Legal Business

‘No blueprint’: Looking back at Lehman’s wind-up

Mandatory Credit: Photo by Anthony Upton/REX/Shutterstock (1031447a) Staff arriving for work at 25 Bank Street, Canary Wharf, the London offices of Lehman Brothers Lehman Brothers after the bank filed for bankruptcy, London, Britain - 15 Sep 2008 BOOM AND BUST SLUMP

Lehman Brothers International (Europe) (LBIE)’s 5,500 employees left the London office at 25 Bank Street on Friday 12 September 2008 expecting to return on Monday morning to their weekly routine. As did their colleagues in the rest of the world.

Not that life had been easy up to that point. Global financial turmoil had been going for around a year and Lehman had just posted a $3.9bn third-quarter loss amid the subprime mortgage crisis. Yet, the sense was that the bank founded in 1850 would be bought out by either Barclays or Bank of America, despite the US government’s resistance to bailing it out.

In New York, the heads of banks including Morgan Stanley, Merrill Lynch, JP Morgan Chase, Goldman Sachs and Citigroup were gathered to discuss Lehman’s fate. Meanwhile, European general counsel (GC) Peter Sherratt got on the phone to request having Linklaters lawyers available to support the board in the ‘remote’ event the deal should fall through. Among them was Tony Bugg, now the Magic Circle firm’s banking head, back then leading its restructuring and insolvency practice.

At 2.30pm on Sunday 14 September, Bugg joined a conference call with Sherratt and a dozen Linklaters partners from its finance, disputes and regulatory practices to be told: ‘You should not do any work on this or tell anyone about this [potential mandate] because we don’t want it to become a self-fulfilling prophecy.’ Linklaters had worked with Lehman on corporate matters before, one of the reasons Sherratt picked the firm. Historic ties with PwC also helped: the Big Four firm had also been put on standby. But Linklaters’ insolvency team had never had any relationship with the investment bank.

‘I had no paperwork and I had never met anybody from there at all,’ recalls Bugg. ‘The general tone of the call was that they believed there would be a deal.’

Three hours later that belief proved unfounded. Around 6pm news hit that Barclays had bowed out. ‘From that point it was absolutely clear this thing was going to go under.’

The first 12 hours

Confidence that Lehman would be acquired meant there was no contingency plan at all. Bugg ‘didn’t even have a script that said: “Lehman contingency work”. And there was no blueprint.’

Yet there were just over 12 hours to put Lehman’s European businesses into administration before the market opened at 8am on Monday morning. A dozen Linklaters lawyers gathered at the firm’s offices in Silk Street alongside William Trower QC and Daniel Bayfield QC from South Square to prepare the papers.

After spending a few hours overseeing the paperwork, Bugg headed to Bank Street, where another group of Linklaters lawyers was working with PwC taking over as administrators.

‘It was the first time I had been to the LBIE building,’ says Bugg. ‘There weren’t a lot of people around; not a lot of activity in the building for something that was about to go under.’

After a meeting with the regulators and the Bank of England, Bugg went home to change from his casual weekend clothes and don a suit. ‘For a moment, I sat down thinking what was going to happen to my life. I realised my career was going to be massively impacted by it. I was 52, I had done a range of things, but this was clearly going to eclipse me and would probably be the last thing I would do in my career. I wasn’t far wrong.’

Returning to Silk Street at 3am, Bugg started a series of meetings with the LBIE directors to prepare their witness statements. Mr Justice Henderson would hold the hearing in one of the firm’s boardrooms overnight.

‘One of the most curious moments was sitting in this series of meetings from 4am until 7.15am with groups of directors who had no idea what was going on and what they had to do. They didn’t really understand how the process of insolvency worked. Peter Sherratt went through the witness statement we prepared for him and was asking me a lot of questions. I said: “Peter, I don’t know anything about your company, but we have got 30 minutes, we need to get these orders done.”’

The orders were stamped at 7.56am on 15 September, less than two hours after the parent company in the US had filed for Chapter 11 bankruptcy. Lehman Brothers’ 158-year history had come to an end. The largest bankruptcy proceedings in history had just begun.

