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Restructuring & Insolvency

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Focus: UK Supreme Court overturns controversial Nortel and Lehman decision

1 August 2013

In brief: The UK Supreme Court has overturned the contentious Court of Appeal decision holding that the Lehman companies were to treat financial contributions to a group pension scheme as expenses of the companies' administrations, ranking higher than debts to other creditors. The UK decision aligns with the Australian position on this issue, and benefits lenders to, and unsecured creditors of, UK companies. Partner Philip Blaxill (view CV), Senior Associate Alicia Salvo and Lawyer Amy Burton report on the decision and its implications.

How does it affect you?

  • The UK Supreme Court has held in Re Nortel; Re Lehman1 that six externally administered companies within the Lehman Brothers group were not obliged to make financial contributions to a group pension scheme in priority to the companies' other debts, overturning the Court of Appeal decision.
  • Lenders to UK companies, who are secured by floating charges, can be confident that their security will rank ahead of potentially sizeable statutory liabilities.
  • Debts owed to unsecured creditors of UK companies will now rank equally with other statutory liabilities incurred by that company before insolvency.
  • The decision brings this aspect of the UK insolvency regime in line with the position in Australia.

Background

The court proceedings arose out of the broader winding up of a number of companies in the Lehman Brothers group.

One of the Lehman companies operated a defined benefits pension scheme for Lehman group employees. The UK Pensions Regulator used its powers under the UK Pensions Act 2004 to issue 'financial service directions' (FSDs) to six Lehman group entities (the target companies), obliging them to provide financial support for the under-funded pension scheme, which had a shortfall of more than £120 million.

The Court of Appeal held that a statutory liability, such as an FSD liability, is an 'expense of the administration' of a company, ranking in priority to other provable debts of the target companies.

The court's decision was in line with previous UK authority on this issue, but was controversial because:

  • the unsecured creditors of the target companies ranked behind the substantial amounts payable under the FSDs; and
  • the 'expenses of the administration' would rank ahead of amounts owing to creditors secured by a floating charge. As statutory liabilities such as FSDs are often unquantifiable until they arise (and can be sizeable in nature, as occurred with the Lehman companies), the decision could have had a significant impact on lenders whose debts were secured by floating charges.

It is important to note that, in the Australian context, there are similar provisions of the Corporations Act 2001 (Cth) that require circulating assets to be applied first to meet any priority payments, including certain administration expenses, before discharging the secured debt.

The UK Supreme Court decision

On 24 July 2013, the UK Supreme Court overturned the Court of Appeal's decision, holding that the target companies were to treat the FSD liability as a provable debt, rather than as an 'expense of the administration'.

The court focused on two key issues:

  • the lack of legislative intent that the FSD liability was to rank in priority as an 'expense of the administration'; and
  • the wide interpretation of the term 'provable debt' in the UK Insolvency Rules.

The court was not convinced that the UK legislature had intended the FSD liability to be an 'expense of the administration' that would rank it ahead of other provable debts.

On the second issue, the court defined 'provable debt' widely, to include obligations to pay a statutory liability that arose before the insolvency of a company.

In considering this second issue, the court referred approvingly to the Australian decision in Lofthouse v Commissioner of Taxation2. In Lofthouse, Justice Warren of the Supreme Court of Victoria held that a statutory liability was a provable debt because it arose from an obligation that existed before the company entered into administration.

The Australian position

Lofthouse is a seminal case in Australia for its proposition that a statutory liability may be characterised as a contingent liability, and therefore a provable debt, provided that the liability arises from an obligation that existed before the appointment of external controllers. In Lofthouse, the contingent liability was the obligation on the company's directors to repay amounts owing to the Commissioner of Taxation for tax deductions made by the company from salary and wages paid to its employees.

The position in Lofthouse has been followed in subsequent Australian cases holding that the following statutory liabilities could be provable debts:

  • fines imposed by the Australian Stock Exchange for breaches of its operating rules;3
  • superannuation guarantee charges for a company's failure to make certain contributions to the superannuation fund of its employees;4 and
  • personal liabilities imposed on company directors under the Corporations Act for insolvent trading breaches.5

The Lehman decision has now aligned the UK and Australian insolvency regimes regarding the treatment of statutory liabilities as provable debts. Lenders providing secured funding to UK companies will also benefit from this decision.

Footnotes
  1. [2013] UKSC 52.
  2. (2001) 164 FLR 106.
  3. McLellan v Australian Stock Exchange Ltd (2005) 144 FCR 326.
  4. DP Excavation & Haulage Pty Ltd (in liquidation) and Others v Commissioner of Taxation (Cth) (2005) 54 ASCR 274.
  5. Official Trustee in Bankruptcy v CS & GJ Handby Pty Ltd (1989) 21 FCR 19.

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