The court was required to determine issues in the administrations of two Lehman Brothers companies (P and L) concerning the priority of certain subordinated debts for the purpose of distributing funds in the administrators' hands.

P and L were intermediate holding companies in the Lehman Brothers group. L was the indirect subsidiary of P. Both were in administration for the purpose of realising their assets for the benefit of creditors. P and L had been able to repay all of their unsecured unsubordinated creditors, which left the claims of subordinated creditors. The administrators held between £300m to £900m to distribute to the subordinated creditors, which was not enough to satisfy all their claims. Consequently, the administrators of both companies sought directions as to how the funds should be distributed. There were a number of competing claims. Claim A was advanced by P against L, under three subordinated loan agreements between P as lender and L as borrower. The purpose of the subordinated loans was to provide regulatory capital. Claim B was advanced against L by another Lehman Brothers company (S) under subordinated notes, which had been issued by L to raise regulatory capital. The claim A loan agreements contained a contractual subordination provision preventing the lender from proving until the "Senior Liabilities" had been discharged and a contingent subordination provision which prevented payment, whether in insolvency or otherwise, unless the borrower's liabilities (as defined) could be paid in full. "Senior Liabilities" meant "all Liabilities except the Subordinated Liabilities and Excluded Liabilities" and "Excluded Liabilities" meant "Liabilities which are expressed to be and, in the opinion of the Insolvency Officer of the Borrower, do, rank junior to Subordinated Liabilities in any Insolvency of the Borrower". The claim B notes, as issued, provided that they were subordinated to the claims of senior creditors, as defined, and also made payment of principal in respect of the notes conditional on the issuer being solvent at the time of, and immediately after, such payment. The claim B notes had been amended to allow for payments of interest to be deferred, and at the same time a new subordination provision had been added which applied when an order had been made for the winding up of the issuer and provided that the rights of noteholders ranked below all debt, including subordinated debt, except for debt that contained a similar subordination provision. L could not satisfy both claim A and claim B and it was therefore necessary to determine the priority between them. If claim A succeeded, P would have funds to distribute to its subordinated creditors but not enough to satisfy all their claims. It would therefore be necessary to determine the priority of two claims against P: claim C, advanced by the ultimate Lehman Brothers holding company (H) as assignor under subordinated loan agreements made between P as borrower and another Lehman Brothers company as lender; and claim D, advanced by the general partner (G) of certain partnerships under subordinated loan notes issued by P.

Held

Judgment accordingly.

Subordination - The ranking of claims in insolvency was determined by operation of law, but unsecured creditors of the same debtor, whose claims would otherwise by law rank equally, could agree to vary the ranking of those claims among themselves but only so as to demote a creditor's interests in relation to other creditors. The loans and loan notes in the instant case involved a combination of contractual subordination, in which the instruments simply stated that the debt was subordinated to and therefore ranked lower than other debts, and contingent subordination, where the debt was payable only in the event of a given contingency being satisfied, Manning v AIG Europe UK Ltd [2006] EWCA Civ 7, [2006] Ch. 610, [2006] 1 WLUK 268 and Lehman Brothers International (Europe) (In Administration), Re [2017] UKSC 38, [2018] A.C. 465, [2017] 5 WLUK 397 followed (see paras 72-107 of judgment). In the case of simple contractual subordination, the debt remained provable and the effect of the subordination provision was to prevent the lodging of a proof until all prior obligations had been satisfied. The subordinated creditor could then lodge a late proof, which would not disturb any prior distribution, and could receive payment if there continued to be a surplus (para.122).

Priority between claims A and B - The contractual subordination provision in the claim A loan agreements operated to subordinate the Subordinated Liabilities to Senior Liabilities and to prevent P as lender from proving in L's insolvency until the Senior Liabilities had been discharged. The contractual subordination had to be read cumulatively with the solvency condition that the borrower had to be able at all times to pay its liabilities (as defined) in full (paras 142-149). P's rights under claim A did not constitute the rights of a senior creditor as that term was defined in the unamended claim B notes, because P's rights were themselves subordinated. Claim B was not a claim A "subordinated liability" because it did not arise under the loan agreements, nor was it an "excluded liability" because it was not expressed to be and did not rank junior to the claim A subordinated liabilities. It was therefore a "Senior Liability" and it followed that, according to the simple contractual subordination provision in claim A, claim A was subordinated to the unamended claim B notes (paras 179-198). However, the making of an order for a distributing administration of L was sufficient to trigger the condition in the new subordination provision in the amended claim B notes (paras 224-225). On that basis the liabilities of L under claim B were expressed to be and were junior to the liabilities of L under claim A: they were Excluded Liabilities because they ranked junior to the subordinated liabilities in any insolvency of the borrower. Claim A, according to those provisions, ranked above claim B (paras 238-240, 243). Claim A consisted of three separate claims under different loan agreements, each containing the same subordination provisions which had the effect that the payment obligation under each agreement was a subordinated liability for the purposes of that agreement, but the payment obligation under any other agreement was a senior liability. That created a loop or circuity. The way to break that loop was to construe the provisions as ineffective as between themselves so that the three A claims ranked pari passu among themselves. Each of the claims was also to be treated as a subordinated liability in the case of each instrument for the purposes of the solvency condition in claim A (paras 151-152, 189, 245-250, 253). There was no good case for rectifying the amended notes (paras 254-269).

Priority between claims C and D - P and H had entered into a settlement agreement releasing all rights and claims between them in October 2011. However, that release did not extend to the rights under the claim C loan agreements which had subsequently been assigned to H. At the time of the release, there was no relation of any kind between H and P in respect of those debts and nothing for H to release (paras 273-287). P's obligations under the claim C loan agreements had been guaranteed by H and the original lender had received part payment from H under the guarantee. That did not prevent the original lender from proving for the full amount of the debt in P's insolvency, nor did it prevent H as assignee from proving for the full amount (paras 288-304). The claim D notes had maturity dates in 2035 and 2036 and were therefore to be discounted as future debts under the Insolvency (England and Wales) Rules 2016 r.14.44, in the absence of any provision for acceleration (paras 314-316). Future interest since the commencement of P's administration was not provable under r.14.23, but statutory interest would be payable after that date (paras 317-318). The notes did not follow the required form for regulatory capital but that did not affect the obligations arising, even if it meant that they would not have qualified as regulatory capital (para.327). The claim C loan agreements contained a simple contractual subordination provision and a contingent debt subordination provision which had to be read cumulatively (para.335). The claim D notes contained a contractual subordination provision and a contingent debt subordination provision (paras 340-348). The effect of the similar simple contractual provisions was to make claim C subordinate to claim D and vice versa (para.358). The circuity was broken by treating the claims as ranking pari passu (paras 363-364). The court rejected an argument on the facts that for commercial reasons it had been intended and agreed that the claim D notes would take priority over P's other subordinated debt to Lehman entities. Such an agreement would contradict the clear terms of the relevant instruments (paras 366-377).