Contractual Rights Vanish Again in the "Bermuda" of Triangular Setoff

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The enforcement of triangular setoffs in bankruptcy, where affiliates set off their claims against the debtor, received another setback in a recent decision in the Lehman bankruptcy cases. See In re Lehman Brothers Inc., No. 08-01420 (JMP) (SIPA), 2011 WL 4553015 (Bankr. S.D.N.Y. Oct. 4, 2011) Judge Peck’s decision followed the Delaware Bankruptcy Court's seminal decision in In re SemCrude, L.P., 399 B.R. 388 (Bankr. D. Del. 2009), which found that affiliated entities do not satisfy the mutuality requirement for triangular setoff under section 553(a) of the Bankruptcy Code.

In Lehman, UBS AG (UBS) terminated a swap agreement it had entered into with Lehman Brothers Inc. (Lehman) just prior to the entry of a liquidation order enforcing an automatic stay with respect to Lehman under the Securities Investor Protection Act (SIPA). Upon termination, UBS held approximately $170 million in collateral posted to secure the parties’ respective obligations. Upon termination and setoff under the swap agreement, $76 million remained for the estate, as agreed by the SIPA Trustee. However, UBS relied on its contractual rights in the swap agreement to set off an additional $23 million that Lehman owed to subsidiaries of UBS who were not party to the swap agreement. The SIPA Trustee objected to the additional setoff, claiming it was impermissible for failing to satisfy the mutuality requirement of section 553(a).

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