General Liens And Financial Collateral

The recent case of Re Lehman Brothers International (Europe) (in administration) [2012] EWHC 2997 (Ch), in which we acted for Lehman Brothers Finance ("LBF"), has much to interest those involved in taking security over financial collateral. The court was asked to consider no less than 27 issues relating to an English law governed master custody agreement ("MCA") between different Lehman's entities, but this note only addresses those likely to be of most interest to lenders. The key issues were the nature of the security created by the MCA made in August 2003 between Lehman Brothers International (Europe) ("LBIE") as custodian and LBF, being one of LBIE's group companies, and the application of the Financial Collateral Arrangements (No 2) Regulations 2003 (the "Regulations") to that security.

Nature of the security

The MCA described LBIE as having a "general lien" over assets held by it as custodian, coupled with rights of retention, sale, and application of proceeds. Most of the assets consisted of de-materialised securities and cash, and the first question was what kind of security interest, if any, LBIE had. English law has, traditionally, only recognised a general lien in relation to tangibles and old-fashioned certificated securities, and the court invited the parties to argue that the time had come to take a broader and more commercial view of what a general lien might apply to, but the parties declined to do so. Given that, the court held that the MCA created a charge in favour of LBIE, and counsel for LBIE conceded that this was a floating charge, because LBF had a contractual right to substitute or withdraw excess collateral. As a result it was unnecessary for the court to decide whether the charge was fixed or floating, which would have entailed a close examination of the extent to which the parties had legal and administrative control over the relevant assets.

A feature of the MCA was that the charge secured not only obligations to LBIE, but also to other Lehman group companies, namely to persons other than the chargee. Despite a lack of authority on the point, the court held that such a charge is conceptually possible. In other words, on this analysis, it is possible for A to create security in favour of B which also secures obligations owed by A to C (or other associates of B), without the need for B to be C's trustee or fiduciary. Such arrangements are sometimes found in banks' standard terms and conditions, but there has...