CarVal UK Ltd. v. Giddens (In re Lehman Bros., Inc.)

• Decision Date: 29 June 2015
• Docket Number: Docket No. 14–890.
• Citation: 791 F.3d 277
• Parties: In the Matter of LEHMAN BROTHERS, INC., Debtor, CarVal UK Limited, as manager of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Corporation, Claimant–Appellant, v. James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., Securities Investor Protection Corporation, Appellees.
• Court: U.S. Court of Appeals — Second Circuit

791 F.3d 277

In the Matter of LEHMAN BROTHERS, INC., DebtorCarVal UK Limited, as manager of CVF Lux Master S.a.r.l., the assignee of Doral Bank and Doral Financial Corporation, Claimant–Appellant

v.James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc., Securities Investor Protection Corporation, Appellees.^*

Docket No. 14–890.

United States Court of Appeals, Second Circuit.

Argued: Feb. 26, 2015.

Decided: June 29, 2015.

Luc A. Despins (Bryan R. Kaplan, on the brief), Paul Hastings LLP, New York, N.Y., for Claimant–Appellant.

Michael E. Salzman (James B. Kobak, Jr., Beatrice Aisha Hamza Bassey, Savvas A. Foukas, Kathleen A. Walker, on the brief), Hughes Hubbard & Reed LLP, New York, N.Y., for Appellee James W. Giddens, as Trustee for the SIPA liquidation of Lehman Brothers Inc.

Kenneth J. Caputo (Josephine Wang, on the brief), Securities Investor Protection Corporation, Washington, D.C., for Appellee Securities Investor Protection Corporation.

Before: KATZMANN, Chief Judge, WALKER and CHIN, Circuit Judges.

Opinion

KATZMANN, Chief Judge:

This case presents the challenging task of fitting a decades-old statute to a financial arrangement of more recent vintage. Enacted in 1970, the Securities Investor Protection Act (“SIPA”) seeks to protect investors who have entrusted their assets to a broker-dealer. If the broker-dealer runs into financial trouble, SIPA authorizes the speedy return of investors' property and ensures that investors will be made whole if the assets are lost. In this case, we must consider how SIPA treats an investor who delivered securities to a broker-dealer as part of a now-common financial transaction known as a repurchase agreement. We conclude that an investor who delivers securities to a broker-dealer as part of a repurchase agreement is not protected by SIPA because the investor did not entrust assets to the broker-dealer.

BACKGROUND

A repurchase agreement—commonly known as a “repo”—involves a matched purchase and sale. First, the “seller” agrees to sell assets, usually securities, to the “buyer” for a fixed price.¹ Second, the buyer agrees to resell those same assets back to the seller at a later date and for a slightly higher price—hence the name “repurchase agreement.”

Viewed from the seller's perspective, repos offer a mechanism for converting idle securities into liquid cash for a limited period. The seller can then employ that cash for investments or other purposes, before returning the cash to the buyer in exchange for the securities at the conclusion of the repo. Viewed from the buyer's perspective, repos provide an outlet for excess cash, and for the temporary acquisition of attractive securities. Moreover, because the resale price is higher than the original sale price, the buyer retains the difference—known as the “repo rate”—as a fee for the transaction. When viewed from a buyer's perspective, the transaction is called a “reverse repo.”

Between January 2000 and May 2001, Doral Bank and Doral Financial Corporation (collectively, “Doral”) entered into six repurchase agreements, with Doral as the seller, and Lehman Brothers Inc. (“Lehman”) as the buyer.² These transactions were governed by industry-standard Master Repurchase Agreements (“MRAs”). Notably, the MRAs describe the relationship between Doral and Lehman as “contractual” and make not mention of a fiduciary relationship. The MRAs gave Lehman full legal title over the underlying securities, and Lehman was free—subject to its obligation to resell the securities on the repurchase date—to sell, transfer, pledge, or hypothecate the securities as it desired. Doral, for its part, received cash in exchange for the securities, and was free to use that cash for its own purposes. Doral also retained an economic interest in the securities, including the rights to receive all principal, interest, dividends, and other distributions. The MRAs protected both Lehman and Doral against changes in the value of the securities by marking the repos to market. If the value of the securities fell, Doral was required to deliver additional securities or cash to Lehman to ensure that the market value of the securities matched the cash held by Doral. Conversely, if the value of the securities rose, Doral could demand additional cash or securities to rebalance the transaction.

Under these agreements, Doral sold several hundred million dollars' worth of securities to Lehman, with the expectation that Lehman would resell the securities back to Doral at the conclusion of the transactions. Unfortunately for Doral, the financial crisis struck while the repurchase agreements were still outstanding, and Lehman fell apart before Doral could repurchase the securities from Lehman. Although Doral still had the cash that Lehman paid for the securities, those securities had apparently appreciated in the meantime such that Doral stood to profit if it had repurchased the securities at the agreed-upon price.

