Lehman Bankruptcy Court Addresses Withholding Scheduled Swap Payments to a Bankrupt Counterparty


On September 15, 2009, the United States Bankruptcy Court for the Southern District of New York (the “Court”) determined that Metavante Corporation (“Metavante”), a counterparty to an interest rate swap agreement with Lehman Brothers Special Financing (“LBSF”), a bankrupt Lehman entity, was no longer excused from performing under the swap (to the extent it had been at all) and no longer had the ability to terminate the swap.

Metavante had entered into the swap with LBSF in November 2007.  Under the terms of the swap, Metavante was to pay periodic amounts on an amortizing notional amount based on a fixed rate and was to receive periodic amounts on the same amortizing notional amount based on a floating rate (i.e., three-month LIBOR).

LBSF filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code (the “Code”) on October 3, 2008.  After that date, in reliance on Section 2(a)(iii) of the ISDA Master Agreement governing the swap, Metavante elected not to make any of the net scheduled payments to LBSF that the swap periodically required.  Section 2(a)(iii) is standard to swap agreements and provides, generally, that a party’s obligation to make a scheduled payment is conditioned on there being no default with respect to its counterparty existing at the time such payment is to be made.  Metavante also elected not to terminate the swap based on the bankruptcy, which constituted a default under the swap documentation.[1]  If Metavante had elected to terminate the swap under the market conditions existing at the time of the LBSF bankruptcy filing or at any time thereafter, Metavante apparently would have owed a substantial payment to LBSF in connection with the early termination.[2]

LBSF essentially requested that the Court (i) compel Metavante to continue to perform under the swap, subject to LBSF’s right as a debtor to choose to assume or reject the contract[3] and (ii) deny Metavante the ability to early terminate the swap.  In making its petition, LBSF argued that Metavante’s failure to make the scheduled payments required by the swap violated the Code because such a suspension impermissibly modified the swap, an executory contract, solely as a result of LBSF’s bankruptcy filing.[4]  LBSF further argued that Metavante’s nearly one-year delay in terminating the swap should result in Metavante’s waiver of its right to do so.

The Court granted LBSF the requested relief.  In particular, the Court referred to an earlier Enron case to support the position that a swap counterparty’s right to early terminate, accelerate, liquidate and net its protected contracts despite its counterparty’s bankruptcy (known as the “safe harbor” provisions) must be exercised “fairly contemporaneously” with the debtor’s bankruptcy filing.

The ISDA Master Agreement itself does not provide a time limit for reliance on Section 2(a)(iii) rights.[5]  Similarly, the Code does not provide a timeframe during which a counterparty must exercise its early termination rights in connection with its protected contracts with a debtor.  The Court’s decision does not resolve these points absolutely, although it does provide some guidance to market participants.  In short, the Court made clear that a party is not indefinitely permitted—if at all—to withhold payments while not moving forward with some urgency to close out its existing protected contracts in reliance on the safe harbor provisions of the Code.[6]  Indeed, the Court found that waiting for almost a year before doing so (or in Metavante’s case, without attempting to do so at all) is certainly too long.

[1] Note that Lehman Brothers Holdings Inc., LBSF’s credit support provider, had filed for bankruptcy protection under Chapter 11 of the Code on September 15, 2008, which itself gave rise to a default under the relevant swap documentation.  Metavante appears not to have argued that it withheld performance based on the existence of this default, as opposed to that of its actual counterparty, LBSF.

[2] Although not necessarily equivalent to the early termination amount that would have been calculated in connection with a termination under the relevant swap documentation, as a point of reference, Metavante recorded in its annual and quarterly filings liabilities in connection with the swap of $13.833 million as of June 30, 2009 and $6.577 million as of December 31, 2008.

[3] See generally 11 U.S.C. § 365.

[4] See 11 U.S. C. § 365(e)(1).

[5] Note, however, that certain market participants (primarily end-users) made efforts to include such a period (e.g., 30-90 days) in connection with the drafting of the 2002 ISDA Master Agreement.

[6] In Enron Australia vs. TXU Electricity Ltd. (2003 NSWSC 1169), a 2003 Australian case involving an electricity swap, the Australian court permitted TXU to withhold performance in reliance on Section 2(a)(iii) while not moving to effect an early termination of the swap.  Obviously, this case did not constitute a precedent for the Court under U.S. bankruptcy law and, apparently, was not persuasive to the Court.