Update on various items including Waterfall I - 23 June 2017

This is an interim update from the Joint Administrators in respect of various activities and initiatives undertaken following the Supreme Court’s judgment on Waterfall I handed down on 17 May 2017.

Supreme Court judgment on Waterfall I

A copy of the Supreme Court’s judgment can be found here and a copy of its statement of conclusions can be found here.

The judgment has, among other things, determined that:

• the subordinated debt ranks below Statutory Interest and non-provable liabilities;
• currency conversion claims do not exist;
• LBIE is not able to make a claim against its contributories under s74 of the Insolvency Act 1986 (a “contribution claim”) while it remains in administration (even on a contingent basis) – any such claim may only be brought by a future liquidator of LBIE;
• a contribution claim will not cover any shortfall in respect of Statutory Interest; and
• any Statutory Interest to which creditors have become entitled in LBIE’s administration (that remains unpaid) may not be claimed in a subsequent liquidation (an issue colloquially referred to as the “Statutory Interest Lacuna”).  

The judgment represents a material deviation from the decisions reached in the lower Courts and has a significant financial impact on the claims that may now be made against the Surplus realised in the administration and the resulting level of certain creditors’ entitlements. It also has an impact on how, if at all, contribution claims against LBIE’s shareholders might be made to reduce any potential deficiency. In particular, all other things being equal, the “base case” illustrative outcome of £0.1bn (in our last Progress Report) being available to pay a dividend against the subordinated debt claim and shareholder claims has now increased to an amount in the region of £2.6bn, calculated as follows:

The Joint Administrators have been considering the impact of the Supreme Court judgment on the Waterfall II and the Waterfall III proceedings (and the planned related Contribution Reserve transaction announced to creditors on 29 March 2017). 

Waterfall IIA and B

The hearing before the Court of Appeal took place in April 2017, with judgment reserved pending the Waterfall I judgment being handed down by the Supreme Court. A further hearing has now been set for 25 July 2017, to consider oral arguments and written submissions arising out of the Supreme Court judgment that the Respondents believe are relevant to the matters being dealt with in the Waterfall IIA and B proceedings. The Court of Appeal has itself convened this hearing for a date prior to its Summer recess. As a result, it is possible that the Court of Appeal’s judgment might be handed down in the Autumn, bringing more of the important disputed matters concerning Surplus entitlements closer to final resolution.

Waterfall IIC

The Waterfall IIC (Cost of Funding) hearing before the Court of Appeal is currently scheduled for July 2018 but might be brought forward to March 2018 (if Counsel are available), now that the duration of the hearing has been shortened following elimination of the German law issues by the Respondents. In the meantime, on 31 May 2017, the Joint Administrators published on their website their preliminary guidance for creditors who might wish to make a certification for a contractual interest rate that will apply to admitted claims arising under an ISDA Master Agreement or similar agreement. That guidance is based on the Joint Administrators’ interpretation of the High Court’s first instance judgment. Feedback has been received from a number of creditors and this is being considered.

Waterfall III

On 29 March 2017, the Joint Administrators posted to their website an update in respect of the further progress made with interested parties concerning the commercial terms upon which the Waterfall III proceedings might be settled. This transaction would have resulted in LBIE having access to a Contribution Reserve which would act as a substitute for the value that would likely otherwise be recovered by LBIE in respect of its contribution claims (up to a maximum of £913m).

Following the Supreme Court judgment on Waterfall I, there is no longer any appetite among interested parties for the transaction to proceed in the form originally envisaged. LBIE and the relevant affiliates have recently resumed discussions around a revised transaction. In light of the Supreme Court judgment, LBIE cannot pursue contribution claims against its contributories while it is in administration.  The withdrawal of such claims would enable the other affiliates to significantly advance the distributions in their estates. As part of the proposed revised transaction, the Waterfall III proceedings would be concluded. There would also be a resolution on a number of other less significant affiliate related-issues. A fuller commentary will be provided in due course.

As to the Waterfall III proceedings themselves (and absent any settlement), consideration has been given to how the Waterfall III proceedings should be taken forward in light of the Supreme Court’s decision in Waterfall I and a hearing took place on 19 June 2017 at which it was directed that the substantive hearing scheduled for September 2017 should proceed but with reference only to the issues relating to the recharge claim raised by LBL. 

