Client Assets Update - Strategy for Return of Client Assets - 05/10/09

This update is further to those posted on this website concerning the proposed scheme of arrangement for trust property creditors (the "Scheme").

A. Background

As mentioned in our update on 15 July 2009, the Joint Administrators made an application to the High Court concerning the jurisdiction of the court under part 26 of CA 2006 to sanction a scheme of arrangement (the "Application") with respect to certain client assets held by Lehman Brothers International Europe ("LBIE"). The Application Notice can be accessed here.

A public hearing of the Application took place before Mr. Justice Blackburne at the Royal Courts of Justice on 29 and 30 July 2009. The High Court handed down its judgment in relation to the Application on 21 August.  Mr. Justice Blackburne concluded that, "Insofar as the scheme is concerned with the distribution by LBIE of property held or controlled by it on trust for its clients (and seeks to do so in ways that will vary or, in some cases, extinguish those rights), there is no jurisdiction to enable this to be done, so as to bind dissentients..." under Part 26 of the Companies Act 2006.  A copy of the full judgment is available here.

As was previously explained in the 14 September 2009 update, the Joint Administrators have appealed the High Court judgment. As the judgement had an adverse effect on the interests of many of LBIE's clients, a request was made for the hearing of the Appeal to be expedited. This wish has been granted by the Court of Appeal and it is expected that the hearing will take place on 26 October 2009.

However, in the meantime, the Administrators are anxious that the appeal process should not lead to any unnecessary delay in the return of client assets. Therefore, in parallel with the appeal process, they are developing alternative proposals that would also assist with the return of client assets, whether or not the appeal is ultimately successful. In addition, they will continue to make bilateral returns. Although the Scheme is the most fully encompassing and preferred solution for the return of creditor assets, and that is why the judgment has been appealed, these other proposals will retain many of the Scheme provisions. Accordingly, the Joint Administrators have been actively discussing with their lawyers and the Scheme working group members (the "Scheme Working Group") these alternative options which could be utilised to expedite the return of trust property irrespective of the appeal decision.

Work is ongoing on evaluating these options but in order to keep creditors appraised of progress, this update summarises the current proposed strategy. Clients will appreciate that circumstances change and events may arise which will necessarily lead to revision or a variation in these proposals.

B.  A Contractual Solution

The Joint Administrators are developing a solution which would offer creditors the ability to voluntarily elect to benefit from the terms of a standardised settlement arrangement (the "Contractual Solution").  The Contractual Solution would have substantially the same provisions as the draft Scheme, including a bar date, and deal with all aspects of determining the value of a creditor's net equity, the allocation and the distribution of trust property that are dealt with under the draft Scheme.  This Contractual Solution has many benefits, in that the key terms have been substantially developed (within the draft Scheme) and that it does not, in itself, require court sanction.  All consenting creditors would agree to be bound between themselves and LBIE by the Contractual Solution.

Clients who choose not to join the Contractual Solution will not be bound by the agreed terms and accordingly the Joint Administrators, their lawyers and the Scheme Working Group consider that it is essential for the overwhelming majority of trust property claimants to agree to be bound by such a Contractual Solution if it is to be effective and efficient. The Joint Administrators believe that this Contractual Solution, which includes appropriate terms from the draft Scheme, would balance all parties' interests and, if widely supported, will be a robust alternative to the Scheme.

As part of the Contractual Solution, the Joint Administrators intend to seek court directions to assist them in protecting and administering client assets, and to reduce the impact of any action by non-signatory parties who seek to disrupt the process and gain an advantage for themselves.  This will be particularly necessary in cases where a shortfall in available securities has to be allocated, in whole or in part, to non-signatories.

In order to expedite the return of trust assets the Joint Administrators expect to distribute those securities with no anticipated shortfall in priority to those where a potential shortfall has been identified.  At this stage the Joint Administrators estimate that of the $8.9bn of securities assets currently under their control (as valued at 30 June 2009) a shortfall of less than $300m is expected.  The Joint Administrators therefore expect to be able to distribute a very significant proportion of the assets under their control without the need to allocate shortfalls to clients.

