FEDERAL COURT OF AUSTRALIA

Singleton, in the matter of Lehman Brothers Australia Limited (in liquidation) [2010] FCA 1491

IN THE MATTER OF LEHMAN BROTHERS AUSTRALIA LIMITED (IN LIQUIDATION) ACN 006 797 760

THE COURT ORDERS THAT:

1.    Pursuant to s 477(2B) of the Corporations Act 2001 the applicant liquidators’ entry into so many deeds in, or substantially to the effect of, the form of deed being Exhibit B in the proceedings (described in the schedule below) as they consider appropriate, be approved.

2.    Pursuant to s 479(3) of the Corporations Act 2001 (Cth) the opinion, advice and direction of the Court is that the applicants will be justified in entering into such deeds as are referred to in Order 1 as they consider appropriate for the purposes of the liquidation.

3.    The costs of this application be costs in the liquidation.

Schedule

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. The text of entered orders can be located using Federal Law Search on the Court’s website.

IN THE MATTER OF LEHMAN BROTHERS AUSTRALIA LIMITED (IN LIQUIDATION) ACN 006 797 760

REASONS FOR JUDGMENT

(Revised from the transcript)

1    This is an application by the liquidators of Lehman Brothers Australia Limited (in liq) for an order of approval under s 477(2B) of the Corporations Act 2001 (Cth), and for directions under s 479(3) of the Act, in relation to a proposed alternative dispute resolution process that the liquidators have devised, and which in individual cases, may take more than three months to resolve.

Background

2    Neil Singleton, one of the liquidators appointed on 2 October 2009, has prepared a detailed affidavit identifying some of the complexities that have arisen in the administration of the company in the liquidation. He explained in the affidavit that the claims, which the alternative dispute resolution process is intended to deal with, concern products sold by the company such as bonds, collateralised debt obligations, residential mortgage-backed securities, credit default swaps, and other associated market investments. The collateralised debt obligations and similar financial instruments were highly complex products. Their true nature may be difficult to understand and may still be unravelling in the financial markets following, among other things, the collapse of Lehman Brothers’ parent company in the United States. I will refer to these as “complex financial products”.

3    In a number of instances, the company entered into an investment advisor and management agreement with persons who were or became its clients, with the aims of, among others, advising them and investing on their behalf on these complex financial products. Mr Singleton has concluded that over 300 persons are likely to have claims against the company based on their purchase of complex financial products with its assistance when it was operating its previous business.

4    By about June 2009, the company was being administered under a deed of company administration. However, on 25 September 2009 a Full Court of this Court held that deed to be void: City of Swan v Lehman Brothers Australia Ltd (2009) 179 FCR 243. That decision was affirmed by the High Court: Lehman Brothers Holdings Inc v City of Swan (2010) 240 CLR 509. In the meantime, the administrators, who are now the liquidators, had called for proofs of debt during the administration. About 204 proofs of debt were lodged by persons in the category of purchasers of the complex financial products. About 77 of those persons, most being local government authorities, are involved as group members in separate proceedings being in a class action that is currently fixed for hearing before me commencing on 28 February 2011: see Wingecaribee Shire Council v Lehman Bros Australia Ltd (No 3) [2010] FCA 747. A mediation in that matter has been set down to occur on 23 and 24 February 2011.

The proposed alternative dispute resolution scheme

5    The liquidators are anxious to provide a means for creditors in the class, but who have not joined in the class action (the claimant group), to have the opportunity to pursue the proof of their claims in an expeditious and fair manner. The liquidators have developed an alternative dispute resolution scheme to afford such a mechanism. It seeks to assess the merits of each of these claims individually and to facilitate negotiations with the claimant, if possible, of an agreed amount for which he, she or it may be admitted to proof as a creditor of the company.

6    If that negotiation fails, a second stage of the scheme will provide for the claimant to elect to have an adjudication by an independent adjudicator chosen by it from a distinguished panel consisting of the Hon AM Gleeson AC QC, the Hon MH McHugh AC QC, and the Hon TRH Cole AO QC, all of whom are former senior appellate judges. The liquidators contemplate that their scheme will enable claimants to agree the quantum of their claims in a substantial number, if not all, of the cases, in a manner that is transparent, just, expeditious and cost-effective. This will also avoid the need for numerous, lengthy and potentially very expensive, highly complex processes and litigation, were the creditors in the claimant group to seek to establish their claims by formal proof or litigation.

