Vol 9 (2012) - Issue 5

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Lehman Brothers International Europe: Client Money Decision

Decision
The Supreme Court handed down judgment in the Lehman Brothers Client Money Application on 1 March 2012. The majority (Lords Clarke, Dyson and Collins) dismissed the appeal by GLG. Lord Dyson gave the lead judgment for the majority. The majority held:

1. that the client money trust arises upon receipt and not upon the segregation of client money, irrespective of whether the firm adopted the 'normal' or 'alternative' approach to segregation of client money;
2. that on a firm’s insolvency all client money identifiable, in whatever account of the firm into which client money has been received, is pooled for distribution; and
3. that the client money pool is to be distributed to all clients in accordance with each client’s respective contractual entitlement to have had client money segregated for it at the date of pooling and irrespective of whether any money had in fact been so segregated or had been recorded by the firm as having been so segregated.

Wider relevance
The decision is likely to have significant consequences for the administration of Lehman Brothers including in particular the identification of client money held in accounts other than the firm’s segregated accounts.
The decision will extend to all current financial service insolvencies. The Client Assets chapter of the FSA’s Handbook ('CASS') has not been substantially revised in the years following the administration of Lehman Brothers in September 2008 and the rule, as now explained by the Supreme Court, will apply to the administration of a number of other estates including the special administration of MF Global UK.

Key issues
Trust on receipt /on segregation
The first key issue was whether the statutory trust arose upon the receipt of client money or only upon its segregation. (So far as client money which arose otherwise than by receipt, e.g. where the firm was required to appropriate and segregate client money from its own resources for a particular client, the Court of Appeal had held that the trust arose only upon appropriation and segregation of the specific sum. Permission to appeal against that aspect of the decision had already been refused). The point taken to the Supreme Court concerned money received from clients and/or third parties on their behalf where the firm operated the 'alternative approach'. It was common ground that the 'normal approach' did not allow the firm any freedom to deal with client money, so that the trust arose upon receipt of the funds.
The Supreme Court held that the 'alternative approach', which allowed a firm to receive client money into its own account for a time, was only one method that a firm might adopt to comply with its obligation to segregate client money and that that method did not affect or undermine the obligation to hold client money as trustee from the moment of receipt.

Client money pool
The second key issue was whether the pool of client money constituted upon a firm’s failure extended to all client money, in whatever accounts, or only to money which had been segregated as at the date of pooling.