C.  Court Applications

In addition to the terms of the Contractual Solution outlined in Paragraph B above, the Joint Administrators expect to make one or more applications ("Applications") to the court to assist them in administering client assets. These Applications will include:

• the setting of a proposed 31 January 2010 bar date on the submission of client asset claims, which Application will be brought on as soon as possible.

Other Applications for directions will be made in due course, including:

• the setting of a bar date on the submission of claims by Lehman affiliates (the "Affiliates") to assert collateral over assets belonging to LBIE's clients - (defined as "Retention Claims" in the draft Scheme). The respondents to this directions application would be the Affiliates. If LBIE is unable to agree a multi-party arrangement amongst the Affiliates for dealing with these liens, then LBIE will need to have this application heard before LBIE makes distributions to those clients who have granted liens to Affiliates.  This is likely to also be the case under the draft Scheme.
• the approval of arrangements for the allocation of trust property to non-signatories, including the sharing of shortfalls (if any);and
• the approval of deductions in respect of costs for non-signatories.

The Joint Administrators are making preparations for a number of these possibilities simultaneously as the expeditious return of client assets remains a core objective of the Administration and we wish to minimise any further delay notwithstanding the unknown outcome of a number of factors which will influence the ultimate choice of appropriate strategy.

D.  Currently Proposed Action Plan and Illustrative Timetable

The principal activities will be with regard to the following issues:

1    Bar Date Application

1.1    It is the Joint Administrator's intention to seek a Bar Date of 31 January 2010 on proprietary claims to segregated property.

1.2    The order would be that from the Bar Date LBIE would be at liberty to effect distributions of trust property on the basis of the information known to it as at a date reasonably proximate to the date of distribution.  This means that if a claimant has failed to notify LBIE of its proprietary claim prior to the date of distribution it will be at risk that LBIE may effect the distribution without regard to its claim.

1.3    The basis of the application would be that at the moment LBIE can only make distributions if it receives an indemnity against unknown claims and that indemnity is supported by adequate security. This is delaying the return of assets to customers who cannot provide such an indemnity or security. By finalising the universe of potential claimants the risk to LBIE which the indemnity covers can be eliminated. LBIE will advertise the Bar Date.

1.4    The application is not specifically linked either to the Scheme or the Contractual Solution.  The Bar Date established by this application could be incorporated into whatever final arrangements are made and it would also apply to any persons not subject to those arrangements so as to ensure they are treated equally.

2    Contractual Solution Document Prepared and Sent out to the Market

2.1    LBIE will prepare and circulate as soon as possible a document to the prime brokerage counterparties and is open for acceptance by any creditor whether or not they have assets held by LBIE (the "Offer Document").  This will set out the full terms of the Contractual Solution. It will be accompanied by a circular describing how the contract will operate. It is anticipated to be distributed during the week of the 23^rd of November.

2.2    Beforehand, the Joint Administrators are liaising with industry bodies, the MFA and AIMA to arrange for promotion of this solution by arranging open seminars in New York and London during the week commencing 5 October 2009.  Confirmations of the details of such arrangements and invitations will be circulated as soon as possible to all affected parties.

2.3    The purpose of such sessions will be to introduce the Contractual Solution more fully and allow for an interactive questions and answers. This will assist in the development of the contractual document and also provide an opportunity for active contributions to the process by the affected clients.

2.4    Offer process

We envisage that the contract will be put in place through a circular to be distributed to all the prime brokerage counterparties and is open for acceptance by any creditor, whether or not they have assets held by LBIE. 

Counterparties will receive a document describing the contract which has attached to it (i) a form of the contract itself and (ii) a form of instrument of accession to the contract.  The contract shall incorporate the Bar Date set by the Application referenced in Paragraph C above.

The document will represent an offer by LBIE which would be open for acceptance for a period of time (yet to be finalised). If sufficient clients accept the offer in that period, then the contract will become binding as between LBIE and every signatory and it could remain open for acceptance by other creditors for some extended period. If the condition as to acceptance by a sufficient number of clients is not met the offer will lapse and the contract will not become effective.

