Case of the week: Insolvency

Lord Hope (Deputy President), Lord Walker JSC, Lord Clarke JSC, Lord Dyson JSC, Lord Collins JSC.

29 February 2012

The Supreme Court considered three issues concerning the meaning and application of the client money rules in Chapter 7 of the Client Assets Sourcebook issued by the FSA. It held that a statutory trust arose on the firm’s receipt of client money; participation in the notional client money pool was not dependent on actual segregation of client money; and the primary pooling arrangements applied to client money held in house accounts.

Appeal dismissed

LBIE was the principal UK trading subsidiary of a US financial services company that had filed for protection from its creditors under Chapter 11 of the US Bankruptcy Code. It was regulated by the FSA and was authorised to hold client monies. In doing so, it operated the ‘alternative’ approach set out in the FSA Client Assets Sourcebook (Chapter 7, 7.4.12G (CASS 7)).

Following LBIE’s entry into administration, the administrators made several applications to the court for directions. The instant appeal was concerned with the

client money rules and the client money distribution rules contained in CASS 7, the central feature of which was that regulated firms were required to segregate their own money and the money held on behalf of their clients by placing the latter in a client account. CASS 7 provided for client monies to be held on trust, and the scheme was intended to ensure that they would be protected in the event of the firm’s insolvency.

In the instant case problems had arisen because LBIE had failed to segregate a large amount of client money and had deposited other, segregated client monies with a bank that ultimately failed.

The issues were whether (i) the statutory trust created by CASS 7.7.2(R) arose upon the firm’s receipt of client monies or its segregation of them; (ii) participation in the notional client money pool established by CASS 7 was dependent on actual segregation of client monies; and (iii) the primary pooling arrangements in CASS 7 applied to client monies held in house accounts.


(1) The statutory trust arose on receipt of client monies. It would

be contrary to client protection and the language of 7.7.2R for it to cease to be the client’s property on receipt but for it to become their property again on segregation.

(2) All client monies were subject to the statutory trust, and where there were possible interpretations the court had to adopt the one affording a high degree of protection for all clients who had money with the firm. The argument that no actual segregation was required for participation in the client money pool was supported both by the language, and a purposive interpretation, of CASS 7.

(3) To exclude from the distribution regime client monies in house accounts would run counter to the policy underlying CASS 7 by creating a bifurcated scheme, under which clients had different levels of protection depending on whether their money was held in a segregated or a house account.


Simon James

The Supreme Court’s decision about Lehman Brothers International (Europe)’s (LBIE) client money has implications in at least three areas.

First, for LBIE’s administration and comparable cases, the Supreme Court has increased the claims on client monies, which means that individual clients will receive a lower return in the event of a shortfall, as with LBIE.

But the Supreme Court has also potentially increased the sums available to clients by treating as client money sums that were not segregated but that should have been segregated. The problem will be in identifying this extra money.

The equitable concepts involved are not easy to apply in practice: they could bring benefits to clients at the expense of unsecured creditors; they could produce nothing; and they will certainly cause delay.

Second, the Supreme Court has not eased the challenges faced by law firms that must apply the rules: what can they do with client monies in their office accounts? Does a right of setoff still work? What about margin?

Firms need to grapple with the minutiae of the rules and with the courts’ interpretation of the rules in order to try to meet their obligations under the rules – no easy task.

Third, the client money rules were meant to provide a quick way for clients to recover their money upon the insolvency of a regulated firm. In the case of LBIE, the rules have manifestly not achieved that aim.

The FSA and its successors will want to look at whether the rules were and are fit for purpose.


Simon James, partner, Clifford Chance

For the appellant

GLG Investments plc

South Square’s Antony Zacaroli QC, David Allison and Adam Al-Attar; Allen & Overy partner Jennifer Marshall


For the respondents


For first respondent CRC Credit Fund Ltd

4 Stone Buildings’ Robert Miles QC and Richard Hill; Simmons & Simmons partner Robert Turner

For the second respondent Lehman Brothers Finance AG

4 Stone Buildings’ Jonathan Crow QC; Maitland Chambers’ Jonathan Russen QC; 3 Verulam Buildings’ Richard Brent; Field Fisher Waterhouse senior associate Andrew Massey

For the third respondent Lehman Brothers Inc

4 Stone Buildings’ Jonathan Crow QC; Maitland Chambers’ Jonathan Russen QC; 3 Verulam Buildings’ Richard Brent; Norton Rose senior associate Mark Craggs

For the fourth respondent the administrators:

20 Essex Street’s Iain Milligan QC; Maitland Chambers’ Rebecca Stubbs; South Square’s Richard Fisher; Linklaters partner Christa Band


For the intervener

Erskine Chambers’ David Mabb QC and Stephen Horan; instructed directly by the FSA