Lehman’s signature subordinated debt decision


The London High Court rendered its judgment Friday July 3, 2020 on the relative classification of more than $ 10 billion of subordinated liabilities in the administrations of two entities of the Lehman Brothers group.

The judgment covers a series of important issues for restructurings and insolvencies, including: the provability and relative classification of regulatory subordinated debt, the effect of partial collateral payments on the provable value of creditors’ claims, discounting of future receivables, the provability of future receivables interest, the construction of amicable settlement releases and the rectification of amendments when their impact on the ranking has “simply not been taken into account”.


Lehman Brothers Holdings PLC (under administration) (“PLC”) and LB Holdings Intermediate 2 Limited (under administration) (“LBHI2”) each issued regulatory subordinated debt under standard loan agreements of FSA, namely “PLC Debt” and “LBHI2 Debt” respectively. Following a series of post-administration transfers, the PLC under-debt is now held by Lehman Brothers Holdings Inc. (“LBHI”), the ultimate parent company of the global Lehman Brothers group. The LBHI2 Sub-Debt is held by PLC.

PLC and LBHI2 have also each issued subordinate regulatory bonds. In the case of PLC, the Notes (the “PLC Subnotes”) were issued to certain limited partnerships, which in turn issued preferred securities known as ECAPS. In the case of LBHI2, the tickets (the “LBHI2 Subnotes”) are held by a subsidiary of LBHI (“SLP3”).

The administrators of PLC and LBHI2 have asked the court to determine the rank of the subordinated claims of each estate. The Trustees of PLC also asked the court to determine whether the PLC Sub-Debt had been released under a New York law settlement agreement dated October 24, 2011 (the “Settlement Agreement”), as well as how the PLC and PLC Sub-Debt Sub-Notes should be valued for distribution purposes.

LBHI / SLP3 argued that PLC’s Sub-Debt and PLC’s Sub-Notes rank pari passu, that PLC’s Sub-Debt was not released by the Settlement Agreement, or partially discharged by guarantee payments and that PLC’s Sub-Notes should be updated in accordance with the Insolvency Regulations.

LBHI / SLP3 also argued that the LBHI2 Sub-Debt and the LBHI2 Sub-Notes rank pari passu before and after certain changes made to the LBHI2 Sub-Notes in 2008, and that while the changes to the LBHI2 Sub-Notes were effect of changing the rank, they should be rectified to reflect the common intention of the parties.


The judge’s conclusions were as follows:

1. The PLC Sub-Debt and the PLC Sub-Notes rank pari passu.

2. PLC’s sub-indebtedness has not been released in accordance with the release clause of the settlement agreement.

3. PLC’s Under-Debt has not been partially paid by payments made to the original creditor by LBHI under a guarantee.

4. PLC sub-notes must be discounted for the future under the insolvency rules to approximately 27% of their face value. This is because subordinated debts are provable debts, PLC Sub-Notes are future debts, and there is no basis on which the holder of the PLC Sub-Notes can prove accrued interest after the date of administration.

5. Certain subordinated guarantees given by PLC rank behind the PLC Sub-Debt and the PLC Sub-Notes, as agreed by the parties.

6. When they were issued, the LBHI2 sub-notes had priority over the LBHI2 sub-debt. Following the changes made in 2008, the LBHI2 Sub-Notes are now subordinated to the LBHI2 Sub-Debt. Changes to the LBHI2 Subnotes do not need to be corrected.

Further details of the judge’s findings are presented below.

General observations of the judge on subordination

A creditor can subordinate his claim using conditional debt subordination and / or simple contractual subordination. The judge commented that for a simple contractual subordination clause to be effective, it “must render creditors unable to prove at least until the obligations prior to that debt have been fully satisfied”.

A creditor can subordinate himself not only within a category of obligation but also between categories of obligation. However, a creditor probably cannot subordinate himself below the shareholders. Shareholders arrive last by the very nature of their legal position and form a category of obligations quite different from that of creditors.