The acceptance threshold will be high (for reasons explained earlier) and set by value of those persons having eligible claims. An eligible claim will be the same as the voting entitlement under the draft Scheme (i.e. the lower of net equity and the trust asset claim).           

Consideration will also be given to arranging a "segregated trust property claimants  meeting" at an appropriate time and venue after issue of the contractual documents at which it may be possible to assess the level of creditor take up of the offer and thereby measure whether the solution is going to be adopted.

3.    Asset Distribution Phases and Trust Application re Shortfalls

The distribution process will be able to commence at an earlier stage if the number of preceding court applications can be minimised. Accordingly, once the population of potential claimants has been established (as a result of the Bar Date application) it should be possible to return assets in cases where it can then be ascertained that there is no stock shortfall, without the need of a further application to protect parties from claims from non signatories. Such distributions will be subject to LBIE having the assets under its control.  Currently $8.9billion of assets are under LBIE's control and LBIE has submitted claims of $7.2 billion for assets which are not currently under its control (including claims against LBI and LBJ).

It is therefore intended that phase one distributions will be made first of stock lines where there are no shortfalls and may include stock lines where there are shortfalls, but only if all claimants are signatories.  It is hoped that this will be achievable with only minor delays when compared to the original timetable anticipated had the draft Scheme proceeded without the current delay.

Phase two distributions will be for stock lines where there are shortfalls and non-signatory claimants.  Such distributions will be made to non-signatories at such time as the position of the non-signatories claim has been satisfactorily determined.  This may involve a number of processes including the seeking of guidance from a court (as detailed in Section C above), which will likely result in delay. 

Interim distributions may be made to signatories pending the outcome of those processes.  Depending upon the size of any shortfall or the size of reserve that would be needed to meet the claim of any non-signatory, it may be possible to make earlier partial interim distributions of stock lines with shortfalls to those LBIE clients who have signed up to the contractual arrangements pending a resolution of any non-signatory claims.  This will be assessed on a stock-line by stock-line basis.

4.    Jurisdiction Appeal to the Court of Appeal

LBIE's legal team and counsel have developed arguments in support of the appeal that the Court does have jurisdiction to sanction a Scheme of Arrangement under part 26 of the Companies Act 2006.   This is due to be heard on 26 October 2009 but the timing of the delivery of the decision remains uncertain.   It is hoped that the Court of Appeal will give its verdict by mid-November 2009,but this means, even if LBIE is successful that the Scheme could  take several further months to implement, as a further Court hearing is necessary to convene the meetings of creditors and, after the creditors' meetings, to sanction the scheme.  In these circumstances, it is anticipated that any revised scheme will build upon the progress made in the interim, for example by incorporating any universal  Bar Date established by the specific application mentioned above, and provide additional benefits to the process by binding all potential parties (including non-signatories to the Contractual Solution) into its terms.

Should the appeal be unsuccessful, the Scheme cannot be pursued any further unless the Joint Administrators decide to appeal to the UK Supreme Court, but, by implementing the alternative steps we have outlined above, the Administrators expect to be well advanced in implementing the Contractual Solution by the time the Court of Appeal delivers its decision.

5.    Estimated Timing

The following table indicates the current estimated timeline. Please note this is a directional indication only and assumes court (and judge) availability and that there are no appeals.

In conclusion, the Joint Administrators wish to reiterate that they remain of the view that the Scheme would provide the best outcome for creditors with claims to trust property.  However, because of the current uncertainty as to whether and when the Court will sanction this, they consider that it is imperative to explore and progress alternative solutions for the return of assets.  Thus they are simultaneously carefully examining, with the creditors' committee and the Scheme Working Group, the merits and practicalities of the options described above and all other possibilities so that they will be in a position to continue to progress the distribution of trust property.  They are also therefore taking the active steps, as outlined, which will benefit the implementation of whatever the precise ultimate solution will be.

The Joint Administrators will continue to communicate with you through this website regarding the progress of the appeal hearing and the date for the Bar Date application, which will be set down as soon as practicable.  Please continue to check the website for information on this and other matters relating to the administration of LBIE.

Please direct any questions you have to clientpositionresponses@lbia-eu.com.