When a company declares bankruptcy, any leftover assets are distributed according to a long-settled pecking order: first the secured creditors get the best pickings, then the unsecured ones may settle for a few scraps, followed by the shareholders who are left chewing on a usually worthless carcass. But what happens to your claim if you think you should be considered a secured creditor but, through no fault of your own, get shunted into the unsecured creditors queue? Chances are you end up in court.
That’s the scenario currently playing out in London as the bankrupt prime broker Lehman Brothers Holdings Inc. tries to overturn a lower court ruling that declared a pool of creditors unsecured. This previous ruling from December 2009 stated that certain investors in the Lehman Brothers International Europe (LBIE) subsidiary whose accounts were not properly segregated are to be treated as unsecured creditors.
The investors who are appealing the December ruling include Lehman Brothers Holdings Inc. and a hedge fund. They are asking for access to money that (perhaps improperly) wasn’t protected by separate accounts. They argue that had LBIE performed its fiduciary responsibilities properly, the funds would have been set up in separate accounts and they would be classified as secured creditors. LBIE fell short of the rules “on a truly spectacular scale,” Justice Michael Briggs said in the December ruling.
LBIE’s unsecured creditors may see returns on billions of dollars in claims cut in half if the failed bank’s parent company wins the case over how funds were separated.
The high-stakes battle is for assets of LBIE held by the company’s European insolvency administrator, PricewaterhouseCoopers. If the parent company and the hedge fund win the case, the money may be taken from the general estate of the U.K. operation, reducing returns for other creditors, said Arun Srivastava, a lawyer for unsecured creditors.
If Lehman wins the case, the “cash available for the unsecured creditors will be depleted and may even be extinguished,” said Srivastava, a lawyer for Hong Leung Bank Bhd, which is representing the unsecured creditors in the case.
The U.K. Financial Services Authority is in the hot seat for allegedly not sufficiently overseeing the accounts. The FSA has since opened a review of client money rules and stepped up enforcement of the issue. The rules are meant to ensure that clients’ money can’t be used by a firm for its own purposes, and so that if it went bankrupt, client money would be protected. According to the December judgment, LBIE failed to identify and segregate “vast sums” of client money, most of which belonged to its affiliates.
London was the home of Lehman’s prime brokerage business that serviced hedge funds. PwC said it holds LBIE’s 7.3 billion pounds of available cash.
LBIE’s administrators said last week it’s offering a plan to unsecured creditors to pay out claims as early as next year using a universal formula for valuing the claims.
A majority of claimants have to agree to the plan for it to take effect, the administrators said.
LBIE affiliates, including the parent, Lehman Brothers Inc. and Lehman Brothers Finance AG, have made claims of more than $3 billion, according to the December judgment. CRC Credit Fund, which is also appealing, is seeking $76 million that should have been put in separate accounts. LBIE held $2.16 billion in segregated accounts when it went into administration in September 2008.
Clients whose money was properly segregated, represented by GLG Investments Plc, will seek to protect their pool of funds to ensure the court doesn’t decide to divide it with the clients whose money wasn’t segregated.
“Everyone’s got something to argue for,” said Mez Raja, a lawyer at CMS Cameron McKenna in London, who’s not involved in the case. “The segregated clients are trying to protect their level of entitlement and they don’t want that to be eroded.”
The FSA will also be represented at the hearing.
The regulator “would like their rules to be interpreted in a way that would protect the client money entitlements,” Raja said.
FSA spokeswoman Cerris Tavinor said the regulator isn’t “supporting one side or the other” and would be “putting forward our interpretation of our rules.”
The FSA fined JPMorgan Chase & Co. a record 33.3 million pounds earlier this month for not properly segregating client accounts, and levied two smaller fines for the same offense days later.
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