Payment of interim dividends to unsecured creditors

A third unsecured creditor interim dividend of 24.7% was paid on 29 November 2013 and a fourth unsecured creditor interim dividend of 7.8% was announced on 28 February 2014. Creditors should now have received the fourth interim dividend which brings the total cumulative dividend rate to 100%. This is unlikely to be the final distribution from LBIE (see below for information on the surplus). In order to be eligible to receive the fourth interim dividend creditors needed to have an agreed and admitted claim in the LBIE administration by 28 March 2014. Further information on the fourth interim dividend can be found in our recent client bulletin. Click here to access this. 

Clients who were unable to agree their claim and have it admitted in the LBIE administration in time for the fourth interim dividend payment (i.e. by 28 March 2014) will, however, be able to receive catch up payments (for the first, second, third and fourth interim dividends) in due course once their claim is agreed and admitted. Dates of such planned catch up payments are set out in Appendix C of the Report. Where a claim has not been agreed or admitted in the administration but a compliant proof of debt (PoD) has been received by the administrators, the administrators continue to make appropriate reserves, unless the claim has been formally rejected and the rejection appeal period has passed. Reserves have also been made for certain other contingencies.

There remains no hard bar date for filing claims against LBIE and it is, therefore, still possible to submit a PoD. Any clients yet to submit a PoD or to agree their claim with LBIE are strongly urged to do so as soon as possible. While there are some complex issues still to be resolved in LBIE’s administration, it is clear that the administration is entering into its more final stages and therefore any negotiations with LBIE concerning claims admittance should now be prioritised (especially as there is a 100% dividend available for unsecured creditors together with a confirmed surplus (see below) and the initiation of litigation by the administrators in respect of unresolved claims is now much more likely). Furthermore, as we reach the sixth year anniversary of the administration, there may be a question as to whether claims might become time barred under the Limitation Act 1980 if not agreed although the position on this is complex.

Indicating a greater engagement by creditors to progress the admittance of claims in the six month period covered by the Report (probably due to the significant dividend available), the Report highlights that overall, admitted or agreed claims increased significantly, with the total admitted or agreed claim value increasing by £1.43bn.

The administrators have stated that no further distributions beyond a rate of 100% will be made until certain issues surrounding entitlements to the surplus are resolved, either by way of compromise with creditors and/or litigation. Further details on how the surplus may be applied are set out below. Creditors should be aware that not all claims to the surplus will be met given that value is likely to break at some level of the waterfall, depending on the final surplus amount.

Estimated outcome for unsecured claims

A revised indicative financial outcome in the Report now shows a surplus in both the low and high case scenarios for the first time.

The potential value range of the surplus, before post-administration interest, currency conversion claims and the subordinated debt, is estimated to be between £3.5bn and £6.99bn.

Clients should be aware that the methodology to calculate entitlements to the surplus is yet to be determined, and in particular there are some difficult issues regarding how certain claims to post-administration interest and currency conversion claims should be calculated. However, individual entitlement to share in the surplus is likely to depend upon the timing of distributions made to the creditor, the nature of the underlying contracts with LBIE and potentially the terms of any agreements with LBIE entered into by the creditor post-administration. An assessment of the subordinated debt and LBIE’s potential contribution claims against its shareholders (see below) is excluded from the indicative financial outcome due to outstanding issues which remain unresolved. The low case outcome has improved largely due to increased settlements with affiliates and on-going progress in agreeing unsecured claims at amounts below their originally claimed PoD values. The updated high case outcome has also improved due to reductions in the value of unsecured claims.

The overall outcome will be affected by numerous outstanding factors including the finalisation of settlements of remaining creditor claims, the outcome of the litigation with AG Financial Products Inc (AGR) (see below), the future recoveries from affiliates, the ability of the administrators to mitigate or eliminate any priority claims and the level of future costs in the administration.

Distributing the surplus

Waterfall application

The waterfall application concerned a number of questions on the ranking of various claims to the surplus (together with LBIE’s shareholders’ obligations to contribute to the debts of LBIE). The judgment in the waterfall application was handed down on 14 March 2014. The key conclusions of a detailed and nuanced judgment were that:

(i) both post-administration interest on ordinary unsecured creditors’ claims (the 8% statutory interest arising pursuant to the Insolvency Rules 1986) and any non-provable claims are payable in priority to any subordinated debt;

(ii) currency conversion claims (claims against a company in administration to reflect adverse currency movement during the course of the administration proceedings) exist as non-provable claims to be paid after ordinary unsecured claims and post-administration interest; and

(iii) the obligation of LBIE’s shareholders to contribute to LBIE’s debts and liabilities (which arises because of LBIE’s status as an unlimited liability company) extends not only to proved debts but also post-administration interest on those debts and non-provable liabilities.

