Lehman Brothers Ruling Calls into Question Enforceability of Cross-Affiliate Netting in Bankruptcy


The U.S. Bankruptcy Court for the Southern District of New York recently issued an opinion in the case of In re Lehman Brothers Holdings Inc. that significantly restricts the scope of setoff rights for energy traders and other participants in derivatives and forward commodity markets. Traditionally, bankruptcy law has required mutuality between the debtor and a creditor as a prerequisite for the exercise of setoff rights by the creditor. In 2005, however, Congress enacted section 561 of the Bankruptcy Code, which provided safe harbor protections for master netting agreements – thus appearing to allow cross-affiliate netting when specifically provided in trading contracts. The Lehman opinion rejects that notion, and instead imposes a strict mutuality requirement on any instances of setoff, including those that fall under the “safe harbor” statutes of the Bankruptcy Code. That decision, if upheld on appeal, could significantly reduce the protection and security that many in the trading markets believed they had.

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