dovetail almost completely with each other'.

Richards J concluded that 'as regards the exclusion of insolvency proceedings, the Judgments Regulation and the EC Regulation on Insolvency must be read in the light of the other, and the same in my judgment is true of the Lugano Convention'.

As for proceedings relating to the insolvency proceedings, Richards J considered the guidance in Gourdain v Nadler that the scope of application of the EC Regulation on Insolvency should not be broadly interpreted, and 'an action is related to bankruptcy if it derives directly from the bankruptcy and is closely linked to proceedings for realising the assets or judicial supervision'.

Richards J concluded that the Swiss proceedings (relating to construction of the derivative agreement and whether the claim should be included in LBF's schedule of claims) were derived directly from LBF's liquidation and closely connected to it, as the Swiss proceedings:

  1. can only arise under Swiss insolvency law
  2. form an integral part of the liquidation proceedings, designed to achieve the primary purpose of such proceedings, which is the distribution of the assets available to the liquidators among those creditors whose claims are admitted—he proceedings must take place in the court dealing with the liquidation
  3. do not simply establish whether the claimant has a good contractual or other claim, but determine the amount and the ranking of the claim for the purposes of the liquidation:
    • the ranking of claims is a matter arising exclusively under the relevant insolvency law
    • the determination of the relevant amount depends on more than just the contractual or similar rights of the claimant and the company in liquidation
    • a good contractual claim can be reduced or even extinguished for insolvency purposes by cross-claims or other matters arising exclusively under Swiss insolvency law
  4. are self-contained—illustrated by the fact that it does not give rise to claim prevention (res judicata) as between the parties in relation to the underlying contractual dispute

The Swiss proceedings couldn't exist, nor have any relevance outside the Swiss liquidation. As such, the Swiss proceedings fell within the exception to the Lugano Convention.

Should the English proceedings be stayed?

Richards J concluded that there were strong grounds against a stay of the English proceedings:

  1. the exclusive jurisdiction clause in favour of the English courts is itself a powerful factor in support of refusal of a stay and the English court is the natural court to consider the issues raised, because they raise contractual questions governed by English law (see The Alexandros T)—additionally, the derivative agreement incorporates the standard terms of the ISDA Master Agreement which is widely used in all types of derivative transactions on the international markets and plays an important role in the efficient functioning of those markets (see AWB (Geneva) SA v North America Steamships)
  2. it is likely the Swiss court will be greatly assisted by having the judgment of the English court on the rights and liabilities of the parties under the derivative agreement, given that it is governed by English law (seeAWB (Geneva) SA v North America Steamships and UBS AG v Omni Holding AG)—the risk of irreconcilable decisions appears to me to be more theoretical than real as even if the Swiss court came to a conclusion contrary to that reached by the English court, its decision would have effect only within the insolvency proceedings in Switzerland and would create no res judicata as to the substantive rights of the parties
  3. the Swiss proceedings are not significantly closer to resolution than the English proceedings
  4. the merits of having issues arising under the derivative agreement determined by the English court had been recognised by the liquidators of LBF in the past—Richards J was left with the feeling that they considered there was a tactical advantage in seeking to have the matter resolved in Switzerland
  5. it is irrelevant that Enasarco commenced proceedings in Switzerland—in reality, Enasarco had no choice at all in the matter, because the liquidators chose to deal with Enasarco's claims only in the Swiss insolvency proceedings and not through further proceedings in the English courts
  6. there's no reason why ARIC should be required to wait for the determination of this issue, it is entitled to have that issue determined as soon as is reasonably practicable—refusing a stay means that the rights and liabilities of all three parties can be determined in one set of proceedings

What does this mean in practice?

This pragmatic decision is welcomed—it is in everyone interests that claims are dealt with quickly and, where possible, by the courts of one country so dividends can be paid to creditors with agreed claims and the insolvency proceedings concluded quickly, rather than incurring the extra cost and delay arising from a multiplicity of proceedings in several different jurisdictions, further eroding the pot of money available to creditors.


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About the author:
Kathy specialises in restructuring and cross-border insolvency. She qualified as a solicitor in 1995 and has since worked for Weil Gotshal & Manges and Freshfields. Kathy has worked on some of the largest restructuring cases in the last decade, including Worldcom, Parmalat, Enron and Eurotunnel.