Summary

The proper construction of a prime brokerage agreement was that the counterparty to the agreement retained a beneficial interest in the securities held by the broker as custodian and in cash derived from those securities. As a result, the counterparty was a secured creditor for both cash and securities in the broker's administration.

Facts

The applicant administrators (X) applied for directions about the administration of a financial services firm (L). X invited the court to determine how they should treat certain cash received by L, after entering administration, in consequence of corporate events or actions which affected securities held by L as custodian under its standard form international prime brokerage agreement. The securities held on behalf of counterparties would generate cash. Under cl.5.2 of the agreement, any cash was held by L free and clear of any trusts and could be used by L in the course of its business. After L went into administration the counterparties could no longer ask L to convert the cash into further securities, so that increasing amounts of cash was being held by L. The first respondent, who was L's counterparty under a brokerage agreement, had been joined in order to contend for a direction that it should receive payment in full of cash derived from its securities, either as trust money, or as an administration expense. The second respondent had been joined to represent all unsecured creditors, with an interest in obtaining a direction that the cash was payable as an accretion to the assets available for distribution to them in the administration. The main issues were (i) whether counterparties had any proprietary rights or interests under the agreement, even in relation to securities, (ii) whether cl.5.2 applied to cash received by L post-administration, derived from securities held as custodian. The first respondent submitted that cl.5.2 had no application to cash held or received by L in respect of which the source was a security or other asset or right already held by L as custodian. Alternatively, it argued that cl.5.2 only applied for as long as L was carrying on business as prime broker and discharging its duties under the agreement.

Held

(1) Construing the agreement, securities held by L as custodian for counterparties were, and remained, held upon trust, such that counterparties retained and continued to retain a beneficial interest in those securities after the commencement of L's administration. (2) (a) Reading cl.5.2 in the context of the agreement as a whole, it was clear that it applied to all, rather than part, of the cash held by L for a counterparty. If cl.5.2 only applied to cash, the ownership of which had been transferred as fresh or added security, it would have been necessary for the agreement to contain provision for the holding of cash to which cl.5.2 did not apply, so that L would have needed to maintain a client account operated in accordance with the Client Asset Sourcebook issued by the Financial Services Authority, and a non-client account to deal with cash held pursuant to cl.5.2. (b) The agreement was silent about what was to happen in the event that L went out of business, ceased to perform the brokerage services, or went into an insolvency process. Therefore, the court's task was to consider what a reasonable addressee would understand the agreement to mean, and then imply a term to that effect, Attorney General of Belize v Belize Telecom Ltd (2009) UKPC 10, (2009) 1 WLR 1988 applied. The reasonable addressee in the instant case consisted of sophisticated parties to the agreement, who might be taken to have been familiar with the nature of securities likely to be delivered to L as custodian, and familiar with their inherent tendency both to generate cash and to turn themselves into cash over time. L's insolvency had been a remote possibility, and the consequences of it going out of business had been overlooked by the draftsman of the agreement, but careful thought about those contingencies would quickly lead to the conclusion that the destruction of the counterparty's proprietary rights in securities without any concomitant benefit to L, either in terms of the ability to use the money for a continuing business, or the preservation of its rights as chargee, could not be consistent with the agreement read as a whole. The transfer of full ownership of cash arising from investments held by L as custodian, after L had gone out of business and ceased to perform its functions, thereby also ceased. The counterparty retained the same proprietary interest in cash derived from the securities as it did from the securities. Accordingly, the cash was client money and could be paid to the counterparties. (3) If cl.5.2 had continued to apply to the cash, it should be paid to the counterparties as an administration expense.

Directions given