Bacnet Pty Ltd v Lift Capital Partners Pty Ltd

IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 622 of 2013

IN THE MATTER OF LEHMAN BROTHERS AUSTRALIA LIMITED (IN LIQUIDATION) BETWEEN: LEHMAN BROTHERS AUSTRALIA LIMITED (IN LIQUIDATION) ACN 066 797 760

JUDGE: JACOBSON J DATE: 28 May 2013 PLACE: SYDNEY

REASONS FOR JUDGMENT 1 The plaintiffs, Lehman Brothers Australia Limited (in liq) (LBA), Marcus Ayres and Stephen Parbery (the Liquidators) move on an amended originating process filed in Court on 22 May 2013. They seek orders under s 411 of the Corporations Act 2001 (Cth) (the Act) convening meetings of creditors of LBA for the purpose of considering a scheme of arrangement between the creditors and LBA. 2 Mr Sheahan SC and Mr Nixon appear for the plaintiffs and filed in Court at the start of the hearing an amended originating process seeking, in addition, orders under s 477(2B) and the corresponding provision in relation to Part 5.3A of the Act, that Mr Ayres and Mr Parbery may enter into a Deed of Release with QBE Insurance (Aust) Ltd (QBE).

Background 3 The background to the scheme may be explained briefly. 4 LBA was formerly known as Grange Securities Ltd. It carried on investment banking, securities and related business in Australia. 5 LBA had two categories of clients. The first are described as Individual Managed Portfolio (IMP) clients. They were clients who gave LBA authority to make investment decisions on their behalf. LBA was therefore in the position of a discretionary funds manager for those clients under what are called IMP agreements. 6 The second category is described as non-IMP clients. They were clients or prospective clients to whom LBA provided ad hoc investment advice. Those who became clients entered into agreements described as non-IMP (non-IMP) agreements. 7 A large part of the financial products which LBA purchased for both categories of clients were structured financial products known as synthetic CDOs. 8 These products offered a high rating allocated to them by rating agencies and a higher return than similar products. The higher returns involved higher risks, although clients may not have been aware of this. 9 When the global financial crisis struck in about 2007 the risks inherent in the CDOs materialised for some, but not all, of these products. This resulted in very large losses for many of the clients. 10 LBA was part of the international Lehman Brothers Group (Group). The Australian company was part of the broader South East Asia Lehman Brothers Group. LBA was reliant on funding from Lehman Brothers Asia Holdings Ltd. Both LBA and Lehman Brothers Asia Holdings were subsidiaries of Lehman Brothers Holdings Inc (LBHI) which had headquarters in New York. 11 Shortly after the collapse of LBHI which filed for Ch 11 bankruptcy protection in the US in September 2008, administrators were appointed to LBA. In October 2009, LBA was ordered to be wound up. 12 In 2007 three applicants brought a representative action under Part IVA of the Federal Court of Australia Act 1976 (Cth). The proceedings are described as Wingecarribee Shire Council and Ors v Lehman Brothers Australia Ltd, NSD 2492 of 2007 (Wingecarribee proceeding). 13 The Wingecarribee proceeding involved claims by both IMP and non-IMP client creditors. Wingecarribee Council was an IMP client. Parkes Council was a non-IMP client. The Swan City Council was initially a non-IMP Client but it later became an IMP client of LBA. 14 The Group members who are represented in the Wingecarribee action comprise 72 client creditors of LBA out of a total of 356 client creditors identified to date by the Liquidators. 15 On 21 September 2012 Rares J delivered his reasons for judgment in the Wingecarribee proceeding in Wingecarribee Shire Council v Lehman Brothers Australia Ltd (in liq) [2012] FCA 1028. In summary, his Honour found that LBA, in selling and advising on the sales of certain investment products to the applicants, acted in breach of the contracts it had with the applicants, engaged in misleading or deceptive conduct, was negligent and was in breach of its fiduciary duties as a financial adviser to the applicants. For those reasons, LBA was found to be liable to compensate the applicants for their losses incurred as a result of their investments. 16 On 3 and 21 December 2012 and 25 March 2013, Rares J made the Common Issues Orders (which determined a number of common questions and answers binding on the applicants, LBA and Group members). On 25 March 2013, Rares J granted Declaratory Relief declaring, amongst other things, the amounts for which the applicants are entitled to be admitted to prove in the liquidation of LBA. 17 On 25 March 2013, the Court also granted leave for LBA to appeal in respect of certain of the Common Issues Orders and some aspects of the Declaratory Relief. The Liquidators have filed LBA's appeal in respect of both the Common Issues Orders and the Declaratory Relief. 18 The particular focus in the appeal is based upon the existence of fiduciary duties to clients and the question of breach of fiduciary duty. 19 The significance of this is that, absent such findings, the ground of contributory negligence would be open to LBA. 20 The appeal challenges that finding only in relation to Swan City Council and Parkes Council. This explains some aspects of the Claim Resolution process (CRP) which is part of the scheme. 21 The arrangements between Wingecarribee Council and LBA were confined to an IMP agreement or agreements. One of the provisions of that agreement was that there was to be an active secondary market for all investment products. 22 Rares J found that there was no active secondary market for the products. It followed that all the investments fell outside the mandate given to LBA and loss flowed directly. This finding underlines the substantial difference which exists between the position of IMP clients and non-IMP clients. 23 Most of the claims by IMP clients fell into the same category as that of the Wingecarribee Council. That is to say, they turn upon whether there was a breach of the conditions of the mandate. If it was, the claim is established and there will be full recovery. 24 Importantly, there will be no real prospect of apportionment for contributory negligence or proportionate liability in an apportionable claim. 25 However, for non-IMP clients, leaving aside the claim for breach of fiduciary duty, most of the claims raise the possibility of apportionment. This is because the claims will be determined as claims in tort or as statutory claims for misleading and deceptive conduct.

