The Legacy of Lehman: the Administration and its legal legacy

This article is part of our series marking the 10 year anniversary of the collapse of Lehman examining today's issues from the perspective of Lehman and Lehman's legacy.

The collapse

7:56am on 15 September 2008: a time and date that will live long in the memory. The European arm of the Lehman Brothers group, Lehman Brothers International (Europe) (LBIE) was placed into administration and one of the largest, most complex collapses in corporate history began. Looking back on the days leading up to the collapse and the days, weeks and months that followed brings individual memories for different people but speak to anyone involved in the financial sector and there is no doubt that some common themes emerge. “Disbelief”, often emerging from a prior conviction that the Lehman group was too big to be allowed to fail, with views divergent to this day on whether that failure should have been allowed to happen. “Fear”, as the scale of the collapse and its wider implications dawned. Certainly sadness, and indeed anger, for many either directly employed by, involved with or linked to Lehman itself and for those entrepreneurs and employees who fought to save businesses and livelihoods in treacherous markets. Others recall a definite sense of excitement - a time of unprecedented challenges, change and fluctuations, the opportunity to make a mark, a determination to find opportunities amid the chaos and, more than anything, a recognition that this was a once in a career event that would have very significant ramifications for the financial markets and beyond. The impact of the Lehman collapse on the legal profession, the courts and litigation is no exception.

This article is written nearly ten years to the day from that landmark moment in September 2008 against a background of ongoing litigation that can be traced back to that moment. There has not been a day post the collapse in September 2008 that there has not been ongoing disputes and applications being dealt with by the Courts of England and Wales, either directly involving Lehman entities or between private groups caught up in the fallout or in many cases actively seeking a role with a view to a profit. Indeed, we launched the very first of the now voluminous applications in the Lehman administration the day after its collapse, seeking to have the moratorium on claims against LBIE lifted in order to allow fund clients to pursue access to trust assets before they matured to cash somewhere within the vast Lehman estate. The courts, rightly on reflection, refused to lift the moratorium on claims although the decision was in the balance until comfort was provided by the Administrators late in the day, promising equivalent treatment between assets and cash on maturity in the event that the proceeds could be found. The first of many sensible decisions made by the judiciary as they, the administrators and different categories of creditors grappled with a collapse of such enormity. The time for litigation and the involvement of the courts in resolving issues that had simply never been addressed or even thought about previously of course eventually came and continues today, evolving to deal with key themes as the administration progressed.

The key themes

One of the biggest themes that emerged at the outset of the administration related to rehypothecation rights and trust assets more generally. LBIE was a major prime broker to fund clients across Europe, America and Asia and custodian of European assets for the wider Lehman group. For many funds LBIE was their sole prime broker and their primary source of liquidity. The status of, and access to, assets held by LBIE under prime brokerage agreements and in particular whether those assets were held on trust for individual clients once they had been rehypothecated, for example lent to another fund for the purposes of taking a short position, was one of the biggest issues that exercised the minds, and stretched the patience, of Lehman’s former clients in the immediate aftermath of its collapse. Without access to funds and assets tied-up in LBIE, without clarity as to the status of the assets and without any clear idea of the timing of the return of such assets, many funds were paralysed and, in some cases, facing collapse themselves. Investors were looking for liquidity and making redemption requests, but the fund assets were out of reach. Individual clauses in prime brokerage agreements, ISDAs, GMRAs and other contractual documentation were pored over, analysed and stretched in ways that the drafters had never intended and decisions made with potentially significant consequences, for example whether to exercise termination rights in agreements that risked converting trust claims to unsecured claims in the LBIE estate.

These issues were complex and eventually resolved through directions applications made by the administrators seeking court approved answers to the questions that the administrators needed clarity over in order to start the process of properly assessing claims and distributing assets. Expensively assembled court rooms filled with respondents and their advisors, appointed to argue either side of each of the questions that the administrators needed to be answered on behalf of a common class of former Lehman client. It was litigation of this nature that dominated the early years of Lehman disputes resolved in the courts. Driven by an expectation that there would be a shortfall in assets available for distribution to LBIE’s creditors and with such large sums of money at stake, judgments were appealed to the Court of Appeal and the Supreme Court with respondents often motivated as much by being able to demonstrate to investors and other stakeholders that they were fighting their corner as by the outcome itself.

However, the background against which this litigation was fought changed as time and the administration progressed. It became clear that there were more assets available for distribution by LBIE than had been first thought. Lehman debt, purchased by savvy investors in pursuit of the opportunities presented by Lehman’s collapse mentioned at the beginning of this article, initially traded at cents in the dollar but crept up over time and became one of the most successful and profitable asset classes of the decade. The litigation moved with the trend. The initial quest to make a good proprietary claim over assets held to avoid those assets falling into the general estate ceased to be important as the eventual repayment of general creditors became more likely. Once it appeared there might be excess funds and so interest to be claimed the value of a general creditor’s claim became more attractive than a proprietary right with no interest. With much of the available Lehman debt purchased by secondary market holders and consolidated, those funds looked to pursue the strategies envisaged when the debt was purchased. The litigation became about priority, who was subordinated to who and who would get paid out first. These issues were played out in a series of further expensively contested battles that became known as the “Waterfall” litigation.

The question turned to what to do with the $7 to $8bn surplus assets currently anticipated to be available for distribution fought out predominantly between purchasers of debt in the secondary market. Most recently a Scheme of Arrangement has been approved relating to the distribution of surplus assets bringing to an end the outstanding issues on appeal in the Waterfall litigation. The end is in sight.

The legacy

From the contrasting emotions of the early days of Lehman’s demise, through the first LBIE creditors meeting held at the O2 Arena in London, the early applications for directions and the subsequent litigation taking place at every level of the courts - evolving against the background of the increasing solvency of the administration - the English courts have provided an essential forum for both the administrators and LBIE’s creditors and former clients to get the answers to the numerous questions posed by this unique event. An allocated Lehman judge allowed knowledge and understanding of the complexities of the administration to be accumulated and the courts stood up well to the test. This can be contrasted with the position in the US where the bankruptcy looks likely to run longer - an unexpected turn of events given the concerns raised at the outset of LBIE’s administration about the fact that the English regime did not provide dedicated protection specific to brokerage firms in the way that the Securities Investor Protection Corporation does in the US. The lessons learned from LBIE’s collapse have also been passed to other large insolvencies; the administration of MF Global in particular appeared to borrow many of the hallmarks of the LBIE directions application processes.

To date more than 90 cases have passed through the Courts of England and Wales involving Lehman Brothers entities, a statistic that highlights not only the seismic implications of Lehman’s collapse, but the scale of the task faced by the courts. The Lehman journey has been a long and complex one, but as we look back on the litigation that it has given rise to and the role of the courts in providing the answers and certainty needed by all parties, it is hard not to conclude that the courts have stood up to the tests posed remarkably well.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.