In the matter of Lehman Brothers International (Europe) (In Administration) and In the matter of the Insolvency Act 1986

This appeal concerned the meaning and operation of the client money rules (CASS 7) made under section 139 of the Financial Services and Markets Act 2000, and in particular the statutory trust stated in CASS 7.7.2R and the client money distribution provisions in CASS 7.9.6R and 7.9.7R. The court was unanimous that the statutory fiduciary relationship (trust in England and Wales and agency in Scotland) arises on receipt of client money, not only on segregation.

The majority of the court (Lords Dyson, Clarke and Collins) held that on a primary pooling event (for example, the firm’s insolvency) the distribution regime in CASS 7 should be given a purposive construction: identifiable client money held in any firm account into which client money has been paid (not only segregated accounts) may be treated as part of the notional pool and the right to participate in the distribution is determined by the client money entitlement calculated in accordance with CASS 7.9.7R (the 'claims' basis), rather than by the amount actually segregated (the 'contributions' basis). This construction, the majority held, best promotes the MiFID/Implementing Directive objectives of a high level of client protection.

A contrary view was expressed by Lords Walker and Hope who would have preferred (on the assumed facts and for practical reasons) that the client money pool consist primarily of segregated funds as identified by the last internal reconciliation and that a final reconciliation at the primary pooling event should be carried out to take account of movements in the short gap period; they favoured the contributions theory for participation. The Supreme Court by majority dismissed the appellant's challenge.

Background and procedural posture:

• The case arose from applications for directions in the administration of Lehman Brothers International (Europe) ("LBIE") about the approach to be taken to client money under CASS 7 (Client Money: MiFID business). Briggs J at first instance made extensive directions ([2009] EWHC 3228 (Ch)); the Court of Appeal ([2010] EWCA Civ 917) varied part of that decision. Permission to appeal to the Supreme Court was given on three closely linked issues concerning CASS 7.

Nature of the application/relief sought:

The administrators sought directions as to how client money should be identified, pooled and distributed on LBIE’s failure (the primary pooling event). Representative claimants (including GLG and CRC) contested the proper construction of CASS 7 and the operation of the client money distribution rules on the assumed facts (substantial under‑segregation and a bank failure of an intermediary holding segregated sums).

Issues framed by the court:

1. When does the statutory trust arise: on receipt of client money or only on segregation?
2. Do the primary pooling arrangements apply to client money held in house accounts (i.e. accounts of the firm where client money was received but not segregated)?
3. Is participation in the notional client money pool (CMP) dependent on actual segregation (contributions basis) or determined by client money entitlement calculated under CASS 7.9.7R (claims basis)?

Court’s reasoning and outcome (concise):

• The court unanimously held the statutory fiduciary relationship arises on receipt of client money (CASS 7.7.2R and FSMA s139), so money received by a firm is subject to the client money rules from receipt.
• The court divided on the second and third issues. The majority (Lords Dyson, Clarke and Collins) preferred a purposive construction of CASS 7 which treats client money identifiable in any firm account as capable of being included in the CMP on a PPE and adopts the claims basis for participation: the client money entitlement must be calculated in accordance with CASS 7.9.7R. The majority considered that this interpretation better fulfils the MiFID/Implementing Directive policy of providing a high level of protection for all clients and gives effect to the statutory distribution machinery.
• The minority (Lords Walker and Hope) concluded that the CMP should primarily comprise segregated funds as identified by the last internal reconciliation and that a final reconciliation at the PPE (to capture movements in the gap between the last segregation and the PPE) should be carried out; they favoured the contributions theory and regarded segregation as an essential component of the protection that CASS 7 was intended to provide. They would therefore have given different directions on distribution in the assumed facts.

Wider context and implications: The court emphasised the centrality of segregation together with the statutory fiduciary character of client money, noted the complexity of the rules (particularly under the alternative approach), and recorded that the chosen construction has significant practical consequences for distribution in large-scale non‑compliance situations. The majority’s approach gives effect to the distribution machinery even where significant client money was unsegregated at the PPE.

Appeal dismissed. The Supreme Court (majority Lords Dyson, Clarke and Collins) concluded that (1) the statutory fiduciary relationship under CASS 7 arises on receipt of client money; (2) on a primary pooling event client money identifiable in any firm account into which client money has been paid may be treated as part of the client money pool; and (3) participation in the pool is determined by the client money entitlement calculated in accordance with CASS 7.9.7R (the 'claims' basis). The minority (Lords Walker and Hope) would have treated the pool primarily as the aggregate of segregated funds identified by the last reconciliation and required a final reconciliation at the PPE (supporting the 'contributions' basis). The majority’s purposive construction, the court held, better fulfils the MiFID/Implementing Directive aim of client protection and gives effect to the CASS 7 distribution regime.

First instance: Briggs J, directions hearing [2009] EWHC 3228 (Ch). Court of Appeal: appeal allowed in part [2010] EWCA Civ 917. Appeal to the Supreme Court: [2012] UKSC 6 (this judgment).