Re Lehman Brothers International (Europe)

The Court of Appeal dismissed the appellant's challenge to Mr Justice Briggs' findings that, as between Lehman Brothers International (Europe) (LBIE) and Lehman Brothers Finance S.A. (LBF), the operation known as "Rascals" gave rise to a trust in favour of the affiliate on acquisition but that beneficial title passed back to LBIE under the first repo on-leg and thereafter remained vested in LBIE throughout the automatic Rascals sequence (the "cradle-to-grave" conclusion). The court accepted the judge's conclusions that (i) a trust of intangible securities can be sufficiently certain in subject-matter (applying and distinguishing authorities on tangible goods), (ii) the parties' course of dealing and accounting produced an estoppel by convention preventing LBF from denying the accounting position, and (iii) the automatic sequence of repos meant title passed to LBIE on the on-leg and did not revert to LBF absent payment on the off-leg.

The court rejected alternative legal bases urged by LBF and others: it did not accept that the Inter-Company Funding Agreement (ICFA) operated to make LBHI the debtor in place of LBF where the contemporaneous records and conduct showed otherwise; nor did it treat mere internal "offset" entries as intrinsically effective at law absent the estoppel or a true set-off found not to have been proved on the evidence. The court left open narrowly defined exceptions for manual Rascals stock loans entered into after the last effective month-end pay-down (31 July 2008) where different accounting timing could leave beneficial title with LBF.

This appeal arose from the collapse of the Lehman group and concerned ownership of securities acquired by LBIE for the account of affiliates under a global settlements practice and then processed by an internal mechanism called Rascals. The Rascals processes (automatic for many fixed-income securities and manual for many equities) involved back-to-back accounting entries implementing on-legs and off-legs of repos or open-ended stock loans so as to achieve regulatory and operational objectives within the group.

Nature of the proceedings and relief sought

• The administrators of LBIE contested the entitlement of LBF to beneficial title in securities appearing in LBIE's depots at the point of LBIE's administration.
• Issues were raised by LBF and other affiliates, and the appeal concerned whether beneficial title ever passed to the affiliate, whether title passed back to LBIE by the first repo on-leg, continuity of title through successive repos, the legal effect of internal accounting "offsets" and any estoppel by convention, and consequences of steps taken after administration (including notices of termination and system tag changes on 16 and 23 September 2008).

Key factual and procedural background

LBIE acted as the European settlement hub, acquiring securities from the street in its name even when bought for affiliates. The Rascals project (implemented from 1996) was designed to address perceived regulatory capital and custody issues by substituting ownership or equivalent proprietary arrangements within the group, recorded by the ITS trade settlement system and fed into the group general ledger (DBS). LBIE settled acquisitions in house depots, used securities for short-term finance by lending them to the street, and the group performed monthly pay-downs that novated unsecured intercompany balances to LBHI.

Issues framed

• Whether the Rascals processes intended to, and did as a matter of law, prevent the affiliate from ever obtaining beneficial title (Respondent's Notice).
• Whether LBIE paid the on-leg price of the first repo so as to reacquire beneficial title, and whether accounting "offsets" or a set-off effected payment.
• Whether title remained continuously vested in LBIE through the sequence of repos (the "cradle-to-grave" argument).
• Whether the ICFA altered the debtor-creditor relationships so as to prevent LBF owing LBIE for acquisition prices.
• Consequences of termination notices after administration and of changes to ITS tags on 23 September 2008.

Court's reasoning on the principal issues

• The court accepted that, on acquisition for an affiliate, LBIE held the securities on trust for the affiliate (subject to a specialised trusteeship that allowed LBIE to mix and use fungible intangible holdings). The judge's application of the line of authority about intangibles (notably Hunter v Moss) meant the trust did not fail for uncertainty of subject-matter.
• The court rejected the submission that the ICFA automatically made LBHI the debtor in place of LBF where the parties' contemporaneous records, mutual course of dealing and the parties' acquiescence pointed the other way. The appellate court concluded that, notwithstanding the ICFA wording, the parties had acted on a shared conventional assumption that LBF was indebted to LBIE in the intercompany records.
• The court held that actual legal payment under the repo terms depended on payment, but because the parties uniformly operated the Rascals machinery by book entries and mutual accounting, an estoppel by convention arose. On that estoppel (which the judge and the Court of Appeal accepted), LBF was prevented from denying that LBIE had paid or was entitled to treat the on-legs as generating title to LBIE. The court was cautious about treating internal ITS "offset" entries as a legal set-off absent the estoppel or fuller proof of legal set-off.
• On continuity, the court adopted the "cradle-to-grave" analysis: title passed to LBIE on the first repo on-leg and, by operation of successive repos and the accounting convention, remained vested in LBIE until resale to the street. The court disapproved arguments that short intra-day gaps or book entries showing settlement of off-legs meant title reverted to LBF where no payment was in fact made.
• The court recognised narrow exceptions for manual Rascals stock loans entered into after the last confirmed month-end pay-down (treated as 31 July 2008): in such late manual cases beneficial title could remain with LBF unless LBIE can show collateral was paid in some other manner or securities were acquired after that date.

Other points

The court recorded that it would not determine issues of lien or equivalent equitable proprietary remedies in this proceeding because earlier case management orders had expressly deferred those issues to other proceedings.

Appeal dismissed and Respondent's Notice dismissed. The court upheld Briggs J's main conclusions: securities acquired for LBF were held by LBIE on trust for the affiliate, but title passed to LBIE under the first repo on-leg and remained vested in LBIE throughout the automatic Rascals sequence by reason of the parties' mutual course of dealing and an estoppel by convention; internal accounting offsets did not by themselves displace that conclusion. Narrow exceptions were left for manual stock loans entered after the last effective month-end pay-down (31 July 2008).

Appeal from Chancery Division (Mr Justice Briggs) [2010] EWHC 2914 (Ch) to the Court of Appeal, neutral citation [2011] EWCA Civ 1544; interlocutory directions below excluded determination of lien issues.