Lehman Brothers Luxembourg Investments S.A.R.L. v Lehman Brothers UK Holdings Ltd

On 13 January 2016 I heard argument on a Part 8 claim brought by Lehman Brothers Luxembourg Investments S.à.r.l. (“the Company”), asking the court to rule on a question which has arisen about the legal status of certain payments made, or expected to be made, to the Company by the administrators of its wholly-owned subsidiary, Lehman Brothers UK Holdings Limited (“LBUKH”). The payments in question are part repayments of subordinated loans made by the Company to LBUKH under three subordinated loan facility agreements (two long term, and one short term) made between June 2004 and July 2005. The issue, in short, is whether the repayments should be held in trust for LBUKH and/or any as yet unknown creditors of LBUKH, or whether the repayments are held by the Company free from any trust and are available, in particular, for distribution to the Company’s own creditors.

The Company considers that the answer to this question is clear, namely that the repayments are not held on trust and are at its free disposal. However, the sums involved are very large: the Company is an agreed creditor of LBUKH for over £1 billion, and the part repayments are likely to be in the region of £100 million. In these circumstances, the Company understandably wishes to have the question determined by the court so that there will be certainty. The claim form therefore seeks orders stating that no trust exists under the standard conditions which govern the three loan agreements, and that the repayments can therefore be received by the Company for use in the ordinary course of its business, including for distribution to its creditors.

The only defendant is LBUKH, which supports the Company’s claim. As I shall explain, the claim is also supported, or at least not opposed, by certain other parties with a potential interest in the outcome. Further, there is nobody, as matters now stand, in whose interest it would be to argue against the claim. I have therefore not had the benefit of adversarial argument on the question, and need to be correspondingly careful before granting what is, in effect, declaratory relief. I was nevertheless satisfied, having read the skeleton arguments of Felicity Toube QC for the Company and Louise Hutton for LBUKH, and having heard brief oral submissions from them, that I could properly make the order sought. I therefore said at the conclusion of the hearing that I would make the order with immediate effect, but would give my reasons in writing later.

This judgment contains the reasons which led me to make the order.

The Company was incorporated on 27 September 2001 under the law of Luxembourg. The Company is a member of the Lehman Brothers Group under the ultimate parent, Lehman Brothers Holdings Inc., which entered an insolvency process under Chapter 11 of the US Bankruptcy Code on 15 September 2008, and came out of bankruptcy on 6 March 2012. The purpose for which the Company was established was to undertake, in Luxembourg and elsewhere, financing operations by granting loans to corporations belonging to the Lehman Group.

The Company is the sole ordinary shareholder of LBUKH, which was incorporated on 17 November 1986 under the law of England and Wales. LBUKH was established as a holding company for various companies in the Lehman Group and existed principally to manage the flow of investment funds between its subsidiaries. LBUKH entered administration on 29 September 2008, two weeks after the order of the English High Court on 15 September 2008 had placed a number of European affiliates and subsidiary undertakings of the Lehman Group into administration. There are currently four joint administrators of LBUKH, one of whom, Gillian Bruce, has provided a witness statement on behalf of LBUKH in the present proceedings.

As Ms Bruce explains in her evidence, realisations in LBUKH’s estate have been greatly in excess of the amounts initially estimated in its statement of affairs dated 7 January 2009. As at 28 September 2015, there were net receipts of £103,728,922 held by the administrators. The only creditors of LBUKH recorded on the statement of affairs were the Company and Lehman Brothers UK Holdings (Delaware) Inc (“Lehman Delaware”). One further small creditor was later identified, whose claim was settled in full, including any claim for statutory interest, by a payment of £70,000. No other creditors have emerged, although a website had been set up to give creditors of the various Lehman entities information about the different Lehman estates. The absence of other creditors is unsurprising, given the inter-company function of LBUKH.

