Restructuring and Insolvency Bulletin - Issue 1 - 2017 - Supreme Court Lehman Waterfall I decision - foreign currency creditors lose over £1.6 billion in failed Lehman Brothers currency conversion claims

by Dechert LLP
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98% of the liabilities of Lehman Brothers International (Europe) (in administration) (“LBIE”) were denominated in non-sterling currencies. The fall in sterling after LBIE entered administration resulted in significant paper losses for creditors, which they sought to recover from the LBIE estate. The recent decision of the UK Supreme Court in Waterfall I refused to recognize such claims.*

The main Lehman Brothers trading company in the UK and Europe was LBIE. LBIE has been in administration since September 2008. At that time, approximately 98% of LBIE’s liabilities were denominated in non-sterling currencies including US dollars and Euros (the so-called foreign currency creditors).  

The Insolvency Rules in the UK provide that foreign currency debts are to be converted into sterling at the official exchange rate prevailing on the date LBIE entered administration (not at the date of payment).

The value of sterling had fallen between the date of LBIE entering into the administration and the date of payment, causing foreign currency creditors to receive less value for their claims against LBIE than they would otherwise have been contractually entitled to receive. There is a large surplus in the LBIE estate and one of the claims before the court as part of the Waterfall I litigation was that foreign currency creditors should be entitled to recover such contractual shortfall as a non-provable debt (being the "Currency Conversion Claims"). The amount at stake for LBIE’s foreign currency creditors exceeded £1.6 billion and it was estimated that there was sufficient surplus to pay that amount in full.

Non-provable debts are liabilities arising after the commencement of the administration, but which are not expenses of the administration. The classic example of a non-provable liability is a personal injury claim arising after the commencement of administration – the injured party can make a claim against the estate but such claim does not constitute an expense of the administration.

While not expressly referenced in UK insolvency legislation, non-provable liabilities continue to be judicially recognized based on the fundamental principle that the assets of a company may not be returned to shareholders while there remains an outstanding unsatisfied liability.

In Lord Neuberger’s judgment in In re Nortel GmbH [2014] AC 209 the description of the ranking of distributions in an insolvency, known as the ‘waterfall’, included non-provable liabilities (which ranked after unsecured provable debts and statutory interest but before shareholders).

On May 17, 2017 the Supreme Court handed down its judgment overturning the decision of both lower courts and ruled that foreign currency creditors did not have non-provable claims to recover losses arising from currency fluctuations following the start of LBIE’s administration.  

Lord Neuberger, giving the primary judgement, concluded that the relevant statutory provisions did not allow for the Currency Conversion Claims to exist as a separate claim in the insolvent estate. His Lordship observed that two reports produced in the lead up to the enactment of the Insolvency Act 1986 (a 1981 working paper by the Law Commission and the 1982 Cork Report) each carefully reviewed and addressed the issue of currency conversion claims. In particular, the Cork Report recommended that “any future Insolvency Act should expressly provide that the conversion of debts in foreign currencies should be effected as at the date of the commencement of the relevant insolvency proceedings”. 

It also weighed on the court that Currency Conversion Claims would provide the foreign currency creditors with a “one way” option on the currency markets as there would be no repayment to the insolvent estate in the event that sterling appreciated to the benefit of the foreign currency creditors.

Lord Sumption supported Lord Neuberger’s judgment, by concluding that the relevant statutory provisions provide a complete code for foreign currency debts and did not allow for Currency Conversion Claims to exist as a separate claim in the insolvent estate. 

In obiter comments Lord Sumption also considered whether insolvency proceedings provide an administrative procedure for distributing a debtor’s assets where there is a deficiency rather than discharging a creditor’s contractual rights and replacing them with a right to receive a distribution out of the insolvent estate.

Lord Sumption suggested that a creditor’s pre-existing legal rights survive a debtor entering into an insolvency process and are only altered as provided by the applicable legislation. In this way, any residual contractual claims would remain enforceable against any surplus “unless the legislation otherwise provides”.  

Unfortunately for the holders of foreign currency claims, the Supreme Court decided that the legislation does codify their position and does not permit them to make Currency Conversion Claims against the surplus in LBIE’s estate.

* The Dechert financial restructuring team in the United Kingdom acts for Lehman Brothers Limited (in administration) with respect to the Waterfall III proceedings in which billions of pounds of claims are the subject of a complex dispute.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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