Waterfall I (Court of Appeal)

The Court of Appeal considered a set of questions arising from the administrations and potential liquidations of entities within the Lehman group, focusing on (a) the ranking of subordinated loans governed by standard-form FSA subordinated loan agreements; (b) whether foreign-currency creditors retain a post-distribution claim for exchange losses; (c) the treatment of statutory interest arising during an administration if the company subsequently goes into liquidation; and (d) the provability and treatment of a contributory’s contingent liability under s.74 of the Insolvency Act 1986.

The court upheld the judge's conclusion that the standard-form subordination provisions make repayment of subordinated loans contingent on satisfaction of statutory interest and non-provable liabilities, so subordinated lenders rank after provable debts, statutory interest and non-provable liabilities. The court also (by majority) upheld the judge's declarations that foreign currency creditors may assert non-provable currency-conversion claims against a company that has paid proved debts and statutory interest in full.

By contrast the court permitted appeals concerning the effect of administration-period statutory interest on a subsequent liquidation: accrued rights to statutory interest under rule 2.88(7) survive the transition to liquidation and should not be treated as extinguished simply because the company later enters liquidation; accordingly the administrator's duty to apply a surplus in paying statutory interest is effective and such interest may not be lost on conversion to liquidation. The court further addressed provability of contingent calls under s.74 and the contributory rule: an administrator may prove in respect of a contributory's contingent s.74 liability and the contributory rule does not extend to prevent proofs in a distributing administration in the circumstances considered.

This was an appeal from the Chancery Division (David Richards J [2014] EWHC 704 (Ch), [2015] Ch 1) in proceedings in which the administrators of several Lehman entities sought declaratory guidance on points arising from distributing administrations and inter-company claims.

Parties and posture: appellants included the administrators of LB Holdings Intermediate 2 Ltd and Lehman Brothers International (Europe) (LBIE) and Lehman Brothers Holdings Inc; respondents included the administrators of Lehman Brothers Limited and certain creditors. The matter came on appeal from the High Court, Companies Court.

Relief sought / nature of proceedings: the administrators sought declarations resolving the ranking of subordinated loans, the entitlement of foreign-currency creditors to currency-conversion claims after distributions, the treatment of statutory interest accrued in administration if there is a subsequent liquidation, and related questions about contributories and provability of contingent liabilities under s.74.

Issues framed by the court:

• whether subordinated loans made under FSA standard forms remain provable and whether they rank after provable debts, statutory interest (rule 2.88 / s.189) and non-provable liabilities;
• whether foreign-currency creditors who were converted to sterling for proof at the administration cut-off date retain a post-distribution claim for currency losses and, if so, how those claims rank;
• whether statutory interest accruing during an administration (rule 2.88(7)) is lost on a subsequent liquidation, or survives as a right enforceable in liquidation;
• whether an administrator can prove in the insolvency of a contributory for that contributory’s contingent liability under s.74, and the effect of the contributory rule in a distributing administration.

Reasoning (concise): the court analysed the insolvency code (Insolvency Act 1986 and Insolvency Rules 1986) and authorities (including Re Nortel, Dynamics, Lines Bros and earlier authorities on provability and currency conversion). On subordination, the standard-form agreements (INPRU/GENPRU form) were read to make repayment contingent on the satisfaction of conditions in clause 5, which the court construed to include statutory interest and non-provable liabilities; that preserves regulatory purpose and gives subordinated lenders an entitlement to prove (albeit contingent and to be valued accordingly) but ranks them after the listed priorities.

On currency conversion the court (majority) held that the conversion rules (rule 2.86 / rule 4.91) operate "for the purpose of proving" and do not extinguish a creditor's underlying contractual right to the foreign currency; where a distribution in sterling leaves a contractual shortfall, the creditor may pursue a residual currency conversion claim as a non-provable liability after payment in full of proved debts and statutory interest, to be dealt with pari passu with other non-provable claims.

On post-administration statutory interest the court held that rule 2.88(7) creates an accrued statutory entitlement in the administration which survives a subsequent transfer into liquidation: an administrator’s surplus is statutorily burdened to pay interest and that burden follows the fund into liquidation (so the right does not disappear).

On s.74 and provability the court held that a contributory's contingent liability to be called under s.74 can be provable in the insolvency of the contributory under rule 13.12(1)(b) (applying the three-stage test from Re Nortel), and that an administrator may lodge proofs on that basis; the contributory rule does not bar proofs in a distributing administration and set-off operates where applicable.

Wider context: the judgments emphasise the broad sweep of the insolvency code to admit claims to proof and the residual complexity when insolvency and currency exposure intersect; the court noted the rarity of unlimited companies and the awkwardness of some procedural lacunae (for example interest spanning administration and liquidation) which may require legislative clarification.

Appeal allowed in part. The Court of Appeal upheld the judge’s construction that the standard-form subordinated loan agreements make repayment contingent upon payment of provable debts, statutory interest and non-provable liabilities, and (by majority) confirmed that foreign-currency creditors may press residual currency-conversion claims as non-provable liabilities after proved debts and statutory interest are paid. The court reversed aspects of the judge’s approach to post-administration statutory interest, holding that accrued statutory interest under rule 2.88(7) survives conversion into liquidation and must be respected; it also held that administrators may prove for contingent s.74 calls in a contributory’s insolvency and that the contributory rule does not prevent such proofs in a distributing administration. The decisions rest on detailed construction of the Insolvency Rules and Act, the FSA-standard subordination wording and the established principles on provability and pari passu distribution.

Appeal from High Court, Chancery Division, Companies Court (David Richards J) [2014] EWHC 704 (Ch), [2015] Ch 1; heard in the Court of Appeal (Civil Division) before Lewison LJ, Briggs LJ and Moore-Bick LJ, judgment [2015] EWCA Civ 485.