LB Holdings Intermediate 2 Ltd, The Joint Administrators of v Lehman Brothers International (Europe), The Joint Administrators of & Ors [2017] UKSC 38

Following Lehman Brothers' 2008 collapse, the Supreme Court resolved multiple insolvency law questions arising from LBIE's surplus administration, including subordinated debt ranking, foreign currency conversion claims, post-administration interest, contributory liabilities in unlimited companies, and the extension of the contributory rule to administrations.

Facts

Lehman Brothers International (Europe) (LBIE), an unlimited company and the Lehman group’s main European trading entity, entered administration in September 2008. Contrary to expectations, LBIE proved able to repay all external creditors in full, generating a substantial surplus. LBHI2 (LBIE’s immediate parent) and LBL (the service company) held LBIE’s shares and were both creditors and potential contributories. LBHI2 had also made three subordinated loans to LBIE in 2006. Numerous creditors held debts denominated in foreign currencies. The administrators sought directions on multiple issues arising from the surplus.

Issues

The Supreme Court addressed seven principal issues: (1) the ranking of LBHI2’s subordinated debt in the waterfall; (2) whether foreign currency creditors could claim a ‘currency conversion shortfall’ as a non-provable liability where sterling depreciated between administration and payment; (3) whether unpaid post-administration statutory interest under rule 2.88(7) could be claimed in a subsequent liquidation; (4) whether contributories under section 74 could be liable for statutory interest and non-provable liabilities; (5) whether LBIE could prove in the administrations of LBHI2 and LBL for their contingent contributory liabilities; (6) whether such liabilities could be set off; and (7) whether the contributory rule applies in administrations.

Judgment

Subordinated debt

The subordinated debt ranks behind both statutory interest and non-provable liabilities. Statutory interest payable under section 189 and rule 2.88(7) constitutes a ‘Liability’ ‘payable or owing by’ LBIE within the meaning of the Loan Agreements, and is payable ‘in the Insolvency’. Non-provable liabilities are also payable ‘in the Insolvency’ because a liquidator must in practice discharge them before distributing any surplus to members. LBHI2 cannot lodge a proof for the subordinated debt until non-provable liabilities have been paid in full.

Currency conversion claims

By majority (Lord Clarke dissenting), the Court held that foreign currency creditors cannot claim any shortfall arising from sterling’s depreciation between the administration date and the date of payment. Rule 2.86 mandatorily converts foreign currency debts into sterling at the administration date and constitutes a complete code for such debts. The Cork Report and Law Commission had specifically considered and rejected the suggestion of subsequent revaluation. Rule 2.72(1)’s reference to recovering a debt ‘in whole or in part’ supports the conclusion that payment in full of a proof satisfies the underlying contractual debt.

Post-administration statutory interest

Rule 2.88(7) interest, if unpaid during administration, cannot be claimed from a subsequent liquidator. Rule 2.88(7) applies only while the company is in administration; section 189(2) only covers post-liquidation interest. Although likely an oversight by the legislature, the Court cannot rewrite the statute. Furthermore, the contractual right to interest does not revive: rules 2.88 and 4.93 and section 189 provide a complete statutory code displacing any judge-made right.

Contributory liability

Section 74 ‘liabilities’ extends to non-provable liabilities (since a liquidator must pay these before any surplus goes to members) but not to statutory interest, because statutory interest is payable only out of an existing surplus and cannot itself create the surplus. LBIE cannot prove in the administrations of LBHI2 or LBL for their prospective section 150 contributory liabilities: calls are made by the liquidator on behalf of the court, the resulting fund is not company property until a winding-up commences, and permitting such proofs would produce serious anomalies. For the same reasons, set-off under rule 2.85 is unavailable.

The contributory rule

The contributory rule in Grissel’s Case, as discussed in Kaupthing (No 2), should be extended to distributing administrations. Administrators may retain sums otherwise payable to contributory-creditors pending resolution of their contributory liability. This avoids the injustice of paying contributories on their proofs whilst they retain unsatisfied contributory liabilities.

Implications

The decision provides authoritative guidance on the operation of the insolvency ‘waterfall’ in surplus administrations, a situation rare but of substantial commercial significance, as illustrated by the Lehman case itself. Key practical points include: (i) subordinated creditors rank behind statutory interest and non-provable liabilities, reflecting the commercial expectation that subordinated lenders are ‘at the bottom of the waterfall’; (ii) foreign currency creditors bear the risk of sterling depreciation between the cut-off date and payment, even in solvent administrations; (iii) there is a legislative lacuna concerning post-administration statutory interest where a company moves from administration into liquidation, which only Parliament can remedy; (iv) section 74 of the 1986 Act remains a powerful tool against members of unlimited companies, extending to non-provable liabilities; and (v) the contributory rule has been extended to administrations to prevent injustice. The judgment also contains important obiter discussion (particularly by Lord Sumption) on the fundamental nature of insolvency proceedings as procedural rather than substantive, leaving open whether payment of a proof in full discharges the underlying contractual debt. The decision matters principally to insolvency practitioners, creditors of unlimited companies, holders of subordinated debt, and foreign currency creditors, and underlines the importance of careful contractual drafting where parties wish to alter waterfall priorities.

Verdict: The Supreme Court allowed the appeals in part. It restored paragraph (i) of David Richards J’s order (subordinated debt ranks behind statutory interest and non-provable liabilities, and cannot be proved for until non-provable liabilities are paid); discharged paragraphs (ii) and (iii) (foreign currency creditors cannot claim currency conversion shortfalls); restored paragraph (iv) (rule 2.88(7) interest cannot be claimed in subsequent liquidation); upheld discharge of paragraph (v) (contractual interest does not revive); varied paragraph (vi) (section 74 covers non-provable liabilities but not statutory interest); and discharged paragraphs (vii), (viii) and (ix) (the contributory rule extends to administrations; LBIE cannot prove for or set off prospective section 150 liabilities). Lord Clarke dissented on the currency conversion issue.

Source: LB Holdings Intermediate 2 Ltd, The Joint Administrators of v Lehman Brothers International (Europe), The Joint Administrators of & Ors [2017] UKSC 38