An appeal of the waterfall application judgment is expected although a formal application for permission to appeal is yet to be filed. The timetable for applying for such permission has been extended to June. While providing answers to some of the big questions posed as to the priority of the claims of ordinary unsecured creditors, the subordinated creditor¹ and LBIE’s shareholders to the surplus the decision has, as is common for LBIE matters, resulted in a number of further questions. These include, among others:

(i) the interpretation of the definition of “Default Rate” in the ISDA Master Agreement in order to determine the entitlement of creditors to recover a compound rate of post-administration interest in excess of the 8% rate prescribed by the Insolvency Rules 1986;

(ii) the effect of post-administration interest on the calculation and adjustment of currency conversion claims; and

(iii) the impact of the release and discharge clauses included in post-administration documentation, such as the Claims Resolution Agreement (CRA) and Claims Determination Deeds, on post-administration interest and currency conversion claims.

¹ The subordinated debt is now owned by the Wentworth joint venture company following an assignment by LB Holdings Intermediate 2 Limited.

Surplus Entitlement Proposal

Whether the administrators seek permission to appeal aspects of the waterfall application judgment and/or apply for directions on further matters concerning the surplus depends, in a large part, on whether a compromise can be reached with creditors concerning the distribution of the surplus. Given the diverging views of the LBIE creditor community on some of the key issues which impact on the distribution of the surplus, the administrators consider that it is highly unlikely that a consensual compromise could deal with all the relevant issues. The administrators note that, should they apply to the court for directions on further matters, a first instance hearing would likely occur in 2015 at its earliest, with any subsequent appeals likely to be heard in 2016.

It is still the administrators’ preference, however, to deal with as many issues as possible via a consensual compromise with creditors, which would likely ultimately take the form of a company voluntary arrangement or scheme of arrangement (although no detailed consideration has been given as to how to frame such arrangement). An initial draft compromise proposal known as the Surplus Entitlement Proposal was published on the PwC website although, for the reasons given above, it seems unlikely that this will be proposed to creditors in its published form.

On 10 March 2014 the Surplus Entitlement Proposal was presented to a small number of major LBIE creditors pursuant to a non-disclosure agreement. The Surplus Entitlement Proposal was consulted on between 10 March and 28 March 2014 and publicised, along with a proposed term sheet and a list of frequently asked questions, on 28 March 2014.

In very broad terms the Surplus Entitlement Proposal attempts to provide some balance to the competing claims and does not strictly follow the order of priority set out in the waterfall application (presumably reflecting the chance of different conclusions being reached on any appeal). The Surplus Entitlement Proposal would see the surplus applied in the following order of priority:

• in the payment of interest – this would be split into two categories of payment, the first category being paid in priority to the second: (i) a payment of 8% per annum (the minimum statutory interest payable under the Insolvency Rules 1986) to all ordinary creditors with admitted claims (i.e. the subordinated creditor would be excluded); and (ii) a top up payment in respect of OTC creditors (broadly those creditors with claims deriving from ISDA or certain other qualifying documentation) of 2% per annum or, if the creditor can successfully assert that a higher rate applies, that higher rate (subject to a cap of 10% per annum) – if a higher rate claim is unsuccessfully asserted no top up interest would be payable to the OTC creditor;

• a part payment of the subordinated debt due to the subordinated creditor of £150 million;

• in the payment of currency conversion claims and subordinated debt in the ratio of 70:30 respectively (until currency conversion claims are paid in full);

• in the payment of the balance (if any) of the subordinated debt due to the subordinated creditor until the subordinated debt has been paid in full;

• in payment of interest in respect of the subordinated debt; and

• in payment of the subordinated creditor’s currency conversion entitlement.

Click here for further information in relation to the Surplus Entitlement Proposal.

