The United States District Court for the Southern District of New York recently affirmed a New York Bankruptcy Court’s decision to uphold a safe harbor provision of the U.S. Bankruptcy Code (the Code) related to distributions under swap agreements in the face of an attempt by Lehman Brothers Special Financing, Inc. (LBSF) to claw back nearly $1 billion in swap transactions.1
The case dealt with distributions of collateral that were made after a number of credit default swap agreements were terminated. Under these agreements if LBSF or its parent company, Lehman Brothers Holdings Inc. (LBHI), filed for bankruptcy the issuers under the swap agreements could unwind the agreements and repay the noteholders. Thus, where LBSF or LBHI were the defaulting parties, the swap documentation granted the noteholders priority in any distribution of collateral after an event of default under the swap agreements.
When LBHI and LBSF filed for bankruptcy in 2008, the event triggered a default under the swap agreements and, in the process of terminating and liquidating the transactions, the noteholders were permitted to apply collateral to satisfy obligations owed to them under the swap agreements. The collateral remaining was insufficient to allow for any payments to LBSF after the noteholders were paid. LBSF sought to have these priority provisions deemed unenforceable ipso facto clauses under Section 365(e) of the Code—i.e., clauses that modify the rights of the debtor because they have filed for bankruptcy. However, the Court upheld the priority provisions and resulting distributions under Section 560 of the Code, which provides a safe harbor from the automatic stay, and allows a swap participant to unwind a swap transaction pursuant to an ipso facto clause.2 The court noted that the underlying purpose of Section 560 is to protect securities markets from disruption and enforcement uncertainty related to claw backs.
LBSF further argued that the safe harbors of Section 560 did not apply in its case because the term “liquidation” in the Code merely referred to the calculation of amounts and not their resulting distributions. The court rejected this interpretation of the definition as unduly narrow, and held that the term liquidation in this context meant “bring[ing] the swap agreement to an end by distributing the Collateral pursuant to the Priority Provisions.”3 Accordingly, in rejecting LBSF’s interpretation, the Court held that the safe harbor provision of Section 560 is specifically intended to end swap agreements and distribute collateral in accordance with the relevant priority provisions thereof.
While the result of this case supports the broad enforceability of ISDA remedies following a bankruptcy, this case illustrates that the parameters of these rights continue to be developed and continue to be challenged by debtors. Practitioners should be cautious when drafting or enforcing these rights in light of this continuing development and be careful to ensure that rights conveyed by an ISDA are also enforceable under the Code.
- Lehman Brothers Special Financing Inc. v. Bank of America National Association, et al. (In re Lehman Brothers Holdings Inc.), No. 17 Civ. 1224 (LGS), 2018 WL 1322225, at *1 (S.D.N.Y. March 14, 2018); see also Lehman Bros. Special Fin. Inc. v. Bank of Am. N.A. (In re Lehman Bros. Special Fin. Inc.), 553 B.R. 476 (Bankr. S.D.N.Y. 2016).
- The relevant text of Section 560 of the Code follows: “The exercise of any contractual right of any swap participant or financial participant to cause the liquidation, termination, or acceleration of one or more swap agreements because of a condition of the kind specified in section 365(e)(1) of this title or to offset or net out any termination values or payment amounts arising under or in connection with the termination, liquidation, or acceleration of one or more swap agreements shall not be stayed, avoided, or otherwise limited by operation of any provision of this title or by order of a court or administrative agency in any proceeding under this title.” 11 U.S.C. § 560.
- In re Lehman Brothers Holdings Inc., 2018 WL 1322225, at *12.
Client Alert 2018-081
