BAR DATE AND PAYMENT OF FIRST INTERIM DIVIDEND TO UNSECURED CREDITORS

The current bar date of 31 July 2012 for lodging proofs of debt (PoD) has now passed. Creditors with claims submitted after this date will not be able to participate in the first interim dividend and will need to wait for a “catch up” dividend of the same rate which will be paid later and will be contingent on there being sufficient funds remaining in the administration. Clients that are yet to submit a PoD are strongly urged to do so.

By 31 October 2012, for all compliant PoDs received by the bar date, the administrators will either admit, reject or make an appropriate reserve for claims which remain under consideration. Reserves will also be made for other relevant contingencies including any relating to client money issues. The administrators currently anticipate that the first interim dividend will be paid on or around 30 November 2012 to creditors with admitted claims but it is possible that this payment may be delayed given certain affiliate issues (referred to below). Currently the administrators are required to declare a first interim dividend by 31 December 2012. By way of reminder in order to participate in the first interim dividend the following must have occurred:

• A valid PoD must have been submitted via the creditors' portal by the 31 July 2012;
• The claim must have been assessed by LBIE;
• The claim must be agreed with the administrators by 31 October 2012 (i.e. executed a Claims Determination Deed (CDD) or similar agreement); and
• Standard settlement instructions must have been provided for a GBP bank account by 31 October 2012.

The Report does not indicate what the level of the first interim dividend is likely to be given that the administrators need to assess all claims admitted by 31 October 2012 and progress other issues which will have a material effect on this. A revised indicative financial outcome in the Report indicating an estimated total dividend level for unsecured, unsubordinated claims of approximately 15% – 95% has been provided. The low case scenario indicative outcome has materially worsened since the previous report largely due to the effects of client money and the unexpectedly high claims that were lodged by certain affiliates, ahead of the 31 July 2012 bar date. The high case outcome indicates a marginal improvement on the position reported on previously reflecting the LBIE/Lehman Brothers Inc. (LBI) settlement terms (further details on this are included below). The Report makes it clear that the likely financial outcome is based on financial assumptions that are likely to change. Therefore, creditors should be careful not to rely on these figures as they are merely a rough indication of the current estimated total dividend level (and given the breadth of the range, the estimate is not very helpful in any event).

Given that the high case scenario for ordinary unsecured creditors has moved close to par, the administrators have stated that they will consider the ranking of subordinated debt and interest on unsecured claims, to the extent necessary, once the range of estimated outcomes has narrowed considerably.

SMALL CLAIMS SETTLEMENT OFFER

In May 2012, the administrators launched the Small Claims Settlement Offer (SCSO) which provides creditors with the opportunity to receive a single payment (of 90% of their agreed claim amount) in full and final settlement of their unsecured claims against LBIE. The SCSO is available to all creditors with an agreed claim of £150,000 or less. Any creditor whose agreed claim amount exceeds £150,000 may also participate, but the maximum payment will be 90% of £150,000 (i.e. a payment of £135,000).

In order to participate creditors must, as well as having their claim admitted by the administrators, enter into a separate agreement with LBIE accepting the SCSO in full and final settlement. As previously advised, these conditions must be met by 31 October 2012.

If a creditor does not wish to accept the SCSO then, provided that its claim is admitted by the administrators, it will automatically be entitled to participate in the first interim dividend and any subsequent dividends made throughout the duration of the administration.

THE CONSENSUAL APPROACH

The Consensual Approach is the process that the administrators have adopted for dealing with unsecured claims. Creditors who have submitted a valid PoD are made an offer which is expressed to be non-negotiable, based on LBIE's determination of the value of the creditor's claim. The creditor is free to accept or reject this offer. If the offer is rejected, the claim will be reviewed in detail on a bilateral basis in accordance with the UK insolvency rules. If the offer is accepted, the creditor enters into a  CDD (essentially a settlement agreement) fixing the value of the claim. While the standard form CDD is expressed to be non-negotiable, we are aware of the administrators accepting limited amendments to its terms. The Report indicates that 732 claims (totalling c.£3.9bn) have now been agreed through this process.

Initially, the Consensual Approach was announced by the administrators to accelerate the resolution of unsecured claims of financial trading counterparties who had not acceded to the Claims Resolution Agreement (the CRA). The administrators have now adapted the Consensual Approach to deal with unsecured claims from creditors who have submitted client asset claims (both CRA signatories and non-CRA signatories). However, certain creditors remain excluded from participating in the Consensual Approach for specific commercial or legal reasons (for example, where the creditor is asserting non-mutual set-off against LBIE receivables). It is also proving difficult to offer a CDD to a client with assets sub-custodied with LBI due to the uncertainties discussed below regarding the resolution of certain issues affecting these claims. In order to be eligible for the Consensual Approach, the relevant creditor must have submitted a PoD which is compliant with UK insolvency legislation.