7    Prior to the commencement of the administration, the company had already been involved in three proceedings concerning complex financial products. Two of those, in the Supreme Court of Queensland, have since been stayed pursuant to s 471B of the Act. The third, brought by Wingecarribee Shire Council in this Court, has now been transformed into the class action.

8    Essentially, Mr Singleton understands that members of the claimant group alleged, or may allege, against the company that it:

    failed to advise them that the collateralised debt obligations that they purchased were exposed to the subprime mortgage market in the United States of America and of the risks associated with such an investment;

    failed to advise them that the collateralised debt obligations were derivatives and generally unsuitable for investment by local governments or persons who were not sophisticated investors;

    breached its duties, as a fiduciary of those creditors, by investing their funds in collateralised debt obligations, either originated by members of the Lehman Brothers group of companies, or third parties;

    failed to avoid conflicts of interest that may have arisen from such a position;

    engaged in conduct that was misleading or deceptive or likely to mislead or deceive in contravention of s 12DA of the Australian Securities Investment Commission Act 2001 (Cth), or the Corporations Act;

    was in breach of contract;

    was in breach of its fiduciary duties; or

    was negligent.

9    Moreover, Mr Singleton understands that members of the claimant group asserted that they were entitled to a wide variety of remedies in the proofs of debt filed in the administration. These included claims for:

    rescission of their agreements;

    the restoration of the claimants to their pre-contractual position by payment of the full face value of the investments at the time they were made, plus any opportunity cost that the claimant investor asserted he, she, or it suffered;

    damages on an expectation basis, calculated by reference to the face value of the investments, less their most recent valuations, plus the expected future coupon return, equivalent to the promised interest or reward under the original contract; and

    other orders available under statute for the recovery of the full face value of the investment.

10    Mr Singleton has given consideration to the notional maximum claims that might be made by all of the over 300 persons who acquired collateralised debt obligations from the company. He arrived at a very significant potential total claim figure for that liability, based on a number of assumptions. Obviously, the validity of the assumptions is a matter that would be the subject of vigorous contest in any litigation, as would be the issues of liability and causation of any potential losses. Certainly, in the class action, the pleadings themselves are well over 100 pages long, involving a large number of complex issues.

11    Mr Singleton has said the Lehman Brothers’ collateralised debt obligation products are in default because the United States based Lehman entities have entered into Chapter 11 arrangements under the United States Bankruptcy Code. However, he has ascertained that the collateralised debt obligations issued by non-Lehman parties are, generally, still not in default and are paying the promised or coupon interest rates. In addition, Lehman Brothers Special Financing Inc, which was the credit swap counterparty, has become in default. This has required the Lehman Brothers companies’ collateralised debt obligations to be “unwound”.

12    Mr Singleton is in advanced negotiations with the United States based Lehman entities and others with a view to trying to resolve those claims and arrive at some arrangement which can be offered to, among others, the claimant group members for whom the alternative dispute resolution scheme is proposed. He expects that if these negotiations are successful, the company will be able to be in a position to see that they are repaid a significant proportion of their initial capital outlay. The company currently holds approximately 13 collateralised debt obligations issued by parties other than Lehman Brothers entities that have a total face value of nearly AUD39 million with maturity dates from 2010 to 2016.

13    Mr Singleton has noted that other creditors of the company lodged proofs of debt for about $435 million, of which about $10 million represented trade creditors. $337 million represented related Lehman Brothers creditors and the balance of about $87 million are subordinated Lehman Brothers creditors. Until the negotiations Mr Singleton is conducting with the Lehman Brothers related parties are resolved, he does not intend to further investigate those claims.

