Pearson & Ors v Lehman Brothers Finance SA & Ors

In determining beneficial ownership of securities held through an intermediary, the court must assess objectively whether the parties intended proprietary rights or merely personal rights. A trust of part of a fluctuating fungible fund may satisfy certainty requirements where the fund and each beneficiary’s proportionate share are sufficiently ascertainable. Commercial permission to mix or use property is a strong indication against a trust, but does not automatically prevent one. Where securities are acquired subject to an agreed repo or stock-loan process intended to transfer title, the process may give the intermediary absolute title, including where payment is made by effective contractual offset. A final off-leg does not return title without the required payment. A Quistclose resulting trust will not ordinarily arise where the transaction was intended to confer unfettered use and security upon the recipient.

The joint administrators of Lehman Brothers International (Europe) sought directions concerning the beneficial ownership of securities acquired for Lehman affiliates and held in LBIE’s depot accounts when LBIE entered administration on 15 September 2008. The securities had been processed under the group’s Automatic Rascals repo system or Manual Rascals stock-loan system.

The principal disputes concerned whether the affiliates acquired proprietary interests on acquisition, whether the Rascals transactions transferred those interests to LBIE, whether the final Automatic Rascals off-leg returned title, and whether payment, novation, insolvency or resulting-trust principles altered the position. The court also addressed the distinct contractual and accounting arrangements applicable to each respondent.

The application was determined by reference to the securities remaining in LBIE’s depots and the particular arrangements with each respondent.

1. Trust principles. A proprietary interest in property legally held by another presupposes a trust. A trust of part of a sufficiently identified fungible mass does not fail for uncertainty merely because the mass fluctuates. Where the parties have authorised depletion and replacement of the fund, any shortfall may be shared pari passu unless the parties intended otherwise.
2. Objective intention. Agency or brokerage is only a pointer towards a trust. The court must examine the whole commercial relationship. Permission to mix and use securities for the intermediary’s own cash flow strongly militated against a trust before Rascals, because the affiliates had personal rights to the economic benefits and no obligation required LBIE to maintain a matching pool.
3. Effect of Rascals. After implementation, eligible securities were acquired on the mutual understanding that they would be Rascalled. That process necessarily assumed an initial proprietary interest in the affiliate, which was then transferred to LBIE by the repo or stock-loan on-leg. The conclusion applied to the securities in issue, subject to the separate uncertainty concerning LBCCA and the limited LBI stock loans.
4. Automatic Rascals. The daily repos were intended to secure continuous title in LBIE from acquisition to resale. Book-entry offsets constituted payment where mutual debts were available for that purpose. The final off-leg did not transfer title back because the affiliates did not pay the repurchase price. The computerised recording of the off-leg did not waive that condition. The administrators’ alternative case under paragraph 64 of Schedule B1 to the Insolvency Act 1986 was addressed but was unnecessary to the result.
5. Manual Rascals and Quistclose. The open stock loans transferred title where collateral had been paid or effective payment was established. The subsequent insolvency did not create a resulting trust: the transactions gave LBIE unfettered use of the securities and were intended to secure repayment of collateral.
6. Respondents. LBF, LBSF and LBCCA/LBAH retained no proprietary interest in the relevant securities. LBI retained a proprietary interest in the ten stock loans for which payment of collateral was not proved, but not in the three for which payment was established.