The Court of Appeal has handed down its judgement relating to how the Administrators of Lehman Brothers International (Europe) ("LBIE") should distribute the client money that LBIE held at the point at which it went into administration.

Client money is money that belongs to a client but is held for safekeeping by an investment firm on behalf of the client under a statutory trust, for example in order to enable the provision of brokerage, trading or portfolio management services by the firm.  The issue at hand was that whilst LBIE was required, under the FSA's rules, to segregate client money from its own money, it consistently failed to do so, resulting in a shortfall in the client money pool available for distribution by the Administrators.  In addition, one of the banks with which LBIE held US$1bn of client money for safekeeping has also become insolvent, thereby further increasing this deficit.  Finally, the FSA's client money rules did not appear to offer an unambiguous procedure for dealing with these issues.

The Court of Appeal judgement overturns the previous High Court judgement on some significant points.

The outcome of the Court of Appeal judgement is that the Administrators are now required to include in the client money pool for distribution any traceable client money (whether or not it was segregated) and distribute it amongst all the clients that had a contractual entitlement to have their money segregated (whether or not LBIE had actually done so, and including LBIE's affiliates), pro rata in accordance with their respective contractual entitlements (which would need to be shown to exist).

Whilst this may appear at the outset to give effect to the intention of the FSA's rules – that all clients share rateably in any shortfall on the failure of a firm - this judgement may have important consequences in terms of investor protection.   Notably, when compared to the High Court decision, the entitlements in the remaining client money pool for clients whose client money was actually segregated would now be significantly diluted by the entitlements of clients whose client money was not segregated (but should have been), including LBIE's affiliates.  The judgement also poses significant practical difficulties for the Administrator in locating, allocating, and distributing the remaining client money – administration distributions for clients (and for unsecured creditors) are likely to be delayed further.  It also further clarifies the extent of a firm's trustee obligations when handling client money under the FSA's 'alternative approach'.

Please click here for our full article on the Court of Appeal judgement, and its consequences.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

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The original publication date for this article was 05/08/2010.