On September 20th, the United States District Court for the Southern District of New York granted BNY Corporate Trustee Services Limited (“BNY”) leave to appeal the bankruptcy court’s decision in the Lehman “Dante” matter.  In its January decision, the bankruptcy court had voided certain document provisions providing for the subordination of a swap counterparty’s rights to an early termination payment when the swap counterparty or one of its close affiliates went into bankruptcy.‪  BNY holds the collateral subject to this dispute.

The dispute arose out of the Dante credit-linked note program under which a special purpose entity issued notes and Lehman Brothers Special Financing Inc. (“LBSF”) entered into a swap agreement in connection with the program.  Following the bankruptcy filings of LBSF and its credit support provider, Lehman Brothers Holdings Inc. (“LBHI”), the program exercised its right to terminate the swaps between them.  The terminations resulted in an amount payable to LBSF.  Pursuant to the terms of the Dante transaction documents, the rights of LBSF to payment as swap counterparty generally had priority over payments to the noteholders.  The documents also provided, however, that upon the occurrence of the bankruptcy of LBSF or LBHI, the noteholders were to receive payment before any payments were made to the swap counterparty.

On January 25th, the bankruptcy court granted summary judgment to LBSF, holding that the subordination provisions—which effectively flip LBSF’s right to get paid from above that of the noteholders to below that of the noteholders—constitute unenforceable ipso facto clauses under the U.S. Bankruptcy Code (the “Bankruptcy Code”) and that any action to enforce the subordination provisions would violate the automatic stay provisions of the Bankruptcy Code.  The bankruptcy court acknowledged that its decision had “the potential of opening up a proverbial ‘can of worms.'”  However, the bankruptcy court did not enter an order requiring BNY to release collateral in a manner consistent with its ruling and, instead, noted that it would be communicating with the English courts to reach a coordinated resolution on a parallel case being litigated there.  On July 19th, the bankruptcy court finally entered an interlocutory order memorializing its decision.  BNY then moved for leave to appeal the order.

In granting the motion for leave, the court noted that its decision should not be interpreted as indicative of whether or not the bankruptcy court’s decision would be upheld and that it was expressing no opinion on the merits of BNY’s appeal.  However, the court also stated that “extraordinary circumstances” were present that warranted an interlocutory appeal.  It further acknowledged that the bankruptcy court’s January decision could enable Lehman’s estate to collect billions of dollars from structured finance transactions that had similar flip provisions subordinating Lehman’s right to be paid a termination amount.  In this regard, the court noted quite plainly that the “LBSF’s efforts to shield [the bankruptcy court’s] unprecedented and—for LBSF—extremely favorable decision from review are, of course, not surprising; indeed, LBSF does not deny that, since the decision was handed down, it has used it as leverage in settlement negotiations concerning billions of dollars worth of similar transactions.”  As the court further noted, the bankruptcy court’s decision had far-reaching implications for the structured finance market and had resulted in uncertainty in the financial community.  In short, the bankruptcy court decision’s “potentially game-changing effect” militated in favor of reviewing the decision immediately.