Client Alert

Court of Appeal Judgment: Waterfall IIA Case

24 Oct 2017

Court of Appeal judgment: Burlington Loan Management and others v Lomas and others (as the joint administrators of Lehman Brothers International (Europe) (in administration)) [2017] EWCA Civ 1462

Summary and background

Today’s Court of Appeal judgment in the so-called “Waterfall IIA[1]” case signals the English Courts’ reluctance to impute established equitable principles in aid of construing English insolvency legislation.  The Court of Appeal’s judgment, in giving the words of the Insolvency Rules 1986 (UK) a strictly literal meaning, has, on the issue at stake, resulted in shareholders obtaining a significantly better financial return than would have been the case had the company not gone into an insolvency process. 

The case is of interest not only to the stakeholders directly affected by this decision, but also to all investors in companies that are susceptible to an English administration or liquidation.  It evinces a strict “four corners of the statute” approach by the English court to statutory interpretation of insolvency law, with little to no room for long-standing equitable principles.  The case signals an important opportunity for the legislature to now revisit the insolvency statute book so as to restore commercial common sense and fairness unless the case is successfully appealed.

This decision is the result of one of several pieces of ongoing litigation involving the question of the proper distribution amongst the various stakeholders[2] in the Lehman Brothers International (Europe) (in administration) (“LBIE”) estate of circa £7.5bn surplus funds (“Surplus”) remaining following payment by the administrators in 2014 of all provable claims.  The administrators, faced with a surplus of such unprecedented size, have sought the directions of the Court to inform their task.  The number of questions requiring answers of the Court has resulted in the case being divided into three primary sections, known as Waterfall I, Waterfall II and Waterfall III.  Waterfall III has reached a settlement and Waterfall I has recently been decided by the Supreme Court.[3]

Before diving into the Court of Appeal’s decisions, it is worth reminding readers of the Supreme Court’s recent approach (excerpted below from Waterfall I) to statutory construction in the context of whether a currency conversion claim[4] exists as a head of claim under the Insolvency Rules.  While in itself uncontroversial, Lord Neuberger’s iteration of the well accepted principle of statutory construction, and application of it in the context of determining the non-existence of currency conversion claims, has no doubt informed the Court of Appeal’s decisions:

Under the United Kingdom’s constitutional arrangements, it is not normally appropriate for a judge to rewrite or amend a statutory provision in order to correct what may appear to have been an oversight on the part of Parliament.  That would involve a court impermissibly usurping the legislative function of Parliament.  As Lord Nicholls of Birkenhead said in Inco Europe Ltd v First Choice Distribution [2000] 1 WLR 586, 592 when discussing the judicial approach to statutes, “[t]he courts are ever mindful that their constitutional role in this field is interpretative” and “[t]hey must abstain from any course which might have the appearance of judicial legislation”.  For this reason, it would be impermissible to have recourse to an entirely new Judge-made rule to fill the gap in the present case.  There has been no such rule nor any similar rule in the past (unsurprisingly, as administration is a new concept and a distributing administration is even newer), and the invention of such a rule would be inappropriate for the reasons discussed in paras 117 to 120 above.  [author’s emphasis]

The decision of the Court of Appeal – Waterfall IIA

The primary issue in question was whether interest under Insolvency Rule 2.88(7) should be calculated on the basis of allocating distributions: (1) first to the payment of accrued Statutory Interest at the date of the distribution, and then in reduction of principal (“Method A”); or (2) first to reduction of the principal, and then to payment of accrued interest (“Method B”)?

The statutory right of an unsecured creditor to interest (referred to as “Statutory Interest”) arises under Insolvency Rule 2.88(7)[5] that provides:

Any surplus remaining after payment of the debts proved shall, before being applied for any purpose, be applied in paying interest on those debts in respect of the periods during which they have been outstanding since the company entered administration.

Putting this question into economic context, if Method A were held to apply, Statutory Interest to be paid to senior creditors would amount to circa £6.4 billion, whereas if Method B were held to apply, it would only amount to circa £5.1 billion.[6]

In arguing for Method A, the members of the senior creditor group (the “SCG”)[7] relied on an equitable principle of long-standing application in financial contracts known as the rule in Bower v. Marris. [8]  Unlike currency conversion claims, Bower v. Marris is not an ‘entirely new Judge-made rule.’  This rule states that:

when a debt carries interest, the law will apply any payment against the debt first to discharge outstanding interest and only secondly to discharge principal.  This presumption can be rebutted if there is evidence of a contrary intention in the relevant law or if the debtor or the creditor appropriates the payment in a different way.[9]

The equitable principle contained in Bower v. Marris had been held to apply by extension in the administration of both personal bankruptcies and commercial insolvencies under applicable law and legislation pre-dating the current Insolvency Act.

