Lehman Brothers Holdings Scottish LP 3 v Lehman Brothers Holdings Plc ((in Administration))
| Jurisdiction | England & Wales |
| Judge | Lord Justice Lewison,Lord Justice Henderson,Lady Justice Asplin |
| Judgment Date | 20 October 2021 |
| Neutral Citation | [2021] EWCA Civ 1523 |
| Court | Court of Appeal (Civil Division) |
| Docket Number | Case Nos: A3/2020/1787 A3/2020/1811 |
[2021] EWCA Civ 1523
Lord Justice Lewison
Lord Justice Henderson
and
Lady Justice Asplin
Case Nos: A3/2020/1787
A3/2020/1810
A3/2020/1811
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
BUSINESS AND PROPERTY COURTS OF ENGLAND AND WALES
COMPANIES COURT (Chancery Division)
Mr Justice Marcus Smith
[2020] EWHC 1681 (Ch)
Royal Courts of Justice
Strand, London, WC2A 2LL
Case No: A3/2020/1787
Mark Phillips QC, William Willson and Edoardo Lupi (instructed by Weil, Gotshal & Manges (London) LLP) for the Appellant
Adrian Beltrami QC and Adam Kramer QC (instructed by Hogan Lovells International LLP) for the Respondent (1)
Sonia Tolaney QC, Richard Fisher QC and Tim Goldfarb (instructed by Alston & Bird (City) LLP) for the Respondent (2)
Peter Arden QC and Rosanna Foskett (instructed by Dentons UK and Middle East LLP) for the Respondent (3)
Case Nos: A3/2020/1810 and A3/2020/1811
Lexa Hilliard QC and Tom Roscoe (instructed by Charles Russell Speechlys LLP) for the Appellant (1)
Sonia Tolaney QC, Mr Richard Fisher QC and Tim Goldfarb (instructed by Alston & Bird (City) LLP) for the Appellant (2)
Mark Phillips QC, William Willson and Edoardo Lupi (instructed by Weil, Gotshal & Manges (London) LLP) for the Respondent (2)
Hearing dates: 4 – 8 October 2021
Approved Judgment
Introduction
The main issues on this appeal concern the order of priority for payment of subordinated debt which came into existence for regulatory purposes. There are four relevant claims which the judge (Marcus Smith J) labelled Claim A, Claim B, Claim C and Claim D. His judgment is at [2020] EWHC 1681 (Ch).
The issues arise in the context of the distributing administration of LB Holdings Intermediate 2 Ltd, (LBHI2) a UK company in the Lehman Brothers group.
The participants and the claims
Both Claims A and B are claims against LBHI2. Claim A arises under two long-term subordinated loan facility agreements and one short-term subordinated facility agreement. Lehman Brothers Holdings plc (PLC) was the lender and LBHI2 was the borrower. Claim B arises out of floating rate subordinated loan notes issued by LBHI2 pursuant to an offering circular. These notes are held by Lehman Brothers Holdings Scottish LP3 (SLP3).
Claims C and D, by contrast, are both claims against PLC. They can be satisfied out of what PLC receives under Claim A. Claim C arises under two long-term subordinated loan facility agreements and one short-term subordinated loan facility agreement. Lehman Brothers UK Holdings Ltd was the lender and PLC was the borrower. Because of assignments, the creditor now is Lehman Brothers Holdings Inc (LBHI), which is the ultimate holding company of the group. Claim D arises out of subordinated loan notes issued by PLC pursuant to offering circulars. This claim is now advanced by LB GP No 1 Ltd (GP1) and Deutsche Bank. The flow of funds is illustrated diagrammatically in an appendix to this judgment.
It is common ground that although the administrators will have substantial funds to distribute to subordinated creditors (somewhere between £800 million and £1 billion, some of which has already been distributed), it is not enough to satisfy all claims by subordinated creditors. It is therefore necessary to resolve the priority as between them.
The waterfall
In Re Nortel GmbH [2013] UKSC 52, [2014] AC 209 at [39] Lord Neuberger said:
“In a liquidation of a company and in an administration (where there is no question of trying to save the company or its business), the effect of insolvency legislation … as interpreted and extended by the courts, is that the order of priority for payment out of the company's assets is, in summary terms, as follows:
(1) Fixed charge creditors;
(2) Expenses of the insolvency proceedings;
(3) Preferential creditors;
(4) Floating charge creditors;
(5) Unsecured provable debts;
(6) Statutory interest;
(7) Non-provable liabilities; and
(8) Shareholders.”
