UK: High Court Rejects Lehman Brothers Proposal For Scheme Of Arrangement

Last Updated: 22 October 2009
Article by Jeremy Mash

The latest decision in the administration of the UK arm of Lehman Brothers ("LBIE") was handed down in late August. The Chancery Division ruled that the court did not have the necessary jurisdiction to sanction the scheme of arrangement which the administrators had proposed for the return of trust assets.

The administrators at PwC have reported that one of the major obstacles to the completion of the administration process is the huge volume of securities held by LBIE in trust for clients. These include prime services clients, those who have deposited securities with LBIE under safe custody arrangements and market counterparties who have posted collateral with LBIE. Not only is there is a huge volume to be dealt with, but the problem is also said to be compounded by deficiencies in LBIE's records and a significant number of clients who have yet to respond to the administrators' requests for statements of what clients understand their own asset positions to be.

This led the administrators to propose a scheme of arrangement which would have provided a system for the resolution of each trust client's position and for analysing any shortfalls in securities over which more than one client had a claim. It would also have included a bar date by which trust client claims were to be submitted so that the scheme would then have been free to proceed.

It was argued for the administrators that the scheme would be confined to clients who not only had proprietary claims but also had pecuniary claims. This gave a potential hook whereby the clients in question could be said to be creditors and therefore covered by section 895 of the Insolvency Act 1986, the statutory provision enabling such a scheme.

However, this raised the fundamental question of whether the court could authorise such a scheme in respect of assets which were not the property of the company in administration but simply held in trust for clients. The arguments against the scheme being permitted were put by the London Investment Banking Association, whose members were particularly affected by the decision.

The judge identified three reasons in particular why the proposed scheme would interfere with the proprietary rights of trust clients. Firstly, clients in the scheme would have to renounce their rights to particular batches of securities which had been bought in their name and instead claim against a pool of identical securities, potentially resulting in a shortfall. Secondly, the bar date might cause the client to lose its property altogether. Thirdly, each client would be required to provide a series of warranties as a condition of having its property back.

He went on to find that while the scheme would have involved settlement of some aspects of trust clients' pecuniary claims, it was abundantly clear that the scheme was largely concerned with LBIE discharging its obligations concerned with holding trust clients' property, including in particular the obligation to return that property to its owners. Those property rights were enjoyed quite independently of any personal claims which those clients might have against LBIE arising out of its defaults. In conclusion, the scheme was not directed at trust clients in their capacity as creditors and the statutory regime for a scheme of arrangement did not apply.

The administrators apparently plan to appeal, so the matter may not be at an end. Media reports have meanwhile speculated that as a result the administration could take many years longer than it would have done under the scheme. This may or may not be the case. The judge himself noted that with or without the scheme, time would still have to be taken establishing the net contractual position between each trust client and LBIE and any lien or other security rights which LBIE might have over a client's assets.

He ended by remarking that, without wishing to be glib in the face of the exceptional difficulty of the LBIE administration, the court has well established processes outside of a scheme of arrangement to assist trustees. Those processes are there to assist in establishing what assets it holds, what competing claims there are to those assets and how the assets should be distributed. This may prove to be the more lengthy route which the administrators end up having to take.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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