The rest of time

Alongside Bugg, banking partners Richard Holden and David Ereira (who joined Paul Hastings in 2015) would lead on a matter that for the following decade would keep busy up to 150 lawyers from the banking, capital markets and litigation practices. The mandate accounted for around 5% of Linklaters’ annual revenue for at least two years, before progressively winding down.

A Linklaters office was set up on the top floor of 25 Bank Street and became one of the firm’s largest worldwide. Hundreds of Lehman’s employees were also retained for years to work on the administration. ‘Until a few years ago, you would go to a Lehman Christmas party and we filled the Guildhall,’ recalls Bugg. ‘There were hundreds of people.

‘My role was a bit like being a GC to a bank going through administration. Yes, Lehman was a broken bank going down, but it was also a real company that the firm acted for in the way you would act for any major corporate client: a relationship team, a group of about 20 partners managing different issues and many of us effectively in-house: I had an office at Lehman until 18 months ago.’

The most urgent issue the team had to address was, of course: where is the money? ‘An investment bank holds billions of securities in various forms; it’s not designed to be shut down at 12 hours’ notice. There was panic because counterparties’ securities were stuck in the system and nothing was designed for an insolvency.’

‘This was clearly going to eclipse me and would probably be the last thing I would do in my career. I wasn’t far wrong.’
Tony Bugg, Linklaters

Financial regulatory partner Michael Kent also worked on Lehman for several months. He recalls the immediate issues with clearance: ‘The clearing house did not keep records of the clients’ details and so needed data from the administrators to transfer the positions. But some of the support staff did not come in on Monday. We therefore were not sure whether we had the right people to tell us where to look and we were concerned about handing over inaccurate data. It got tense.’

A lot of the effort in the first few days was focused on reassuring plummeting markets or, as Bugg puts it: ‘Making people understand that although Lehman wasn’t trading anymore, it was stable and was going to realise its assets, and eventually unlock all the securities that were stuck in the system’.

The main creditors were hedge funds, commercial banks and insurers, alongside some corporates and governments. ‘You didn’t have time to test the advice, you had 20 decisions to make every day, no time to quality check, you just had to do your very best, take a decision and implement it,’ says Bugg. It took until 2010 to return all securities, with an 8% interest per annum. Unsecured creditors followed. ‘Between 2011 and 2014 we created a framework to allow creditors to sell their claims to hedge funds. Eventually the hedge funds became the principal owners of the debt.’

By 2012 it became clear that the bank was going to be solvent, by 2014 that there would be a £7bn surplus thanks to the company’s capital buffer. By that point it had become essentially a matter for litigators to deal with thousands of claims. ‘Many of the claims were under derivatives contracts – highly complex. Instead of litigating every one of them, we used a negotiation procedure where the creditor was incentivised to agree a number quickly to get paid immediately. We have some disputes left in relation to interest calculation and a few outstanding claims that need to be resolved. It will probably take us another year or two, but gradually we are in the process of putting it to bed.’

Lesson learned?

As many speak of another downturn looming, the natural question is, what has been learned from the collapse of Lehman? Beyond the obvious increase in regulation and capital requirements for banks, the work on Lehman’s administration inevitably taught regulators some hard lessons.

The G20 has pushed for reforms to the derivatives market to make it mandatory for standardised over-the-counter derivatives to be centrally cleared. The goal is to reduce the risk of a chain reaction and panic that people might never get their money, as in the early days after Lehman’s collapse. Administrators taking over future insolvent entities will have clearer roadmaps to deal with it more quickly thanks to required wind-up plans. Reforms to bankers’ pay, bonuses and personal accountability have reduced the incentives for excessive risk taking.

Yet those wanting reassurance that an event like Lehman will never happen again will be disappointed. Remuneration reforms have not been implemented uniformly across the world, with the EU going full steam ahead while the US is still sitting on a draft. And the other changes introduced as a result of Lehman’s collapse have been aimed at dealing with the consequences of a crash rather than preventing it. But that doesn’t make them any less important.

Concludes Kent: ‘By its very nature, a bank can conceivably go bust, but prior to Lehman it had not been required actively to prepare for that eventuality.’

marco.cillario@legalease.co.uk

Read more on Linklaters in ‘Back to the future’