The insurance 26 LBA had access to two categories of insurance cover which gave rise to potential recoveries in respect of the claims against it. The first were 11 policies issued in the United States to LBHI or the ultimate holding company, Lehman Brothers Inc. Those policies provided potential cover in an amount of $100 million. 27 The second category comprised policies issued in Australia by QBE which provided for cover of up to $10 million. 28 The Liquidators made claims on the policies but those claims were strenuously resisted. Lengthy negotiations took place which included mediations that were held in the USA and Australia. 29 The negotiations and the mediation process resulted in settlements with the US insurers and QBE. The US insurers agreed to pay $45 million and QBE agreed to pay $3 million. Those amounts will together comprise the Insurance Proceeds Fund under the scheme. Only the client creditors will have access to that fund. 30 It is a condition of the payment of the amounts referred to above that each insurer be provided with releases from the ultimate claimants. In particular, the United States insurers have insisted on such releases to avoid direct claims against them under s 3420 of the New York Insurance Code. 31 QBE's requirement that there be releases is founded upon the possibility of direct claims being made against it under s 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW). 32 Similar releases were upheld as a valid requirement of a scheme of arrangement in Re Opes Prime Stockbroking Ltd (2009) 179 FCR 20; affirmed on appeal, Fowler v Lindholm (2009) 178 FCR 563. 33 I will refer to those authorities later.

The objects of the scheme 34 There are two principal objects of the scheme. 35 The first object is to provide for the realisation of the insurance proceeds for the benefit of all client creditors. This is to be achieved in the manner referred to above. 36 The second object is to expedite the resolution of all claims in the administration of LBA so as to bring that process to completion at the earliest possible time. 37 This is to be achieved by two essential features of the scheme. The first is to provide for the termination of the appeal from the decision of Rares J in the Wingecarribee proceeding. 38 This is a critical feature of the scheme because the ongoing uncertainty and delay in completing the appeal process is delaying the resolution of all other claims. No one can be paid until the litigation is finalised. 39 The second feature of the scheme is the mechanism for resolution of the claims of all other client creditors. This is to be dealt with under the CRP which is set out in a schedule to the scheme. 40 There are two important parts of the CRP. First, the scheme provides for the admission in full of the debts of the applicants in the Wingecarribee proceeding. 41 It also provides for the payment of $3.5 million to those client creditors, or at their direction, to compensate them for the burden of undertaking the litigation. The practical effect of this is that the payment will be made to the litigation funder on account of fees payable to it under its litigation funding agreement. 42 The second step is the structure contained in the CRP which provides for the resolution of all claims. I will refer to this in more detail later.