It is this ordering of priorities that is called the “waterfall”. As Lord Neuberger subsequently made clear, however, in Re Lehman Brothers International (Europe) (In administration) (No 4) (“ Waterfall 1”) [2017] UKSC 38, [2018] AC 465 at [17], his description was not intended to be a quasi-statutory statement of immutable legal principle. As can be seen from this description of the waterfall, shareholders come last in the queue.
The actual decision in that case was that subordinated debt, which ranked for regulatory purposes as capital, was payable after non-provable liabilities, but before any return to shareholders.
Regulatory capital
For many companies, the amount of its capital is the nominal amount for which shareholders subscribe. Shares may be ordinary shares or preference shares. The terms on which the preference shares are issued may entitle the holders of preference shares to priority over ordinary shareholders in the event of an insolvency. In the case of banks, however, certain loans may also qualify as capital for regulatory purposes.
David Richards J explained the regulatory regime in detail in Waterfall 1 at first instance: [2014] EWHC 704 (Ch), [2015] Ch 1. It is not necessary to repeat that description. It is sufficient to note, for the purposes of these appeals, that the regulators permitted three types (or tiers) of capital, which David Richards J described as follows:
“[43] The characteristics of tier 1 capital were that it was able to absorb losses, it was permanent, it ranked for repayment upon winding up, administration or similar procedures after all other debts and liabilities and it had no fixed costs, such as an obligation to pay dividends or interest. The most common example of tier 1 capital is ordinary share capital.
[44] Tier 2 capital was capital which did not meet the requirements of permanency and lack of fixed costs which were required for tier 1 capital. There were two types of tier 2 capital. Upper tier 2 capital was capital which was perpetual but which carried servicing costs which could not be waived at the firm's option. It specifically included cumulative preference shares. Lower tier 2 capital was capital which was either not perpetual or had fixed servicing costs that could not generally be waived or deferred. It was required generally to have an original maturity of at least five years and specifically included medium-to long-term subordinated debt.
[45] Tier 3 capital was described by GENPRU as forms of capital conforming less well to the characteristics of tier 1 capital. It specifically included subordinated debt of short maturity.
[46] Subordination was a characteristic of all three tiers of capital.”
Such subordinated debt could take the form of a loan facility agreement or subordinated loan notes. Priority for payment as between these various forms of regulatory capital would be in reverse order (i.e. Tier 3 before Tier 2; and Tier 2 before Tier 1). Thus the very structure of regulatory capital shows that there can be relative priority as between the various tiers. It follows that the mere fact that something is intended to be regulatory capital does not necessarily tell you anything about its place in the queue.
Subordination
In principle, debts other than preferential debts rank equally between themselves and, after the preferential debts, must be paid in full unless the assets are insufficient for meeting them, in which case they abate in equal proportions between themselves: Insolvency (England and Wales) Rules 2016 (“IR”) rule 14.12. This is the familiar pari passu principle.
The pari passu principle (which ultimately derives from the maxim that “equality is equity”) is an important principle in insolvency law. In Re Golden Key Ltd [2009] EWCA Civ 636 Arden LJ put it this way:
“[5] Pari passu provisions are commonly found in debentures. A provision for pari passu repayment can, however, be implied if it is clear that the debenture holders are to stand on an equal footing (see for example Murray v Scott (1883–4) 9 App Cas 519). Accordingly, where a document on its true interpretation provides for the distribution of assets to a group of persons as between whom no distinction is to be drawn, the court will imply a requirement to make distributions proportionately even though the words “equally” or “ pari passu” are not used. Such an implication is not, however, possible where the document evinces an intention that the distribution should be on some other basis.
[6] Given its importance, the concept of pari passu distribution can be taken to be part of the background to the issue of the [commercial paper] that would have been known to the parties. …The concept of pari passu distribution may also be a factor which makes one interpretation more plausible than another.”
Mr Phillips QC, for SLP3, argued that in order to displace the pari passu principle there must be “clear and unequivocal language to the contrary.” I do not consider that Arden LJ went that far. What she said was that the instrument in question must evince a contrary intention; and in deciding whether it did, the pari passu principle “may be” a factor for preferring one interpretation over another. Moreover, Arden LJ was dealing with the rights of persons holding under the same title (or deriving rights from the same contract) as between themselves,...
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