MF Global UK Ltd, Re Investment Bank Special Administration Regulations 2011

This is an application to enable a settlement agreement to be made which would compromise and release all tracing and other claims between MF Global UK Limited (MFGUK) as trustee of the trust of client money and the general estate of MFGUK acting by its joint administrators.

The client money trust arises under the rules applicable to investment firms which receive from or hold money for their clients, contained in chapters 7 and 7A (CASS 7 and CASS 7A) of the Client Assets Sourcebook section of the Financial Services Authority Handbook. These rules required investment firms to segregate such money and hold it on trust for their clients and, in circumstances including an administration of the firm, to distribute the money held for clients among the clients, pro rata according to their entitlements. For these purposes all client money held at the relevant date is pooled. For this reason I will refer, as the parties did, to the client money trust as the client money pool (CMP), and to MFGUK in its capacity as trustee as the CMP Trustee.

These rules, albeit in an earlier version, were analysed in Lehman Bros International (Europe) v CRC Credit Fund Ltd[2012] Bus LR 667 for the purpose of determining the basis on which clients were entitled to participate in the distribution of client money. The Supreme Court held that the distribution should be on the basis of the amount which the firm should at the relevant time have been holding for the clients respectively, not the amount of client money in fact held for them at that time.

MFGUK was part of the MF Global group which carried on business as broker-dealers in financial markets throughout the world. The group’s principal operations in London were carried on by MFGUK. It and other companies in the group entered insolvency proceedings in the United States and England on 31 October 2011. Administrators of MFGUK were appointed under the Investment Bank Special Administration Regulations 2011.

MFGUK held funds in, at least, two different capacities. It held money for clients as trustee of the client money trust. It also held money beneficially on its own account. The client money trust arose out of the same business operations as resulted in its own assets and liabilities, profits and losses. Clients could be both beneficiaries under the trust and creditors or debtors of the firm. On their appointment, the administrators therefore became responsible both for the duties and rights of MFGUK as the CMP Trustee and for the due administration of the general estate of MFGUK. The potential for conflict of duty between these two capacities is one of the principal reasons for the present application.

It is common ground that at the date of administration there was a shortfall in the CMP. The shortfall arose because MFGUK was required, but failed, to treat a number of clients as being entitled to the protection of CASS 7 and was, therefore, required but failed to segregate money received from or on behalf of those clients but, instead, treated them as creditors.

These accepted breaches of trust gave rise to two possible claims by the CMP Trustee against the general estate of MFGUK.

First, there could be a proprietary claim to any client money received by MFGUK from or on behalf of clients which remains identifiable in any of the house accounts of MFGUK or in its traceable proceeds. Secondly, personal claims to compensate the CMP for the breaches of trust could be made. Estimates of the amount of the personal claim ranged between approximately $9.4 million and approximately $43.9 million plus administration costs resulting from the breach of trust, which would be no more than approximately $1-2 million.

The assets available both in the CMP and in the general estate were such that, even without resolution of these claims, by April 2014 cumulative distributions amounting to 76 pence in the £ to unsecured creditors, and amounting to 78.5 cents in the $ to clients out of the client money trust assets, had been made or announced. Further distributions were not possible without resolution of the issues between the CMP and the general estate. Those issues included not only the CMP’s proprietary and personal claims against the general estate but also possible claims by the general estate against the CMP in respect of funds comprising part of the CMP which the firm would have been entitled, but for the administration, to withdraw for its own account.

The administrators formed the view that it would be beneficial both to clients and to general creditors if these claims could be compromised rather than fought out through court proceedings. There are a number of reasons for this.

First, the total level of recoveries from both the CMP and the general estate is expected to be high. Distributions from the general estate are expected to total between 94 and 100 pence in the £. It is expected that distributions from the client money trust will total between 85 and 90.5 cents in the $.

Second, the existence of clients’ claims against the general estate referred to above, as well as the high level of recoveries, means that the resolution of many, perhaps all, of the outstanding issues is unlikely to make a material difference in terms of the likely outcome for clients and creditors.

Third, the proprietary or tracing claims face practical difficulties. An immense amount of work would be required to identify payments of money into MFGUK’s accounts representing client money and to work out whether such money remained identifiable in those accounts as at the date of administration. By way of illustration, in the 11 days before the commencement of the administration there were approximately 10,000 receipts and payment instructions in respect of MFGUK’s 259 house bank accounts with an aggregate value of over £30 billion. Once that investigatory work was complete, a number of complex legal issues would be likely to arise. These include issues such as the correct treatment where trust money is paid into an account, but the balance on that account is later reduced below the level of the payment in, and thereafter non-trust money is paid into the account. A further issue is whether for these purposes different accounts with the same credit institution should be aggregated, a question which was raised but not resolved in relation to Lehman Brothers. These issues would be likely to involve appeals.