The scheme creditors 43 A person will be a scheme creditor if the person has a claim against LBA in respect of an unsecured debt, or an unsecured claim against, LBA and the circumstances giving rise to the claim arose on or before 26 September 2008. 44 There are five proposed classes of scheme creditors as follows: (a) "Client Creditors", being: (i) the applicants and group members in Wingecarribee Shire Council & Ors v Lehman Brothers Australia Ltd (in liq) No. NSD 2492 of 2007 (the Wingecarribee Action); and (ii) any other person who has a claim against LBA arising from: A. the provision by LBA of investment advice or investment management services in respect of the acquisition of an investment product; or B. any alleged representation by LBA in relation to an investment product or investment management services offered by LBA; or C. the sale by LBA of an investment product. (b) "Trade Creditors", being suppliers of goods and services to LBA; (c) Lehman Brothers Asia Holdings Limited (in liquidation) (LB Asia Holdings), being a related party of LBA which is to receive a release from Client Creditors, LBA and the Liquidators; (d) Lehman Brothers Australia Granica Pty Ltd (subject to Deed of Company Arrangement) (LB Granica), being a related party of LBA the claim of which is subordinated to the claims of all other creditors (the Subordinated Claim); and (e) all other Scheme Creditors who are not Client Creditors, Trade Creditors, LB Asia Holdings or LB Granica (Other Creditors).

The key commercial terms of the scheme 45 It is sufficient to record the key commercial terms of the scheme that were set out in the overview of the explanatory statement as follows: The payment by the US Insurers of US$45 million (inclusive of GST, if any) to LBA for distribution to Client Creditors in accordance with the provisions of the Scheme; Client Creditors, LBA and the Liquidators will provide releases in favour of the US Insurer Parties; The payment by QBE of $3 million (inclusive of GST, if any) to LBA for distribution to Client Creditors in accordance with the provisions of the Scheme; Client Creditors and LBA will provide releases in favour of QBE; The compromise by LB Asia Holdings of its claims against LBA; Client Creditors, LBA and the Liquidators will provide releases in favour of LB Asia Holdings; Trade Creditors will receive at least 75 cents in the dollar on the amount of their Established Scheme Claims; the Wingecarribee Action and the associated appeal will be dismissed or discontinued; a procedure is established, the CRP, for the independent adjudication of the claims of Client Creditors if the Scheme Administrators and any Client Creditor have not been able to agree on the amount of the Client Creditor's Scheme Claim; and Scheme Creditors will provide releases in favour of the Liquidators and accept their entitlements under the Scheme in full satisfaction of all claims which they have against LBA.

The Liquidators' recommendations 46 The Liquidators recommend that scheme creditors vote in favour of the scheme. Their reasons include their opinion that the scheme provides an efficient procedure under the CRP for determining the claims of client creditors, that the scheme offers a more cost effective and speedy distribution to scheme creditors than a winding-up, and that it is likely to provide a higher return for scheme creditors. 47 The Liquidators estimate, based on the material presently available to them and based on the assumptions set out in sections 6.2 - 6.3 of the draft Explanatory Statement, that: (a) if the Scheme becomes effective, the Scheme will deliver: (i) a dividend of 75 cents in the dollar for Trade Creditors, to be paid within 3 months of the Effective Date; (ii) a dividend of 40.7 to 49.9 cents in the dollar for Client Creditors, with at least an interim dividend being paid within five months of the Effective Date; and (iii) a dividend of 35.2 to 44.7 cents in the dollar for all other Scheme Creditors (other than LB Granica, which will receive a zero dividend) , with at least an interim dividend being paid within five months of the Effective Date; (b) if the liquidation proceeds without the scheme: (i) creditors, except for LB Granica, will receive a dividend of 33.2 to 41.6 cents in the dollar; and (ii) save for a relatively small interim dividend to Trade Creditors and other creditors who are not Client Creditors, payments of dividends will not occur until 2015 or 2016.