After Lehman entered into SIPA liquidation on September 19, 2008, Doral submitted timely claims asserting that it was entitled to recover this profit. The SIPA Trustee denied these claims, concluding that Doral was not a “customer” of Lehman, and therefore was not protected by SIPA. Doral promptly objected to the Trustee's denial, but shortly thereafter transferred its claims to CVF Lux Master S.a.r.l. pursuant to Federal Rule of Bankruptcy Procedure 3001. CVF Lux Master S.a.r.l. is managed by CarVal Investors UK Limited (“CarVal”), the appellant in this case.

On June 25, 2013, the bankruptcy court (Peck, Bk. J. ) affirmed the Trustee's determination that the repos did not make Doral or CarVal a customer under SIPA. In re Lehman Bros. Inc., 492 B.R. 379 (Bankr.S.D.N.Y.2013). CarVal appealed the bankruptcy court's decision to the district court. On February 26, 2014, the district court (Cote, J. ) affirmed the bankruptcy court. In re Lehman Bros. Inc., 506 B.R. 346 (S.D.N.Y.2014).

DISCUSSION

This appeal turns on a single issue: was Doral a “customer” of Lehman for purposes of SIPA? If Doral was a customer of Lehman, then under SIPA the appellant is entitled to the prompt return of any property that Lehman was holding on Doral's behalf—i.e., the securities that Lehman never resold to Doral as required by the repurchase agreements, less the contractual repurchase price. Conversely, if Doral was not a customer of Lehman, then the SIPA door is closed, and the appellant is relegated to pursuing a claim for those unreturned securities in the ordinary course of Lehman's bankruptcy proceedings. We begin our analysis of this question by first reviewing the principles articulated by our SIPA caselaw. We then turn to how these principles treat repurchase agreements. We conclude by addressing (1) the appellant's reliance on Matter of Bevill, Bresler & Schulman Asset Mgmt. Corp. (Cohen v. Army Moral Support Fund), 67 B.R. 557 (D.N.J.1986), and (2) the appellant's contention that Congress spoke to the treatment of repos in various statutes enacted since SIPA's passage.³

I. The Securities Investor Protection Act of 1970

Congress enacted SIPA in 1970 in response to “a business contraction [in the securities industry] that led to the failure or instability of a significant number of brokerage firms.” Sec. Investor Prot. Corp. v. Barbour, 421 U.S. 412, 415, 95 S.Ct. 1733, 44 L.Ed.2d 263 (1975). These failures sent shockwaves through the securities market as investors who had handed their assets over to broker-dealers suddenly lost access to their property. Existing bankruptcy safeguards did not adequately protect investors because investor assets were frequently commingled with the broker-dealer's other assets, and thus would be tied up for years in extended bankruptcy proceedings. H.R. Rep. 91–1613, 1970 U.S.C.C.A.N. 5254, 5257. As more and more investors lost access to assets they had previously thought safe, the “situation ... threatened a ‘domino effect’ involving otherwise solvent brokers that had substantial open transactions with firms that failed.” Barbour, 421 U.S. at 415, 95 S.Ct. 1733.

SIPA was designed “to arrest this process, restore investor confidence in the capital markets, and upgrade the financial responsibility requirements for registered brokers and dealers.” Id. To accomplish these goals, SIPA created special procedures for the liquidation of failed broker-dealers. SIPA trustees administer what is in effect a “bankruptcy within a bankruptcy” for investors who had property on account with the broker-dealer. See 15 U.S.C. § 78fff–2. The trustee amasses “customer property” and “[e]ach customer shares ratably in this fund of assets to the extent of the customer's net equity at the time of filing.” In re New Times Sec. Servs., Inc., 463 F.3d 125, 127 (2d Cir.2006) (internal quotations marks and citation omitted). If this fund of customer property is insufficient to make investors whole, the trustee may dip into a special trust fund bankrolled by fees assessed on the community of broker-dealers. This fund is administered by the Securities Investor Protection Corporation (“SIPC”)—one of the appellees in this case—which is a private nonprofit membership organization created by SIPA. See Sec. Investor Prot. Corp. v. Morgan, Kennedy & Co., 533 F.2d 1314, 1316 (2d Cir.1976).

But a claimant only gets these special protections if it is a “customer” of the broker-dealer. SIPA defines a customer as:

any person (including any person with whom the debtor deals as principal or agent) who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral, security, or for purposes of effecting transfer.

15 U.S.C. § 78lll(2)(A). Whether a claimant qualifies as a customer is determined on a transaction-by-transaction basis. See In re New Times, 463...