On May 5th, the United States Bankruptcy Court for the Southern District of New York issued a decision declaring that a party’s right to setoff in an International Swaps and Derivatives Association, Inc. (“ISDA”) Master Agreement is unenforceable in bankruptcy unless “strict mutuality” exists.
The dispute arose out of several ISDA Master Agreements (the “Agreements”) entered into between Lehman Brothers Holdings Inc. (“LBHI”) (sometimes as guarantor, sometimes as counterparty) and Swedbank AG (“Swedbank”). Each of these agreements provided that bankruptcy was an event of default triggering an early termination and one of the Agreements contained a provision allowing Swedbank a right of setoff upon the occurrence of an event of default. Shortly following the date of its bankruptcy, Swedbank placed an administrative freeze on a general deposit account LBHI had with Swedbank, blocking LBHI from withdrawing any amounts but still allowing funds to flow into the account. As a result of post-petition deposits, the balance in the account increased. LBHI filed a motion to prevent Swedbank from using the funds in the account to set off amounts allegedly owed by LBHI to Swedbank under the Agreements.
The main thrust of LBHI’s argument was that the funds deposited in the account after LBHI’s bankruptcy petition constituted post-petition deposits and, therefore, lacked the requisite mutuality to be set off against LBHI’s alleged pre-petition indebtedness. Significantly, the court held that the United States Bankruptcy Code (the “Bankruptcy Code”) safe harbor provisions for derivatives, by their plain terms, “do not alter the axiomatic principle of bankruptcy law, codified in section 553, requiring mutuality in order to exercise a right of setoff.” As a result, the court held that Swedbank violated the automatic stay of the Bankruptcy Code by freezing LBHI’s assets, purportedly to effect setoff, and ordered Swedbank to release LBHI’s funds deposited in the account post-petition.
For additional information on this decision, please see Client Alert.