Reed Smith Client Alerts

The Second Circuit affirmed the judgment of lower courts upholding the application of certain swap agreement safe harbors in section 560 of the U.S. Bankruptcy Code (the Bankruptcy Code). The decision clarifies, on the facts of the case, that (1) terms related to safe harbor rights in an ancillary document can form part of a swap agreement if properly incorporated by reference into the swap agreement, (2) a “liquidation” under the Bankruptcy Code safe harbors includes more than merely ascertaining the precise amount of debt or damages, and (3) a collateral trustee may exercise safe harbor rights on behalf of a swap participant.

Authors: Craig R. Enochs James M. Pappenfus

On August 11, 2020, the U.S. Circuit Court of Appeals for the Second Circuit (the Second Circuit) affirmed the distribution of collateral proceeds under the safe harbor protections of section 560 of the Bankruptcy Code.1 The case stems from the chapter 11 bankruptcy proceedings of Lehman Brothers Holdings Inc. (LBHI). The case in question was brought by Lehman Brothers Special Financing Inc. (LBSF), a subsidiary of LBHI, in 2010 to claw back payments it made to certain noteholders (the Noteholders) and other parties in the wake of LBHI’s bankruptcy.

Several LBSF entities formed a special-purpose entity (the Issuer) for the purpose of issuing notes to the Noteholders pursuant to an indenture (the Indenture). The notes were collateralized by securities acquired with the proceeds of the note issuances (the Collateral), which Collateral was held by trustees (the Trustees) for the benefit of the secured parties. LBSF then entered into a credit default swap with the Issuer under an ISDA master agreement (the ISDA), and the terms of those documents incorporated by reference the priority of payment provisions of the Indenture (the Priority Provisions).