Lehman Bros. Special Fin. Inc. v. Bank of Am. Nat'l Ass'n (In re Lehman Bros. Holdings Inc.)

• Decision Date: 28 June 2016
• Docket Number: Case No. 08–13555 SCC Jointly Administered,Adversary Proceeding No. 10–03547 SCC
• Citation: 553 B.R. 476
• Parties: In re Lehman Brothers Holdings Inc., et al., Debtors. Lehman Brothers Special Financing Inc., Plaintiff, v. Bank of America National Association, et al., Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

553 B.R. 476

In re Lehman Brothers Holdings Inc., et al., Debtors.Lehman Brothers Special Financing Inc., Plaintiff

v.Bank of America National Association, et al., Defendants.

Case No. 08–13555 SCC Jointly Administered

Adversary Proceeding No. 10–03547 SCC

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

Signed June 28, 2016

As Amended July 8, 2016

APPEARANCES:¹ WOLLMUTH MAHER & DEUTSCH LLP, 500 Fifth

Avenue, New York, New York 10110, By: William A. Maher, Esq., Paul R. DeFilippo, Esq. (argued), William F. Dahill, Esq. (argued), Vincent T. Chang, Esq. (argued), Jason E. Glass, Esq., Mara R. Lieber, Esq. Counsel for Plaintiff Lehman Brothers Special Financing Inc.

CLEARY GOTTLIEB STEEN & HAMILTON LLP, One Liberty Plaza, New York, New York 10006, By: Carmine D. Boccuzzi, Jr., Esq. (argued), Brent Tunis, Esq., Emily Balter, Esq., Counsel for Goldman, Sachs & Co. and Goldman Sachs International

SIDLEY AUSTIN LLP, One South Dearborn, Chicago, Illinois 60603, By: Bryan Krakauer, Esq. (argued), Mark B. Blocker, Esq., Allison Ross Stromberg, Esq., Counsel for Principal Life Insurance Co.

SIDLEY AUSTIN LLP, One South Dearborn, Chicago, Illinois 60603, By: Bryan Krakauer, Esq. (argued), 787 Seventh Avenue, New York, New York 10019, By: Nicholas P. Crowell, Esq., Jon W. Muenz, Esq., Counsel for PCA Life Assurance Co. Ltd.

MORGAN, LEWIS & BOCKIUS LLP, 399 Park Avenue, New York, New York 10022, By: Joshua Dorchak, Esq. (argued), Counsel for Continental Insurance Co. of Brentwood Tennessee, Marsh & McLennan Master Retirement Trust, Marsh & McLennan Companies, Inc. Stock Investment Plan, Modern Woodmen of America, Inc., PHL Variable Insurance Co., Phoenix Life Insurance Co., Putnam Dynamic Asset Allocation Funds—Growth Portfolio, Putnam Intermediate Domestic Investment Grade Trust, and Putnam Stable Value Fund

CLEARY GOTTLIEB STEEN & HAMILTON LLP, One Liberty Plaza, New York, New York 10006, By: Jeffrey A. Rosenthal, Esq. (argued), Counsel for Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch International

CHAPMAN AND CUTLER LLP, 111 West Monroe Street, Chicago, Illinois 60603, By: Franklin H. Top III, Esq. (argued), Counsel for U.S. Bank National Association, as Successor Trustee

SIDLEY AUSTIN LLP, 787 Seventh Avenue, New York, New York 10019, By: Nicholas P. Crowell, Esq. (argued), Alex J. Kaplan, Esq., Alex R. Rovira, Esq., Andrew P. Propps, Esq., Counsel for Genworth Life & Annuity Insurance Co., Magnetar Constellation Master Fund, Ltd, Magnetar Constellation Fund II, Ltd, Magnetar Constellation Master Fund III, Ltd, and UniCredit Bank, AG (London Branch)

MEMORANDUM DECISION ON OMNIBUS MOTION OF THE NOTEHOLDER DEFENDANTS TO DISMISS THE FOURTH AMENDED COMPLAINT

SHELLEY C. CHAPMAN

, UNITED STATES BANKRUPTCY JUDGE

TABLE OF CONTENTS

BACKGROUND ...482

A. Structure of the Transactions ...483

B. The Transaction Documents and the Priority Provisions ...484

C. The Bankruptcy Cases and Termination of the Transactions ...486

D. The BNY

and Ballyrock Decisions ...487

E. The Adversary Proceeding ...489DISCUSSION ...490

A. Motion to Dismiss Standard ...490

B. Analysis of the Priority Provisions ...491

1. The Priority Provisions in Type 1 Transactions Modify LBSF's Rights and Therefore Are Ipso Facto Clauses ...494

2. Even If the Priority Provisions in Type 2 Transactions Ipso Facto Modified LBSF's Rights, Any Such Modifications In Pre–Pre Transactions or Pre–Post Transactions Occurred Before the LBSF Petition Date and Thus Do Not Violate Sections 365(e)(1), 541(c)(1), or 363(l) of the Code ...495

