Courting clarification

When Lehman Brothers went into meltdown back in September 2008, insolvency lawyers knew that unwinding the bank would take years. And so it has proved, not just for Lehman but all the other financial institutions that failed at the height of the crisis.

Much business restructuring was necessary following the numerous bank failures and the restructuring community has been waiting several years for today’s legal clarification delivered by the Supreme Court in Kaupthing Singer & Friedlander (in administration) and in the matter of the Insolvency Act 1986 (see judgment).

The case looks directly at whether the rule established in Cherry v Boultbee back in 1839 is compatible with the Insolvency Act (1986) and whether that could be applied to a case being pursued by HSBC against Kaupthing Singer & Friedlander (KSF), which is in administration.

Allen & Overy partner Andrew Denny instructed 3-4 South Square’s Gabriel Moss QC to lead Richard Fisher, also of 3-4 South Square, for HSBC.

Moss faced Robin Dicker QC and Tom Smith, also of 3-4 South Square, for KSF, having been instructed by Freshfields Bruckhaus Deringer partner Sarah Parkes.

The case concerns the insolvent KSF and its now defunct subsidiary Singer Friedlander Funding (KFF). Three years ahead of its collapse KSF raised £250m through issuing a five-year floating rate bond on the London Stock Exchange. The bonds were issued by KFF, which had been set up specifically for that purpose. They were guaranteed by KSF and the proceeds of the notes were lent to KFF.

The legal issues arose after both companies went into administration and the creditors began to queue up. At issue was whether KSF would be liable to continue paying KFF in respect of the loan agreement.

The administrators of KSF sought to find a way out of the liabilities and applied the 170-year old Cherry v Boultbee rule.

Essentially this rule, which was established through disputes over wills in the 19th century, states that a party cannot seek dividends from an estate until they have contributed what they owe to that estate. Should the debtor be unable to make the contribution, the dividend is paid out of the money owed. Should the debt be a greater sum than the dividend the debtor will not receive any payment at all.

In December 2009 the High Court found this an acceptable way of handling the bank’s debt and said  that the only debt KSF was liable for was in respect of the guarantee it issued. It was not liable to pay KFF anything in respect of the bonds, meaning that bondholders would not recover 100p in the pound.

Given the far-reaching ramifications of the case and its knock-on effect, the appellants were given permission to leapfrog the Court of Appeal for a Supreme Court hearing where a five-judge panel was convened.

The Supreme Court noted that the CoA had been bound by a 2006 ruling handed down in the appeal of SSSL Realisations. Moss argued, and the court accepted, that that the decision in that case was wrong. 

In overturning the High Court ruling the court accepted that the precedent created by the first instance decision would lead to the reversal of the rule against ‘double proof’ that effectively forced a guarantor to wait until creditors’ debts have been settled before any claim can be made.

Freshfields partner Ken Baird comments: “This is a highly significant ruling from the Supreme Court that will end months of debate on a complicated point of law.

“Restructuring professionals will now be able to predict with much greater certainty the potential outcomes for creditors with competing claims in highly complex capital structures, giving creditors a far better understanding of how their claim is likely to develop.”

The clarification is to be welcomed and its impact will be felt by lawyers who are currently delving into the depths of insolvency law to find the best deals for the creditors of the insolvent banks.