Thursday, September 3, 2020
After almost 10 years of litigation, the Second Circuit has weighed in on an attraction in an adversary continuing arising out of the Lehman Brothers chapter. The August 11, 2020, resolution confirms {that a} trustee’s termination of a swap settlement falls throughout the protected harbor of Part 560 of the Chapter Code, and additional holds that if a swap settlement incorporates the phrases of an indenture (or different doc governing a belief) specifying cost priorities, then these provisions additionally fall inside Part 560’s protected harbor.
At difficulty on this attraction had been dozens of artificial collateralized debt obligations (CDOs) and their associated swap agreements. Every CDO entered right into a credit score default swap settlement with Lehman Brothers Particular Financing, Inc. (LBSF). Beneath the phrases of the swaps, LBSF agreed to make common funds to the CDOs, and the CDOs agreed to offer credit score safety to LBSF for sure reference obligations. Every CDO owned a basket of extremely rated securities to function collateral and be certain that adequate funds had been obtainable to make credit score safety funds.
The swap agreements include provisions as to how you can calculate every swap cost. The indentures governing the CDOs contained the cost precedence provisions, together with the place every swap cost to LBSF would fall within the waterfall. Beneath the indentures’ cost precedence provisions, if LBSF defaults underneath the swap settlement, LBSF’s cost rights are subordinated to the cost rights of noteholders.
The chapter submitting of Lehman Brothers Holdings, Inc. (LBHI) constituted an occasion of default underneath every swap settlement, and the CDO trustees terminated the swaps. LBSF was “within the cash” when the CDO trustees terminated its swaps, and the CDOs owed LBSF substantial termination funds. However as a result of LBSF was the defaulting celebration underneath the swap agreements, its proper to obtain cost was subordinated to the proper of the noteholders to obtain cost on account of their notes.
LBSF sued, looking for to get better roughly $1 billion in distributions that the CDO noteholders obtained after LBSF’s default. LBSF’s most important argument was that cost priority-shifting provisions within the indentures constituted ipso facto clauses, that are typically unenforceable in chapter as a result of they set off or modify cost obligations. See 11 U.S.C. § 365(e)(1).
The Second Circuit disagreed and held that even when the cost precedence provisions had been ipso facto clauses, they had been permissible underneath Part 560 of Chapter Code. That part of the code creates an exception to the overall prohibition on ipso facto clauses. Particularly, Part 560 permits swap individuals to “trigger the liquidation, termination, or acceleration of a number of swap agreements” on account of a counterparty’s chapter, or “to offset or web out any termination values or cost quantities” arising from such termination.
The Second Circuit famous that Part 101(53B) of the Chapter Code defines “swap settlement” to incorporate “any settlement, together with the phrases and situations included by reference in such settlement which is” a swap. Primarily based on the code’s “sweeping definition” of swap settlement, the courtroom concluded that every of the credit score default swaps included by reference the cost precedence provisions within the indentures. Subsequently, the Courtroom concluded that the cost precedence provisions within the indentures are additionally “swap agreements” for functions of Part 560 of the Chapter Code.
The courtroom additional said that the appliance of the cost precedence provisions, together with the distribution of funds to noteholders (versus LBSF) in following these provisions, constituted the “liquidation” of a swap settlement for functions of Part 560.
As a result of Part 560 of the Chapter Code applies to swap individuals, the courtroom needed to decide whether or not the CDO trustees had been entitled to terminate the swaps on behalf of their CDOs. In the end, the courtroom decided that the trustees had been exercising the CDOs’ proper to terminate their swap contracts with LBSF, and in so doing, the CDO trustees had been exercising the rights of swap individuals.
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