Lehman Delaware is an unsecured unsubordinated creditor, and was paid its proved claim of £5.5 million in full on 4 September 2014. By a deed of waiver and confirmation in the form of a letter dated 20 November 2015, Lehman Delaware confirmed that it had “no further claims whatsoever against LBUKH and the Administrators, whether actual, contingent, current, provable or otherwise”. It follows that Lehman Delaware has irrevocably waived any claim which it might otherwise have for statutory interest, that being one of the questions subject to a pending appeal to the Supreme Court in the “Waterfall” litigation: see In Re Lehman Bros International (Europe) (in Administration) (No. 4) [2015] EWCA Civ 485, [2015] 3 WLR 1205 (“Lehman (No. 4”).

The Company is an agreed creditor of LBUKH in the amount of £1,053,076,219.24, being the total amount advanced by the Company to LBUKH under the three subordinated loan agreements. On 16 February 2015, the Company was paid a first dividend of £50,000 in respect of its debt, which it placed in a trust account at Barclays Bank Plc pending determination of the present claim. The probable total distribution which the Company will receive remains uncertain, but according to Ms Bruce the administrators expect to be able to distribute between £70 million and £79 million in the first half of 2016, and subject to final tax clearance a further cash dividend of between £22 million and £32 million may follow later in the year.

The Company entered into three subordinated loan facility agreements with LBUKH, namely:

Each agreement is in substantially the same standard form, which follows the standard Financial Services Authority (“FSA”) templates in use at the time (although the two long term agreements, dated 23 July 2004, in fact used an earlier 1998 version of the template). This gives rise to a problem, because neither LBUKH nor the Company was ever regulated by the FSA (now the Financial Conduct Authority, “the FCA”), but each agreement contains provisions designed to ensure compliance with various requirements of the FSA, and makes certain provisions subject to the consent of the FSA. The probable explanation for this curious feature of the documentation appears to be that a number of other intra-group loans were made using the same templates, and the ultimate end borrower in the series of loans was Lehman Brothers International (Europe) (“LBIE”), which was regulated by the FSA. It may therefore have been thought appropriate to make the intermediate loans subject to the same requirements as a loan made directly to LBIE.

The problem remains, however, that there are a number of provisions in the loan agreements between the Company and LBUKH to which no meaningful content can be given in the absence of regulation of either entity by the FSA or the FCA. Counsel therefore submitted that, as a matter of construction, the inappropriate references to the FSA or its regulatory requirements should be disregarded, on the footing that something has plainly “gone wrong with the language”: see Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101, at [22] to [25] per Lord Hoffmann. I am cautiously prepared to proceed on this basis, while recognising that if the present issue turned on any of the offending provisions, I would probably need much fuller evidence of the relevant surrounding circumstances before I could reach a firm conclusion on their intended purpose and the extent to which they should be disregarded. In adopting this approach, I am encouraged by the fact that notice of the present proceedings was given to the FCA, which stated on 2 October 2015 that it had no objection to the application and would not seek to intervene.

It may also be relevant to note that each of the three agreements shows signs of having been carelessly drafted. For example, the two long term agreements omit the words “the payment of such sum shall be void for all purposes” from paragraph 5(5) of the standard terms, and in paragraph 7(2) of the variable terms of the short term agreement the maximum amount of the facility is wrongly shown in figures as $800 million (although it is correctly stated, in words, as eight thousand million US dollars).

In each agreement, the variable terms identify the date, and the effective date, of the agreement, the identities of the lender and the borrower, the nature and maximum amount of the facility, the basis upon which interest shall be calculated and paid, and the terms for repayment. The terms for repayment are expressly made subject to paragraph 5 (subordination) of the standard terms.

Paragraph 5 of the standard terms in the short term loan agreement is headed “Subordination”, and provides as follows:

“5(1) Notwithstanding the provisions of paragraph 4, the rights of the Lender in respect of the Subordinated Liabilities are subordinated to the Senior Liabilities and accordingly payment of any amount (whether principal, interest or otherwise) of the Subordinated Liabilities is conditional upon –

(a)

(if an order has not been made or an effective resolution passed for the Insolvency of the Borrower …) the Borrower being in compliance with not less than 100% [the figure is 120% in the two long term agreements] of its Financial Resources Requirement immediately after payment by the Borrower …; and

[(b)] the Borrower being “solvent” at the time of, and immediately after, the payment by the Borrower and accordingly no such amount which would otherwise fall due for payment shall be payable except to the extent that the Borrower could make such payment and still be “solvent”.

