Hedge funds that did not have funds segregated by Lehman Brothers International Europe (LBIE) when the bank went into administration in 2008 have lost the first part of their fight to recover the money.

In a recent judgment Mr Justice Briggs ruled the UK Financial Services Authority (FSA) rules do not require LBIE's administrators to top up pools of segregated client money with funds that were not segregated prior to the bank's insolvency.

The ruling is a blow for funds including the CRC Credit Fund and Claren Road Credit Master Fund, which stood as representatives of unsegregated clients in the UK High Court case.

However, hedge funds that had money segregated, represented in court by the GLG European Equity Fund, Paragon Capital Management Fund and Goldman Sachs GSIP Master Company (Ireland), will recover their assets.

Justice Briggs said the FSA's client money rules were unclearr but nevertheless said the $1 billion pool of client money was to be distributed to segregated clients. LBIE did not have to top up that pool to correct any shortfalls.

He criticised LBIE's actions, pointing out that its "shocking underperformance" had led to client money claims exceeding $3 billion, including unsegregated clients that were subsidiaries of parent company Lehman Brothers Holdings.

That "extraordinary amount" compared to a pool of segregated money of "only" $2.16 billion.

Justice Briggs also ruled LBIE did not have to top up a shortfall caused by the insolvency of German affiliate Lehman Brothers Bankhaus, with which LBIE had deposited $1 billion of segregated funds.

Counsel for the unsegregated clients and the FSA argued in court that the European Markets in Financial Instruments Directive (MiFID) should require member states to adjust domestic property and insolvency law to afford investors a high degree of protection.

 "In my judgment," said Justice Briggs, "it is clear that neither Mifid nor the Mifid implementing directive imposes any such obligations, upon either the legislatures or the courts of member states. On the contrary, the thrust of both directives is that each member state is to achieve a harmonised degree of protection for investors, but taking its domestic property and insolvency law as it finds it."

LBIE joint administrator and PricewaterhouseCoopers partner Steven Pearson said: "I understand that the way in which LBIE determined entitlements to client money were market practice. This judgment could have wider market consequences if other market participants need to reappraise whether further amounts now need to be segregated."

The return of client money could still be held up as a number of parties to the case have been granted permission to appeal, including the CRC Credit Fund.

Any appeals must be filed by January 15 2010.