Lessons from Lehman: What insolvency issues can be drawn from the latest Waterfall case?

Jessica Walker, senior associate at Mayer Brown International, discusses the insolvency issues raised by the Lehman case in the Supreme Court.

Lehman Brothers International (Europe) (in Administration) (LBIE) has provided the English courts with plenty of opportunity to consider interesting points throughout the course of its nine-year administration (and counting). Most recently, in Re Lehman Brothers International (Europe) (In Administration) [2017] UKSC 38, the Supreme Court has had the opportunity to consider issues that very rarely arise in an insolvency because they relate to the implications of LBIE having a surplus once all unsecured creditors have been paid in full.

While several of the points dealt with in the case in question are specific to the relationships between LBIE and its shareholders, LB Holdings Intermediate 2 Ltd (LBHI2) and Lehman Brothers Ltd, and others relate to the unusual position of those shareholders given that LBIE is not a limited liability company, some parts of the Supreme Court’s decision have wider interest and application. Of most general interest are questions relating to:

• the interpretation of subordination clauses;
• the value of foreign currency claims in an insolvency; and
• the ability to recover post-administration interest in a subsequent liquidation.

The interpretation of subordination clauses

LBHI2 had granted to LBIE a number of subordinated loans. The relevant loan agreements provided that the liabilities owed by LBIE to LBHI2 were subordinated to all other liabilities payable or owing by LBIE unless LBIE was solvent, meaning that it was able to pay all of its liabilities disregarding any “obligations which are not payable or capable of being established or determined in the Insolvency of [LBIE]”. The Supreme Court was required to consider the meaning of these words.

The surplus in LBIE’s administration arose because all unsecured creditors’ provable debts will be paid in full. Provable debts are those for which the insolvent company has liability at the date on which company entered administration, including contingent and future claims, together with any interest to which they are entitled up to that date.

However, there are other categories of claims that fall to be paid after provable debts, namely any claims for debts for which the company was not liable at the date of administration. Those “non-provable debts” as well as statutory interest accruing on provable debts after the date of administration are only payable if all unsecured creditors are paid in full.

LBHI2 contended that its loans were not subordinated to claims for non-provable debts or post-administration interest. It argued that non-provable debts were not “payable in the insolvency” of LBIE because they would only be paid if LBIE were in fact solvent (insofar as all creditors’ claims were paid in full). In respect of statutory interest, LBHI2 argued that it was not payable or owing by LBIE itself but rather it is only payable by an administrator or liquidator under statutory rules.

The Supreme Court disagreed with both of these arguments. It ruled that non-provable debts are payable “in the Insolvency” because a liquidator’s duties cannot be completed until any surplus has been paid to members and there cannot be a surplus if there are still non-provable debts. It also ruled that, even though statutory interest is payable by an administrator or liquidator, the statutory provisions simply reflect the fact that the company would be liable to pay interest up to the date of payment but for the insolvency. As such, statutory interest is a liability of LBIE to which LBHI2 was subordinated under the loan agreements.

The language of the subordination provisions in the loan agreements did not clearly exclude these categories of liabilities from the amounts payable in priority to the subordinated debt. Therefore, subordinated creditors should ensure that the clauses setting out the terms of the subordination are drafted using sufficiently precise language so that it is clear to all parties what liabilities take priority to the subordinated debt.

The value of foreign currency claims in an insolvency

Many of LBIE’s creditors had claims for debts payable in currencies other than sterling. Under English insolvency law, all foreign currency debts are converted into sterling at the official rate on the date of administration. The issue in this case was that sterling had depreciated since the date of LBIE’s administration back in September 2008 so LBIE’s foreign currency creditors argued that the difference in their recovery as a result of that depreciation should be payable as a non-provable debt. Otherwise there would be a contractual shortfall borne by those creditors.

The Supreme Court rejected this argument on the grounds that there was no intention for foreign currency creditors to have two bites at the cherry: the law was clear that the payment of a provable debt in accordance with English insolvency law served to satisfy the underlying contractual claim in full. In addition, if the foreign currency creditors’ argument was correct then it would have to apply in reverse: if sterling appreciated between the date of administration and the date of payment then claims would have to be reduced. This was not the intention of the applicable rules.

The decision affirms that certain costs and losses arising as a result of an insolvency will fall to be met by the relevant creditor. It might be possible to include a clause in a contract that the debtor will be liable for any currency fluctuation between the date on which any statutory conversion takes place and the date of payment, so creating a contingent provable claim for any reduction in the amount payable as a result of a depreciation in sterling. However, it is debateable whether such a clause would be enforceable as a matter of public policy as it is designed to circumvent the order of priority in insolvency legislation. As such, the key to protecting a creditor’s position is likely to be through good account management and keeping outstanding amounts to a minimum at all times.

Recovering post-administration interest in a subsequent liquidation

The Supreme Court also considered whether statutory interest payable to creditors by an administrator could be claimed instead from a subsequent liquidator if the insolvent company went into liquidation following its administration. The Supreme Court’s decision was that it could not: statutory interest payable by an administrator was only payable and could only be claimed from the administrator and not from a subsequent liquidator. This is because the offices of administrator and liquidator are separate and there is no trust of assets handed over from the former to the latter.

While this is perhaps not a controversial decision, it serves as a reminder to creditors in any insolvency to review correspondence and reports from an administrator or liquidator and to submit claims promptly in order to avoid missing out on any returns that may be available.

To sum up

Even where a case covers issues that are unlikely to appear in many insolvencies, it can still provide useful learning points for creditors generally. In this most recent Lehman case, those are:

1. when drafting a subordination clause, it is important to be completely clear about what liabilities are superior;
2. where foreign currency transactions are involved, the creditor should limit as far as possible the amount of exposure and potentially look to recover any losses as a result of currency fluctuation; and
3. in any insolvency, creditors should keep updated about the progress of the insolvency and ensure that all claims are submitted promptly.

This case serves as yet another reminder that creditors must be on top of the game to ensure as far as possible that they are not at risk of irrecoverable claims in an insolvency process.

Jessica Walker is a senior associate at Mayer Brown International.