Applicable principles under s 411 48 I am satisfied that the terms of the explanatory statement and the scheme contain proper disclosure of the material facts necessary to enable the creditors to exercise their judgment in voting on the scheme in accordance with the principles discussed in the authorities: see Re NRMA Insurance Ltd (2000) 33 ACSR 595 at [15]-[18]; see also Re CSR Ltd (2010) 183 FCR 358 at [12]. 49 I am also satisfied that the scheme is of such a nature and cast in such terms that if it achieves the statutory majority at the meetings, the Court would be likely to approve it: FT Eastman & Sons v Metal Roof Decking Supplies Pty Ltd (1977) 3 ACLR 69 at 72. This includes the provision for releases which I will discuss later.

Classes of creditors 50 The principles are well established. They follow from the seminal English authority of Sovereign Life Assurance Co v Dodd [1892] 2 QB 573. The test focuses upon legal rights. It is not a test based upon identical treatment but upon community of interest. The Court must ask itself whether the rights of different groups viewed in the overall context of the scheme are so dissimilar as to make it impossible for them to consult together: Re Hills Motorway Ltd (2002) 43 ACSR 101 at [12]-[13] and Re HIH Casualty and General Insurance Co Ltd (2006) 200 FLR 243; 57 ACSR 791 at [70]-[71]. 51 In Re Opes Prime at [66] Finkelstein J pointed to the undesirability of giving a power of veto to each class. His Honour emphasised the need for a practical business-like approach to the issue of class creation. 52 The issue which arises in the present application is whether the client creditor class should be further subdivided into a number of sub-classes. One class would consist of the applicants in the Wingecarribee proceeding. The other class would then consist of all remaining client creditors but it may be asked whether that class could be subdivided again. 53 The further possible subdivision would be to separate the remaining creditors into IMP client creditors and non-IMP client creditors. 54 This question, that is to say, the possible sub-division and further subdivision, turns upon the terms of the scheme which apply to the applicants in the Wingecarribee proceeding and the terms of the CRP. 55 The applicants in the Wingecarribee proceeding are to be admitted as client creditors without the need to prove the quantum of their claims. This is hardly surprising because the quantum was determined by Rares J after a lengthy and expensive proceeding. 56 The legal rights of those parties are no different from the rights of the other client creditors by reason of this difference. It is not impossible for them to consult together by reason of this difference of treatment which flows from and underlies the overall nature of the scheme. 57 The other difference of treatment is that the applicants in the Wingecarribee proceeding are to receive a payment of $3.535 million as a contribution for their efforts in conducting the proceeding. This amount will then be directed to be paid to the litigation funder as part of the sum payable by the applicants to the funder for funding the litigation. 58 The payment will result in a dilution of approximately 0.7 cents in the dollar for the dividend payable to client creditors and 0.3 cents in the dollar for the dividend to other creditors. 59 A similar issue arose in the Re Opes Prime matter where the scheme provided for a larger payment to the litigation funder and a larger dilution than in the present matter. The Full Court held that it was legitimate for the liquidators to conclude that the effect of the payment was to put the creditors who had incurred the costs of the litigation in the same position as those who did not incur costs: see Fowler v Lindholm at [78]. 60 In my opinion, the same conclusion applies here where the liquidators have reached the view that the payment is justified because, inter alia, the litigation funding has produced benefits for all client creditors. 61 Those client creditors who were not applicants in the Wingecarribee proceeding share in the Insurance Proceeds Fund with the applicants, and obtain the benefit of the CRP which will enable their claims to be determined efficiently and expeditiously. All the client creditors share that interest. The differences between the position of the applicants in the Wingecarribee proceeding and the other client creditors are not sufficient to warrant the applicants having a right of veto under the scheme. 62 The second possible subdivision of client creditors turns on differences between the provisions of the CRP applicable to IMP client creditors, and those which apply to non-IMP client creditors. The differences arise from the differing nature and strength of the claims. The differences of treatment are most likely to arise in respect of claims which are apportionable claims. 