Lehman Bankruptcy Court Issues Safe Harbor Decision

by Cadwalader, Wickersham & Taft LLP

On December 19, 2013, Judge James M. Peck of the United States Bankruptcy Court for the Southern District of New York issued his latest decision in the Lehman Brothers cases addressing the scope of the safe harbor provisions of the Bankruptcy Code.  Michigan State Housing Development Authority v. Lehman Brothers Derivatives Products Inc. and Lehman Brothers Holdings Inc. (In re Lehman Brothers Holdings Inc.).  Judge Peck’s decision confirms that the contractual provisions specifying the method of calculating the settlement amount under a swap agreement are protected by the Bankruptcy Code’s safe harbors.  The decision follows the reasoning of the amicus brief filed by the International Swaps and Derivatives Association (“ISDA”), which was prepared by Cadwalader.


Michigan State Housing Development Authority (“MSHDA”) entered into an ISDA master agreement (the “Swap Agreement”) with Lehman Brothers Derivatives Products (“LBDP”) in May 2000, pursuant to which MSHDA and LBDP entered into interest rate swaps.  The Swap Agreement provided that upon the occurrence of an Event of Default with respect to a party, the non-defaulting party had the right to terminate outstanding transactions and calculate the settlement amount due using “Market Quotation” and “Second Method.”  The Schedule to the Swap Agreement also included “Trigger Events” that constituted additional termination events.  If a Trigger Event occurred with respect to a party, the Schedule provided that the non-defaulting party had the right to calculate the settlement amount using the “Mid-Market” valuation method.

Following the September 2008 bankruptcy of Lehman Brothers Holdings Inc. (“LBHI”), MSHDA and LBDP entered into an assignment and amendment agreement with Lehman Brothers Special Financing (“LBSF”) (a non-debtor at the time) pursuant to which LBDP assigned all of its rights and obligations under the Swap Agreement to LBSF.  The assignment agreement also contained a paragraph, referred to as the “Liquidation Paragraph,” that amended the valuation method to be used in the event of a termination.  The Liquidation Paragraph provided that if MSHDA terminated the Swap Agreement due to the non-payment or bankruptcy of LBSF, MSHDA was to use Market Quotation to calculate the settlement amount.  However, if the Swap Agreement was terminated for any other reason, the non-defaulting party was required to use Mid-Market to calculate the settlement amount.

Following LBSF’s bankruptcy filing in October 2008, MSHDA terminated the Swap Agreement and paid a $36 million settlement amount which it calculated using the Market Quotation Method.  In response, LBSF argued that the Liquidation Paragraph was an ipso facto provision unenforceable under Section 365(e)(1) of the Bankruptcy Code, and that as a result, MSHDA was required to calculate the settlement amount using the Mid-Market method, which would have increased the settlement amount due to LBSF by approximately $23 million. 

ISDA submitted a brief of amicus curiae in support of MSHDA’s position, arguing that the Bankruptcy Code safe harbors protect the right to terminate, liquidate and accelerate swap agreements in accordance with their terms, and that the act of liquidating necessarily includes calculating the settlement amount owed in accordance with the contractually specified methodology.  ISDA emphasized that such protections are necessary to insulate the financial markets from the uncertainty that would result if counterparties to financial contracts were not permitted to enforce their rights upon default.

The Court’s Opinion

The question before the Court was whether the Liquidation Paragraph, despite its ipso facto nature, fell within the safe harbor protections under Section 560 of the Bankruptcy Code, which permits “the liquidation, termination or acceleration” of swap agreements.

In addressing the breadth of Section 560, the Court first noted that where the statutory language is clear, the court’s duty is to enforce the statute according to its terms.  The Court reviewed the ordinary meaning of the word “liquidation,” and found that “liquidation” means “the act of determining by agreement the exact amount of something that otherwise would be uncertain.”  Based on this definition, the Court determined that the right to liquidate a swap agreement must mean the right to determine the exact amount payable under the swap agreement.  Accordingly, the Court found that MSHDA’s use of Market Quotation to calculate the settlement amount due to LBSF was a part of MSHDA’s protected contractual right to liquidate the Swap Agreement.  The Court noted that unless the act of liquidation is performed in accordance with the agreed method, the right to liquidate would lose all practical meaning.

The Court was unpersuaded by LBSF’s argument that the right to calculate a settlement amount was ancillary to the right to liquidate, which was based on the Court’s previous decisions in the BNY Trustee, Ballyrock and Calpine Energy cases.  In each of these previous cases, the Court determined that certain ancillary or incidental rights fell outside of the protections of the safe harbor.  However, the Court found that each of these three cases was distinguishable from the MSHDA case. 

In the BNY Trustee case, the Court held that a “flip clause” that subordinated payments due to LBSF as a result of its bankruptcy filing was an unenforceable ipso facto clause that was not protected by Section 560.  In that case, the flip clause was contained in a supplemental agreement that was not part of the swap agreement, and the Court determined that the flip clause did not expressly deal with liquidation, termination or acceleration.  In the MSHDA case, the Court found that BNY Trustee was inapplicable because the Liquidation Paragraph was part of the Swap Agreement and the Liquidation Paragraph dealt expressly with the liquidation of the Swap Agreement.  The Court noted that the act of liquidating and the method of calculation “are so tightly intertwined to the point that liquidation without a defining methodology is impossible to perform.”  The Court similarly found that Ballyrock was distinguishable because that case also dealt with a provision that altered payment priorities and that did not directly deal with liquidation, termination or acceleration. 


The MSHDA decision is important because it firmly establishes that calculation of a termination payment is an integral part of liquidation.  In addition, the MSHDA decision places clear limits on the reach of the BNY Trustee and Ballyrock decisions.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Cadwalader, Wickersham & Taft LLP | Attorney Advertising

Written by:

Cadwalader, Wickersham & Taft LLP

Cadwalader, Wickersham & Taft LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.