The Court of Appeal has dismissed the application of representative creditors regarding the distribution of a surplus of LBIE's estate and their entitlement to statutory interest for periods after the administration starting.
This decision is the latest in the series of the Waterfall proceedings which relate to the administration of Lehman's European business, LBIE. Upon repaying all creditors 100 pence in the pound and settling administration expenses, the administrators of LBIE were left with a surplus estimated at £7.39 billion. The administrators then looked to the court for direction on how to distribute the surplus. However, the number of issues requiring the court's direction meant the case was split into Waterfall I, Waterfall II and Waterfall III.
In this latest judgment the Court of Appeal ruled on the remaining live issues in Waterfall II. After a full hearing in the Court of Appeal of the Waterfall II issues, the Supreme Court delivered its judgment in the separately progressing Waterfall I. As a result of the Supreme Court’s judgment a number of the Waterfall II issues fell away, in particular all of those described as Waterfall IIB. This left a narrower scope of issues, relating to those known as Waterfall IIA and IIC. The Court of Appeal’s judgment therefore determined only those remaining issues, all of which concerned the amount of statutory interest payable under rule 2.88 of the Insolvency Rules 1986 (IR86), which is now rule 14.23 of the Insolvency (England and Wales) Rules 2016.
The main question for the Court of Appeal was to determine if interest under rule 2.88(7) IR86 should be calculated on the basis of the rule in the Bower v Marris case of 1841 (2-page / 350KB PDF), which allocates dividends to the reduction of statutory interest before payment of the principal; or payment of the principal before the reduction of statutory interest. The difference between calculating statutory interest using the two methods was £1.3bn.
The senior creditors argued that the approach in the Bower v Marris case was, amongst other things, "ordinary commercial conduct" and "used in the exercise of a judge-made jurisdiction to award interest in cases of corporate insolvency, in the event of a surplus, for its origins in the mid-nineteenth century until 1986". The subordinated creditors argued that pre-1986 authorities were irrelevant and that Bower v Marris did not apply.
In considering IR86, the Court of Appeal held that the language used in the Insolvency Rules was "a complete and clear code for the award of statutory interest on provable debts" and that pre-1986 authorities such as the Bower v Marris case did not apply as they were no longer relevant.
The Court of Appeal also held that:
- statutory interest on contingent debts ran from the date of the commencement of the administration;
- statutory interest does not continue to compound following payment of the final dividend;
- there was no ground for compensation for late payment of statutory interest. This was due to there being good reason why it was inappropriate for administrators to immediately proceed with the payment of statutory interest;
- the payment of statutory interest needed to be regulated in a pari passu process of administration by reference to a single date, namely the cut-off date and that this also applied to foreign judgments that carry interest at the foreign judgments rate; and
- "the rate applicable to the debt apart from the administration" in rule 2.88(9) IR86 includes, in the case of a debt which is a close-out sum under a contract, a contractual rate of interest and a contingent right to interest triggered on action taken by a creditor.
While the IR86 have always made provision for interest payable in the event of a surplus arising in liquidation, bankruptcy or administration, these surpluses are normally so insignificant that the parties involved will usually agree a compromise. This ruling from the Court of Appeal provides clarity on how to interpret insolvency legislation and how interest should be calculated, which will provide insolvency practitioners with greater comfort when calculating interest.
Whilst there is market speculation that the representative creditors will attempt to appeal the decision to the Supreme Court, this decision along with the future hearing on Waterfall II tranche C, will go a long way to determining how to construe the interest provisions of the IR86.
Stephen O'Grady and Kevin Mulligan are restructuring experts at Pinsent Masons, the law firm behind Out-Law.com