In 2010, the Regulator gave notice of its intention to issue FSDs against six Lehman Brothers group companies and 25 companies in the Nortel group (see box "What is an FSD?"). The administrators in each case asked the courts to rule on how the FSDs would rank in the relevant insolvencies.

The High Court and the Court of Appeal both followed existing authorities to hold that FSDs issued after the appointment of administrators would rank as an expense of the administration under rule 2.67(1)(f) of the Insolvency Rules 1986 (SI 1986/1925), and would therefore be payable ahead of the administrators' own remuneration (see News brief "Insolvency and pension deficits: FSDs take priority").

These decisions, while understandable on the strict wording of the Insolvency Rules, introduced so much uncertainty about the estimated financial outcome of insolvencies that borrowers and lenders alike put off restructurings pending resolution of the issue. The cases also continued an unfortunate trend of disputes based on inadequate or incomplete drafting in insolvency legislation, following a period of almost continuous statutory reform.

The overwhelming view among insolvency professionals was that, if the Court of Appeal's decision were to be affirmed by the Supreme Court, it would have a devastating effect on the promotion of the rescue culture. The Supreme Court's decision was probably the most nervously awaited in the insolvency and lending market since Spectrum Plus in 2005 (see News brief "Charges on book debts: a wasted opportunity?").

The court had three options. It could find that the FSD liability was:

The Regulator, having succeeded in convincing the lower courts that FSDs ranked as expenses (but acutely aware of the industry's concerns regarding the implications), argued in the alternative that the liability ranked as a provable debt. The Regulator was so concerned about the effect of the earlier judgments on insolvent companies that it had sought to reassure the industry that it would act reasonably in exercising its powers (www.practicallaw.com/6-521-0877).

The court, itself highly sensitive to the practical implications and policy considerations, held that the FSD (or CN) liability would be a provable debt, this being "the sensible and fair answer". Having accepted that the liability must fall within only one of the three options, the court found that the liability would not be an expense and that, while a "black hole" debt could theoretically exist, the FSD liability would escape that particular fate.

The court held that the liability was a contingent liability (and therefore a provable debt under rule 13.12(1)(b) of the Insolvency Rules) because it satisfied the following three-limb test:

The court was satisfied that membership of the relevant group of companies was sufficient to create the necessary legal duty giving rise to a real prospect of an FSD liability being incurred.

In future, courts will need to consider how tenuous a step needs to be to create a link giving rise to a provable debt. It is clear that this can be as little as incorporation, where liability arises by virtue of a company's membership of a particular group, suggesting that the threshold may be rather low. Arguably, this creates as much uncertainty as it solves.

The court also took the opportunity to provide guidance on the scope of administration expenses generally. In order for a liability to rank as an expense, the court held that the liability must be connected with the administration or relate to something done within the administration, usually by the administrator or on his behalf.

In addition, an unprovable statutory liability that could have arisen pre or post-appointment will only be payable as an expense where the nature of the liability suggests that Parliament must reasonably have intended that to be the case; otherwise it will fall into the "black hole", with no prospect of repayment.

Insolvency practitioners are likely to seize on this new guidance to argue that a range of liabilities not intrinsically linked to the administration are not expenses of the administration. The court's pragmatic decision in this case suggests that its approach to other difficulties arising out of the administration expense regime (including the payment of rent as an expense under the Goldacre principle (www.practicallaw.com/7-501-5192)) may be resolved in favour of a test based as much on intention and common sense as the letter of the legislation.