Whether “liquidation” includes the wind-down of transactions and the distribution of proceeds The Second Circuit analyzed the terms of the ISDA purporting to incorporate the Indenture by reference, which stated that amounts payable to LBSF were “subject in any case to the Priority of Payments set out in the Indenture.” Applying relevant precedent, the Second Circuit affirmed that such language sufficiently incorporated the Priority Provisions into the ISDA, and thus the Priority Provisions formed part of the swap agreement at issue.Ģ. ![]() The lower courts held, and the Second Circuit affirmed, that the Priority Provisions were included in the swap agreement definition because, on its face, the definition includes any terms or conditions that are incorporated by reference in a swap. LBSF argued, therefore, that the scope of the section 560 safe harbor did not extend to the Priority Provisions and the distribution to the Noteholders was improper. Instead, LBSF argued that the Priority Provisions – which were included in the Indenture, not the ISDA – did not form part of the swap agreement at issue. 3 Neither party disputed that the ISDA itself was a swap agreement. One of the elements of section 560’s safe harbor is that the contractual rights to liquidate, terminate, or accelerate obligations must be included in a “swap agreement” – a term defined by the Bankruptcy Code. 2 In short, it creates an exception to the ipso facto restrictions and the automatic stay, and permits the exercise of a swap participant’s contractual rights to cause the liquidation, termination, or acceleration of swap agreements. LBSF argued that the Priority Provisions did not satisfy the Bankruptcy Code definition of a “swap agreement,” and therefore were not entitled to the section 560 safe harbor permitting the termination, liquidation, or acceleration of obligations under executory contracts notwithstanding the Bankruptcy Code’s restriction on ipso facto clauses and the automatic stay.Īs an initial matter, we note that section 560 of the Bankruptcy Code provides a safe harbor for the benefit of swap participants. Whether the Priority Provisions are included within the scope of protections afforded to “swap agreements” Each of those arguments is described below.ġ. At the Second Circuit, LBSF made three primary arguments, none of which prevailed. LBSF subsequently brought suit to recover the amounts distributed to the Noteholders. The Trustees liquidated the Collateral and, because LBSF was the defaulting party, the proceeds thereof were distributed to the Noteholders before LBSF. Accordingly, the credit default swaps (which were in-the-money for LBSF) were terminated. Ultimately, LBHI’s chapter 11 filing triggered a cross-default under the ISDA with LBSF designated as the defaulting party. In the event that LBSF was the defaulting party under the ISDA, the Indenture instructed the Trustees to terminate the credit default swap and liquidate the Collateral, distributing the proceeds thereof to the Noteholders before LBSF. The Priority Provisions contemplated several scenarios that would trigger a return of the Noteholders’ principal and proceeds of the Collateral, each with specific payment waterfalls. LBSF then entered into a credit default swap with the Issuer under an ISDA master agreement (the ISDA), and the terms of those documents incorporated by reference the priority of payment provisions of the Indenture (the Priority Provisions). The notes were collateralized by securities acquired with the proceeds of the note issuances (the Collateral), which Collateral was held by trustees (the Trustees) for the benefit of the secured parties. Several LBSF entities formed a special-purpose entity (the Issuer) for the purpose of issuing notes to the Noteholders pursuant to an indenture (the Indenture). (LBSF), a subsidiary of LBHI, in 2010 to claw back payments it made to certain noteholders (the Noteholders) and other parties in the wake of LBHI’s bankruptcy. ![]() The case in question was brought by Lehman Brothers Special Financing Inc. 1 The case stems from the chapter 11 bankruptcy proceedings of Lehman Brothers Holdings Inc. Circuit Court of Appeals for the Second Circuit (the Second Circuit) affirmed the distribution of collateral proceeds under the safe harbor protections of section 560 of the Bankruptcy Code.
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