Lehman v Firth Rixson (2022) – Lehman is back, and it can collect on its debts

February 23, 2023
(Last updated: September 7, 2023)

Home > Knowledge Hub > Blog > Lehman v Firth Rixson (2022) – Lehman is back, and it can collect on its debts

Grant & Others v Firth Rixson Acquisitions Corporation (Europe) Ltd & Another (Re Lehman Brothers International (Europe)) [2022] EWHC 2532 (Ch)

A recent High Court case involves the administrators of Lehman Brothers’ European firm, and raises the possibility of the bank returning as a going concern.

Facts of the Case:

This case involved two interest rate swaps between Lehman Brothers International Europe (LBIE) and two different entities from the Firth Rixson Group. The case was heard in 2021 and judgement was handed down in October 2022. The court held for LBIE: FR has the opportunity to appeal.

One of the swaps was in sterling and the other in US Dollars and they were both governed by an ISDA Master Agreement.

The agreement was finalised and LBIE and the Firth Rixson Group entered into the two interest rate swaps in late 2007, which were then terminated just over three years later.

The sterling swap was governed by a 1992 ISDA, and the dollar swap was novated to a 2002 ISDA after a year. However, there is little practical difference between the two agreements relevant to the facts of the case.

LBIE was placed in administration in September 2008, thus failing to make the required payment in each agreement. This gave rise to a ‘failure to pay’ Event of Default under section 5(a)(vii) of the 1992 ISDA.

The morning they entered administration, Lehman was in the money on the swaps. If the transactions were terminated, Firth Rixson would have owed around £8m and $53m. Unlike Lehman’s other counterparties, FR declined to close out their ISDAs in the wake of the bank entering administration, to avoid paying out on these obligations.

Since the original bankruptcy, there have been a series of other events and court orders that could constitute Events of Default, notably a 2018 Scheme of Arrangement with creditors, a US court order relating to this scheme, and two European court orders of a similar nature.

Exit from administration and potential ramifications

The administrators of Lehman Brothers International Europe intend for the firm to exit administration in the near future, with control returning to the directors. This was announced in 2020, and the administrators therefore initiated court proceedings.

The potential exit from administration and the length of time that has passed makes this a fairly unique scenario – when Firth Rixson declined to close out their agreements in 2008, they could hardly have expected Lehman to exit administration over 14 years later.

Since entering administration, LBIE has paid off all outstanding creditors, and would be able to pay off new debts as they fall due. In 2020, this theoretical balance sheet solvency led PWC, Lehman Europe’s administrators, to announce that they intended to conclude the administration and hand powers back to the directors in the coming years. This announcement triggered the court case, as the administrators wished to revive their obligations.

Section 2(a)(iii):

Often referred to as the ‘flawed assets clause’, this section of the ISDA is designed to mitigate counterparty credit risk. It protects against any increasing credit risk that might occur if actual payments are made. If an Event of Default (or potential Event) has occurred and is continuing, the non-defaulting party has no obligation to make payments to the defaulting party.

Crucially, as Hildyard J noted, there is no increased credit risk on Firth Rixson’s part. They are the net debtors, so LBIE’s financial situation is not relevant to the equation.

In Lomas v Firth Rixson in 2012, it was confirmed that payment suspension is potentially indefinite if the Event of Default is never cured. The court mentions that Firth Rixson was probably banking on Lehman’s dissolution as a result of the administration, meaning that they never needed to pay the outstanding sums. In the event, Lehman’s pending exit from the administration has thrown up this unusual scenario whereby a long-lasting Event of Default will cease, thus reviving potential obligations many years after they were first suspended.

