Repayment in full—ranking debt after Lehmans (Re Lehman Brothers International (Europe) (in administration))

Following the collapse of Lehman Brothers in 2008, what happens when it turns out that their main trading company in Europe is able to repay its external creditors in full? Barry Isaacs QC at South Square Chambers explains the key legal issues and arguments before the Court of Appeal.

Original news

Re Lehman Brothers International (Europe) (in administration) [2015] EWCA Civ 485, [2015] All ER (D) 139 (May)

What was the background to the appeal?

The case arose from the collapse of Lehman Brothers in September 2008, when Lehman Brothers’ main trading company in Europe (LBIE) and one of its shareholders entered administration. Its other shareholder entered administration in January 2009. The issues addressed arose in large part because it had emerged that LBIE is able to repay all its external creditors in full.

What were the legal issues that the Court of Appeal had to decide?

The Court of Appeal addressed a large number of questions, of which the following were the most significant:

  • does the subordinated debt rank for payment in priority to or after statutory interest and non-provable debts?
  • if a creditor who is owed money in a foreign currency receives less than the sterling equivalent at the date of payment, does it have a non-provable claim in LBIE’s administration or liquidation in respect of that loss (a ‘currency conversion claim’)?
  • does the right to statutory interest which has accrued during LBIE’s administration (‘post-administration interest’) survive if LBIE goes into liquidation?
  • do the ‘debts and liabilities’ in section 74 of the Insolvency Act 1986 (IA 1986) mean only the provable debts of the company, or do they include statutory interest and non-provable liabilities? Is LBIE entitled to prove, while in administration, for the liability of its contributories under IA 1986, s 74, or is it only entitled to prove if it is liquidation?

Why did these issues arise?

The ranking of subordinated debt is an issue because LBIE has assets sufficient to pay statutory interest and non-provable debts. The existence of currency conversion claims arises for the same reason, and because LBIE has creditors with substantial debts denominated in foreign currencies which have appreciated between the date of conversion into sterling and the payment date. The existence of post-administration interest also arises because there is a surplus, and because the judge held that, if LBIE were to go into liquidation, creditors would not receive post-administration interest. The issues in relation to the liability under IA 1986, s 74 arise because LBIE is an unlimited company in administration and therefore has contributories who are potentially liable under IA 1986, s 74.

What were the main legal arguments put forward?

Subordinated debt

It was said on behalf of the subordinated lenders that the payment of statutory interest out of the surplus under rule 2.88(7) of the Insolvency Rules 1986, SI 1986/1925 (IR 1986) in administration or IA 1986, s 189(2) in liquidation is not payment of a sum ‘payable or owing by the Borrower’ within the meaning of the subordinated debt agreements. Rather, it is a direction to the administrator or liquidator about how to deal with a fund under his control. It was also said that statutory interest and non-provable claims were not ‘payable or capable of being established or determined in the Insolvency of the Borrower’.

Currency conversion claims

The argument in favour of the existence of the currency conversion claims is threefold. The first strand is reliant on the theory of ‘reversion to contract’ expressed in Re Humber Ironworks and Shipbuilding Company (1869) LR 4 Ch App 643, which was that, as soon as it is ascertained that there is a surplus, creditors are remitted to their contractual rights. The second strand takes as its starting point the proposition that a winding up is a collective enforcement process and contends that the underlying debt is unaffected by the enforcement process. If one method of enforcement turns out to realise insufficient amounts to satisfy the judgment, it remains unsatisfied and the judgment creditor may turn to another form of execution. The third strand is that the payment of the debts and liabilities of a company before any distribution to members is divided into a first stage of payment of provable debts and a second stage of payment of non-provable claims. Both IR 1986 rr 2.86 and 4.91 open with the words ‘[f]or the purpose of proving a debt’. Accordingly the conversion of the foreign currency debt into sterling is applicable only to the first stage, leaving any residual foreign currency loss to be dealt with as an unprovable liability at the second stage.

Post-administration interest

It was argued that where the insolvency code intends to create a charge it does so expressly—see IA 1986, Sch B1, para 99, creating charges securing a former administrator’s expenses and remuneration and certain other obligations. Since there is no such provision, there is no obligation to pay post-administration interest.

Liability under IA 1986, s 74

The appellants contended that the liability of members under IA 1986, s 74 is circumscribed by the extent and purposes of the power to make calls, which exists only for the specified purposes of the statutory scheme. Leaving aside expenses and the adjustment of the rights of contributories, those purposes are confined to the payment of provable debts.

