European Update - UK Court of Appeal judgment on Lehman Waterfall II Parts A and B

UK Court of Appeal judgment on Lehman Waterfall II Parts A and B - Statutory interest

The Court of Appeal has dismissed all appeals brought by creditors relating to the extent and calculation of creditors’ entitlements to statutory interest on their debts for periods after the commencement of the administration of Lehman Brothers International (Europe) (“LBIE”).


LBIE entered administration on 15 September 2008 and the joint administrators (the “Joint Administrators”) were appointed. All of LBIE’s unsecured creditors’ have since been repaid in full.

Litigation has been ongoing for several years in connection with the distribution of LBIE’s assets, and the Waterfall II Parts A and B judgment addresses key issues relating to distribution of the surplus in the administration (previously estimated to amount to between £7.1bn and £8.1bn (the “Surplus”)). In the most recent appeal, the UK Court of Appeal considered five issues all relating to the payment of statutory interest pursuant to Rule 2.88 of the Insolvency Rules 1986 (the “Rules”).

Rule 2.88, in the form applicable to the LBIE administration at the time of the appeals, required that once all proved debts have been repaid in full during an administration, the surplus must first be used to pay statutory interest on those debts for the period from the start of the administration to the date of payment. Statutory interest is the greater of 8% per annum and “the rate applicable to the debt apart from the administration” (usually the contractual rate).

It is noted that references to the numbering of the Rules in this article is to the Rules pre-amendment by the Insolvency (England and Wales) Rules 2016 (“IR 2016”), which amended and replaced the Insolvency Rules 1986 on substantially similar terms[1].

Bower v Marris

Under English law the equitable presumption is that, any repayments of a debt will first be applied to discharge outstanding interest (if applicable) and then to discharge principal. This presumption is rebuttable where there is evidence of a contrary intention in the relevant law or if the debtor or the creditor collects the payment in a different way (the “B v M Principle”).

The High Court has previously held[2] that the B v M Principle did not inform the drafting or intended operation of the Rule 2.88(7) when calculating the statutory interest due to creditors in an administration.

The appealing creditors had argued that the B v M Principle should be applied to a reading of Rule 2.88(7), such that dividends should be first allocated to the reduction of statutory interest and only once fully paid, to the payment of the proved principal debt. This argument was rejected by the court at first instance (which held that dividends paid to creditors are treated as payments of principal, with interest payable thereafter from the surplus). The difference between the two approaches, in cash terms, was estimated (in early 2015) to be potentially around £1.3 billion.

The Court of Appeal also dismissed this appeal on the basis that the B v M Principle approach is incompatible with Rule 2.88 and that there is a built-in assumption that the whole of the principal of the relevant debts will already have been paid by dividend, otherwise, there will be no relevant surplus. Further, the court expressed an unwillingness to re-calculate how dividends already paid had discharged provable debts in the administration as that would “require that aggregate sum to be re-opened, to the intent that dividends are re-allocated first to interest and only then to principal…".

No compounding of statutory interest

The court considered whether, where the relevant statutory interest rate to be applied under Rule 2.88(9) is the “rate applicable to the debt apart from the administration”, and such rate is a compounding rate, statutory interest continues to compound following the payment in full of the principal amount.

It had already been agreed that, where a provable debt had carried a compound interest rate that exceeded 8% per annum (on a simple basis) (the judgment rate), that compounding rate could be applied as the "rate applicable to the debt apart from the administration" under Rule 2.88(9).

The Court of Appeal held that it was “clearly right” that statutory interest is only payable in respect of periods (following the commencement of the administration) during which the relevant debts were outstanding and that once the provable debt had been repaid in full, accrued statutory interest could not continue to compound.

No compensation for time taken to pay statutory interest

The court considered whether a creditor is entitled to further interest, damages, or any other form of compensation in respect of the time taken for statutory interest to be paid. The appellants argued that the court should recognise a common-law entitlement to compensation for the late payment of a statutory entitlement.

The appeal was dismissed on the basis that while Rule 2.88 identifies the condition for when statutory interest must be paid, it does not specify a time for payment. It was held that the usual difficulties in an administration means that there is no cause of action for late payment; and further that the legislation makes no provision for the payment of interest on statutory interest. The administrators had not breached any duties in delaying payment of such interest (they had acted with all reasonable speed as they were required to do) and if they had in fact committed a breach of their duties, the appropriate remedies should be pursued pursuant to Schedule B1 to the Insolvency Act 1986 and not in connection with the surplus claims.

Statutory interest on contingent debts is payable from the date of administration

This court considered whether statutory interest payable in respect of an admitted provable debt which was a contingent debt as at the date of administration was payable from that date or from the later date (if any) when the debt ceased to be contingent.

The appellants argued, amongst other things, that by paying statutory interest to a creditor for a period when his debt remained contingent, the insolvency scheme would fail to apply pari passu treatment to all creditors. The appeal was dismissed and it was held that Rule 2.88 provides the same regime for statutory interest for all provable debts (whether currently due, due only in the future, or contingent).

The administration “cut-off date” applies to foreign judgment rates of interest

The court considered whether the “rate applicable to the debt apart from the administration” in Rule 2.88(9) can include: (a) a foreign judgment rate of interest applicable to a foreign judgment obtained after the date of administration; or (b) a foreign judgment rate of interest which would have become applicable to the debt if the creditor had obtained a foreign judgment, when it did not in fact do so.

The appeal was dismissed on the basis that it would be wrong to have regard, under Rule 2.88(9), to a rate of interest applicable to a foreign judgment obtained after the “cut-off date” (the commencement of the administration). The court held that including hypothetical judgment debts within the language of Rule 2.88(9), would lead to “such speculative uncertainty in what is otherwise a relatively simple and straightforward code for the payment of statutory interest that it should, and must, be rejected”.

Statutory interest on close-out sums may be payable at a contractual rate only triggered by steps taken after the cut-off date

This issue concerned whether the words “the rate applicable to the debt apart from the administration” in Rule 2.88(9) include, in the case of a provable debt that is a close-out sum under a contract (for instance under an ISDA Master-based agreement), a contractual rate of interest that began to accrue only after the close-out sum became due and payable due to action taken by the creditor after the cutoff date. The Court of Appeal, agreeing with the court of first instance highlighted that it “would run counter to the inclusion of future and contingent debts for the purpose of proof” if, as the appellants creditors argued, pre-existing contractual rights to interest could be excluded simply because they are contingent or lie in the future.

It was held that this did not create tension with the reasoning put forward in respect of the foreign judgments issue. Considering the point by reference to the cut-off date would exclude foreign judgments not yet obtained, but include every actual, future or contingent interest entitlement in the pre-existing contract. Rule 2.88(9) expressly allowed for “an examination of the parties’ contractual relationship as at the cut-off date, to ascertain what is the appropriate statutory rate of interest payable thereafter”. 


[1] In particular we refer in this article to rules 2.88 and 4.93 of the Insolvency Rules 1986 (“IR 1986”) in relation to statutory interest, to which rule 14.23 of the IR 2016 corresponds, and rule 2.86 of the IR 1986 in relation to foreign currency claims to which rule 14.21 of the IR 2016 corresponds.

[2] Lomas and others v Burlington Loan Management Ltd and others [2015] EWHC 2269.