Fourth, a resolution of these issues through a settlement agreement rather than through protracted court proceedings would significantly accelerate the final distributions from the CMP and the general estate and would involve significant cost savings.

On account of these solid grounds for attempting to seek a compromise agreement, I gave directions on 1 May 2014 to enable meaningful negotiations to take place, notwithstanding the dual capacities of the administrators. I directed that for the purposes of such negotiation, and for the purposes of the present hearing, one of the administrators, Richard Fleming, should represent MFGUK as CMP Trustee, with named leading and junior counsel and a team from the administrators’ solicitors led by a named partner, and that one of the other administrators, Richard Heis, should represent the general estate, again with named leading and junior counsel and a different team from the administrators’ solicitors led by a different named partner. I further directed that, if a settlement was agreed in principle pursuant to negotiations between these parties, all persons who have claims or who have asserted claims as clients or creditors should be notified in writing of the agreement, with an opportunity to be heard at any hearing to approve the compromise.

Negotiations were successful in arriving at the terms of a compromise agreement. The final negotiations were preceded by position papers provided by the parties and by discussions between the legal teams to narrow the issues.

The process of negotiation is described in evidence filed by or on behalf of Mr Fleming and Mr Heis. In view of the difficulties involved in establishing the quantum of any proprietary claims and the fact that there was likely to be a high level of distribution from the general estate, the negotiations focused on the personal claims for breach of trust. The maximum value of the claim advanced for the CMP was approximately $43 million, plus costs. The primary position on behalf of the general estate was that there should have been a final reconciliation of client money as at the date of administration, in which event the general estate would have been required to pay approximately $9.4 million to the CMP. The settlement agreement provides for a compromise of this claim by the payment of a little over $31 million from the general estate to the CMP, payable in full even if the dividend payable by the general estate to unsecured creditors is less than 100p in the £.

In order to make a final distribution of client money, the CMP will have to sell or otherwise realise all of its remaining non-cash assets and resolve all outstanding claims against it. It was agreed that the general estate would pay approximately $29.86 million for an assignment of all outstanding receivables due to the CMP. This amount incorporated a discount on the book value of the assets (approximately $32.55 million) which took into account the risk of non-recovery, the costs of recovery and the time value of money. It was further agreed that the general estate should be given credit of approximately $12.84 million for the netting of a liability of the CMP against a general estate asset in a proposed settlement with a third party.

The amount payable for the assignment of receivables will be subject to adjustment, to reflect any receipt of receivables by the CMP prior to payment of the settlement amount and to take account of any movements in the US dollar value of the receivables as a result of exchange rate changes. Adjustments will also be made if the proposed settlements with third parties are not achieved.

Finally, agreement was also reached as to the sharing of costs of the two estates down to the closure of the CMP.

Notification of the terms of the proposed settlement, together with an explanation of the key issues, the procedure followed in its negotiation and an explanation of the impact of the settlement on the likely final distributions from the CMP and the general estate, was given to creditors and clients in accordance with the directions contained in my earlier order. The administrators have also held discussions with the creditors and clients who constitute the creditors committee. No objections to the proposed settlement have been received from any party and none appeared at the hearing of this application.

I am satisfied on the basis of the evidence before the court and the submissions made by counsel for the CMP and the general estate, that the terms of the proposed settlement are in the best interests of both the CMP and the general estate.

Although the application is made jointly by the CMP Trustee and by the administrators, the legal basis of the application differs as between MFGUK in its capacity as trustee of the client money trust and the administrators of MFGUK acting in the interests of the general estate.

As trustee of the client money trust, MFGUK relies on the powers conferred by section 15 of the Trustee Act 1925. So far as relevant, it provides:

The only express statutory limitation on this power is contained in section 69(2) of the Trustee Act 1925:

The terms of the client money trust are contained in CASS 7 and CASS 7A. While there is no doubt that they create a statutory trust, the terms of the trust and the powers of the firm as trustee are not spelt out as they would normally be in the case of a traditional private law trust. This is not surprising given the very different context of the trust of client money, as discussed in the Lehman Bros case referred to above.

