970 F.3d 91
2d Cir.2020Background
- In 2008 Lehman Brothers Holdings Inc. (LBHI) filed Chapter 11; Lehman Brothers Special Financing Inc. (LBSF), an affiliate, later filed its own Chapter 11 and sued ~250 noteholders and trustees over distributions from 44 synthetic CDOs.
- Each synthetic CDO: an Issuer sold Notes, bought high‑grade securities as Collateral, entered into an ISDA swap with LBSF, and the Indenture prescribed a Priority of Payments for Collateral proceeds.
- LBHI’s bankruptcy triggered Events of Default under the ISDA, early termination of swaps, liquidation of Collateral, and distributions under the Indenture waterfall that subordinated LBSF’s recovery to Noteholders because LBSF was the defaulting party.
- LBSF alleged the Priority Provisions were unenforceable ipso facto clauses (and asserted related state‑law claims and clawback theories); defendants moved to dismiss.
- The Bankruptcy Court dismissed, holding (inter alia) that even assuming ipso facto clauses, §560’s safe harbor for swap agreements permitted the Priority Provisions’ enforcement; the District Court affirmed, and the Second Circuit affirmed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Are Priority Provisions unenforceable ipso facto clauses? | Priority Provisions downgrade LBSF solely because of bankruptcy and thus are barred by §365 and related anti‑ipso‑facto rules. | Even if they are ipso facto clauses, §560 protects enforcement in the swap context. | Court assumed arguendo they were ipso facto but held §560 renders enforcement permissible. |
| Are the Priority Provisions part of the "swap agreement" for §560? | Indenture provisions stand apart from the ISDA swap and are not protected by §560. | ISDA Schedule incorporates Indenture priority language by reference, making them part of the swap agreement. | The Schedule’s "subject to the Priority of Payments" language incorporates the Priority Provisions into the swap. |
| Does "liquidation" under §560 include distributing collateral proceeds per the priority waterfall? | "Liquidation" means ascertaining or calculating termination values; distribution is a separate concept not sheltered by §560. | "Liquidation" includes winding down the swap and distributing collateral proceeds; protection would be hollow otherwise. | "Liquidation" reasonably includes distribution of proceeds; §560 protects that conduct. |
| Were the trustees acting as "swap participants" under §560 when they liquidated and distributed? | Trustees are not swap counterparties and thus not §560 swap participants. | Trustees exercised contractual rights granted by the Issuer (a swap participant) and therefore acted as the Issuer’s agent in exercising swap rights. | Trustees exercised the contractual rights of a swap participant; their actions fall within §560. |
Key Cases Cited
- Merit Mgmt. Grp. v. FTI Consulting, Inc., 138 S. Ct. 883 (statutory safe‑harbor interpretation principles)
- Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (assumption/rejection of executory contracts and consequences)
- Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011) (standard of review for bankruptcy appeals; de novo statutory review)
- PaineWebber Inc. v. Bybyk, 81 F.3d 1193 (2d Cir. 1996) (incorporation by reference principle for contract documents)
- Thrifty Oil Co. v. Bank of Am. Nat’l Tr. & Sav. Ass’n, 322 F.3d 1039 (9th Cir. 2003) (legislative history on swap safe harbor protecting market stability)
- Lehman Bros. Holdings Inc. v. BNY Corp. Tr. Servs. Ltd., 422 B.R. 407 (Bankr. S.D.N.Y. 2010) (contrasting bankruptcy court decision on ipso facto and §560)
- Lehman Bros. Special Fin. Inc. v. Ballyrock ABS CDO 2007‑1 Ltd., 452 B.R. 31 (Bankr. S.D.N.Y. 2011) (Judge Peck’s contrary view that priority subordination fell outside §560)