How are creditors’ and sureties’ claims dealt with in an insolvency of the principal?

The case of Lehman Brothers Holdings Scottish LP 3 v Lehman Brothers Holdings Plc (in Administration) [2021] EWCA Civ 1523 offers useful insight into how creditors’ and sureties’ claims are dealt with in an insolvency of the principal.

The case considers the ability of (a) a surety and (b) a creditor / beneficiary to prove in insolvency proceedings of the principal where the surety had paid part of the debt from the principal to the creditor and given up indemnity rights as against the principal. However, the question is how much could the surety prove for in the insolvency proceedings of the principal?

Background Facts

The case was a complex one involving several issues arising following the insolvency of the Lehman Brothers group. However, what will be of particular interest to sureties is the decision of the Court of Appeal in relation to the surety’s position.

The principal debtor, Lehman Brothers Holdings Plc (PLC), was in administration. PLC had benefited from a loan under a facility provided by Lehman Brothers UK Holdings Limited (the Creditor).  PLC’s obligations were guaranteed by Lehman Brothers Holdings 1 Limited (the Surety).

The Issues

The Surety and the Creditor entered into a settlement arrangement under which the Surety: 

• paid 36% of the money owed to the Creditor by PLC;
• expressly agreed to release its right to an indemnity from PLC; and
• became the assignee of the entirety of the Creditor’s claims against PLC.

On this basis, the Surety claimed to be entitled to prove in the administration of PLC for the whole amount of the loan i.e. 100%.

The issue for the Court was whether the Surety (as assignee of the Creditor) could prove for (i) 100% of the amount or (ii) 64%, i.e. after giving credit for the 36% it had paid as surety.

The “Rule Against Double Proof”

Absent robust bond documentation and counter indemnities, the common law position is that:

• a surety of the whole may potentially be precluded from proving in the insolvent estate of a principal unless and until the beneficiary had made a full recovery;
• the creditor remains entitled to prove for the full amount of the claim against the principal; and
• the creditor is not obliged to discount that claim on account of recoveries received or receivable from the surety (as this is substituted with an obligation for the creditor to account to the surety for any surplus).

As indicated above, the facts in this case are somewhat different to the usual position as the Surety had (a) expressly agreed to release its right to an indemnity from PLC and (b) taken an assignment of the Creditor’s claims against PLC.

The Decision

The net effect of the settlement arrangements, including the Surety releasing its indemnity rights against PLC as principal, was that:

• the entitlement to prove in the administration for the 36%, which the Surety had paid to the Creditor, had been lost, and 
• the Surety only took an assignment of the Creditor’s net entitlement to prove in the administration.

The Court decided, in effect, that the Surety could only prove for 64%.

Implications

Well drafted bond instruments and counter indemnities will provide that a beneficiary is only permitted to make a claim in the principal’s insolvency proceedings net of a surety’s bonded amount. As such, in our experience, a surety is able to navigate the rule against double proof and retain its entitlement to make a claim in the principal’s insolvency proceedings for the full indemnified amounts.

However, the distinguishing factor in this case is that the Surety had waived its right to an indemnity against the principal as part of overall settlement arrangements.

We consider such waiver to be the exception rather than the rule, and is likely reflective of the Surety and PLC being connected parties.

The resulting decision, however, serves as a useful reminder that indemnity waivers should be carefully considered as they may result in unintended consequences.

Until such time as this decision may be clarified or reversed, sureties would continue to be well advised to exercise caution when drafting settlement agreements.