Vol 11 (2014) - Issue 4

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Re Lehman Brothers International (Europe): High Court Rules in Favour of Creditors’ Claims for Post-Administration Interest

Now in its sixth year, the administration of Lehman Brothers International (Europe) Ltd ('LBIE') continues to throw up complex legal questions. The latest decision, handed down by Mr Justice David Richards in the High Court, is a compendious, insightful and at times challenging judgment which deals with a wide range of interconnected issues concerning the payment of distributions. This article discusses some of the key issues addressed by the Court, most notably in relation to the payment of post-administration interest. The Court has granted the parties permission to appeal the decision.

Subordination
One of the more unusual aspects of the LBIE administration is that unsecured creditors are likely to be repaid in full. When the Lehman group collapsed in September 2008, in what turned out to be the eye of the global financial crisis, the prospect of a full recovery seemed highly remote. However, it subsequently became clear that whilst creditors of the group (particularly creditors of the US Lehman companies) would, on average, find themselves out of pocket, those with claims against LBIE would fare substantially better than most. News of a potential surplus saw claims changing hands well above par and raised the prospect of returning value to LBIE's parent companies in the United States.
The issue at the centre of the Lehman application concerned claims owed by LBIE to its immediate holding company (Lehman Brothers Holdings Intermediate 2 Limited ('LBHI2')) in relation to USD 2.25 billion of subordinated loan debt, which constituted part of LBIE's Tier 3 regulatory capital (the 'Subordinated Liabilities '). The instrument under which the loans were made stated that LBHI2 could not, without the prior written consent of the FSA:
'(d) attempt to obtain repayment of any of the Subordinated Liabilities … [or] (e) take or omit to take any action whereby the subordination of the Subordinated Liabilities … to the Senior Liabilities might be terminated, impaired or adversely affected'.

LBHI2, joined as respondent by Lehman Brothers Holdings Inc. (the US parent holding company in Chapter 11), accepted that the Subordinated Liabilities should rank behind LBIE's other unsecured debts, but argued that this was the full extent of the subordination and that, as such, they were not subordinated to statutory interest or any 'non-provable' liabilities (discussed below) payable in the administration.
Pursuant to Rule 2.88(2) of the Insolvency Rules 1986 (the 'Rules'), interest is not provable for the period of administration. However, Rule 2.88(7) allows the payment of interest to the extent that a surplus remains after all proved debts have been repaid at a rate comprising the greater of (i) the contractual rate and (ii) the statutory rate under the Judgments Act 1838, currently set at 8%. Given the ultra-low interest rates which prevail in the current economic environment, such a recovery would be manna from heaven to yieldhungry investors.
LBHI2 argued, amongst other things, that the effect of Rules 2.88 (2) and (7) prevented the administrators of LBIE paying any interest before they had repaid the subordinated claims. However, the Court did not agree and found that the 'Senior Liabilities' included statutory interest and non-provable claims accruing since the administration began, and therefore had priority over LBHI2's claims.
As Richards J himself remarked, the Court's reading of the subordination provisions is perhaps not all that surprising. However, the finding emphasises the importance of clear drafting in subordination provisions, and draftsmen may consider recommending to their clients the benefits of specifically providing for the application of proceeds in circumstances where a surplus of assets is available.