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Court uses inherent trust jurisdiction to authorise a synthetic compromise of proprietary claims (High Court)

by Practical Law Restructuring and Insolvency
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In Re MF Global UK Ltd (in special administration) [2013] EWHC 1655 (Ch) (14 June 2013), the High Court considered whether the court's inherent jurisdiction over trusts enabled it to make an order sanctioning a procedure for settling claims and distributing monies held in a client money trust.
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The High Court has held that the court's inherent jurisdiction over the way a trust is administered can be used to facilitate the distribution of trust assets, despite the existence of unresolved claims by actual or potential beneficiaries.
It was common ground that the court's powers under the Trustee Act 1925 did not apply to the type of trust involved, which was a trust over client money held by MF Global UK Limited (MFG UK). MFG UK went into special administration under the Investment Bank Special Administration Regulations 2011 (SI 2011/245) in 2011.
The client money trust was created by the terms of the Client Asset sourcebook (CASS) of the Financial Conduct Authority, which were drafted with the aim of ensuring the timely return of client money to clients following the insolvency of a custodian of such money. However, neither CASS nor the special administration legislation contain procedures that would enable the special administrators to distribute client money before all actual and potential claims were identified and adjudicated (if necessary) through the courts.
The special administrators therefore proposed a procedure that would allow them to distribute the majority of the client money, even though:
  • After a distribution had been made, claims to the client money fund could still be made by currently unknown claimants.
  • The special administrators had rejected a number of claims and these rejections could be, but had not yet been, challenged in litigation.
The court held that its inherent jurisdiction over trusts had two particular elements that allowed it to authorise the proposed procedure. First, the established practice of making Re Benjamin orders (following Re Benjamin [1902] 1 Ch 723) allowed the court to direct the special administrators to distribute client money, despite there being potentially unknown claimants. Separately, the court had jurisdiction to direct a distribution despite the existence of known but rejected claims to client money. This jurisdiction was based on cases where the court had authorised a distribution of trust property, despite the existence of rejected but potentially valid claims by third parties. However, the court's jurisdiction to make this type of direction applied equally where there were rejected claims by purported beneficiaries of the trust. (Re MF Global UK Ltd (in special administration) [2013] EWHC 1655 (Ch) (14 June 2013).)

Background

Trust of client monies under CASS

Under the Client Asset sourcebook (CASS) of the Financial Conduct Authority (FCA), client funds held by investment firms for their clients (client money) must be segregated from the firm's own funds and held for the clients on the terms set out in Chapter 7 of CASS (CASS 7). This chapter creates a trust of client money and means that, on the insolvency of an investment firm, client money is not available for distribution under general insolvency legislation.
Chapter 7A of CASS (CASS 7A) sets out the client money distribution rules that apply in certain circumstances, such as the entry of an investment firm into a formal insolvency procedure, known as a primary pooling event (PPE). A PPE means that the client money held in each client money account of the firm is treated as pooled and must be distributed among clients pro rata according to their entitlement.
The overall purpose of CASS 7A is to ensure the timely return of client money to clients following a PPE. However, CASS 7A does not contain any procedures for the submission and adjudication of claims to client money, or the method of distributing funds in respect of agreed claims.
For more information on CASS 7 and CASS 7A, see Practice note, FCA client money rules: CASS 7.

Schemes of arrangement cannot compromise proprietary claims

In Re Lehman Brothers International (Europe) (in administration) [2009] EWCA Civ 1161, the Court of Appeal held that it was not possible for the administrators of Lehman (an investment firm) to use a scheme of arrangement to compromise the claims of parties who had a proprietary (i.e. beneficial) interest in assets being held by the bank pursuant to various custody arrangements. However, the Court of Appeal noted in that case that:
"I hope, indeed I would expect, that, if the administrators decide to make an application under the Trustee Acts or pursuant to the court's inherent equitable jurisdiction, in relation to dealing with beneficiaries' rights, the court will provide effective assistance, by arriving at a practical and fair outcome, while ensuring that delay and costs are kept to a minimum."
(Re Lehman Brothers International (Europe) [2009] EWCA Civ 1161, at paragraph 86.)
For more information on the Lehman case, see Legal update, Court of Appeal considers the meaning of "creditor" for the purpose of a scheme of arrangement.

Investment Bank Special Administration Regulations 2011

Following the collapse of the Lehman Brothers group, the Government enacted the Investment Bank Special Administration Regulations 2011 (SI 2011/245) (Special Administration Regulations 2011). The Special Administration Regulations 2011 provide for a single "special administration" procedure for insolvent investment banks. This involves the bank's assets either being returned to clients, or retained if the bank can be rescued as a going concern. However, where an investment bank is also a deposit taking institution, the FSA may apply to court to place the bank in a modified form of bank insolvency or bank administration, the details of which are set out in schedules to the regulations.
Detailed rules on the conduct of an investment bank special administration process came into force on 30 June 2011 (the Investment Bank Special Administration (England and Wales) Rules 2011 (SI 2011/1301) (Special Administration Rules 2011)). These rules supplement, rather than alter, the operation of the CASS rules in an insolvency context. They are based on Part 2 of the Insolvency Rules 1986 (SI 1986/1925). However, neither the new rules nor the CASS rules contain any provisions that enable a special administrator to distribute client money in respect of agreed claims without the concern that disputed or late claims will subsequently affect the amount that should have been distributed.
For more information on the Special Administration Regulations 2011 and the Special Administration Rules 2011, see Legal updates, Special administration regime for investment firms: revised draft regulations published and Insolvency rules relating to investment bank special administration regime in force from 30 June 2011.