Firth Rixson justified not paying Lehman through their interpretation of Section 2(a)(iii), submitting that the various Events of Default brought about by Lehman’s bankruptcy were continuing, and thus payment obligations remained suspended. As I have just mentioned, the earlier Lomas v Firth Rixson case confirmed that if the Event of Default is continuing indefinitely, then the suspension of the payment obligation is also indefinite. While obligations

cannot be entirely extinguished, as per Pioneer Freight Futures Co ltd v Cosco Bulk Carrier Ltd [2011] 2 All ER (Comm) 1079, their suspension can be essentially permanent if there is no material change in the scenario. Firth Rixson had relied on this suspension for over 10 years by the time of the case.

They subsequently argued that, even if the original Event of Default – in this case, Lehman being placed into administration – has been cured, it can be considered ‘continuing’ if the effects continue to be felt by the non-defaulting party.

Lehman’s administrators argued under the Insolvency Act 1986 that no Events of Default will continue relating to the section 5(a)(vii) provisions regarding administration. If the suspensory condition was lifted, Firth Rixson would once more become liable for their obligations under the two original swap agreements, as they were not terminated by the non-defaulting party.

Legal Issues:

The first legal issue discussed in this case is whether or not LBIE’s failure to pay Event of Default under Section 5(a)(i) of the ISDA Master Agreement could be cured by mandatory insolvency set off and therefore Firth Rixson cannot rely on the suspensory nature of Section 2(a)(iii) to withhold payment.

The second legal issue is whether or not the Bankruptcy Event of Default – Insolvency and Inability to Pay Debts under Section 5(a)(vii)(2) of the ISDA Master Agreement was a one-off event or has the capacity to be continuing.

The third legal issue is the question of whether or not the Administration Event of Default under Section 5(a)(vii)(4) and (8) can be cured. If this is the case and it can be cured, is this only due to the creditor’s administration not continuing?

The fourth legal issue is whether or not an “arrangement […] with or for the benefit of its creditors” occurred which would give rise to a potential Event of Default under the ISDA Master Agreement.

The fifth legal issue is whether or not an Event of Default under the ISDA Master Agreement will arise due to the order made under the US Bankruptcy Code.

The sixth legal issue is whether or not an Event of Default would occur due to the Spanish and French exequaturs.

Judgement:

As a simple introduction to Hildyard J’s judgement, he was asked to consider three known Events of Defaults and then three other potential Events of Default which Firth Rixson argued. The Court dismissed all of Firth Rixson’s claims and found in favour of LBIE.

Failure to Pay Event of Default – Section 5(a)(i):

The first Event of Default that arose is a Failure to Pay Event of Default under Section 5(a)(i) of the ISDA Master Agreement. This was due to LBIE entering into administration and failing to make two payments under the interest rate swaps to Firth Rixson. The Court viewed that the effect of the mandatory set-off, which was incurred due to LBIE’s notice under the Insolvency Rules 1986, was to cancel a double claim from both parties to the other and implement one claim from LBIE to Firth Rixson. In turn, this meant the Event of Default had been cured.

Bankruptcy Event of Default – Insolvency and Inability to Pay Debts – Section 5(a)(vii)(2):

As outlined in the facts, LBIE was unable to pay its debts when they fell due and therefore constituted an Insolvency and Inability to Pay Debts Bankruptcy Event of Default under Section 5(a)(vii)(2) of the ISDA Master Agreement.

LBIE argued:

That this was a one-off incurable event which was actually incapable of continuing.

Firth Rixson argued:

Until there was a withdrawal of the admission, the Event of Default would be continuing.

Despite agreeing with Firth Rixson, the Court believed that due to publicity and reports of LBIE’s renewed solvency and ability to pay, it had been corrected. Subsequently, LBIE was asked to submit a notice expressing they could pay their debts and the matter was resolved.

Bankruptcy Event of Default – Administration – Section 5(a)(vii)(4) and (6):

Due to LBIE entering into administration this gave rise to a clear Event of Default by way of entering into administration under Section 5(a)(vii)(4) and (6) of the ISDA Master Agreement. There was no dispute over this between the two parties. They also both agreed that Firth Rixson were able to rely on Section 2(a)(iii) of the ISDA Master Agreement due to the event still continuing up to this point.