The Report indicates that the administrators have now commenced a bilateral claims agreement process with those creditors who have formally rejected LBIE’s offer under the Consensual Approach. The time required to agree claims on a bilateral basis will depend upon certain factors such as: (i) the complexity of the claim; (ii) the level of additional evidentiary documentation that needs to be provided; and (iii) the number of creditors that request to have their claims dealt with by this process. It seems probable that the majority of creditors seeking to have their claims agreed through bilateral negotiation will not participate in the first interim distribution.

LBI AND LBIE SETTLEMENT DISCUSSIONS

The Report and the announcement by the administrators on 12 October 2012 indicates that considerable progress has been made in settlement discussions with LBI to resolve LBIE’s House and Omnibus claims against LBI. This has resulted in the signing of non-binding heads of terms between the parties on 4 October 2012. The non-binding heads of terms cover how a settlement might be effected during the next year and how the key value items in the proposed settlement would impact the various interested parties. The heads of terms is subject to documentation and approval by both the US Bankruptcy Court (at present a hearing is anticipated in the first quarter of 2013) and the English High Court. If approved, this will allow the administrators and the Trustee for LBI to proceed with plans to allocate and distribute assets to their estates' respective clients. Details of the non-binding heads of terms and the impact  of this potential settlement on LBIE's clients who are affected by the Omnibus claim (broadly those clients who have a client asset claim against LBIE but where the client's securities and cash were held by LBI) can be found here.

It should be noted that the parties have agreed, on a binding basis, to limit the maximum recoveries that each would make from the other's estate in the event that a consensual settlement is not eventually completed and the respective claims need to be resolved through litigation. This is designed to enhance distributions to other creditors in both estates through a reduction in the quantum of required reserves otherwise needed if LBI and LBIE had continued to assert the full value of their filed claims without set-off or net equity adjustments.

LBIE's administrators have stated that there will continue to be a material mismatch of the securities recovered from LBI compared to those due to LBIE's underlying clients. As a result LBIE will not be in a position to return like for like securities to its clients. Therefore, it is likely that LBIE will need to liquidate the securities with the realised proceeds being added to cash received from LBI and then being allocated to LBIE clients via a consensual contractual proposal which will take a consistent approach to all LBI related positions of LBIE's clients affected by the Omnibus claim. This will include affected CRA and non-CRA claimants. It is not yet clear whether this pro rata allocation will be based on asset values as at 19 September 2008, current asset values or a mixture of both.

The administrators have indicated that further details of LBIE's proposed methodology to resolve issues arising from the Omnibus claim will be provided to LBIE's affected clients in the next few weeks. Such clients will also receive an updated and rolled forward LBI statement. Previous statements issued to clients reported the client cash and securities positions as at 19 September 2008. The revised statements will use June 2012 valuations and will capture the impact of corporate actions and income arising in the period. This information will likely impact the ultimate allocation of the Omnibus claim recoveries. Therefore, clients are encouraged to review the statements and accompanying guidance notes carefully when they are received and to provide the administrators feedback as soon as possible. 

CLIENT ASSETS

The Report states that the administrators continue to make progress in returning client assets through the CRA and other bilateral processes. The return of certain client assets remains blocked by LBI related issues (see above). Further, Lehman entites subject to insolvency proceedings in Hong Kong (LBHK) are yet to release any client assets held for LBIE clients pending resolution of the extended lien dispute (see below for further details).

The administrators are still working towards the resolution of over-claims (i.e. multiple claims to the same asset) against both assets held within and outside LBIE’s control. The Report indicates that over-claims of c.£0.4bn were materially resolved or reconciled in the last six months.

PRE-ADMINISTRATION CLIENT MONEY

The Supreme Court judgment in respect of client money on 29 February 2012 held that: (a) any identifiable client money in the house accounts should form part of the client money pot for distribution to client money claimants; and (b) all clients for whom client money ought to have been segregated are entitled to distributions, whether any such money was in fact segregated. For further information on the client money judgment please click here for our client bulletin.

This requires the administrators to trace client money wherever held and place such funds in the client money pool. The Report indicates that this tracing exercise can only be completed once the administrators have identified the gross client money amount that should have been segregated so as to keep the tracing exercise cost-effective. To date, however, approximately £1.6bn of assets have been identified in the house estate which represent potentially traceable client money.

In order to facilitate an interim distribution from the client money pool, the administrators have identified the following steps which need to be undertaken: (a) formulate and publish a view on the principles that should be applied by LBIE to calculate client money entitlement; (b) prepare and distribute client money determinations (CM Determination) for individual counterparties based on these principles; (c) monitor counterparties' responses to the CM Determinations; (d) consider a client money bar date application (see below); and (e) operationally prepare for a client money interim distribution in the first half of 2013.