The basis of the proposed alternative dispute resolution process

14    Mr Singleton and his co-liquidator, Steven Parbury, have identified their principal problem in adjudicating on the proofs of debt of the claimant group as being the determination of any losses they have suffered. This is because many of those persons still hold the original complex financial products that they invested in or purchased. Mr Singleton noted that, until such time as those investments have been realised or returned and the amount of loss crystallised, it may be that no loss was suffered by those persons. He pointed out that each of those persons’ proofs of debt, if called for in the liquidation, would need to be assessed on a case by case basis. At this stage, the liquidators hold valuations for some, but not all, of the products in the non-Lehman Brothers group of collateralised debt obligations. As he sees it, the real issue for the liquidators will be whether the loss alleged to have been suffered by the claimant group is one capable of being proved in the liquidation.

15    Accordingly, the liquidators have proposed a scheme in which each member of the claimant group will be asked to sign a deed of alternative dispute resolution. The deed will provide that the company, the liquidators, and the claimant will be bound to participate in the alternate dispute resolution process, and by the rules it specifies. The parties will have to negotiate and act in good faith. The rules of the scheme will provide that the claimant must furnish the liquidators with all relevant and necessary information in support of their claims. The liquidators would obtain a valuation report by an independent expert, use that to assess each claim, have regard to all relevant, necessary information in support of it, and then make an offer to compromise it.

16    Each claimant would then be offered three options. First, the claimant could accept the offer, which would result in the liquidators admitting the claimant as a creditor of the company in the amount of the offer. That would be then documented in a deed of settlement and release.

17    Secondly, the claimant could reject the offer and, either, elect to opt out of the scheme, or make a counter offer. If the creditor opted out, then the liquidators would adjudicate on the claim in accordance with their statutory obligations under the Act. That could give rise to the right of the claimants to appeal to the Court in the event that the claimant was dissatisfied with the liquidators’ determination of the proof of debt: cf Div 6 of Pt 5.6 of the Corporations Act and regs 5.6.47–5.6.54 of the Corporations Regulations 2001 (Cth). Alternatively, if the claimant made a counter-offer, accompanied by a statement of reasons, for its calculation, the liquidators could either accept, reject, or further negotiate it. If it were accepted, the liquidators would admit the claimant to proof in that sum and, again, the parties would enter into a deed of settlement and release. If it were rejected, the liquidators could either make a further counter-offer or require the claimant to elect to have the claim assessed by an independent adjudicator, being one of the three former judges to whom I have referred to above, or opt out of the scheme, in which case, the creditor would be able to pursue any remedies available under the Act.

18    Thirdly, the claimant could proceed to an adjudication by the independent adjudicator, in which case the result would be binding on the parties.

19    The scheme rules set out in detail the obligations of the parties to participate in this process. It is likely that if a claimant entered a deed of alternative dispute resolution, as proposed, the process that would be followed would take longer than three months to complete. This is because of the nature of the financial products involved and the complexities and difficulties of proving and considering each individual’s claims. Hence, the first part of the liquidators’ application seeks an order, pursuant to s 477(2B) of the Act, approving their entry into an obligation to pursue that potentially lengthy process pursuant to s 477(2B) of the Act.

Consideration

20    I am satisfied that the amended terms of the deed of alternative dispute resolution, that have been propounded by the liquidators following my discussion with counsel earlier today, offer a practical and apparently sensible means by which creditors in the claimant group can seek to establish their claims in an appropriate and potentially less burdensome way than under a formal proof of debt procedure, including appeals that are available under the Act.

21    In the circumstances of this liquidation, as I have indicated, the complex financial products are sophisticated and not easily understood. There is a large number of potential claimants who will seek to prove in liquidation. The liquidation is very involved. The company is currently a party to the class action which is a significant piece of litigation. It has taken some time to bring it to the point of being ready for hearing, albeit in recent times the parties have moved very expeditiously and co-operatively for that purpose.

22    For these reasons, I am also satisfied that the liquidators would be justified in entering into deeds in the form of the deed of alternative dispute resolution with such of the persons in the claimant group who had previous dealings with the company in respect of the collateralised debt obligations and other complex financial products. I am satisfied that I should grant the liquidators the relief they seek.

Associate:

Dated:    14 January 2011