In approaching the issue, the Court of Appeal first considered whether, on the face of the Insolvency Rules, there was any ambiguity or lacuna needing to be filled by judge-made rules.  Finding in the negative – that the language of IR.2.88(7) is ‘simple’ and ‘clear[10] – and noting the Supreme Court’s decision that the Insolvency Rules provide a complete statutory code for the recovery of interest on proved debts in administrations, the Court concluded that there was no room for the operation of Bower v Marris

The court did not appear to consider the argument that the legislature drafted IR.2.88(7) with Bower v Marris – a case of more than 250 years’ standing and which describes a sound equitable principle of even longer-standing – in mind.  Although the Court of Appeal appreciated the merits of the application of Bower v Marris, it nevertheless seemed to be heavily influenced by one particular aspect of the approach of the Supreme Court’s decision in Waterfall I,[11] stating as follows: 

The [SCG’s] best point was, in our view, that a Bower v Marris approach to the computation of interest would better avoid the distribution of any part of a surplus which might otherwise find its way into the hands of the company’s contributories (by comparison with the full vindication of creditors’ contractual rights) than would the application of the apparently clear statutory scheme to be found in Rule 2.88. . .  Prior to the Supreme Court’s decision in Waterfall I, this consideration might have been of real weight.  But the same underlying principle (about preventing contributories from receiving any part of that which would otherwise have been payable to creditors in accordance with their contractual rights) did not persuade the Supreme Court to recognise currency conversion claims, as a means of achieving the same objective, and it cannot in our view prevail if the outcome would be to require an approach to the computation of interest which is, as we have said, clearly inconsistent with the simple and complete statutory code set out in Rule 2.88.  [paras 35 and 36] [author’s emphasis]

Elsewhere, the Court of Appeal noted the following:

Following the Supreme Court’s decision in Waterfall I, it is clear that the concept of foreign currency claims in particular, and the reversion to contract analysis in general, no longer prevail in the way they had previously done in this court. . .  (at [194]. . .   Lord Neuberger also made a number of broader obiter observations to the effect that, in his view, the effect of payment in full of a proved claim in an insolvency was to extinguish a creditor’s underlying contractual debt, replacing it with a set of statutory rights (at [98]-[112]). . .   as the majority of the Supreme Court agreed with Lord Neuberger, it appears that the reversion to contract analysis must be taken to be, for now at least, almost completely dead and buried. . .  As with a currency conversion claim, the contractual right (whether to recover interest or to be paid at a particular rate) had been replaced by legislative rules.  A contractual right could not revive simply because those rules contained a casus omissus or because they resulted in a worse outcome for a creditor than he would have enjoyed under his contract(at [202]-[222]).  [at paras 14 – 16]  [author’s emphasis]


It is submitted that there may have been a conflating of two different issues in the judgment: reversion to contract (which the Supreme Court has held is impermissible in the context of ascertaining statutory interest), on the one hand, and the imputation of equitable principles (such as Bower v Marris) which do not necessarily rely for their effect on reversion to contract.  This, taken together with the oblique statement by the Court of Appeal that the strict approach to statutory interpretation may be temporary, as well as the fact that the composition of the Supreme Court has recently changed significantly, suggests that the decision may not be a final determination of the issue. 

The Court of Appeal decided other matters in Waterfall IIA (including the fact that no compensation would be available for delay in paying Statutory Interest), but those other matters may be of limited interest to those not party to the case.

More Waterfall?

The Waterfall litigation continues: in 2018 an appeal in Waterfall IIC is scheduled to determine additional questions about the scope of Statutory Interest insofar as it relates to claims arising under ISDAs.

[1] So-called due to the case being about the proper distribution (or payment ‘waterfall’) of the surplus moneys left in the estate following payment of the provable claims.

[2] Being the senior creditors, subordinated creditors and shareholders.

[3] The Joint Administrators of LB Holdings Intermediate 2 Limited v The Joint Administrators of Lehman Brothers International (Europe) and others [2017] UKSC 38.  Waterfall I had the effect of resolving the issuers that were, until then, still outstanding in Waterfall IIB.

[4] The Senior Creditor Group (“SCG”) had argued that creditors should have the benefit of a claim for the difference between: (i) the amount of the contractual entitlement to payment in the original currency of the claim; and (ii) the dividends paid in sterling, converted back to the original currency at the date of payment.

A shortfall arose for many creditors due to the requirement under the Insolvency Rules 1986 (UK) that foreign currency creditors convert their claims into sterling at the conversion rate applicable on the date of administration. However, by the time distributions were actually paid on the claims, sterling had depreciated against the contractual currency in many cases.

[5] The rate of Statutory Interest is set out in Insolvency Rule 2.88(9) as follows: The rate of interest payable under IR.2.88(7) is whichever is the greater of the rate specified in [Section 17 of the Judgments Act 1838 on the date when the company entered administration] or the rate applicable to the debt apart from the administration. 

[6] Figures accurate as at 2015.

[7] Morrison & Foerster LLP represents one of the members of the SCG.

[8] Bower v. Marris (1841) Cr&P 351, 41 ER 525.

[9] This summary of the principle for which Bower v Marris stands quoted from Practical Law in its case report of the first instance judgment Lomas and others v Burlington Loan Management Ltd and others [2015] EWHC 2269 (Ch).  

[10] [at paras 25 and 26.]

[11] Rejecting the existence of currency-conversion claims.



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