The filing on 15 September 2008 for Chapter 11 protection under US bankruptcy laws by the Lehman Brothers ultimate parent company, Lehman Brothers Holdings Inc., led to several UK-based entities of the Lehman Group entering administration.
Whilst there are similarities between administration under English law and the US Chapter 11 procedure, there are major differences. This briefing summarises the administration regime under English law and draws on issues that counterparties to UK-based entities of the Lehman Brothers group may wish to consider when assessing their risks and evaluating their legal position.
The relevant UK-based Lehman Brothers entities are Lehman Brothers International (Europe), Lehman Brothers Limited, Lehman Brothers Holdings PLC and LB UK RE Holdings Limited, to which Tony Lomas, Steven Pearson, Dan Schwarzmann and Mike Jervis, partners at PricewaterhouseCoopers LLP, were appointed joint administrators on 15 September 2008.
What is an administrator?
The administrator is a licensed insolvency practitioner who is appointed to manage the company's affairs, business and property. The administrator essentially takes over the running of the company from the board of directors. The administrator is the agent of the company and, as such, he has no greater powers than the company would have, so, for example, he is bound by contracts that the company has entered into.
How is the administrator appointed?
An administrator may be appointed in one of three ways:
- by the court;
- out of court, by the holder of a qualifying floating charge, being security, which includes a floating charge over the whole or substantially the whole of the assets of the company and meets certain other requirements; or
- out of court, by the company or its directors.
The effect of appointment is the same in each case. The appointment of administrators to the relevant Lehman Brothers UK-based entities was made by court appointment.
What is the effect of administration?
Whilst a company is in administration a moratorium is imposed, which means:
- except with the consent of the administrator or the permission of the court:
- no step may be taken to enforce security over the company's property;
- no step may be taken to repossess goods in the company's possession under any hire purchase agreement, which includes a conditional sale agreement, chattel leasing agreement and a retention of title agreement; and
- no legal process (including execution, distress and diligence) may be instituted or continued against the company or property of the company; and
- no resolution may be passed or order made for the winding up of the company, except in special circumstances.
The moratorium does not apply to any security interest created or otherwise arising under a financial collateral arrangement (Financial Collateral Arrangements (No 2) Regulations 2003 (SI 2003 No 3226) (the "Regulations"), which are security arrangements (by way of title transfer or other security arrangements (eg, a mortgage or charge) over cash or financial instruments.
In addition, the Regulations provide that, in general, contractual close-out netting provisions (for example, those provisions of the ISDA Master Agreement) will continue to apply notwithstanding the appointment of an administrator.
How does administration affect contractual rights?
The moratorium does not prevent the termination of a contract that includes a right for the counterparty to terminate the contract if the company goes into administration. Counterparties to UK-based Lehman Brothers entities should check their contracts to determine whether termination is permitted.
If there is no right to terminate, but the administrator commits a repudiatory breach or fails to perform a contract, the other party can make a claim in damages against the company but will not be able to pursue that claim by legal proceedings without the consent of the administrator or the leave of the court. The claim will rank as an unsecured creditor for dividends in any distributions made by the administrator or in a subsequent winding up (see below). A repudiatory breach of a contract is a breach which goes to the root of the contract and entitles the other party to elect to treat such breach as a repudiation of the whole contract.
What are the administrator's functions?
The administrator must perform his functions with the objective of:
- rescuing the company as a going concern, unless that is not reasonably practicable or the second objective would produce a better result for the company's creditors; or
- achieving a better result for the company's creditors as a whole than would be likely if the company were wound up; or
- realising property in order to make a distribution to one or more secured or preferential creditors (but only if it is not reasonably practicable to achieve either of the other objectives and without unnecessarily harming the interests of the creditors of the company as a whole).
The administrator must exercise his functions as quickly and efficiently as is reasonably practicable.
How are creditors involved in the administration process?
Within eight weeks of his appointment the administrator must send to every creditor of whose claim and address he is aware his proposals for achieving the purpose of the administration. A meeting of the creditors of a company in administration must be held no later than ten weeks from the commencement of the administration, during which the administrators will make a presentation about their proposals for the company. Creditors must submit details in writing of their debt not later than 12 hours on the business day before the day fixed for the meeting to be entitled to vote at the meeting.