The Dispute:

Despite the number of issues considered, the dispute was principally over the question as to whether once LBIE came out of administration- would the Administration

Event of Default classed as continuing?

LBIE argued:

That the administration Bankruptcy Event under Section 5(a)(vii)(4) and (6) would ultimately be cured. This is because as soon as the administrator’s appointment had been terminated, LBIE’s administration would end.

Firth Rixson argued:

That LBIE’s administration was principally a liquidation which altered creditor’s rights.

The Court decided with LBIE on this matter; therefore, the Event of Default was viewed as not continuing and therefore it was cured.

As noted within the introduction Judge Hildyard J was asked to consider three known Events of Default which were: the Failure to Pay Event of Default under Section 5(a)(i), the Insolvency and Inability to Pay Debts under Section 5(a)(vii)(2), and the Administration Bankruptcy Event of Default under Section 5(a)(vii)(4) and (6). In addition to this, Firth Rixson also tried to argue for three other potential Events of Default. These will be discussed below:

Scheme of Arrangement Event of Default – Section 5(a)(vii)(3):

The first claim from Firth Rixson was that the Scheme of Arrangement provided a benefit for its creditors which would give rise to an insolvency-based Event of Default under Section 5(a)(vii)(3) of the ISDA Master Agreement. However, the Court did not view this as an Event of Default on the basis that the justification for LBIE entering into the scheme was not due to financial implications, but rather mediation between the parties.

Insolvency Event of Default – Chapter 15 (Section 5(a)(vii)(4) and (8):

The second claim was an Order under Chapter 15 in the United States of America. This order would have potentially given rise to an Event of Default under Section 5(a)(vii)(4) and (8) of the ISDA Master Agreement due to insolvency. Despite this Hildyard J neglected the claim on the basis that that was not the purpose of the Order.

Exequaturs

The final claim from Firth Rixson was another potential insolvency-based Event of

Default under Section 5(a)(vii) (4) and (8) of the ISDA Master Agreement based

on Exequaturs being made in another jurisdiction. However, once again the Court dismissed Firth Rixson’s claim.

Commercial Impact and Takeaways

Any case that clarifies important provisions of the ISDA Master Agreement will also be of relevance to similarly structured documents i.e. GMRA, GMSLA, facility agreements etc. The case clarified two terms in the context of Events of Default- “continuing” and “arrangement”. The Court held that “continuing” should be interpreted with respect to the Event(s) of Default rather than their effects. Therefore, once LBIE had exited Administration and confirmed its ability to resume its obligations the Event of Default would cease to apply. Hildyard LJ further clarifies that a creditor “arrangement” would only constitute an Event of Default if such arrangement altered the counterparty’s credit risk. By implication, the converse case will now definitively apply, any company that makes an arrangement that does permanently alter a creditor’s rights will have a continuing Event of Default hanging over it. The ISDA Master agreement contains a representation that no such Event has occurred or is continuing, material breach of this representation is itself an Event of Default. While the arrangement may have acted to restore solvency and, in the case of new counterparties, may be some time in the past. Firth Rixson relied on Section 2(a)(iii) to avoid paying its debt to LBIE, the case has made such reliance both less and more predictable. It has confirmed that a firm may exit administration and that previous Events of Default will no longer apply. The counterparty’s risk in this scenario is difficult to quantify and therefore difficult to hedge. On the other hand, it is now clear that an arrangement that does affect a creditor’s rights will be a continuing Event of Default and may therefore be relied on by the counterparty.

In practical terms, the circumstances that gave rise to the judgement are relatively rare. It is uncommon for a company to enter administration, successfully pay its administrators and exit with an ability to fully resume its obligations. However, the case has important implications for anyone either seeking to rely on the continuance of an Event of Default or for those who may seek to make a creditor arrangement.

What now?

Firth Rixson has been given leave to appeal. Although it is difficult to see any grounds on which such an appeal may be successful, the amount of their debt plus interest will make a compelling argument for continuance of this saga.