On July 18, 2013, the City of Detroit, Michigan became the largest city to file for rehabilitation under Chapter 9 of the United States Bankruptcy case. Detroit, through its financial manager, is seeking to restructure approximately $18 billion in accrued liabilities, including unsecured debt and other liabilities of $11.5 billion, and secured obligations—including swap obligations—of $7.3 billion. READ MORE
On March 9th, the ISDA Determinations Committee for Europe unanimously concluded that The Hellenic Republic (Greece) had triggered a restructuring “credit event” under credit default swap (“CDS”) contracts in connection with the exchange of its debt with private creditors. The committee’s determination was based in large part on the imposition and use by Greece of retroactive “collective action clauses” (“CACs”) on bonds governed by Greek law which bound all holders of such debt to the decisions of a supermajority. In accordance with the 2003 ISDA Credit Derivatives Definitions, a restructuring credit event (whether due to a reduction of coupon, extension of maturity or other specified change) is not triggered unless the restructuring “occurs in a form that binds all holders.” READ MORE
With an enormous €14.5 billion bond maturing on March 20th, Greece continues to negotiate with its private sector investors on the reduction of approximately €100 billion of its total €350 billion of debt. Agreement with these investors is intended to reduce the country’s debt from 160% of GDP to 120% of GDP by 2020 and is required in order for Greece to secure from the European Union and International Monetary Fund the second installment of bailout funds, approximately €130 billion, necessary for the country to avoid default. However, the negotiations have been complicated and, perhaps, compromised, not only by Greece’s economic deterioration, but also, at least to some extent, by the involvement of smaller private investors who have purchased Greek debt—and, in some cases, credit default swap (“CDS”) protection on Greece—since the deal was announced in October 2011. At that time, the expectation was that approximately 90% of debt holders would voluntarily agree to the terms of the restructuring, which generally entailed an exchange of existing debt for new, longer-dated bonds. There is now concern that, as currently contemplated, significantly fewer debt holders will voluntarily agree to the proposed terms of the restructuring. One reason for this appears to be the purchase (at a deep discount) of large amounts of Greek debt from banks by funds and others more insulated from political and other pressures to accept a restructuring. This has resulted not only in a decline in debt holders willing to participate in an exchange of debt, but also in the tougher negotiation of terms for the new debt. READ MORE
Structured finance transaction documents have typically included subordination provisions in their post-default waterfalls, effectively changing a swap counterparty’s right to get paid from above that of the noteholders to below that of the noteholders. In January 2010, in a case relating to the “Dante” credit-linked note program, a New York bankruptcy court voided certain document provisions providing for the subordination of Lehman Brothers Special Financing Inc.’s rights as swap counterparty to an early termination payment when the swap counterparty or one of its close affiliates went into bankruptcy. In effect, the bankruptcy court held that such clauses altering the priority of payment constitute unenforceable ipso facto clauses under the U.S. Bankruptcy Code (the “Bankruptcy Code”). After an appeal was filed, the parties settled the matter later that year, leaving market participants with substantial uncertainty in connection with similar clauses.[1]
The same issues have arisen in the United Kingdom, but with a different outcome. In Belmont Park Investments Pty Limited & ors v. BNY Corporate Trustee Services Limited and Lehman Special Financing Inc., the U.K. Supreme Court decided on July 27th that a “flip” clause in the relevant documentation did not violate the common-law principle of “anti-deprivation,” which (similar to the Bankruptcy Code’s ipso facto rule) invalidates contractual provisions having the effect of transferring the property of a debtor upon its insolvency, hence depriving the bankruptcy estate of that asset. In its decision, the court first reviewed the anti-deprivation principle’s development to describe its nature and limits. In doing so, the court noted that the absence of good faith, or an intention to obtain an advantage over creditors in the bankruptcy, was an essential element in the application of the principle. Indeed, the court pointed out that, historically, where the principle has been held not to apply, good faith and commercial sense of the transaction have been important factors. Applying this understanding to the transaction at issue, the court concluded that there was no evidence that the “flip” clauses were deliberately intended to evade insolvency law (as evidenced by the numerous other non-bankruptcy defaults that also would trigger a change in priority). The court further noted that Lehman itself had designed, arranged and marketed the Dante program, and that the flip clauses (more specifically, noteholder priority to collateral upon a Lehman bankruptcy) was a very material factor in the notes obtaining a triple-A rating, hence enabling Lehman to sell them to non-banks. In addition, the collateral was purchased with funds supplied by the noteholders, not Lehman. In bolstering its conclusion, the court also emphasized that “party autonomy” (i.e., the ability of sophisticated counterparties to agree to commercial terms at arms’ length) was at the heart of English commercial law, particularly where complex financial instruments are involved.
The inconsistency of the New York and U.K. decisions leaves market participants with a stark difference of opinion across jurisdictions and may raise the possibility of forum-shopping in connection with future structured finance transactions.
[1] For a detailed summary of this litigation, please see DMIR November 2010, DMIR October 2010 and DMIR January 2010.
On November 17th, Lehman Brothers Special Financing Inc. (“LBSF”) and its official unsecured creditors’ committee filed a joint motion to stay BNY Corporate Trustee Services Limited’s (“BNY”) appeal for 90 days in the “Dante” matter, pending final settlement of the dispute between LBSF and Perpetual Trustee Company Limited (“Perpetual”).
The reason for the motion was LBSF’s settlement in principal with noteholder Perpetual, an Australian trustee with noteholders of its own. On September 20th, the United States District Court for the Southern District of New York granted to BNY leave to appeal the bankruptcy court’s January decision. This decision had voided certain document provisions related to the Dante credit-linked note program providing for the subordination of LBSF’s rights as swap counterparty to an early termination payment when the swap counterparty or one of its close affiliates went into bankruptcy. In effect, the bankruptcy court had held that these 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. BNY holds the collateral subject to this dispute and had brought the appeal in its capacity as trustee.[1]
The motion for the stay was granted and, on November 24th, LBSF filed another motion seeking the court’s approval of a settlement with Perpetual. If the final settlement between LBSF and Perpetual is approved by the court, it is expected that LBSF will then request that the BNY appeal be dismissed. Such a dismissal will leave uncertainty as to the enforceability of similar flip clauses.
[1] For a detailed summary of the Dante matter, please see DMIR October 2010 and DMIR January 2010.
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. READ MORE
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.
On January 25, 2010, the United States Bankruptcy Court for the Southern District of New York issued a decision in the Lehman bankruptcy case holding that provisions that subordinate a swap counterparty’s rights to payment when the swap counterparty or one of its close affiliates goes into bankruptcy are unenforceable. These types of provisions are used in many structured finance transactions, and thus this decision may have implications for the structured finance markets and the ratings of structured finance transactions. For more information on this case and its potential impact, read the related Orrick Client Alert.
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. READ MORE
On August 11, 2009, Judge James Peck of the Federal bankruptcy court in New York denied a motion by a unit of The Bank of New York Mellon Corp. (“BNYM”) to dismiss an action by a subsidiary of Lehman Brothers Holdings Inc. relating to the priority of claims in connection with credit-linked notes (“CLNs”) issued by a program known as “Dante”. The Lehman subsidiary had entered into credit default swaps relating to the CLNs and claims that it is owed $70 million in connection with their early termination. The BNYM unit acted as trustee under the Dante program. READ MORE
