On 20 October 2021, the Court of Appeal (Lewison, Henderson and Asplin LJJ) handed down its judgment ([2021] EWCA Civ 1523) in a landmark case concerning how a surplus (estimated to be between £800 million and £1 billion) should be divided among the subordinated creditors in the administrations of LB Holdings Intermediate 2 Ltd (“LBHI2”) and Lehman Brothers Holdings PLC (“LBH PLC”).
Sonia Tolaney QC and Tim Goldfarb represented Deutsche Bank A.G. (London Branch) in its successful appeals in the priority dispute in LBH PLC’s administration, and in resisting related appeals in the LBHI2 administration. The result is a comprehensive victory for Deutsche Bank and other holders of preferred securities (the “ECAPS”) issued by the Lehman Group, whose recovery depended on the outcome of both priority disputes.
The proceedings arose out of two directions applications made by, respectively, the administrators of LBHI2 and LBH PLC. Deutsche Bank was an original party to the PLC application, and successfully applied to be joined to the LBHI2 application to represent the interests of the ECAPS holders across both applications ([2018] EWHC 2017 (Ch)).
The priority disputes turned principally on the contractual interpretation of complex subordination provisions in the competing debt instruments across the two estates, and how those provisions interrelated.
Deutsche Bank was successful at first instance in relation to the priority dispute in the LBHI2 estate. Marcus Smith J held ([2020] EWHC 1681 (Ch)) that properly construed, the subordinated notes held by a limited partnership (“SLP3”) controlled by LBHI (the former Lehman Group’s US-based parent company) subordinated themselves to the subordinated debt claims held by LBH PLC, and dismissed an attempt by SLP3 to rectify the terms of the notes to establish their seniority.
The Judge, however, agreed with LBHI that the competing claims in the LBH PLC estate ranked for distribution pari passu. Since LBHI’s claims were much larger, that would have meant that LBHI would recover the bulk of the surplus flowing to PLC. In reaching that conclusion, the Judge adopted a novel approach, holding that although the subordination clauses in the competing debt instruments were clear and effective when viewed in isolation, the interaction between the competing debt instruments resulted in a circularity whereby each purported to subordinate itself to the other and, in those circumstances, the Judge felt able to ignore the contractual provisions and impose a pari passu ranking.
SLP3 appealed the Judge’s conclusions in the LBHI2 application and Deutsche Bank appealed the conclusions in the PLC application (together with the liquidators of the general partner of the Issuers of the ECAPS (“GP1”)).
SLP3’s appeal was unanimously dismissed. The Court of Appeal agreed with the Judge that SLP3’s subordinated notes contained an expression of subordination to the subordinated debt held by LBH PLC ([37]-[48]), and held that there was no relevant mistake for the purposes of rectification ([63]-[65]).
Deutsche Bank and GP1 succeeded in full in their appeals in the LBH PLC application – the Court of Appeal held that the ECAPS Issuers’ claims were senior to LBHI’s claims as a matter of contractual interpretation ([77]-[92]), relying on the commercial arguments Deutsche Bank submitted were relevant to the factual matrix in support of this textual construction ([91]).
Deutsche Bank also succeeded in its appeal on a novel point concerning the treatment of guarantee payments in an insolvency. The Court of Appeal accepted Deutsche Bank’s case that the effect of a partial payment under a guarantee, and a release by the surety of its indemnity claim against the principal debtor, meant that the usual rules in an insolvency did not apply, and that the principal creditor had to reduce the amount of its proof by the amount of the partial payments under the guarantee ([93]-[172]).
This important decision addressed the legal basis for the rule against double proof and the corollary that a creditor is entitled to retain its claim in full in an insolvency, notwithstanding partial payments under a guarantee. The Court of Appeal unanimously held that these rules were a judge-made legal fiction that should not be applied where there was no competition between a creditor and a surety.
Sonia Tolaney QC and Tim Goldfarb were instructed (with Richard Fisher QC) for Deutsche Bank by Alston & Bird.
A copy of the judgment is available here.