There is nothing in the provisions of CASS 7 and CASS 7A which expressly excludes the statutory power of compromise contained in section 15. It would be very surprising if it were excluded. The operation of the client money rules, and the pooling and distribution of client moneys which occurs on events such as insolvency prescribed by the rules, combined with the complexity of the operations of many investment firms, make it not only foreseeable but highly likely that difficulties and disputes will arise. These difficulties are well illustrated by the various proceedings which have taken place in the cases of both Lehman Brothers and MF Global. The difficulties relate both to the entitlements of clients and those claiming to be clients and to claims as between the trust and the general estate and other third parties. In order to enable the client money trust to be administered as effectively and as economically as possible, it is essential that the trustee should have a power to compromise claims. Nothing in CASS 7 or CASS 7A, in my view, suggests any intention to the contrary.

I am satisfied therefore that MFGUK in its capacity as the trustee of the CMP has the power to compromise the claims between it and the general estate on the terms which have been negotiated. In making the present application, it is not surrendering the exercise of its discretion to enter into the compromise agreement to the court. Rather this application falls into that category described in an unreported judgment of Robert Walker J in 1995 and cited by Hart J in The Public Trustee v Cooper[2001] WTLR 901 at 923:

The present application is not a perfect fit within that description. First, as indicated above, it has been necessary to consider whether the CMP Trustee has the necessary power to compromise these claims, although it has not proved a difficult question to answer. Secondly, compromise of difficult legal issues is not necessarily in the same category as decisions whether to dispose of the principal asset of the trust. I would prefer not to say whether, in a different case, it is “most unlikely that the court would be persuaded in the absence of special circumstances to accept the surrender of discretion” on the making of a compromise. Having said that, I would readily accept that (as I do in the present case) that experienced professional trustees and insolvency practitioners, with the benefit of expert legal advice, are well-placed to negotiate and decide on a compromise.

The circumstances which make it appropriate for the CMP Trustee to make the present application arise out of, first, the fact that the individuals acting on behalf of the CMP and the general estate hold office as joint administrators of MFGUK and are partners in the same firm of accountants. Secondly, there is a close inter-relationship between the persons who are, or claim to be, clients with beneficial interests in the CMP and creditors of the general estate. In many cases, they are the same people.

In my judgment, these are considerations which make it appropriate that the CMP Trustee should apply for liberty to enter into the proposed settlement agreement.

The approach to be adopted by the court on such an application is, I believe, accurately set out in Lewin on Trusts (18^th ed. 2008) at para 29-299:

Applying this approach, I am satisfied that Mr Fleming, with the benefit of appropriate legal advice, and acting on behalf of the CMP Trustee has properly formed the view that the proposed compromise is for the benefit of clients as beneficiaries of the trust and that there is no reason why the court should not give liberty to the CMP Trustee to enter into the proposed compromise, and indeed every reason why it should do so.

I have earlier indicated the reasons which led the administrators to conclude that it would be sensible to seek an overall compromise. They have all been important considerations in the conclusion to which the CMP Trustee has come.

In addition, Mr Zacaroli QC appearing on behalf of the CMP Trustee, explained the other considerations to which Mr Fleming has had regard.

First, Mr Fleming has of course taken and relied on legal advice. Without waiving privilege, Mr Zacaroli explained that the personal claims raise novel legal issues, particularly in relation to the unusual type of trust constituted by the CASS rules, involving amongst other features constantly fluctuating amounts to be held on trust. These factors would lead any reasonably prudent claimant to discount the full value of its claim.

Secondly, if there is no settlement, the CMP will continue in existence at a considerable cost for a period of 2 to 3 years. This would involve substantial further costs, quite apart from the costs of litigation. The upper estimate of those costs is of the order of $11 million. This needs to be set against the discount of $13-15 million involved in the settlement as against the maximum possible amount of the CMP’s claim.

Thirdly, for all clients other than those described as “decreased clients”, the size of the likely payments from the general estate are such that the proposed compromise of the CMP’s claims make little if any material difference to their position. The position of decreased clients was considered in Re MF Global UK Ltd[2013] EWHC 2556 (Ch), [2014] 1 BCLC 91. They are clients with open positions at the commencement of the administration which later closed at a lower value. Other clients, being those whose open contractual positions increased after the pooling event occurring on the appointment of the administrators, and those clients whose contractual positions were unchanged can recover either against the CMP or by way of their contractual claim against the general estate. The increase in their open positions after the pooling event gives rise to a contractual claim but not to a claim against the CMP. Decreased clients by contrast, have claims against the CMP which are larger than their contractual claims. An element of their claims is therefore recoverable only out of the CMP and their position is therefore generally improved by an increased distribution from the CMP. The greater the recovery by the CMP, the greater the recovery by decreased clients.

