Summary

  • Lehman Brothers Australia has been forced to abandon its originally proposed creditors’ scheme of arrangement in favour of a more limited scheme after a creditor assigned its debt to another party which did not support the scheme.
  • Such a situation can easily be avoided by the scheme company negotiating a voting and standstill agreement with key creditors.
  • The mere fact that certain creditors have agreed, in advance, to vote in favour of a scheme is not, of itself, enough to require those creditors to be placed in a separate class for voting purposes.

In the midst of press criticism at the pace of the creditor recovery exercise relating to Lehman Brothers Australia Ltd (LBA) relative to the recovery exercise in the US, the liquidators of LBA have been forced to abandon the originally proposed scheme of arrangement which would have dealt with all creditor claims outside of a formal winding up process.

Shortly before the scheme meetings, a related body corporate of LBA, which was in a class of its own for voting purposes (and hence had a veto right over the entire scheme), assigned its claims to the parent company of LBA which then refused to support the scheme.

This situation highlights the importance of signing up major creditors to voting and standstill agreements, even if they are related bodies corporate of the scheme company and presumed to be ‘supportive’ of the scheme.

The first Lehman Brothers Australia creditors’ scheme

In May 2013, LBAconvenedmeetings of creditors to vote on a proposed creditors’ scheme of arrangement which would have facilitated the compromise of the claims of all the unsecured creditors of the company.

One of the notable features of the proposed scheme was that, if approved, it would have resulted in a settlement of all claims former clients of LBA had against LBA in relation to investment advice by LBA.

LBA had reached settlement agreements with its insurers pursuant to which, in return for releases from liability from the client creditors of LBA (which releases would be obtained under the scheme), the insurers would pay $48 million into a scheme fund that LBA would then distribute to client creditors.

Just five  days before the scheme meetings, LBA’s liquidators were informed that one of the scheme creditors, Lehman Brothers Asia Holdings Ltd (LB Asia), a related party of LBA, had assigned its debt to the New York-based parent of LBA and LB Asia, Lehman Brothers Holdings Inc. (LB Holdings). LB Holdings then informed LBA’s liquidators that it did not support the scheme and would direct LB Asia to vote against it.

LB Asia had been placed in a class of its own for voting purpose given that its rights under the scheme were sufficiently dissimilar to the rights of the other creditors. This gave LB Asia an effective veto right over the entire scheme due to the requirement that the scheme be approved by each of the five  classes of creditors.

As LBA’s liquidators were unable to negotiate a resolution with LB Holdings, the liquidators were forced to abandon the proposed scheme.

The revised Lehman Brothers Australia creditors’ scheme

LBA’s liquidators were forced to proceed with a new creditors’ scheme of arrangement which, on its face, was inferior to the originally proposed scheme as it will:

  • involve only client creditors and will not settle the claims of any of the other unsecured creditors of LBA
  • distribute only the insurance proceeds and will not distribute any of LBA’s other assets to creditors (including client creditors)
  • provide only partial, not full, satisfaction of the client creditors’ claims
  • mean that LBA’s unsecured creditors, including client creditors, will now have to prove in the company’s liquidation, which would have been avoided under the original scheme, and
  • not settle the ongoing class action proceedings. The class action litigation will likely continue with an appeal by LBA against findings made at first instance in the Federal Court. Those proceedings would have been settled by the original scheme.

Commentary

The ongoing LBA saga highlights just how easy it can be for a carefully structured creditors’ scheme – negotiated over an extended period – to fall over if one or more key creditors assign their debts before the scheme meeting.

The saga also serves as a salutary reminder – for both creditors’ schemes and members’ schemes – of the potential completion risk created by placing a person in a class of their own as such a person will have a veto over the entire scheme. It can be dangerous to assume that such a person will not switch allegiances (even if they are a related body corporate of the scheme company, as was the case in the LBA scheme).

Such a situation can easily be avoided by the scheme company negotiating a voting and standstill agreement with key creditors.

There is greater scope to obtain such agreements in a creditors’ scheme than in a members’ scheme where bidders are limited to locking up 20% of the shares and/or votes in advance. In the case of creditors’ schemes it is well accepted that the mere fact that certain creditors have agreed, in advance, to vote in favour of a scheme is not, of itself, enough to require that those creditors be placed in a separate class for voting purposes.

By way of example, in the complex debt-for-equity creditors’ scheme of arrangement involving Centro, the ‘Signing Senior Lenders’ – who represented more than 83% of the senior debt – agreed to vote in favour of the scheme of arrangement.