553 B.R. 476
Bankr. S.D.N.Y.2016Background
- LBSF sued ~250 noteholders, issuers, and trustees to recover ~ $1 billion distributed after termination of swaps tied to 44 synthetic CDO transactions, alleging distributions violated ipso facto rules and state law.
- Transactions had three components: (i) issuances of secured notes; (ii) ISDA swaps between Issuers and LBSF; and (iii) Collateral held by Trustees subject to contractual payment waterfalls (Priority Provisions) determining who receives liquidation proceeds.
- LBHI’s bankruptcy filing (Sept. 15, 2008) triggered Events of Default under the swaps, making LBSF the defaulting swap counterparty; LBSF filed bankruptcy Oct. 3, 2008.
- The parties grouped the 44 transactions by timing: Pre-Pre (termination and distributions before LBSF petition), Pre-Post (termination before but distributions after LBSF petition), and Post-Post (termination and distributions after LBSF petition). The Court also categorized transactions as Type 1 (priority for LBSF as default option that ‘‘flips’’ on LBSF default) and Type 2 (waterfall not fixed until termination).
- LBSF contended the Priority Provisions were unenforceable ipso facto clauses under 11 U.S.C. §§365(e)(1), 541(c)(1), 363(i) and that distributions violated the automatic stay; defendants argued no ipso facto modification occurred, and alternatively the distributions are protected by the §560 safe harbor.
- The bankruptcy court granted defendants’ motion to dismiss Counts I–XIX with prejudice, holding (1) Type 1 priority provisions modified LBSF’s rights but were protected by §560; (2) Type 2 provisions did not modify LBSF’s rights (or, for Pre-Pre/Pre-Post, any modification occurred pre-petition); and (3) state-law claims fail as a result.
Issues
| Issue | Plaintiff's Argument (LBSF) | Defendant's Argument (Movants) | Held |
|---|---|---|---|
| Whether Priority Provisions are unenforceable ipso facto clauses | Priority Provisions stripped LBSF of a pre-existing payment-priority right solely because of bankruptcy, so they are unenforceable | Many Priority Provisions did not modify rights post-LBSF petition; some confer only contingent rights fixed at termination; where modified, §560 protects distributions | Type 1 provisions modify LBSF’s rights (ipso facto) but §560 protects distributions; Type 2 provisions do not modify LBSF’s rights (no ipso facto effect) |
| Which petition date governs ipso facto analysis (LBHI vs. LBSF) | LBHI’s petition should trigger ipso facto protections ("singular event" theory) | Anti-ipso facto provisions refer to the petition of the debtor whose rights are affected (LBSF); do not adopt singular-event approach | Court rejects the singular-event theory; LBSF’s petition date is the relevant date for timing analysis |
| When does a modification of LBSF’s rights occur — upon termination notice or upon distribution? | Modification not effective until liquidation and actual distribution (so could occur after LBSF petition in Pre-Post cases) | Modification occurs when the Event of Default and Early Termination notice designate LBSF as Defaulting Party; priority flips then | Modification occurs upon designation/termination notice (Early Termination) — thus for Pre-Pre and Pre-Post transactions any modification occurred pre-LBSF petition |
| Whether §560 safe-harbor protects distributions made pursuant to Priority Provisions | §560 does not protect these distributions because waterfall/distributions are ancillary and not the exercise of a swap liquidation/termination right; also trustees/notenolders are not ‘swap participants’ | Enforcement of priority and distributions are integral to liquidation/termination of the swaps and were rights of the Issuers (swap participants); §560 should be read broadly | §560 applies: distributions were part of the liquidation/termination process and Issuers are swap participants, so the distributions cannot be stayed, avoided, or limited |
Key Cases Cited
- Lehman Bros. Special Fin. Inc. v. BNY Corp. Trustee Servs. Ltd., 422 B.R. 407 (Bankr. S.D.N.Y. 2010) (held priority provisions unenforceable as ipso facto clauses)
- Lehman Bros. Special Fin. Inc. v. Ballyrock ABS CDO 2007-1 Ltd., 452 B.R. 31 (Bankr. S.D.N.Y. 2011) (denied dismissal; treated priority flip clauses as modifying rights)
- Michigan State Hous. Dev. Auth. v. Lehman Bros. Special Fin. Inc. (In re Lehman Bros. Holdings Inc.), 502 B.R. 383 (Bankr. S.D.N.Y. 2013) (interpreted §560 to protect contractual calculation/settlement mechanisms)
- Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011) (discusses pleadings-stage invocation of safe-harbors)
- Picard v. Ida Fishman Revocable Trust (In re Bernard L. Madoff Inv. Sec. LLC), 773 F.3d 411 (2d Cir. 2014) (interprets financial safe-harbors broadly)
- Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V. (In re Enron Corp.), 651 F.3d 329 (2d Cir. 2011) (supports broad reading of safe harbors to promote market stability)
- In re Tribune Co. Fraudulent Conveyance Litig., 818 F.3d 98 (2d Cir. 2016) (confirms expansive application of bankruptcy safe-harbors)