Carval Investors Uk Ltd. v. James W. Giddens, for the Sipa Liquidation of Lehman Bros. Inc. (In re Lehman Bros. Inc.)

• Decision Date: 26 February 2014
• Docket Number: Nos. 13 Civ. 5381 (DLC), 13 Civ. 5964 (DLC).,s. 13 Civ. 5381 (DLC), 13 Civ. 5964 (DLC).
• Citation: 506 B.R. 346
• Parties: In re LEHMAN BROTHERS INC., Debtor. Carval Investors UK Limited, as manager of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Corporation, and Hudson City Savings Bank, Appellants, v. James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., Appellee. Federal Deposit Insurance Corporation, as receiver of Westernbank Puerto Rico, Appellant, v. James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., Appellee.
• Court: U.S. District Court — Southern District of New York

506 B.R. 346

In re LEHMAN BROTHERS INC., Debtor.

Carval Investors UK Limited, as manager of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Corporation, and Hudson City Savings Bank, Appellants,

v.James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., Appellee.

Federal Deposit Insurance Corporation, as receiver of Westernbank Puerto Rico, Appellant,

v.James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., Appellee.

Nos. 13 Civ. 5381 (DLC), 13 Civ. 5964 (DLC).

United States District Court, S.D. New York.

Signed Feb. 26, 2014.

Luc A. Despins, and Bryan R. Kaplan, Paul Hastings LLP, New York, NY, for appellants CarVal Investors UK Limited, as manager of the assignee of Doral Bank and Doral Financial Corporation.

Hugh McDonald, Dentons U.S. LLP, New York, NY, Gene R. Besen, Dentons

U.S. LLP, Dallas, TX, for appellant Hudson City Savings Bank.

Peter Feldman, John Bougiamas, Otterbourgh, Steindler, Houston, & Rosen, P.C., New York, NY, for appellant FDIC, as Receiver for Westernbank Puerto Rico.

Michael E. Salzman, James B. Kobak, Jr., Beatrice Hamza Bassey, Savvas A. Foukas, Seth Schulman–Marcus, and Kathleen A. Walker Hughes Hubbard & Reed LLP, New York, NY, for appellee James W. Giddens, Trustee.

Josephine Wang, and Kenneth J. Caputo, Securities Investor Protection Corporation, Washington, DC, for appellee the Securities Investor Protection Corporation.

DENISE COTE, District Judge.

CarVal Investors UK Limited, as manager of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Capital (collectively, “Doral”), the Hudson City Savings Bank (“Hudson”), and the Federal Deposit Insurance Corporation (“FDIC”), as receiver of Westernbank Puerto Rico (“Westernbank”), appeal from a June 25, 2013 Order of the Bankruptcy Court denying them “customer” status under the Securities Investor Protection Act of 1970, 15 U.S.C. § 78aaa et seq. (“SIPA”), with respect to their repurchase transactions with Lehman Brothers Inc. (“LBI”) prior to its bankruptcy. See In re Lehman Bros. Inc., 492 B.R. 379 (Bankr.S.D.N.Y.2013) (“Bankruptcy Decision”). For the following reasons, the decision of the Bankruptcy Court is affirmed.

BACKGROUND

The following description of the transactions at issue is taken from the Bankruptcy Decision.¹ On April 6, 2012, appellee James W. Giddens, as trustee for the liquidation of LBI (“Trustee”), filed a motion in the Bankruptcy Court seeking approval of his decision to deny “customer” status under SIPA for a series of claims filed by Doral, Hudson, and the FDIC on behalf of Westernbank (collectively, the “Banks”) with respect to long-term repurchase agreements between the Banks and LBI (“Agreements”).

A repurchase agreement is a financial transaction consisting of two steps. First, a seller (here, the Banks) delivers securities to a buyer (here, LBI) in exchange for a quantity of cash that is generally less than the value of the securities. This difference in value is referred to as the “haircut.” Second, the parties agree that the buyer (LBI) will return those securities to the seller (Banks) on a future “repurchase date,” in exchange for a cash payment from the seller (Banks) in the amount originally transferred, plus a financing charge, called a “repo rate.” ²

In September 1999, Hudson entered into two repurchase transactions with LBI for $100 million in securities. Sometime prior to that date, LBI had offered Hudson long-term structured repurchase agreements as a means to finance Hudson's acquisition of a position in highly liquid mortgage-backed securities. In 1998, Westernbank entered into three separate long-term structured repurchase agreements with LBI, each with a term of 15 years. Westernbank's purpose for investing in the securities through its repurchase agreements was to receive the fixed coupon income that was paid by the issuer of the securities. Between 2000 and 2001, Doral entered into six repurchase agreements with LBI.