A creditor can only be subordinate to others and cannot unilaterally promote himself above other creditors.

PLC Sub-Debt and PLC Sub-Notes are classified pari passu

The judge held that on a literal interpretation of the chords, PLC’s sub-debts and PLC’s sub-notes are each “superior liabilities” for the purposes of the other instrument, creating an endless loop or dead end, with as a result, neither can be paid until the other is paid in full.

In such circumstances, the judge concluded that the contractual provisions of subordination are ineffective with each other and that the instruments rank pari passu by default in law.

PLC’s Sub-Debt was not released in accordance with the Settlement Agreement

It was argued that the mutual releases between PLC and LBHI (among others) in the settlement agreement extended to debts acquired by LBHI after the effective date of the settlement agreement, including the sub- PLC debt.

After hearing expert testimony on New York law, the judge, concluding that the terms of the settlement agreement were clear and unambiguous, concluded that:

a) one of the terms in the definition of “Causes of Action” relates to the transfer of a claim after the Effective Date;

b) notwithstanding the general nature of the release, there had to be a legal relationship between PLC and LBHI which could be released on the effective date. A relationship which arises entirely after the Effective Date (via a transfer of receivables) cannot reasonably be the subject of a discharge, discharge or acquittal; and

c) this interpretation of the release is consistent with certain other provisions of the Settlement Agreement, including: (i) a guarantee that each party was the owner of all claims it waived; and (ii) a restriction on the transfer of claims, which could have provided for a release of the assets acquired subsequently, but did not do so.

PLC’s Under-Debt has not been paid in part by payments made to the original creditor by LBHI under a guarantee

When a principal debtor is insolvent, a creditor has the right to prove the full amount of the debt notwithstanding the partial payment by the guarantor. As such, the original creditor’s claim was not reduced by the security payments.

In law, there is no reason why an assignee, like LBHI, has less of a right to prove than the assignor.

PLC sub-ratings must be updated for the future in accordance with Insolvency Rule 14.44

Rejecting the argument that subordinated debts are not provable, the judge concluded that it is not necessary for a debt subordinated by simple contractual subordination or conditional debt subordination to lose its status as provable debt and become an obligation. not provable. Mere contractual subordination has the effect of preventing the filing of evidence until all previous obligations have been fulfilled.

The PLC subnotes were carefully drafted documents and it was not conceivable that the effect of the insolvency rules on the discount could have been overlooked. As such, there can be no implication of an acceleration clause and the PLC Subnotes must be discounted as provable future debts.

The judge also concluded that there was no reason to circumvent the statutory provision that no interest is provable with respect to the period after the date of administration.

The changes to the LBHI2 sub-scores changed their classification with respect to the LBHI2 sub-debts from senior to junior and did not have to be rectified due to a common error

The judge concluded as a construction issue that under the initial conditions of the LBHI2 sub-notes, the LBHI2 sub-notes had priority over the LBHI2 sub-debts.

However, according to their modified terms, the judge considered that the degree of subordination of the LBHI2 sub-ratings had been modified. The judge considered that the modified LBHI2 sub-notes are subordinated by reference to the preference shares and therefore rank lower than all the other debts, including the subordinated debts, but have priority over all the shares and other creditors of which the receivables are subordinated by reference to the rights of shareholders. It considered that the LBHI2 Sub-Debts are not subordinated by reference to the rights of the shareholders, they therefore have priority over the modified LBHI2 Sub-Notes.

The Judge concluded that there was no evidence that LBHI2, as Issuer, or SLP3, as Holder, took into account the relative classification of LBHI2 Sub-Notes and LBHI2 Sub-Debt at the time. of the subscription or at the time of modifications. There was no evidence of any intention as to how the LBHI2 sub-ratings and LBHI2 sub-debts would rank against each other: this seemed like a question that just hadn’t been answered. taken into account. There was therefore no basis for rectification.

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