The administrators have now formulated a view on the principles which will apply to calculate client money entitlements. These are based on the forms of contract used by LBIE, the contents of the Supreme Court judgment and the comments made by certain interested parties. These principles were communicated to creditors in May 2012 and can be accessed here. The Report further indicates that the administrators have already made significant progress with preparing CM Determinations which will be communicated to the relevant creditors shortly. It is expected that this task will be substantially completed by the end of 2012. A further update detailing the number and value of agreed CM Determinations will be published when the agreement process is sufficiently advanced.

At present, there is no bar date for the submission of client money claims. However, the administrators are keeping this matter under review and may consider making an application to the High Court at some future point in time for an order specifying a date by which all claims for client money should be lodged.

LITIGATION

BTB derivative side letters

The High Court handed down its judgment in April 2012. The judgment was not in LBIE’s favour and is now subject to appeal by LBIE. If LBIE is successful on appeal and the BTB side letter is held to be valid, LBIE will be entitled to settle with Lehman Brothers Finance (LBF) on certain ‘back-to-back’ trades at the same value that is settles the trade with its street counterparty. The appeal is due to be heard in December 2012, unless a proposed settlement agreement is reached with LBF in the interim.

Extended Liens

The substantive High Court hearing in relation to extended liens that was held in September 2012 and judgment is expected shortly. Custodied assets have been returned to affiliates that satisfied the necessary release conditions set by the High Court in 2011, where the relevant agreement existed. Other affiliates are at various stages of this process. These proceedings could have a material impact on LBIE’s recoveries of its assets held by affiliates, as well as on LBIE’s ability to appropriate assets in LBIE’s control to settle clients' indebtedness to affiliates. Proceedings in Hong Kong have also been commenced in relation to the extended lien issue.

ISDA – section 2(a)(iii) judgment

The Court of Appeal decision concerned an entitlement to withhold payment of certain live derivative positions that relevant counterparties had declined to terminate. Following the Court of Appeal's decision, certain respondents applied for leave to appeal to the Supreme Court with a decision on whether leave will be granted still pending. During this period, LBIE have agreed a commercial settlement with one of the respondents. The administrators are seeking commercial solutions with other respondents where possible.

LEHMAN AFFILIATES

The Report outlines progress that the administrators have made to seek the return of client assets and money from various Lehman affiliates and to resolve the claims of affiliates in LBIE’s administration. The LBI/LBIE settlement is set out above. Other key points include:

• Lehman Brothers (Luxembourg) S.A. (LB Lux) filed claims of £11.8bn of which £11.5bn was characterised as an administration expense claim intended to rank in priority to general unsecured creditors. On 4 October 2012, a conditional withdrawal of all but c.£0.1bn of the claims was achieved (and the c.£0.1bn is to be an unsecured claim). However, as a precautionary measure, the administrators have separately issued proceedings in the High Court to seek a determination on the administration expense status, in the event that the settlement is delayed. The settlement of this issue is one that will have a material bearing on the time and amount of the first interim dividend. 
• The return of assets from LBHK remains contingent on the outcome of the High Court extended liens application and LBHK’s own local proceedings regarding the same matter (see above).
• Following extensive negotiations with LBIE and Lehman Brothers Japan (LBJ), progress has been made towards an agreement in principle as to the terms and related indemnity required to enable the return of the final tranche of Japanese stock-lending assets. However, the lack of waivers from two entities which have asserted earlier claims against LBJ is an obstacle to concluding the agreement.
• LBIE is still awaiting confirmation from the court of the Netherlands Antilles that there are no further inbound claims to be filed by Lehman Brothers Securities N.V. (LBS) against LBIE. A court hearing is expected in November 2012.
• Settlement discussions between LBIE and LBF have further advanced, although a formal agreement appears to remain some way off. LBF filed a PoD in July 2012, which LBIE asserts includes a number of duplicated items and some heads of claim that are not provable at this time or at all. LBIE has reprioritised its focus and engagement with LBF to ensure that appropriate priority is given to reducing the value of the filed claim or agreeing a significant lower amount. If agreed in time, this could materially assist the administrators in maximising the first interim distribution to unsecured creditors.
• The administrators are continuing proceedings in the German court to recover $1bn of pre-administration client money held by Lehman Brothers Bankhaus AG (Bankhaus). On 3 May 2012, a German court ruled in LBIE's favour determining that its claim should rank pari passu with other unsecured creditors and should not be subordinated as being a shareholder contribution in the Bankhaus estate. Bankhaus has appealed this judgment and filed the ground for its appeal in September 2012. LBIE's reply will be filed in the coming months. An appeal is unlikely to be heard before early 2013.

ADMINISTRATORS' WEBINAR

The administrators plan to host a one-hour webinar on 12 November 2012 which will give creditors an opportunity to hear a summary of recent developments and to participate in a question and answer session. Further details of the webinar will be posted on the PwC Lehmans website in the near future.

Click here for a copy of the full Report.