Given the divergent views of the creditor community aired in the consultation period and the likelihood that compromise pursuant to the Surplus Entitlement Proposal will be unachievable the administrators are also considering a narrower proposal that addresses some of the interest claims to the surplus only (although details are not yet available). The administrators have indicated that, with creditor consensus on a compromise proposal, this may allow a fifth distribution to be made to unsecured creditors (i.e. a distribution of some of the surplus) in Q3 2014. While the administrators clearly favour resolution of the issues concerning the distribution of the surplus by way of a compromise with creditors, when forming views on any compromise put forward by the administrators, clients will need to balance the benefit of potential earlier payments, against the potential increased entitlement to the surplus should issues be litigated with a favourable outcome for that particular creditor’s position.

Further updates as to the progress made on issues concerning the distribution of the surplus will be made on the PwC/Lehman website.

The Consensual Approach and the resolution of creditors’ claims

The Consensual Approach is the process the administrators have adopted for dealing with unsecured claims. Please click here for our bulletin on the 12 October 2012 progress report which contains further details on the Consensual Approach. While creditors’ claims continue to be agreed under the Consensual Approach, there has been an increasing focus on bilateral negotiations when an offer under the Consensual Approach is rejected. 222 claims are currently subject to the bilateral negotiation process.

Currently 350 creditors have submitted proofs of debt totalling £1.06bn in respect of which LBIE has not made offers (due to either legal, commercial and/or valuation issues). The administrators continue to focus on the consensual withdrawal of what the administrators’ view as invalid claims and the formal rejection of such claims. In the Report period 200 claims (totalling £0.48bn) have been withdrawn and 42 claims totalling £0.18bn were rejected (with the period to appeal such rejection passing). A number of creditors have appealed the administrators’ rejection notices and these claims will now be subject to adjudication by the English court. Given that LBIE’s administration is now entering into its more final stages it is expected that the resolution of claims may result in further applications to court where mutually agreeable resolutions are not achievable. Litigation to resolve disputed claims is expected to increase.

Client assets

LBI settlement and the arising omnibus trust

The LBI Consensual Proposal and the LBI settlement became effective as of 7 June 2013 (for further information on the LBI Consensual Proposal and the LBI settlement click here). Two separate interim distributions have now been paid to consenting beneficiaries providing a cumulative interim distribution rate of 106% of total best claim value. With certain exceptions for US tax payers, LBIE reserved approximately 30% of the best claim value of each beneficiary from each distribution in order to account for potential US withholding tax liabilities. Agreement has now been reached with the Internal Revenue Service (IRS) in respect of the first interim distribution and LBIE expects to be in a position to release back to consenting beneficiaries some or all of the excess reserves made in respect of US withholding tax in respect of the first distribution, net of the appropriate tax. This is known as the third distribution. A Notice of Intended Distribution will be sent to consenting beneficiaries on 20 May 2014 which will contain a detailed statement as to how much of the reserve will be released and how this has been calculated. It is understood that negotiations continue with the IRS in relation to US withholding tax and the second interim distribution.

The third distribution is proposed to be paid on 12 June 2014, with 28 April 2014 given as the cut-off date. Each consenting beneficiary must be eligible for the purpose of the distribution both on the cut-off and distribution date. Clients who are consenting beneficiaries for the purpose of the omnibus trust should check their status on the LBIE portal in respect of the third distribution and are reminded that each consenting beneficiary needs to provide and confirm standard settlement instructions for payment in USD via the portal.

At the moment, it is not clear what the amount of any further dividend will be but we note that the high-case estimate for omnibus claims is 109.9% and 106% has already been distributed so we would not expect any further distribution to be substantial.

LBIE is in the final stages of assessing the status of the omnibus trust for UK tax purposes. HMRC have agreed that no inheritance tax will arise on the trust, provided certain conditions are met. LBIE expect these conditions to be easily met. HMRC have also agreed that no capital gains tax will arise in respect of transactions entered into by the trust up to mid-December 2013. LBIE is, however, still in the process of agreeing the income tax position on income earned since LBIE received funds from LBI. However, the Report highlights that the risk of material UK tax liabilities remains low.

LBIE continues to liaise with LBI over a limited number of post-completion matters. A number of disputed client accounts have been resolved, with transfers of funds between LBI and LBIE.

Other client assets

The Report highlights that around 8,000 client asset holdings have now been fully returned to counterparties representing a total value of approximately £14bn. In addition, the exercise to agree allocation of client assets that were in partial shortfall among non-CRA counterparties has now been substantially concluded.