63 Where a claim arises under an IMP agreement, for example, that the CDOs were not an authorised investment because they were purchased in breach of the investment guidelines, the claim would not be apportionable and no issue of contributory negligence could arise. Accordingly, no defence of contributory negligence is available to LBA where the claim is for breach of fiduciary duty: see Rules 46, 51-52 and 62 of the CRP. 64 The claim of a non-IMP client is less likely to be one of breach of fiduciary duty. Rule 63 of the CRP provides that where a non-IMP client creditor establishes a claim under general law or statute in respect of which a defence of contributory negligence would be available, the independent adjudicator is required to assume that there was contributory negligence and must decrease the claim by 15% on account of notional contributory negligence. 65 In practice, because of the way in which dividends are calculated, the actual reduction in the dividend payable in respect of such claims is 10.1%. 66 It is possible that an IMP client creditor may establish a claim which is apportionable. In that event, the claim may be reduced to reflect contributory negligence on the part of the client creditor. This is reflected in Rule 62(b) of the CRP. 67 Unlike the position of non-IMP client creditors, the extent of any reduction for contributory negligence for IMP client creditors is not fixed by the CRP Rules. Rather, the questions of whether any reduction should be made, and the extent of the reduction, are matters for the independent adjudicator. 68 This difference of treatment between IMP client creditors and non-IMP client creditors derives from the different nature and strength of the claims. Ordinarily, IMP client creditors did not make investment decisions themselves but authorised LBA to make the decisions within the investment guidelines. 69 By contrast, non-IMP client creditors made their own investment decisions. The evidence in the Wingecarribee proceeding suggests that they were provided with documentation concerning the products. Some had investment staff. Some invested public moneys. 70 Nevertheless, I do not consider that the different rules applicable to IMP client creditors and non-IMP client creditors make it impossible for them to consult together with a view to their common interest. All client creditors have an interest in having their claims resolved quickly, efficiently and inexpensively. 71 This will be achieved by having the claims of IMP client creditors and non-IMP client creditors being determined by the defined processes and procedures under the CRP. Most importantly, all client creditors will have access to the sums of $45 million and $3 million to be contributed to the Insurance Proceeds Fund by the US insurers and QBE. 72 There is a further difficulty in the subdivision into IMP and non-IMP client creditor classes. Some client creditors will be both IMP client creditors and non-IMP client creditors. This was the case of Swan City Council in the Wingecarribee proceeding. 73 The CRP deals with this situation by providing for claims in respect of the IMP period to be adjudicated in accordance with the rules applicable to IMP client creditors. Claims in respect of the period in which they were non-IMP clients will be adjudicated in accordance with the rules applying to non-IMP client creditors. 74 To divide those client creditors into separate classes would be a difficult process and may well cause confusion between them. It would be contrary to the practical business-like approach of which Finkelstein J spoke in Re Opes Prime. In my opinion this further subdivision of client creditors should not be made.

The releases 75 The releases are covered by the decision of the Full Court in Fowler v Lindholm at [69], [72]. See also Bacnet Pty Ltd v Lift Capital Partners Pty Ltd (in liq) (2010) 183 FCR 384 at [144]-[145]. 76 There is the requisite element of "give and take" because the client creditors receive the benefit of the sum of US$45 million from the US insurers and $3 million from QBE. Each of those insurers has articulated grounds of defence for resisting the claims. The Liquidators consider the grounds of defence to be plausible.

Other matters 77 The other matters which I have taken into account are set out in the comprehensive written outline of submissions of Mr Sheahan SC and Mr Nixon. I have marked the submission as MFI 1 and they have been placed with the Court papers. 78 For the reasons set out above, I made orders on 22 May 2013 concerning the scheme meetings and other related orders. I certify that the preceding seventy-eight (78) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jacobson.