(2)

For the purposes of sub-paragraph (1)(b) above, the Borrower shall be “solvent” if it is able to pay its Liabilities (other than the Subordinated Liabilities) in full disregarding –

(a)

obligations which are not payable or capable of being established or determined in the Insolvency of the Borrower; and

(b)

the Excluded Liabilities.

(3)

Interest will continue to accrue at the rate specified pursuant to paragraph 3 on any payment which does not become payable under this paragraph 5.

(4)

For the purposes of sub-paragraph (1)(b) above, a report given at any relevant time as to the solvency of the Borrower by its Insolvency Officer, in form and substance acceptable to the FSA, shall in the absence of proven error be treated and accepted by the FSA, the Lender and the Borrower as correct and sufficient evidence of the Borrower’s solvency or Insolvency.

(5)

Subject to the provisions of sub-paragraphs (6), (7) and (8) below, if the Lender shall receive from the Borrower payment of any sum in respect of the Subordinated Liabilities –

(a)

when any of the terms and conditions referred to in sub-paragraph (1) above is not satisfied, or

(b)

where such payment is prohibited under paragraph 4(3),

the payment of such sum shall be void for all purposes.

(6)

Any sum referred to in sub-paragraph (5) above shall be received by the Lender upon trust to return it to the Borrower.

(7)

Any sum so returned shall then be treated for the purposes of the Borrower’s obligations hereunder as if it had not been paid by the Borrower and its original payment shall be deemed not to have discharged any of the obligations of the Borrower hereunder.

(8)

A request to the Lender for return of any sum referred to in sub-paragraph (5) shall be in writing and shall be made by or on behalf of the Borrower or, as the case may be, its Insolvency Officer.”

The “Subordinated Liabilities” are defined as meaning “all Liabilities” to the Company “in respect of the Loan or each Advance made under this Agreement and all interest payable thereon”, while the “Senior Liabilities” are defined as meaning “all Liabilities except the Subordinated Liabilities and Excluded Liabilities”. For present purposes, the definition of “Excluded Liabilities” may be ignored, because there are none. Accordingly, the basic principle of subordination effected by the opening words of paragraph 5(1) was to make the Company’s rights to repayment of principal and interest on the loans subject to the Senior Liabilities, which in the present context means all other liabilities of LBUKH. The definition of “Liabilities” could hardly be wider, as it embraces:

“all present and future sums, liabilities and obligations payable or owing by the Borrower (whether actual or contingent, jointly or severally or otherwise howsoever).”

In order to give effect to the principle of subordination, payment of any amount by LBUKH in respect of the loan is then made conditional upon the matters set out in sub-paragraphs 5(1)(a) and (b). As Lewison LJ said in Lehman (No. 4) at [38], this is one of the three ways in which subordination agreements can be drawn. In respect of a similarly worded clause in a different agreement, he said:

“Clause 5 imposes conditions on the right to repayment. If no insolvency process has begun then the condition in clause 5(1)(a) must be satisfied. Whether or not an insolvency process has begun, the condition in clause 5(1)(b) must also be satisfied. In my judgment clause 5(1) means that the right to repayment of the subordinated debt is a contingent right, contingent on the satisfaction of clause 5(1)(b) and, if appropriate, clause 5(1)(a) as well.”

In the present context, the condition in paragraph 5(1)(a) may be disregarded, because the definition of “Insolvency” includes administration, and LBUKH has been in administration since 29 September 2008. The only condition which has to be satisfied, therefore, is the “solvency” condition in paragraph 5(1)(b). Provided LBUKH is “solvent”, within the meaning of the sub-paragraph, “at the time of, and immediately after” any payment which it makes to the Company, the condition will be satisfied. If, however, the condition is not satisfied, any payment received by the Company from LBUKH will be “void for all purposes” under sub-paragraph (5), and will be held by the Company upon trust to return it to LBUKH under sub-paragraph (6).

