Judgment has now been handed down by Marcus Smith J in another important case regarding the Lehman estate. This gives much needed clarity on how subordinated debts rank as between themselves.
The judgment concerned:
- an application for directions made by the Joint Administrators of LB Holdings Intermediate 2 Limited (LBHI2), concerning the relative priority of its subordinated creditors; and
- an application for directions made by the Joint Administrators of Lehman Brothers Holdings PLC (PLC), concerning the relative priority of its subordinated creditors.
Dentons acted for LBHI2 in these high-profile proceedings.
The judge analysed the three possible types of subordination (legal, structural and consensual) and, in particular, the three ways of consensually subordinating a debt (trust subordination, contingent debt subordination and simple contractual subordination). The judge found that more than one of these ways of subordination could be used in the same debt instrument.
The judge also came to the conclusion that a debt using simple contractual subordination was provable, albeit the proof must be filed late.
LBHI2's subordinated debt consists of:
- three subordinated loans, based on the then standard FSA forms (Claims A1, A2 and A3); and
- subordinated notes (Claim B).
Based on the wording of the subordination clauses, the judge found that Claims A1, A2 and A3 ranked ahead of Claim B.
Claims A1, A2 and A3 contained both simple contractual subordination and contingent debt subordination (in the form of a solvency condition). As between Claims A1, A2 and A3 there was circularity as, on the terms of their simple contractual subordination clause, each regarded the other as senior liabilities. The judge found that, where different subordination provisions resulted in circularity, then, as between those instruments as a matter of law, they ranked pari passu (i.e. rateably).
A related problem was that, on the terms of the solvency condition, each claim required the other two claims to be paid before the condition could be satisfied. However, the judge found that, as Claims A1, A2 and A3 ranked pari passu as a matter of law, then payment to creditors could not be withheld by virtue of the solvency condition.
The judge also found that:
- Claim B could not be rectified on the grounds of mistake;
- PLC's subordinated debt and subordinated notes ranked pari passu;
- PLC's subordinated notes were a provable future debt and should be discounted; and
- a settlement agreement entered into by PLC and one of its subordinated creditors had not released a subordinated claim acquired by the subordinated creditor after the settlement had been entered into.