For over a decade, Lehman Brothers Special Financing (“LBSF”) has been litigating the enforceability of so-called “flip clauses” in connection with the post-bankruptcy liquidation of swap agreements. These clauses, which are common in structured financing transactions, specify the priority of payments when a swap provider (like LBSF) is in default. In particular, these clauses purport to subordinate the swap provider’s payment priority below that of noteholders when termination payments are owed due to the provider’s default.

When LBSF’s holding company (Lehman Brothers Holdings Inc.) filed a chapter 11 petition in September 2008, that filing placed LBSF in default under various swap agreements to which LBSF was a party. In a 2010 complaint involving 44 synthetic collateralized debt obligations (“CDOs”) that LBSF created, LBSF sought to claw back over $1 billion that had been distributed to noteholders in connection with the early termination of swap transactions, arguing that the flip clauses in those transactions were ipso facto provisions and therefore unenforceable. (Ipso facto clauses are contractual provisions that modify a debtor’s contractual rights solely because it petitioned for bankruptcy; the Bankruptcy Code generally treats such provisions as unenforceable.) The noteholders defended the distributions on various grounds, including by invoking the safe harbor codified in section 560 of the Bankruptcy Code, which exempts “swap agreements” from the Bankruptcy Code’s prohibition of ipso facto clauses.^[1] Read our key takeaways here.