Case of the week: Banking & Finance
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29 February 2012
In the Matter of Lehman Brothers International (Europe) (in administration) (2011) EWCA Civ 1544. Court of Appeal Civil Division. Lloyd LJ; Tomlinson LJ; Patten LJ. 21 December 2011
The court determined the beneficial ownership of certain securities as between companies within the Lehman Brothers group.
Lehman Brothers International (Europe) (LBIE), which is in administration, appealed against a decision ((2010) EWHC 2914 (Ch)) concerning the beneficial ownership of certain securities known as ’Rascals’ (Regulation and Administration of Safe Custody and Global Settlement).
The respondents were the joint administrators of Lehman Brothers Finance (LBF), another company within the group into which all securities acquired in its time zone were settled on acquisition.
The respondent company, like other LBIE subsidiaries, acquired securities from third parties using the complex ’Rascals processes’. Through inter-company repurch-ase agreements and stock loans, the affiliates granted LBF proprietary interest in the underlying security in exchange for monetary consideration. This left the affiliates with a contractual right to recover their proprietary interest in equivalent securities for monetary consideration at a future date.
The commercial intent of the processes was usually that they should apply for the whole or substantially the whole of the period between the acquisition of the security from the street by LBF and its eventual resale to the street.
The two methods of Rascals processing were automatic and manual Rascals. LBF claimed beneficial title to all those securities remaining in its depots that it had acquired for LBIE’s account.
At first instance, the judge found in favour of LBF.
As to the automatic Rascals process, LBF was treated as paying the price on the on-leg of the first repurchase agreement (repo), by way of set-off against LBIE’s debt to it for the acquisition price.
The judge had found that both companies had adopted a mutual system of book-keeping that recorded LBF as a secured creditor. It had been open to him to hold that LBIE knew of and acquiesced in the creation of the automatic Rascals system for reasons of regulatory compliance and that this required LBF to hold the beneficial title in the securities. The panel was also entitled to find that both LBIE and LBF benefited from the use of the Rascals process in this way.
Those findings on estoppel overrode the terms of an inter-company funding agreement dating from 2000 to which both companies had been parties and which, on the face of it, had the effect that LBF was not to be treated as a lender to LBIE in respect of transactions since June 2000.
LBIE was treated as paying the price on the off-leg of the first repo when, and not until, the next repo opened. At that time, the price was treated as set-off against LBF’s new obligation under the on-leg of the new repo. By the same token, LBF was treated as paying the on-leg price under that repo at the same moment. Beneficial title to the securities passed to LBF under the on-leg of the first repo and remained throughout the Rascals process until a resale to the street.
The position in respect of the manual Rascals process was the same in principle. However, if there were any securities that were subject to that process on 15 September 2008 when the group collapsed, having been made the subject of a stock loan after 31 July 2008,
being the date of the last monthly pay-down, then LBF did not have beneficial title to the securities.
- Gabriel Moss QC, South Square
- William Willson, South Square
- Tim Parkes, Herbert Smith
- Iain Milligan QC, 20 Essex Street
- Daniel Bayfield, South Square
- James Gardner, Linklaters
Two themes emerge from this complex Lehman-related case that dealt with the ownership of the ’Rascals’ securities. First, when contractual relationships between group companies are tested on an insolvency, the courts will look at not only to what the contracts say, but also to what the parties did. Here, the contract said one thing but the inter-company processes and accounting treatment were
on a different footing.
The court decided that in circumstances where the conditions for an estoppel by convention had been satisfied that involved LBIE taking title to the Rascalled securities and being treated as having paid the price for the on-leg of a repo or stock loan, Lehman Brothers Finance was estopped from seeking to rely on the contract to say that LBIE had not acquired title to the relevant securities because it had not paid for the on-leg.
The court was inclined to the reality of the situation rather than a contractual fiction.
The second relates to trust law, and specifically the question of whether a trust over fungible assets fails because the subject-matter (intermediated securities) cannot be sufficiently identified as they had been pooled in non-segregated accounts and used, among other things, to satisfy short positions.
The court rejected this argument, focusing on there being no identification of the subject-matter of the trust and putting to one side difficulties in identifying the trust assets to a later date. Once again, it drew on ancient principles of trust law and applied them to the modern facts of a failed investment banking business.
Rob Hickmott, partner, Quinn Emanuel Urquhart & Sullivan