Withholding Tax

The HMRC appeal on withholding tax remains scheduled for a hearing at the end of October 2017 before the Court of Appeal. Any distribution of Statutory Interest to creditors will be affected by the outcome of this hearing. Accordingly, as matters stand and pending the outcome of the appeal, any distributions of Statutory Interest to the vast majority of creditors will be subject to tax reserving of at least 20%. Further guidance will be given at the appropriate stage.

Interim Distribution of Statutory Interest

On 29 March 2017, the Joint Administrators posted to their website information relating to a proposal to distribute all or a significant part of creditors’ basic (Judgments Act rate) Statutory Interest entitlements in the near future.  The Joint Administrators emphasised the need for all of the Respondents to the Waterfall II proceedings to approve such a proposal in order for it to be successfully implemented. The Joint Administrators have been informed by Wentworth that it will not approve the proposal and it will therefore no longer be pursued.

Alternative Distribution Options

Three broad approaches continue to be contemplated, as follows:

a) an interim partial distribution of Statutory Interest on alternative terms to those of 29 March 2017 (with majority creditor approval including the support of all of the Respondents to the Waterfall II proceedings);

b) an interim partial distribution of Statutory Interest (without the need for majority creditor approval); and

c) overall resolution of all material disputed matters, implemented through a company voluntary arrangement or scheme of arrangement.

The Joint Administrators will explore creditor appetite for each of these approaches, while continuing to marshal the ongoing Waterfall proceedings, in the hope that agreement can eventually be reached between the Respondents to the Waterfall II proceedings to enable all or a substantial part of the realised Surplus to be distributed sooner rather than later. While the Waterfall II A and C proceedings remain ongoing and absent agreement on a cap on higher-rate Statutory Interest entitlements, any interim partial distribution would require a level of reserves that would result in distributions of a very small sum (if a reserve could be calculated such that a distribution is even possible).

Statutory Interest Lacuna

As a result of the Supreme Court’s judgment in the Waterfall I proceedings, unpaid Statutory Interest could be lost if LBIE entered liquidation prior to such interest being paid.  The Joint Administrators will object to any attempt by any party to force the premature liquidation of LBIE, as they consider that this would not be in the interests of LBIE’s creditors as a whole.   

In taking this position, the Joint Administrators are mindful of many matters, including the following:

• in 2016, the Court extended the term of LBIE’s administration to 2022 and in doing so noted that, unless some specific advantage of a liquidation is shown over distribution in an administration, the implication of the Court having granted permission to distribute is that an administration should be maintained for as long as is reasonably necessary to complete the process of distribution;
• the Court in that extension application, was clear that the Joint Administrators should be allowed to “complete their mandate” in administration, in a context that clearly envisaged the distribution of Statutory Interest;
• there is currently Statutory Interest of around £5.2bn payable in the administration (but potentially not in a liquidation) with a large enough realised Surplus to pay this subject to the ongoing Waterfall proceedings;
• the Supreme Court has confirmed that the subordinated debt is subordinated to Statutory Interest;
• the Supreme Court has noted that “forcing an administrator to move the company into liquidation would potentially wreak real unfairness on all the other creditors of the company”; and
• there are a number of other adverse consequences of going into liquidation, some of which are referred to either in the latest Progress Report or the Joint Administrators’ post on their website of 29 March 2017.

Other matters

The Joint Administrators have reviewed the headcount and resource reduction scheduled to be completed by 31 July 2017 and concluded that these arrangements should continue as planned.

An offer (described in the last Progress Report as the Small Deed Offer) for approximately 160 counterparties to sell their admitted unsecured claims was launched at the end of March. The terms of the offer, when assessed against the elimination of currency claims, means the offer is no longer viable from LBNL’s perspective as the purchaser. Accordingly, it has been withdrawn. 24 counterparties had already been accepted and received value amounting to just over £2m for their Surplus entitlements on admitted claims amounting to £4.2m. 6 counterparties had rejected the offer.

As advised in the website announcement of 22 May 2017, the estate’s hedging strategy has been revised with consequences that estate currencies are being converted to GBP, other than a minimum expected amount needed to meet remaining non-GBP obligations.

The Joint Administrators are always interested to hear creditors’ views on the matters they are dealing with in the administration and invite any feedback that creditors would like to provide on the matters referred to in this update.