Lehman Brothers Special Financing Inc. v. BNY Corporate Trustee Service Limited

Perpetual Trustee Company Limited (Perpetual), an Australian company, held two series of credit-linked synthetic portfolio notes. The collateral securing the notes included credit-default swaps entered into between Lehman Brothers Special Financing Inc. (LBSF) (plaintiff) and a special-purpose vehicle named Saphir Finance Public Limited Co. (Saphir). BNY Corporate Trustee Services Limited (BNY) (defendant) held the swaps in trust for Saphir’s creditors. These creditors included both LBSF, as the swap counterparty, and Perpetual, as the noteholder. LBSF’s parent company, Lehman Brothers Holdings Inc., served as guarantor of LBSF’s swap payment obligations. Under the terms of the swap, LBSF would normally have priority interest in the swap payments over Perpetual, an arrangement known as swap-counterparty priority. However, the transaction documents also provided that in the event of a default, priority would flip to noteholder priority, which would favor Perpetual and thereby subordinate LBSF. The transaction documents provided that default events would include the filing of bankruptcy by any party to the transaction, including LBSF or its parent, Lehman Brothers Holdings. Subsequently, on September 18, 2008, Lehman Brothers Holdings filed for bankruptcy, and soon after, on October 2, LBSF also filed for bankruptcy. Following the filing of these bankruptcy petitions, Saphir exercised its right to terminate the swaps. LBSF initiated an adversary proceeding against BNY, seeking a declaratory judgment that the contractual provision that purported to authorize a flip from swap-counterparty priority to noteholder priority constituted an unenforceable ipso facto clause in violation of the Bankruptcy Code. The bankruptcy court granted summary judgment in favor of LBSF, holding that the contractual provision was an unenforceable ipso facto clause under the Bankruptcy Code and that the Bankruptcy Code’s carveout for swap agreements did not apply. BNY filed for leave with the federal district court to appeal the bankruptcy court’s ruling.