Swap Agreement

Second Circuit Affirms Enforceability of Flip Provisions in Swap Agreements Under Bankruptcy Code Safe Harbor

 

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.

SDNY Holds Trustee Cannot Evade Section 546(g) Safe Harbor by Bringing Avoidance Action Under State Law

On June 11, 2013, Southern District of New York Judge Jed Rakoff dismissed the complaint of the Trustee for the SemGroup estate seeking to avoid a novation made to Barclays pre-bankruptcy under a swap agreement.  The Court held that the pre-bankruptcy transaction constituted a safe harbored transfer made in connection with a swap agreement and thus could not be avoided by the estate.  The Court held further that the safe harbor applied to actions brought under state law fraudulent transfer theories, not just those brought under federal law.  Judge Rakoff stated that to permit the trustee to proceed under state law would allow estates to evade the safe harbor by delaying litigation until post-bankruptcy.  Whyte v. Barclays Bank PLC, 12 Civ. 5318 (JSR), 2013 U.S. Dist. Lexis 82040 (S.D.N.Y. June 11, 2013).  Read More.