Lehman Bros. Special Fin. Inc. V. Branch Banking & Tr.

Jackson Walker advised one of the noteholders on the deal. Sidley Austin advised Genworth Life and Annuity Insurance Co., Magnetar Constellation Fund II LTD, Magnetar Constellation Fund III Ltd, Magnetar Constellation Master Fund Ltd, UniCredit Bank AG and PCA Life Assurance Co Ltd. Wollmuth Maher & Deutsch LLP represented Lehman Brothers Special Financing, Inc. Cleary Gottlieb Steen & Hamilton LLP advised Goldman, Sachs & Co. and Morgans Financial Limited. Morgan, Lewis & Bockius LLP advised Branch Banking and Trust Company, Continental Life Insurance Company of Brentwood Tennessee, Country Life Insurance Company, Marsh & McLennan Companies, Inc. Stock Investment Plan, Marsh & McLennan Master Retirement Trust, Modern Woodmen of America, PHL Variable Insurance Company, Phoenix Life Insurance Company, Putnam Dynamic Asset Allocation Funds, Putnat Intermediate Domestic Investment Grade Trust, Putnam Stable Value Fund and Susquehanna Bank and MBIA inc. Chapman and Cutler LLP advised U.S Bank National Association and Trustee U.S. Bank Trust National Association. Nixon Peabody LLP represented Deutsche Bank Trust Company Americas, State Street Bank and Trust Company, State Street Global Advisors, State Street International Ireland Limited and ZAIS Investment Grade Limited X. Kleinberg, Kaplan, Wolff & Cohen advised Elliot International L.P. and the Liverpool Limited Partnership. Ballard Spahr LLP represented First Northern Bank and Trust Company. McGuire Woods LLP advised Garadex Inc., Gatex Properties Inc., and Morgan Stanley & Co. Chaffetz Lindsey LLP represented General Security National Insurance, SCOR Reinsurance Company and Natixis Financial Product LLP. Wuersch & Gering LLP advised LGT Bank In Liechtenstein Ltd. Lathrop GPM advised MoneyGram Securities LLC. McCarter & English advised Security Benefit Life Insurance Co. Hunton Andrews Kurth LLP represented Shenandoah Life Insurance Company. Olshan Frome Wolosky LLP advised Mariner LDC and Tricadia.

During the global financial crisis in 2008, Lehman Brothers Holdings Inc., which at the time was the nation’s fourth-largest investment bank, filed for Chapter 11 bankruptcy reorganization in what would become the largest bankruptcy proceeding in U.S. history. Over the course of a decade, Lehman Brothers and its bankrupt affiliates, including Lehman Brothers Special Financing Inc. (LBSF), filed multiple adversary proceedings. One of those proceedings was filed by LBSF in the Bankruptcy Court for the Southern District of New York against the 250 noteholders, the note issuers, and the trustees of certain synthetic collateralized debt obligations (CDO), and the proceeding eventually made its way to the U.S. Court of Appeals for the Second Circuit.

At the heart of LBSF’s claims were certain “Priority Provisions” that subordinated LBSF’s interests to those of the noteholders in the event Lehman Brothers filed for bankruptcy, which it did at a time when LBSF was allegedly “in the money” (i.e., when LBSF’s swap position had value). Specifically, when Lehman Brothers filed for bankruptcy, it triggered an event of default under the CDOs’ related swap and indenture agreements that authorized the trustees to liquidate the collateral securing the CDO notes and that gave the noteholders priority in payment of the proceeds over LBSF. When the trustees exercised their contractual power to liquidate the collateral and distribute the proceeds to the noteholders, LBSF became the last in line under the payment schedule and there was not enough money left at the bottom of the barrel when it was LBSF’s turn to collect. LBSF complained that the liquidation proceeds should have been paid to LBSF first, instead of to the noteholders, because the Priority Provisions in the complex financial instruments of its own creation were unenforceable ipso facto clauses. LBSF’s complaint led to a nearly decade-long dispute over whether the Priority Provisions were in fact ipso facto clauses – contractual clauses that are generally prohibited by the Bankruptcy Code because they modify a debtor’s contractual right solely because it petitioned for bankruptcy – and, if they were ipso facto clauses, whether they were rendered enforceable by virtue of the safe harbor provisions of section 560 of the Bankruptcy Code.

In its August 11, 2020 decision, the Second Circuit affirmed both the bankruptcy and district courts’ judgments interpreting section 560 in favor of the defendant noteholders. With the dismissal, LBSF failed to claw back roughly $1 billion in payments made to the noteholders in connection with the CDOs, as those payments were protected by the safe harbor.

In the opinion, the Second Circuit held that, even if the Priority Provisions were ipso facto clauses, their enforcement was nevertheless permissible under the section 560 safe harbor. Section 560 exempts swap agreements from the prohibition of ipso facto clauses by protecting a swap participant’s contractual right to terminate, liquidate, or accelerate a transaction upon a counterparty’s bankruptcy. In other words, as the Second Circuit put it “this safe harbor permits swap participants to modify or terminate an executory contract solely because of the commencement of a bankruptcy case.” Since the Priority Provisions were part of the swap agreement component of the CDO transactions, the trustees’ liquidation of the CDO collateral and priority payment of the liquidation proceeds to the noteholders was permissible under the safe harbor.

The Jackson Walker team included Emilio B. Nicolas (Picture), J. Scott Rose, Jennifer F. Wertz, and Jorge A. Padilla.