Facts

On 31 October 2011, MF Global UK Limited (MFG UK) went into special administration by court order, under regulation 7 of the Special Administration Regulations 2011. For more information, see Legal update, MF Global UK becomes first investment firm to enter the special administration regime.
MFG UK had carried on business as a broker-dealer in London and, following its entry into special administration, held approximately US$ 950 million of client money on trust for clients pursuant to CASS 7 and CASS 7A. The special administrators had identified over 4000 clients that they considered to have a claim to client money, and had agreed over 3000 claims. There were however a large number of claims that had been disputed or were yet to be either formally agreed or disputed.
The special administrators needed a process to deal with rejected claims and unknown claims that would allow them to proceed with a timely distribution of the client money held by MFG UK. Without such a process, the special administrators would have to issue proceedings to determine the existence and extent of all rejected client money claims. If they wished to make a distribution before all claims were adjudicated by the court, the administrators would have to reserve in full for such claims. This would be expensive, time consuming and would still not prevent currently unknown claims from being submitted at a later date, after the available funds had already been distributed.
The special administrators therefore proposed a bespoke distribution procedure to deal with the submission and adjudication of claims. The procedure was adapted from the Special Administration Rules. The special administrators asked the court to authorise the procedure, by making an application to the court for directions on the administration of the client money trust and the distribution of its assets. The administrators asked the court to make an order with the following key directions:
  • The administrators could proceed with a distribution of client money if:
    • They gave notice directly to known creditors of an intention to make a distribution and also advertised this intention by advertising on the website set up for the administration of MFG UK and in certain newspapers.
    • The only persons with a claim to client money were those who had lodged a claim by a bar date specified in the notice of proposed distribution.
    • Any rejected claim would not be treated as a claim to client money unless the claimant had given notice of a court application to vary or reverse the rejection.
  • The administrators would not have any liability to a client that established its claim after they had made a distribution.
  • The beneficial interests of clients in the client money trust would not be varied. In particular, the exclusion of any claimant from a distribution was without prejudice to the claimant's rights to:
    • participate in any subsequent distribution if they established their claim; and
    • pursue any tracing or similar remedy.
The FCA was happy with the terms of the proposed distribution procedure. Accordingly, the court had to decide whether it had jurisdiction to make the order sought.

Decision

The court held that it had jurisdiction, and made the order sought by the special administrators. The court noted that it did not have any statutory jurisdiction (for example under the Trustee Act 1925) in the context of administering a client money trust, but that it did have an inherent jurisdiction in relation to trusts more generally. The relevant features of this inherent jurisdiction that allowed it to make the requested order were:
  • Where trustees have difficulty establishing of possible claimants to the trust property, the court can make a Re Benjamin order, following Re Benjamin [1902] 1 Ch 723. A Re Benjamin order can allow the trustees to distribute the trust property on the basis that there are no further claimants. This protects trustees but also preserves the right of any subsequently identified beneficiary to pursue other remedies. Accordingly, the court had jurisdiction to make the order requested insofar as it dealt with unknown claimants.
  • However, a Re Benjamin order can only be used in situations where it is impossible or impracticable to establish a particular fact or claim; it does not include situations where a claim is known to exist but which the trustees have rejected.
  • That said, the fact that the proposed order does not in this respect neatly fit within the Re Benjamin line of cases does not mean that it falls outside the proper scope of the inherent jurisdiction of the court.
  • There is authority that the court has power to permit a trustee to distribute trust property, despite the existence of claims or potential claims from third parties. There is no reason in principle why such orders cannot also be made in the context of rejected claims to a beneficial interest. There is no fundamental distinction between the two categories of claims in this context.
  • The purpose of the court's inherent jurisdiction is to give practical effect to a trust. The purpose of the client money trust established by the CASS rules was to protect the position of clients and to facilitate the timely return of client money in the event of the failure of the firm. The proposed order would help achieve this purpose, while respecting the interests of claimants with serious but unresolved claims.
Having established that the court had jurisdiction, the court held that it was appropriate for it to exercise its jurisdiction and make the requested order. Both the order and the underlying proposed distribution procedure were in the best interests of both the clients and the proper administration of the client money trust. It was highly unlikely that clients did not know about the special administration and they could be taken to know about their right to make a claim to client money. The proposed distribution procedure gave claimants a full opportunity of lodging and pursuing their claims and it was reasonable that clients should have the burden of pursuing a rejected claim.

Comment

This case provides a pragmatic solution to the logistical difficulties faced by practitioners seeking to wind up the businesses of an insolvent investment firm, and who are dealing with trust assets. Where debts, rather than proprietary interests in a trust, are involved, English restructuring law already provides solutions to the need to crystallise and adjudicate a potentially very large number of outstanding claims, to enable a timely distribution in respect of agreed claims. These solutions are the scheme of arrangement and the company voluntary arrangement. However, these tools do not let a trustee compromise the proprietary rights of beneficiaries.
Interestingly, the decision in this case makes clear that, like a scheme and CVA, the court has no inherent jurisdiction to compromise the proprietary rights of beneficiaries. Accordingly, the solution that it provides is not a complete one. It may therefore be some time before the affairs of MFG UK are fully wound up, as the administrators may need to reserve some assets to cover potential claims for the remaining limitation period applicable to them.

Case

Re MF Global UK Ltd (in special administration) [2013] EWHC 1655 (Ch) (14 June 2013).
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Published on 27-Jun-2013
Resource Type Legal update: archive
Jurisdictions
  • England
  • Wales
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