The English Supreme Court has considered various new categories of creditor claims against a company with unlimited liability in administration where, unusually, there was enough money to pay all creditors and a surplus existed.

In proceedings commonly referred to as the Waterfall I litigation, the Supreme Court considered issues relating to the distribution of funds from the estate of Lehman Brothers International Europe (in administration) (LBIE), in circumstances where there was a surplus of assets amounting to approximately £8 billion.

Unsurprisingly, various unsecured creditors, including another Lehman group company, Lehman Brothers Holdings Intermediate 2 Limited (LBHI2), sought a recovery against the surplus. The Waterfall I litigation was intended to resolve certain lacunas in UK insolvency legislation relating to currency conversion claims, statutory interest, and the ranking of subordinated debt, in addition to other issues concerning LBIE’s, somewhat unusual, structure as an unlimited company.

The issues:

Ranking of subordinated debt

The court first considered where subordinated debts ranked in the order of payments. LBHI2 was the holder of subordinated loans made to LBIE. LBHI2 contended that its claims should rank ahead of statutory interest payable under the Insolvency Rules 1986 and other non-provable liabilities. In contrast, the LBIE administrators argued that LBHI2 was not entitled to prove for the subordinated debt until all liabilities, including statutory interest and non-provable liabilities, were paid in full. LBHI2 was effectively arguing that it should be paid before claims for statutory interest and non-provable liabilities.

Currency conversion claims

Many unsecured creditors of LBIE originally had claims denominated in US dollars. It is a principle of UK insolvency legislation that foreign currency debts are exchanged into pounds sterling as at the date of the insolvency, in this case the administration. Accordingly, unsecured creditors’ claims were converted to sterling on 15 September 2008. Since that date however, the pound has depreciated as against the US dollar causing unsecured creditors to suffer currency conversion losses, totalling in the region of £1.3 billion. As a result, the creditors sought to recover the difference.

How does this work in practice? By way of example, if a creditor (C) with a claim of US$100 had its claim converted to £65 as at the date of the administration but, due to currency fluctuations in the period between the date of administration and the date of payment, that £65 claim would now be worth US$80 when payment is made; C would have lost US$20. It is that US$20 shortfall that the creditors in Waterfall I sought to claim.

Payment of statutory interest

In accordance with the Insolvency Rules 1986, unsecured creditors are entitled to statutory interest on the debts proved in the administration. Statutory interest accrues from the date of the administration until the date of repayment of the debt. Whilst the Insolvency Rules 1986 applied to the case at hand, the analogous provision for payment of interest in the event of a surplus is now contained within rule 14.23 of the Insolvency (England and Wales) Rules 2016.

The question that arose in this case was whether the statutory interest from the date of administration could be claimed once LBIE was then put into liquidation - could this interest only be claimed whilst LBIE was in administration?

The Supreme Court judgment

In respect of the above issues, the Supreme Court held that:

  • Statutory interest and non-provable liabilities must be satisfied before any of the surplus monies can be used to pay subordinated debts.
  • It is not open to foreign currency creditors to claim for any currency exchange shortfall as a non-provable debt of an administration.
  • The payment of statutory interest accruing whilst a company is in administration is only payable during the period of the administration, and cannot for example be claimed during subsequent liquidation proceedings.

The Supreme Court recognised that a number of gaps exist in UK insolvency legislation, but declined to either give guidance on or rewrite the statutory provisions on the basis that the legislation had not intended for these gaps to be filled. In so doing, the court has left this task for the legislature.

HFW perspective

The judgment is noteworthy insofar as it addresses a number of gaps in the UK insolvency regime, however whether it has wide application is yet to be seen especially given the rarity of administrations resulting in a surplus to creditors and the fact that unlimited companies are not commonly utilised. It also remains to be seen how such issues will be dealt with under the Insolvency (England and Wales) Rules 2016, which have now superseded the Insolvency Rules 1986.

There are a range of options available to potential creditors which may help mitigate the risk of losing money when a counterparty becomes insolvent and is unable to pay its debts:

  • Depending on the value at stake, potential creditors may wish to take security in the form of a fixed charge over an asset(s) of the counterparty. This way, if the counterparty does become insolvent, the asset over which the fixed charge exists will not fall into the insolvent estate.
  • Retention of title provisions can be very effective, especially with the sale and purchase of goods. These provisions usually provide that the seller will retain legal ownership of the goods until they have been paid for in full by the buyer.
  • Small and medium sized enterprises may also choose to insure against the risk of a counterparty’s insolvency by taking out insurance. Trade credit insurance will insure against accounts receivable losses should a counterparty enter into insolvency.
  • Larger enterprises may also be able to hedge their potential exposure, especially in relation to currency fluctuation losses.

As the Waterfall I name suggests, there is further litigation in the pipeline, aptly named Waterfall II and Waterfall III, which will focus on interest on debts, set-off, and contributory claims. These cases are expected to further shape the UK’s insolvency legislation so watch this space for further changes to the legislative landscape later this year.

The judgment is available at