This would also be the case, by virtue of sub-paragraph 5(b), if the payment were prohibited under paragraph 4(3), but the provisions of that paragraph, which in certain circumstances require the permission of the FSA to be obtained, relate only to payments made before the relevant repayment date. Since the repayment date for all three loans has already occurred, this further condition can also be ignored.

The issue, therefore, comes down to this: was LBUKH “solvent”, within the meaning of paragraph 5(1)(b), when it made the initial repayment of £50,000 to the Company, and (more importantly) will it also be solvent when the further proposed repayments are made?

In my judgment, the answer to this question is indeed clear. LBUKH is solvent for the purposes of paragraph 5(1)(b), and this will continue to be the position unless and until some further liability, at present unknown, comes to light. Provided that LBUKH has no notice of any further liabilities when it makes the proposed further repayments to the Company, the solvency condition will be satisfied, because the question has to be judged “at the time of, and immediately after” the payment. The mere theoretical possibility that a further liability might come to light in the future would be irrelevant.

The starting point of the analysis, in my view, is that the “Liabilities” of LBUKH, despite the width of the definition quoted above, cannot sensibly be construed as including liabilities and obligations which are unknown and may never materialise. If that construction were correct, the possibility of an unknown creditor coming to light could probably never be eliminated, with the consequence that the definition of “solvent” in paragraph 5(2) could never be satisfied, and repayments of the subordinated loan could never be made. There are three factors from which I derive support for this view. First, the focus in paragraph 5(1)(b) on “the time of, and immediately after, the payment” by LBUKH indicates that the question of solvency has to be determined by an examination of the borrower’s liabilities as they are known to be at that time (including, of course, known contingent liabilities). Secondly, in the absence of very clear language, the parties cannot reasonably have contemplated that LBUKH should have to establish the negative proposition that there was no possibility of any unknown creditors coming to light in the future. Thirdly, paragraph 5(4) provides machinery for establishing solvency in the form of a report by the Insolvency Officer of LBUKH, which is to be treated and accepted by the parties as correct and sufficient evidence of solvency “in the absence of proven error”. I do not see how failure to make provision for future liabilities, which are ex hypothesi unknown, could possibly be regarded as a proven error. On the contrary, this provision strongly suggests to me that the question of solvency has to be determined in a commercially sensible manner. As Ms Toube QC submits, the time at which “proven error” should be determined is now, and not some theoretical future time.

If solvency is to be determined on the basis of known liabilities at the time of repayment, there can be no question but that the condition is currently satisfied. There are only two known creditors of LBUKH apart from the Company, and they have both been paid in full. Neither of them still has a contingent claim to statutory interest on its debt. Furthermore, it is now well over seven years since LBUKH entered administration, and despite the advertisements and procedure for proof of debts described in the evidence, no further creditors have yet come to light. The possibility of any creditors emerging in the future must therefore be remote in the extreme.

On the evidence before me, I am satisfied that the solvency condition is satisfied without the need for a formal report under paragraph 5(4). It might be possible to regard Ms Bruce’s statement as in substance constituting such a report, but I prefer not to rely on this argument when there is no formal report and it has not been approved by the FCA. There is only one qualification which needs to be added. In the unlikely event of a further liability coming to light before the proposed repayments are made, it would of course be necessary for LBUKH to settle that liability in full before the repayment was made. Otherwise, the condition in paragraph 5(1)(b) would not be satisfied at the relevant time, and the payment would be received by the Company upon trust to return it to LBUKH. That possibility apart, however, I am satisfied that the Company is entitled to the relief claimed.

For completeness, I should also note that the position of the Company is supported by its major unsecured creditor, Lehman Brothers Limited, and by its unsecured subordinated creditor, Lehman Delaware. In addition, the application is not opposed by LBIE.