The decreased clients were held in Re MF Global Ltd [2014] 1 BCLC 91 to have personal claims against the general estate for the default of MFGUK in setting aside the funds required for their claims as at the pooling date. These were referred to as shortfall claims. The shortfall claims may be asserted either by the CMP Trustee or by clients as beneficiaries. If proceedings were bought by the CMP Trustee, the outcome of those proceedings would bind the beneficiaries. Likewise, as it seems to me and as both Mr Zacaroli QC and Mr Pascoe QC submitted, a settlement of such claims entered into by the CMP Trustee will likewise bind the clients as beneficiaries. It follows that the decreased clients will lose their shortfall claims as a result of the proposed settlement.

These are all considerations which the CMP Trustee has had to take into account in considering whether it is appropriate to settle the potential claims on the terms proposed. Having regard to all the factors mentioned above, the CMP Trustee is satisfied that the settlement is in the best interests of the decreased clients as well as the other clients. This is a view with which I agree, although I need only be satisfied that the CMP Trustee’s decision is a reasonable decision taken on proper grounds.

The basis of the application by the administrators in their capacity as such arises under the provisions of the insolvency legislation. They have a clear power to compromise claims under para 60 of schedule B1, and para 18 of schedule 1, to the Insolvency Act 1986, as applied by reg. 15 of the Investment Bank Special Administration Regulations 2011. In commercial matters, administrators are generally expected to exercise their own judgment rather than to rely on the approval or endorsement of the court to their proposed course of action: see Re T&D Industries plc[2000] 1 WLR 646. While the compromise of claims raising difficult legal issues may not be on all fours with a purely business decision, administrators commonly exercise the power of compromise without recourse to the court and in general apply to the court for directions only if there are particular reasons for doing so: see Re Lehman Brothers International Europe[2013] EWHC 1664 (Ch). The present application is made by the administrators in their capacity as such for the same reasons as the application made by the CMP Trustee, in particular because the administrators are involved on both sides.

Many of the reasons which make the proposed compromise a good outcome for the CMP apply equally to the general estate.

There are additional reasons why Mr Heis considers it to be in the interests of the general body of unsecured creditors.

First, the early closure of the CMP following the proposed settlement will crystallise the value of parallel claims against the general estate. Until that time there is a significant foreign exchange risk, arising because the value of parallel claims is calculated by reference to the sterling value of US dollar distributions from the CMP as at the dates of such distributions. Secondly, the settlement will reduce the value of parallel claims against the general estate. By increasing the assets of the CMP, the amount to be paid in settlement will result in a higher level of distribution out of the assets of the CMP, thereby reducing the value of the parallel claims against the general estate. Thirdly, as explained above, the proposed settlement will eliminate all shortfall claims against the general estate. Fourthly, the elimination of shortfall claims and the reduction of parallel claims substantially offsets the reduction in the assets available to the general estate resulting from the payment of the proposed settlement amount. Fifthly, Mr Heis has calculated that the effect of additional costs resulting from a full tracing exercise and full litigation of the issues would, even if the general estate were to be wholly successful and obtain an order for recovery of its costs, leave the general estate worse off than its position following the proposed settlement.

For all these reasons, Mr Heis, with the benefit of his own expert legal advice, has concluded that the proposed settlement is in the best interests of the general estate and the general body of unsecured creditors. I am satisfied that this is, at the very least, a reasonable conclusion for him to reach and it is accordingly an appropriate case in which to direct that he be at liberty to enter into the proposed settlement.

For the reasons given in this judgment, and explained in the evidence and submissions put before the court, I am entirely satisfied that it is appropriate to make the order sought, giving liberty to the CMP Trustee and to the administrators to enter into the proposed settlement agreement.

Two further matters are dealt with in the order.

First, in exercise of powers conferred on it by section 138A of the Financial Services and Markets Act 2000, the Financial Conduct Authority has given a direction that MFGUK may, in a final distribution of the CMP, disregard the client money entitlement of any client that has not submitted a client money proof but is shown in MFGUK’s records as having a client money entitlement, provided that the various steps set out in the direction are taken. Consequent upon this direction, the Client Money Distribution Procedure, previously approved by the court, will be amended by deleting the requirement to retain a provision for such claims.

Secondly, a sum of $83,000 of uncollected client money in respect of approximately 35 admitted client money proofs is held by the administrators in circumstances where the claimants have not completed the formalities required to receive the sums due to them. They have not responded to communications encouraging them to complete these formalities. The Insolvency Service has agreed to receive this sum into the Insolvency Service Account at the Bank of England, subject to a direction of the court to that effect. This appears to me a sensible way of dealing with this matter, as an alternative to the conventional route of a payment into court. I accordingly make the necessary direction.