Lehman Brothers International (Europe) v CRC Credit Fund Ltd

The Court of Appeal considered the scope and timing of the statutory trust created by the Financial Services Authority's Client Assets Sourcebook (CASS7) under section 139 FSMA and its interaction with the MiFID Directives. The court held that CASS7 imposes a statutory trust on client money from the moment the firm receives it, not only upon segregation into client accounts. It also held that, on a primary pooling event (for example administration), the client money pool includes both monies in segregated client accounts and identifiable client money held in the firm’s house accounts, and that distribution of the pooled fund is to be made on a claims (entitlement) basis rather than a contributions basis. The court further held that sums which the firm merely owes to clients but has not appropriated or segregated for them (for example unpaid manufactured dividends not set aside) do not qualify as client money under CASS7.

The appeal concerned competing interpretations of CASS7 in the context of LBIE's entry into administration on 15 September 2008 and substantial client monies which had been held under the firm's alternative approach to segregation. The main legal questions were:

• Whether the statutory trust imposed by CASS7 arises on receipt of client money or only on segregation;
• Whether the client-money pool formed on a primary pooling event comprises only monies in segregated client accounts or also identifiable client money in house accounts;
• Whether participation in the pool depends on actual contribution to the segregated pool (contributions basis) or on contractual entitlement to client money (claims basis); and
• Whether sums merely owed by the firm to a client (but not appropriated or segregated) are "client money".

Background and procedure: the appeal came from Briggs J (Chancery Division) whose conclusions were that a statutory trust arose on receipt but that pooling was limited to segregated accounts and distribution should be on a contributions basis as at the firm's last internal reconciliation prior to the primary pooling event. The Court of Appeal (Arden LJ, Lord Neuberger MR, Sir Mark Waller) heard argument from numerous parties including LBIE affiliates, funds with segregated accounts and representatives of non-segregated clients, plus submissions from the administrators and the FSA as interested party.

Issues and reasoning:

• On timing of the trust the court concluded (following textual analysis of CASS7.2.1R and CASS7.7.2R and having regard to the objectives of MiFID and the Implementing Directive) that the statutory trust applies on receipt of client money. The court considered the verbs "receives" and "holds" and the purpose of immediate protection and found a trust from receipt workable and consistent with the Directives’ aim to prevent use of client funds for the firm's account.
• On the composition of the pool the court accepted that the term "client money account" in CASS7.9.6R must be read in context and that CASS7's purpose points to pooling of all identifiable client money (both segregated and identifiable monies in house accounts) because CASS7.9 applies to a firm that "holds client money" and the distribution regime is designed to facilitate timely return of client money to clients on failure.
• On the basis for sharing the court preferred a claims/entitlement basis. "Client money entitlement" in CASS7.9.6R was read as referring to contractual entitlement (calculated in accordance with CASS7.9.7R and Annex 1) rather than a pure contributions measure derived from the firm's last reconciliation; practical "glitches" and adjustment problems under a contributions approach weighed against it.
• On self-generated debts the court held that sums which the firm merely owed to a client but had not appropriated or segregated were not client money for CASS7 purposes; a trust requires identifiable property to which it can attach.

Disposition: the Court allowed the appeals in part: it upheld the judge's conclusion that the statutory trust arises on receipt, but overturned his conclusions limiting pooling to segregated accounts and restricting distribution to a contributions basis; it confirmed that sums merely due and payable by the firm but not segregated are not client money.

Appeal allowed in part. The court held that (1) CASS7 imposes a statutory trust on client money from the moment the firm receives it; (2) on a primary pooling event the client-money pool includes both monies in segregated client accounts and identifiable client money in the firm’s house accounts; (3) distribution of that pool is on a claims (contractual entitlement) basis (calculated in accordance with CASS7.9.7R/Annex 1), not merely on a contributions basis; and (4) sums merely owed by the firm to clients but not appropriated or segregated do not constitute "client money" under CASS7.

On appeal from the Chancery Division (Briggs J) [2009] EWHC 3228 (Ch) to the Court of Appeal, neutral citation [2010] EWCA Civ 917. The Court of Appeal heard argument and delivered this judgment allowing the appeal in part (see Arden LJ, Lord Neuberger MR and Sir Mark Waller).