The Civil Division of the Court of Appeal handed down judgment in the case of CRC Credit Fund Ltd and Others v GLG Investments Plc (Sub-Fund: European Equity Fund) and Others [2010] EWCA Civ 917 on the 2nd of August 2010. The case concerned the trustee status and distribution of client funds by the appellant Lehman Brothers International (Europe).

The appellants operated an “alternative approach” for receipt of client funds; monies received were paid into the house accounts of the appellant, and then segregated into client accounts according to a reconciliation of funds conducted the previous day. Funds were not paid directly into client accounts. Some client funds remained in the house accounts at the point of entry into administration and errors were present which meant assets were not properly segregated. Further, certain transactions remained outstanding.

The provisions relevant to client funds before the court were contained in chapter seven of the Client Assets Sourcebook ("CASS7”). This was issued pursuant to s 139 of the Financial Services and Markets Act 2000 (the Act) by the Financial Services Authority (FSA) and amended to comply with the Markets in Financial Instruments Directive (2004/39/EC) (the 2004 Directive) and implementing Commission Directive (2006/73/EC). The Directives were intended to ensure adequate arrangements were made to safeguard client’s ownership rights.

The High Court determined that a statutory trust was created upon the receipt of client funds rather than the later segregation of funds into client accounts. The provisions of CASS7 were also held to provide for a pool of funds. The pool, which offered a higher than normal level of protection, was held to be open only to funds held in the segregated accounts. Discussing whether access to the pool was on grounds of general claim or contribution the court determined that for ease of distributing the funds only those with monies in a segregated account would be entitled to participate.

Before the Court of Appeal, the issues were set out as firstly, at what point the appellant became statutory trustee. The second, third and fourth issues related to fund distribution. Interpreting CASS7, the court determined that the drafter assumed compliance with the EU Directive.

Determining the point at which a statutory trust arises, the court first considered whether the European Directives expressly authorised or required the FSA to impose a trust upon receipt. Referring to art 13(8) of the 2004 Directive, the court found the FSA was required to establish a statutory trust on receipt. Further, provisions of CASS7.7.2R were interpreted to impose a trust upon receipt.

Discussing the second issue, whether under CASS7 all identifiable client money was pooled, or instead only segregated funds, the court could not draw guidance from either Directive. Interpreting the meaning of the words “Client money account”, comprised in CASS7.9.6R, the court heard submissions including those relating to speed of distribution and the idea of a single trust created upon receipt of funds with no further extended trust for segregated funds. Finding that s 139 of the Act allows for pooling of house and client accounts, in interpreting the words of the provision the court found that all identifiable client money was to be included.

Thirdly, considering whether access was on grounds of general claim versus claim based on contribution, the court proceeded on the basis of the answer given to the previous question: namely that all identifiable client money be pooled. The critical issue was defined as whether those with only a contractual right, holding no proprietary right, should share. The relevant term in CASS7.9.6R (2) “client money entitlement” was defined as one of contractual entitlement and therefore access could be made on a claim as opposed to a contributions basis.

The fourth issue raised concerned the point at which money owed by the appellant to a client became “client money” for the purposes of being included in the pool. The court heard argument that the creation of “client money” within the meaning of CASS7 was at the point it became due and the firm became obliged to segregate the money. Relying for this on Hunter v Moss [1994] 1 WLR 452, it was submitted no transfer of money was actually necessary. In rebuttal, it was submitted that to accept this reasoning would give preferential status to unsecured creditors. Dismissing the appeal on this issue, the court held that monies not yet allocated for purpose but which were due and payable could not said to be “client money”.

Dismissing the first and fourth issues, the court allowed the appeal on the second and third issues.