The principal argument in relation to proof of the liability under IA 1986, s 74 turned on whether the third element of the test in Re Nortel GmbH (in administration) [2013] UKSC 52, [2013] 4 All ER 887 was satisfied—that is, whether proof it is consistent with the statutory scheme. Re Pyle Works (1889) 44 Ch D 534 points to the conclusion that an administrator cannot prove for a call that could only be made by a liquidator. So, too, do the statutory provisions which give the power to make the calls to the court and, by delegation, to the liquidator as an officer of the court.

What did the Court of Appeal decide, and why?

Subordinated debt

The subordinated debt is repayable on contingencies that include payment of statutory interest and payment of any non-provable liabilities. As a matter of construction of the subordinated loan agreements, the payment of statutory interest is payment of a sum payable or owing by the borrower within the meaning of the agreements. This is because:

  • the statutory provisions governing statutory interest are not expressed as directions to the office-holder;
  • the office-holder acts as agent of the company, and
  • the surplus is vested in the company and interest is therefore paid from the company’s bank account

Statutory interest and non-provable claims are payable or capable of being established or determined in the insolvency of the borrower. Statutory interest is payable only because of IA 1986, s 189 or IR 1986, r 2.88 and therefore forms part of the insolvency code. The liquidator’s duties continue until the moment comes to make a distribution to members whether under IA 1986, ss 107 or 143(1). That being so, the liquidator must pay those claims before making a distribution to members.

Currency conversion claims

On this issue, Lewison LJ dissented. The majority, Briggs LJ and Moore-Bick LJ, held that the conversion into sterling of foreign currency debts as at the cut-off date is, as IR 1986, rr 2.86 and 4.91 make clear, for the purpose of proof only. There is nothing in the IA 1986 or in the IR 1986 which prevents the foreign currency creditor reverting to his contractual rights, once the process of proof and payment of statutory interest has run its course, if there is then a surplus.

Post-administration interest

IR 1986, r 2.88(7) applies to a surplus which arises or can be shown to have arisen in the course of the administration—but the requirement to pay interest is not limited to a direction to the administrator. It is a statutory instruction that the surplus cannot be applied for any purpose other than paying statutory interest. It is not necessary to select a suitable private law label by which to describe this statutory instruction. There is no conflict with IA 1986, s 189, which is concerned with a surplus in a liquidation. If a fund comes into the hands of the liquidator already burdened by an obligation to pay interest to creditors who proved in the administration, so much of the fund as must be applied for that purpose will not count in the liquidation as making up part of any future surplus. The judge’s solution that an entitlement to statutory interest could be pursued in a liquidation as an independent non-provable claim was inconsistent with the prevailing policy to discourage and where possible to eliminate non-provable claims.

Liability under IA 1986, s 74

A contributory’s liability under IA 1986, s 74 extends to all the liabilities of the company. If, as IA 1986, s 74 expressly provides, that liability extends to adjusting the rights of contributories, which are at the bottom of the waterfall of liabilities, the contributory’s liability encompasses liabilities that are higher up the waterfall. It follows that the liability encompasses the creation of a surplus out of which to pay statutory interest since that ranks higher than both non-provable claims and the rights of contributories as between themselves.

If, at the time when a contributory enters an insolvency process a potential future call cannot be proved, then such a claim, when it materialises, would not rank as a provable claim but would be relegated to the dwindling category of non-provable claims, because the cut-off date would have been missed. That would run counter to the clear trend of expansion of provable claims and reduction of non-provable claims that have characterised the development of the insolvency code since Re Pyle Works was decided. It would also be a defect in the insolvency code if members of a contributory were entitled to be paid out before a claim under IA 1986, s 74 could be made.

To what extent is the judgment helpful in clarifying the law in this area?

The judgment, being one of the Court of Appeal, is binding at first instance. However, as the judge recognised, the issues are difficult and free of authority. The parties have applied for permission to appeal to the Supreme Court.

Barry Isaacs QC appeared for LBHI at first instance and on appeal. He specialises in insolvency and restructuring, banking and finance, and commercial litigation. He is an Associate of the Society of Actuaries. In recent years, Barry has appeared in numerous cases in the Supreme Court/House of Lords (eg, Lehman Brothers/Nortel, Rubin/New Cap Reinsurance, Sigma Finance, Mainstream Properties, Three Rivers v Bank of England), in the Court of Appeal (eg, Woolworths, Davenham Trust, FKI v Stribog, Golden Key, Whistlejacket Capital, OT Computers), and at first instance, including several major trials and arbitrations.

Interviewed by Kate Beaumont.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Further Reading

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Waterfall of payments in liquidation, administration and administrative receivership

Obligation to settle liabilities before the receipt of any dividend—contributories and calls

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First published on LexisPSL Restructuring and Insolvency

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