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Focus: The Lehmans aftermath – using a scheme of arrangement to release third party claims

4 October 2013

In brief: The Federal Court recently made orders convening a meeting of creditors of Lehman Brothers Australia Limited (in liq) to consider a scheme of arrangement providing for the release of creditors' claims against the company's insurers. The case illustrates the use of schemes of arrangement as a flexible and effective way of implementing a broad settlement between creditors and interested third parties in the wake of a corporate collapse. Partner Chris Prestwich (view CV) and Law Graduate Elise Ho report.

How does it affect you?

  • The decision in Lehman Brothers Australia Ltd, in the matter of Lehman Brothers Australia Ltd (in liq) (No 2)1:
    • demonstrates the broad approach the court will adopt as to what constitutes a 'compromise' or an 'arrangement' between a company and its creditors for the purposes of a proposed scheme of arrangement; and
    • illustrates the use of schemes of arrangement to effect a broad compromise between a company, its creditors and third parties, including requiring creditors to release claims against third parties.

Facts and background

The liquidators of Lehman Brothers Australia Limited (in liq) (the company) sought orders under section 411 of the Corporations Act 2001 (Cth) (the Act) to convene a meeting of creditors for the purpose of considering a (revised) proposed scheme of arrangement between the company and a certain class of creditors (the scheme creditors). A scheme of arrangement is a compromise or arrangement between a company and its creditors that can modify or adjust the creditors' rights and that, if approved by a special majority of voting creditors and the court, binds all or particular classes of creditors.

Events leading to the proposal of the scheme by the company's liquidators were:

  • the scheme creditors had obtained a judgment against the company in relation to investment advice they received2;
  • they had asserted an ability to enforce that judgment directly against certain overseas insurers; and
  • the insurers had disputed their liability both to the company and the scheme creditors.

The proposed scheme (if approved) involves the third party insurers making a US$45 million payment to the company for distribution to the scheme creditors. In return, the insurers will receive the benefit of a release of all claims against them from the scheme creditors.

Release of third party claims

In Australia, schemes of arrangement have been used to effect a broad settlement of claims between a company, its creditors and a third party. In the Opes Prime3 and Lift Capital4 matters, the court approved a scheme of arrangement that required scheme creditors to release their claims against the insolvent company's third party financier, in return for a payment into the scheme fund.

In this case, the court accepted that there was an 'adequate nexus' between the scheme creditors, their claims against the company and their claims against the insurers. Accordingly, the court held that a scheme of arrangement, if agreed to by the requisite majority of scheme creditors, could be used to release all scheme creditors' claims against the insurers.

Did the proposed scheme involve a 'compromise' or 'arrangement'?

The proposed scheme does not provide for any compromise by the scheme creditors of their claims against the company. The scheme creditors would retain their right to prove in the liquidation for the entire amount of their claims (less amounts recovered under the scheme). That raised the question of whether the proposed scheme amounted to a 'compromise' or 'arrangement' within the meaning of s411(1) of the Act.

Justice Jacobson confirmed that s411 of the Act is to be construed liberally, and 'compromise' and 'arrangement' are not to be given narrow or pedantic interpretations. While a compromise or arrangement must have some element of 'give and take', that 'give and take' need not be between the creditors and the company but may be between the creditors and a third party.

The court noted that a 'compromise' and an 'arrangement' are separate concepts, and held that the proposed scheme was:

  • a 'compromise', as it would resolve a dispute as between the scheme creditors as to who had priority regarding the insurance proceeds (the scheme provides for any priority claims to the insurance proceeds to be relinquished. That dispute would likely have involved the company as a party; and
  • an 'arrangement', as the scheme creditors' claims against the insurers were 'significantly interrelated' with their claims against the company, and the insurers' payment would reduce the scheme creditors' claims against the company.

Conclusion

Schemes of arrangement are very powerful instruments. To be effective, a scheme must be agreed to by 75 per cent in value and 50 per cent in number of each class of creditors that is entitled to vote, and must also be approved by the court. Schemes of arrangement provide a flexible means of effecting a global settlement, involving not just the scheme company and its creditors but also third parties.

Footnotes
  1. [2013] FCA 965.
  2. Wingecarribee Shire Council & Ors v Lehman Brothers Australia Ltd (in liq) [2012] FCA 1028.
  3. (2009) 178 FCR 563.
  4. (2010) 183 FCR 384.

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