Notably, following the resolution of the extended liens litigation in Hong Kong, client assets held by Lehman entities subject to insolvency proceedings in Hong Kong (LBHK) on behalf of LBIE’s clients were released to LBIE in mid-March-2014. The return of those assets to counterparties is expected to commence shortly. Where clients have claimed client assets from both LBHK and LBIE, the duplicate claim will need to be resolved before assets are recoverable.

Issues in relation to over-claims (i.e. multiple claims to the same asset) continue to be resolved with the remaining over-claim issues predominantly relating to LBHK-linked securities.

Given the significant progress made (in particular the conclusion of the extended liens litigation) the resolution of the majority of the remaining material client asset matters are expected by the end of 2014. Accordingly, the administrators are focussing on the steps required to wind up the client asset estate – this may involve seeking directions from the court.

Pre-Administration Client Money

There has been significant progress in resolving the client money estate, most notably the on-going litigation with Lehman Brothers Bankhaus A.G. (LBB) being settled. The settlement will result in 50% of LBIE’s £0.81bn client money claim being admitted as an unsecured claim by LBB, with the balance having subordinated status. A number of formalities need to be completed before LBIE will receive a “catch-up” dividend at the rate of 39.5% on its unsecured claim. The LBB settlement has also enabled LBIE to receive $0.21bn from LBHI under its related guarantee. Further information on the LBB settlement can be found below.

Progress has been made in relation to unresolved client money entitlements (CME) with the majority of counterparties continuing to elect to take an unsecured claim and assign their CME to LBIE’s nominee. CME have now been agreed and resolved for 76% of counterparties, and work has been completed on a further 11% for which court directions are expected to be required. This group includes counterparties whom LBIE has been unable to contact, counterparties refusing to engage or counterparties who are dissolved.

The administrators recently presented a proposal to counterparties that had retained CME, to settle their remaining entitlements at 100% of their CME (plus, where applicable, a currency allowance) in exchange for an assignment of their CME to LBIE’s nominee. The proposal was presented to all 55 counterparties. As at 14 March 2014, 54 had accepted the offer, with discussions continuing with the remaining counterparty. The administrators expect the majority of further outstanding CME to be assigned to LBIE’s nominee in satisfaction of indebtedness due to LBIE or in exchange for the admission of an unsecured claim, with only $0.03bn remaining to be paid into the UK High Court for “orphaned” type claims. One major sticking point to the resolution of the client money estate concerns the assertion of Barclays Capital (BarCap) that it acquired LBI’s CME. The issue is subject to US litigation between LBI and BarCap and LBIE’s negotiations with BarCap and LBI have stalled. Accordingly, it is unlikely that the issue will be resolved before the conclusion of the US litigation.

Given the strong asset position of the client money pool and limited claims against it (the claims of LBIE’s nominee for assignments aside) the administrators now consider that there is unlikely to be any good or economic reason to undertake a tracing exercise and are looking at options to begin to wrap up the client money estate. Accordingly, the administrators intend to make an application to the UK High Court for directions on a number of issues including: (i) requesting a hard bar date for the submission of client money claims; (ii) how to deal with the client money claims of a small number of non-responsive, uncontactable or legally dissolved counterparties; (iii) whether the court agrees that there is no good reason to undertake a tracing exercise; and (iv) options for calculation of final payments.

Further background information on pre-administration client money can be found in our bulletin on the tenth progress report – please click here to access this.

Key litigation and the resolution of disputes

Subordinated debt and contribution claims against shareholders

Many of these issues were considered in the waterfall application (see above). For a full copy of the judgment and other background material, click here. As well as considering issues as to the surplus, LBIE is continuing to work through the consequences of the waterfall judgment and how resolution can be reached with LBIE’s shareholders (in particular in relation to the shareholders’ potential contribution claims). As highlighted above the waterfall judgment is expected to be appealed.

LBI and BarCap

As highlighted above, US litigation continues in relation to BarCap’s claim that it acquired LBI’s CME and this continues to affect the resolution of the client money estate.

Extended liens (LBHK)

The extended liens litigation in Hong Kong has now been resolved with the Hong Kong court ruling that LBHK should distribute to LBIE certain client assets previously held subject to extended liens. Accordingly, client assets held by LBHK on behalf of LBIE’s clients were released to LBIE in March 2014.

