One year on, the Lehman Brothers collapse is still making waves, writes David Cowling, this time in courtrooms rather than boardrooms
The non-contingent creditors of Lehman Brothers Australia Limited unanimously voted to adopt a Deed of Company Arrangement (DOCA) in May. However, that DOCA is now the subject of a court challenge.
It's not unusual for a DOCA to be challenged in court, but it this is no ordinary court challenge.
For a start, it's being heard initially by a full court of the Federal Court (the overwhelming majority of DOCA challenges are single judge affairs).
Then there's the legal question being considered by the full court. DOCAs are typically challenged on the grounds that creditors voted for the DOCA based on misinformation or the majority of creditors required to approve the DOCA was achieved only by related parties voting in favour or that the effect of the DOCA is unfairly prejudicial, discriminatory or oppressive to a minority of creditors. The contingent creditors that have commenced the proceedings challenging the DOCA have done just that, but rather than pushing to have the full court consider these issues, they have convinced a single judge that it would be worthwhile for a full court to hear seven separate questions.
The separate questions are based on an argument about the statutory provisions under which DOCAs are set up: essentially can a DOCA require a creditor to release third parties from any liability to the creditor? The contingent creditors want to be able to claim against Lehman Brothers and maintain the right to pursue separate litigation against other Lehman entities.
By coincidence, a not dissimilar issue was recently considered by a differently constituted full court in litigation arising from the collapse of Opes Prime. That full court ruled that a scheme of arrangement under section 411 of the Corporations Act 2001 can require creditors to give up claims they may have against third parties. While parts 5.1 and 5.3A of the Corporations Act 2001 are not identical, those that have been around long enough will recall that DOCAs were introduced largely to overcome the procedural difficulties, delay and expense associated with part 5.1 schemes, so, it will be interesting to see whether the Lehman full court attaches greater significance to the choice of insolvency regime, rather than to the practical outcome of the proposal.
The Lehman case and the Opes Prime case may be pointers to the future direction of corporate insolvency in Australia.
Traditionally, liquidators and external administrators have been faced with a limited range of claimants against the defunct company: secured creditors; preferred creditors (mostly the failed company's employees); and other unsecured creditors (principally trade creditors and the taxman).
Secured creditors, of course, can generally safeguard their own interests. Employees enjoy both statutory priority and the protection of the General Employee Entitlements and Redundancy Scheme (GEERS). The taxman's relatively lowly status as an ordinary unsecured creditor is greatly offset by his ability to pursue directors for their company's tax debts.
Trade creditors, however, have always been at the bottom of the heap, dependent upon there being some crumbs left over from the secured creditors and employees. Interestingly, all trade, employee and related party creditors voted in favour of the Lehman DOCA.
In recent years, the trade creditors' position has started to deteriorate further, as a new class of claimant has arisen. This category first hit the headlines after the collapse of Sons of Gwalia, when a slew of disgruntled shareholders effectively won the right to claim their capital losses as an unsecured debt owing to them in the company's insolvency.
Such claims can greatly expand the number of unsecured creditors claiming against the company's liquidated assets, thus diluting trade creditors' already paltry returns. Importantly, they can also affect the course of the insolvency administration: the votes of Sons of Gwalia's shareholders were decisive in determining the sale plans for the company's assets.
A similar phenomenon can be seen at work in the Lehman Brothers litigation. A group of some of the contingent creditors (largely local governments and statutory authorities), former investment clients of Lehman Brothers, have taken the DOCA challenge process in a totally new direction. It has been reported that, if they are successful, there will be moves to ditch the DOCA process and proceed to winding up. On the assumption that this will produce a smaller return for unsecured creditors, Lehman's trade creditors may be the ultimate losers. Unlike the former investment clients, however, they will not have any other avenues of recourse.
David Cowling is a partner in litigation and dispute resolution at Clayton Utz. The firm is acting for the administrators of Lehman Brothers Australia Limited