The Wollmuth Maher & Deutsch team was led by Paul R. DeFilippo.

The Cleary Gottlieb Steen & Hamilton team was led by Carmine Boccuzzi for Goldman, Sachs & Co. and Lewis Liman for Morgans Financial Limited.

The Morgan Lewis team was led by Joshua Dorchak, John Goodchild and Rachel Jaffe Mauceri for Branch banking and Trust Company; Joshua Dorchak also represented Continental Life Insurance Insurance Company of Brentwood Tennessee, Country Life Insurance Company, Marsh & McLennan Companies, Inc. Stock Investment Plan, Marsh & McLennan Master Retirement Trust, Modern Woodmen of America, PHL Variable Insurance Company, Phoenix Life Insurance Company, Putnam Dynamic Asset Allocation Funds, Putnat Intermediate Domestic Investment Grade Trust, Putnam Stable Value Fund and Susquehanna Bank; Kevin Biron advised MBIA inc.

The Chapman and Cutler LLP team was led by Franklin H. Top III.

The Nixon Peabody LLP was led by Christopher Desiderio.

The Kleinberg, Kaplan, Wolff & Cohen team was led by Matthew Gold.

The Ballard Spahr LLP team was led by William Slaughter.

The McGuire Woods LLP team was led by John Thompson.

The Chaffetz Lindsey LLP team was led by Scott Walter Reynolds.

The Lathrop GPM was led by Brian Dillon.

The McCarter & English team was led by David Adler.

The Hunton Andrews Kurth LLP team was led by Joseph Saltarelli.

The Sidley team was led by Nicholas Crowell, Alex Rovira and  Andrew Propps; Crowell and Propps also advised PCA Life Assurance Co. Ltd. with Jon W. Muenz.

The Olshan Frome Wolosky team was led by Thomas Fleming.

Involved fees earner: Leslie Heilman – Ballard Spahr Stillman & Friedman LLP; William Slaughter – Ballard Spahr Stillman & Friedman LLP; Franklin Top III – Chapman and Cutler LLP; Carmine Boccuzzi – Cleary Gottlieb Steen & Hamilton; Lewis Liman – Cleary Gottlieb Steen & Hamilton; Brian Dillon – Gray Plant Mooty; Peter Ivanick – Hogan Lovells; Nicole Schiavo – Hogan Lovells; Joseph Saltarelli – Hunton Andrew Kurth; Emilio Nicolas – Jackson Walker L.L.P.; Jorge Padilla – Jackson Walker L.L.P.; J. Scott Rose – Jackson Walker L.L.P.; Jennifer Wertz – Jackson Walker L.L.P.; Matthew Gold – Kleinberg, Kaplan, Wolff & Cohen; David Adler – McCarter & English; John Thompson – McGuireWoods; Kevin Biron – Morgan Lewis; Joshua Dorchak – Morgan Lewis; John Goodchild, III – Morgan Lewis; Rachel Jaffe Mauceri – Morgan Lewis; Christopher Desiderio – Nixon Peabody LLP; Thomas Fleming – Olshan Frome Wolosky LLP; Scott Walter Reynolds – S. Reynolds LLC; Nicholas Crowell – Sidley Austin LLP; Jon Muenz – Sidley Austin LLP; Andrew Propps – Sidley Austin LLP; Alex Rovira – Sidley Austin LLP; Paul DeFilippo – Wollmuth Maher & Deutsch LLP; Gregory Hauser – Wuersch & Gering;

Law Firms: Ballard Spahr Stillman & Friedman LLP; Chapman and Cutler LLP; Cleary Gottlieb Steen & Hamilton; Gray Plant Mooty; Hogan Lovells; Hunton Andrew Kurth; Jackson Walker L.L.P.; Kleinberg, Kaplan, Wolff & Cohen; McCarter & English; McGuireWoods; Morgan Lewis; Nixon Peabody LLP; Olshan Frome Wolosky LLP; S. Reynolds LLC; Sidley Austin LLP; Wollmuth Maher & Deutsch LLP; Wuersch & Gering;

Clients: Continental Life Insurance Company of Brentwood, Tennessee; Country Life Insurance Co; Deutsche Bank; Elliot International Lp; First Northern Bank & Trust; Garadex Inc.; Gatex Properties, Inc.; General Security National Insurance Co; Genworth Life and Annuity Insurance Co.; Goldman Sachs & Co.; Goldman Sachs International; Lehman Brothers Special Financing Inc; LGT Bank Liechtenstein; Magnetar Constellation Fund II Ltd.; Magnetar Constellation Fund III Ltd.; Magnetar Constellation Master Fund Ltd.; Mariner Investment Group, LLC; Marsh & McLennan Companies, Inc.; MBIA Inc.; Modern Woodmen of America; MoneyGram; Morgan Stanley; Morgans Financial Limited; Natixis Financial Products LLC; PCA Life Assurance Co Ltd; Phoenix Life; Putnam Dynamic Asset Allocation Balanced Fund ; Putnam Intermediate Domestic Investment Grade Trust; Putnam Stable Value Fund; Reinsurance Group of America; SCOR SE; Security Benefit Life Insurance Co; Shenandoah Life Insurance Co; State Street; State Street Global Advisors, Inc ; State Street International Ireland Limited; Susquehanna Bancshares; The Liverpool Limited Partnership; Tricadia Capital Management, LLC; Truist Financial Corporation; UniCredit Bank AG; US Bank National Association; ZAIS investment grade limited X;

Author: Ambrogio Visconti