Pension scheme deficit

Following the UK Supreme Court judgment in July 2013, which decided that a liability derived from any Financial Support Direction (FSD) issued by the Pensions Regulator should be treated as a provable unsecured claim, the Upper Tribunal now has the role of deciding whether an FSD should be made, and against which entities. LBIE is one of six affiliates that the Pensions Regulator’s Determinations Panel decided should receive an FSD in connection with the Lehman Brothers pension scheme deficit. A 15-day substantive hearing is listed for February 2015. The Upper Tribunal is expected to issue further directions in July 2014.

Further, the UK High Court has held that the aggregate liability under contribution notices could exceed the amount of £0.12bn claimed as a statutory debt due from Lehman Brothers Limited (the pension scheme employer). This decision has been appealed and the hearing is scheduled for Q2/Q3 2014. LBIE is therefore continuing to hold a reserve of £0.12bn in respect of any liability that may arise in connection with an FSD.

Asset recovery

The Report indicates that significant progress was made and a total of £1.6bn was recovered from counterparties. The strategy for recovering assets continues to be focussed on those counterparties with the majority of the remaining value and the Report highlights escalation plans for a number of remaining debtor groups to progress the matter to settlement, or, if necessary, litigation. It is also expected that the majority of claims against low value counterparties will be resolved over the next 6 months. Further, there has been an increased use of litigation to safeguard claims against debtors or prosecute recovery actions across debtor counterparties. The biggest single debtor that is subject to litigation is AGR and if such litigation is successful, LBIE expect to recover £0.55bn.

A number of client asset claimants are also LBIE’s debtors and the collection of such debtor balances has progressed through the use of indebtedness determination deeds and a simplified process for smaller debtors.

The administrators note in the Report that they are mindful that the complete debtor population also needs to be resolved as soon as possible given the impact of the Limitation Act 1980 later this year and are therefore seeking to accelerate resolution of the remaining population of debtors – such time pressure is also likely to increase the likelihood of litigation to resolve claims.

Lehman affiliates

The Report highlights the progress that has been made with a number of affiliates, including notably LBB and LBHK. Key points are highlighted below.

• Lehman Brothers (Luxembourg) S.A. (LB Lux)

Following the effectiveness of the LB Lux settlement on 4 October 2012, £0.15bn has been received as a first distribution share from LBHI with respect to LB Lux. LBIE continues to work with the LB Lux liquidators and LBHI to maximise the value that will accrue to LBIE from the Luxembourg estate pursuant to a supplemental settlement agreement executed in October 2013.

• LBB

The LBB settlement became effective on 14 March 2014, resulting in expected recoveries of at least £0.16bn and reduced inbound claim reserves of £0.58bn. The related proceedings in the German Supreme Court relating to LBB’s counterclaim have now been withdrawn by mutual consent. LBB has now developed its own insolvency plan to finalise matters within its estate, incorporating admittance of a net LBIE claim against LBB of €65m and admittance of an ordinary unsecured claim against LBB, derived from LBIE’s Client Money claim against LBB. In due course LBIE will sign a document in support of LBB’s plan which will enable LBIE to receive cash distributions on its claim.

• Lehman Brothers Japan (LBJ)

Resolution of issues has advanced considerably leaving no material matters to resolve. As a result catch up dividends have been paid by LBIE to LBJ with recoveries from LBJ being received by LBIE.

• LBIE Seoul branch

A solvent liquidation in respect of LBIE’s Seoul branch commenced on 30 August 2013. This has allowed client funds, pursuant to Korean Regulations, to be returned to LBIE. Work to expedite the return of further funds continues (although the timing of such return is dependent on the resolution of local tax matters, claims settlement and regulatory compliance).

• LBHK

The final Hong Kong court hearing regarding third party security interests was held in January 2014 (see above). Asset returns subject to competing claims (estimated at c. £40m) continue to be resolved. A supplemental settlement deed has also been signed to finalise inbound claims for LBHK entities.

• Storm Funding Limited

Settlement has been reached with Storm Funding Limited, resulting in an inbound claim of £0.16bn. A settlement deed was executed on 17 March 2014.

Administrators’ webinar

The administrators hosted a one-hour webinar at 14:00 GMT on Tuesday 6 May 2014, giving creditors the opportunity to hear a summary of the current circumstances of the administration. There was also a question and answer session. ‎The webinar can be accessed again on the PwC website from Thursday 8 May at www.pwc.co.uk/lehman.

Click here for a copy of the full Report.