3. The Section 560 Safe Harbor Protects The Distributions ...500

C. LBSF's State Law Claims Fail to State a Cause of Action ...507

1. Counts XIII–XVI ...507

2. Count XVII ...508

3. Count XVIII ...508

4. Count XIX ...509

CONCLUSION ...509

APPENDIX A ...510

APPENDIX B ...510

Plaintiff Lehman Brothers Special Financing Inc. (“LBSF”) has brought this adversary proceeding against some 250 defendant noteholders, note issuers, and indenture trustees seeking to recover approximately $1 billion that was distributed to the defendant noteholders following the commencement of the Lehman Brothers chapter 11 proceedings in September 2008. The distributions were made in connection with the early termination of hundreds of swap transactions to which LBSF was a counter-party; the early terminations were solely triggered by LBSF's default, which occurred when Lehman Brothers Holdings Inc. (“LBHI”) filed its chapter 11 petition on September 15, 2008. The question at the core of this matter is the enforceability of an alleged ipso facto clause in the applicable transaction documents. If the clause is not enforceable (and the distributions not protected by any applicable “safe harbor”), LBSF will be entitled to recover the distributions. Imbedded in that simple question lie a number of vexing and intriguing issues, including:

• Were LBSF's priority rights modified by application of the alleged ipso facto clauses?

• Was a modification of LBSF's rights, if any, effective upon LBSF's receipt of a valid termination notice or not until distributions with respect to such termination were made?

• Is it the chapter 11 filing date of LBHI or the subsequent filing date of LBSF that is the relevant point in time for purposes of the analysis of the enforceability of the alleged ipso facto clause?

• To what extent do the safe harbor provisions of the Bankruptcy Code protect some or all of the distributions from clawback?

Although it has been six years since the Court first addressed similar issues in the context of certain credit-linked synthetic portfolio notes issued under the multi-issuer secured obligation program known as the “Dante Program,”² no other court has addressed the precise issues presented by the forty-four transactions at issue here.

Against that backdrop, and for the reasons that follow, the Court concludes that Counts I through XIX of the adversary complaint fail to state a cause of action upon which relief can be granted and therefore grants the Motion (as defined below). The Court's analysis is as follows.³

BACKGROUND

The Omnibus Motion to Dismiss (the “Motion”)⁴ before the Court filed by certain noteholder and trust certificate holder defendants (the “Noteholders”) in the above-captioned adversary proceeding relates to Counts I through XVI, XVIII, and XIX of LBSF's Fourth Amended Complaint.⁵ The Motion was joined by certain other defendants in the adversary proceeding, each in its capacity as an indenture trustee for one or more of the transactions that are the subject of the adversary proceeding (such defendants, the “Trustees” and together with the Noteholders, the “Movants”).⁶ In addition to joining the Motion, certain of the Trustees also moved to dismiss Count XVII of the Complaint, which is asserted solely against the Trustees.

By the Motion and the Joinders, the Movants seek dismissal of Counts I through XIX of the Complaint pursuant to Fed.R.Civ.P. 12(b)(6)

.⁷ The Movants argue that LBSF has failed to state a claim upon which relief can be granted because, among other things, (i) the contractual provisions at issue are not unenforceable ipso facto clauses because they did not modify LBSF's rights after LBSF's bankruptcy petition date and (ii) even if such provisions were unenforceable ipso facto clauses, the distributions at issue are protected by certain safe harbor provisions of the Bankruptcy Code (the “Code”). LBSF argues that the provisions at issue are unenforceable ipso facto clauses and are not protected by the safe harbor provisions identified by the Movants. LBSF has also asserted a variety of other bankruptcy and state law claims against the Movants.

The relevant facts before the Court, while complex, are largely undisputed. LBSF, an indirect subsidiary of LBHI, initiated this adversary proceeding on September 14, 2010. The dispute arises out of a multitude of financial transactions involving certain credit default swap agreements (the “Swaps”) to which LBSF was a party. Pursuant to each Swap, among other things, LBSF purchased credit protection from certain special-purpose entities (the “Issuers”) in connection with forty-four synthetic collateralized debt obligation transactions (the “CDOs”) between and among LBSF and its affiliates, on the one hand, and the Issuers, on the other.⁸ In each of these transactions, LBSF and the Noteholders held competing interests in collateral securing each Issuer's obligations to LBSF under the Swap and to the Noteholders under their notes. The transaction documents include provisions that govern the priority of payment upon a distribution of proceeds from the liquidation of such collateral after termination of the Swap (the “Priority Provisions”). In each transaction at issue in this adversary proceeding, LBSF alleges that the Noteholders improperly received distributions as a result of the enforcement of the Priority Provisions.

A. Structure of the Transactions

Each Swap was one of three components of a larger transaction between and among LBSF, an Issuer, a Trustee, and certain Noteholders. Although the general structures of the Transactions⁹ are similar, each was entered into pursuant to its own set of transaction documents (the “Transaction Documents”), the terms of which vary to some extent and govern the rights of the Issuers, Trustees, the Noteholders, and LBSF between and among themselves.

First, in connection with each CDO, each Issuer issued one or more series of Notes (or, in certain circumstances, trust certificates)¹⁰ pursuant to indenture or trust agreements (or, with respect to the trust certificates, trust documentation, and with such indentures and trust agreements, the “Indentures”) to a group of Noteholders (the “Issuances”), and used the proceeds from the Issuances to fund the Issuer's purchase of certain liquid investments to serve as collateral.¹¹ Second, each Issuer and LBSF entered into one or more Swaps whereby the Issuer sold synthetic credit protection on certain reference entities to LBSF.¹² The...