The creditors will then consider the proposals and either approve them without modification or approve them with modification to which the administrators consent. After the meeting, the administrators must report the result of the meeting to the court. The administrator must then manage the company’s affairs, business and property in accordance with the proposals that have been agreed by the creditors.
The administrator will send regular progress reports to the creditors, the court and the Registrar of Companies, covering each six-month period from the date that the company entered administration until the administration ends, or until he ceases to act. These reports provide full details of the progress of the administration to date, including a receipts and payments account and any other relevant information for the creditors.
After the initial creditors' meeting, further meetings of creditors may be held under certain circumstances, for example, if a sufficiently large body of creditors requests a meeting or if the court directs a meeting to be held.
A creditors' committee might also be established at the creditors' meeting (and usually is where the administration is sufficiently complex that a standing committee will assist the administrator). The committee is charged with assisting the administrator to discharge his or her functions and meetings will be held when and where determined by the administrator, except that the administrators must hold a meeting if requested to do so by a member of the committee. The creditors' committee will vote on resolutions proposed by the administrator dealing with various aspects of the conduct of the administration.
We shall be offering counterparties a "meeting service" when details of the creditors' meeting are known.
What are the administrator's powers?
An administrator has wide ranging powers including a general power to "do all such things as may be necessary for the management of the affairs, business and property of the company", effectively taking over the management of the company from the directors.
The administrator's specific powers include the power to do anything necessary or incidental to the performance of his functions. In addition, the administrator may make a distribution to secured and preferential creditors without the leave of the court and to unsecured creditors with the leave of the court.
The administrator has the power to deal with charged property. He can use floating charge assets without the leave of the court provided he accounts to the floating chargeholder for the proceeds, but if he is proposing to dispose of assets subject to a fixed charge this can only be done if authorised by the fixed charge holder, or in the absence of such authorisation, the court on terms:
- that the whole of the net proceeds of sale are applied in or towards discharging the amount secured; and
- that he makes up the difference between the sale price and the market value.
An administrator also has power to apply to the court to set aside certain antecedent transactions such as transactions at an undervalue and preferences.
How do creditors prove a debt and how are such debts treated?
A person claiming to be a creditor of the company and wishing to recover his or her debt must submit a written proof of debt to the administrator. The proof of debt must be submitted in accordance with the deadlines set by the administrator. The proof must set out the details of the claim and the total amount as at the date the company entered administration less any payments made to him after that date in respect of that claim and any adjustments for set-off. This shall include details of any documents by reference to which the debt can be substantiated, but it is not essential that such documents are attached to the proof or submitted.
A proof may be admitted for dividend for either the whole or part of the amount claimed. If the proof is rejected in whole or part the administrator shall send written reasons to the creditor as soon as reasonably practicable. If a creditor is dissatisfied with the administrator's decision he or she may appeal to the court within 21 days of receiving the administrator's written reasons.
The priority of payments in an administration is as follows:
- fixed charges;
- expenses of the administrator;
- preferential creditors (which include limited amounts towards employee claims);
- prescribed part;
- floating charges;
- unsecured creditors, who rank pari passu (ie, equally between themselves); and
The prescribed part provisions apply only where the floating charge to which the provisions are applied was created after 15 September 2003. The administrator must deduct the prescribed part from the company's net property which would otherwise go to floating charge holders and make it available for unsecured creditors, up to an amount of £600,000 (unless to do so would be disproportionate to the benefits). Fixed and floating charge holders do not participate in the prescribed part. There are no fixed or floating charges over Lehman Brothers Limited (in administration) registered at Companies House.
How and when will the administration come to an end?
An administration will automatically terminate at the end of 12 months unless extended by the court or by consent.
It is possible to move from administration to creditors' voluntary liquidation if the administrator thinks that each secured creditor has been paid, or had set aside for him, the total amount that he is likely to receive and a distribution will be made to unsecured creditors. This is done by filing a notice with the Registrar of Companies and sending a copy to each creditor. The appointment of the administrator ceases on the filing of the notice and the company will be wound up as if a resolution to wind it up had been passed.
If the administrator thinks that the company has no property which will be available to creditors (including secured creditors) he or she may apply to the court to terminate the appointment and the company will normally be dissolved three months later.
The administration may also be terminated by the court on the application of a creditor or the administrator.