All three Banks believed that they owned the securities transferred through the Agreements. Hudson entered into the repurchase agreements with the expectation that it owned the underlying securities and that they would be returned. Westernbank considered the securities that it transferred to LBI as its own and treated them accordingly. Similarly, Doral held the securities transferred to LBI as assets on its balance sheets and recorded the matching obligations to repurchase these securities on their respective repurchase dates as corresponding liabilities.

The securities transferred to LBI per the Agreements (“Purchased Securities”), were never returned to the Banks by LBI. The Purchased Securities form the basis of the claims at issue.

Several aspects of the Agreements are particularly relevant to the principal dispute between the parties. The Agreements were governed by an industry-standard Master Repurchase Agreement (“MRA”), which sets forth the basic rights of the parties to the transaction. The MRA described the relationship between the Banks and LBI as a “business and contractual relationship” and stated that each party represents and warrants that “it will engage in such transactions as principal.”

The MRA protected both parties against changes in the value of the Purchased Securities by including a mark-to-market provision in all repurchase transactions. If the value of the Purchased Securities fell, to ensure that LBI was fully collateralized, the Banks were required to deliver additional securities or cash to LBI to make up the shortfall. Conversely, if the value of the Purchased Securities rose, the Banks were entitled to demand additional cash or Purchased Securities to rebalance the transaction.

Additionally, the MRA provided that LBI was free to use the Purchased Securities for its own purposes until the repurchase date. LBI acquired full legal title over the securities, and—subject to its obligation to provide the securities on the repurchase date—it was free to sell, transfer, pledge, or hypothecate the Purchased Securities as it desired. The Banks, for their part, retained an economic interest in the Purchased Securities, including the rights to receive all coupon interest and redemption payments.

These Agreements were “bilateral” repurchase arrangements. In contrast to “safekeeping” or “hold-in-custody” repurchase agreements where the underlying securities are kept in an internal safekeeping account by a buyer or seller throughout the duration of the agreement, in a “bilateral” repurchase agreement a seller actually delivers securities to a buyer. Accordingly, when the bilateral Agreements were initiated, the Banks transferred full legal title of the Purchased Securities to LBI and gave LBI discretion to use those securities in other repurchase agreements, sales, transfers, pledges, or hypothecations until the repurchase date.

LBI did just that. It established separate accounts for each of the Banks with respect to the Purchased Securities, which would record transaction activities but would not, and did not, hold any of the Purchased Securities while the Agreements were open. Accounts of this type are referred to as “delivery-versus-payment” (“DVP”) accounts, as compared to custodial “safekeeping” accounts, in which LBI would segregate the customer's assets from those securities available for LBI to use in its proprietary business. LBI then used the Purchased Securities for its own purposes, including in repurchase transactions or collateral pledges involving other counterparties. Because the DVP accounts did not require LBI to retain cash or property in the accounts throughout the term of the Agreement, on the date that LBI commenced liquidation proceedings (“Commencement Date”), the Purchased Securities were not held by LBI, but were in the possession of third parties.

Following the bankruptcy of LBI, the Banks submitted timely claims asserting that they were entitled to recover under SIPA as “customers” of LBI. The Trustee denied these claims, and the Banks filed a notice of objection. The parties provided an agreed-upon record to the Bankruptcy Court and submitted extensive briefing on the issue of whether the Banks were entitled to “customer” status under SIPA.

On June 25, 2013, the Bankruptcy Court affirmed the Trustee's determination that the Agreements did not entitle the Banks to SIPA “customer” status. Relying in relevant part on the Second Circuit's decision in In re Bernard L. Madoff Inv.Secs. LLC, 654 F.3d 229 (2d Cir.2011)(“ Madoff ”), the Bankruptcy Decision recognized that a claimant's “cash or securities must be entrusted with a broker-dealer in order to qualify for customer protection under SIPA,” and found that because LBI did not hold any of the Purchased Securities in the Banks' DVP accounts on the Commencement Date, “the key possessory elements that are needed to establish entrustment” of the Banks' securities were absent. In re Lehman, 492 B.R. at 380, 388. This conclusion was underscored by the fact that LBI's right to hypothecate the Purchased Securities meant that it had no legal obligation to hold these securities. Id. at 388–90. The Bankruptcy Decision also found unpersuasive the Banks' reliance on a decision by the bankruptcy court of the District of New Jersey, Cohen v. Army Moral Support Fund (In re Bevill, Bresler & Schulman Asset Mgmt. Corp.), 67 B.R. 557, 599 (D.N.J.1986) ( “Bevill Bresler ” ).

Hudson and Doral filed a notice of appeal of the Bankruptcy Decision on August 1. On August 12, Hudson and Doral moved to certify a direct appeal to the Second Circuit pursuant to 28 U.S.C. § 158(d)(2)(A). At the request of the parties, briefing on the merits was stayed pending a determination of the motion for certification. By Stipulation and Order of September 12, the FDIC indicated that it would neither oppose nor join the instant motion, but agreed that the Court's decision regarding certification will apply equally to the...