Vol 18 (2021) - Issue 1

Article preview

Second Circuit Upholds Swap Termination in Flip Clause Litigation: In re Lehman Brothers Holdings Inc., 970 F.3d 91 (2d Cir. 2020)

Synopsis
In a dispute arising from the Lehman Brothers bankruptcy, the US Court of Appeals for the Second Circuit (the 'Court of Appeals') recently upheld the dismissal of a lawsuit seeking to unravel the termination of swap agreements, the liquidation of related collateral and the shift in payment priority of certain creditors. The court founded its ruling on the 'safe harbour' provision of section 560 of Title 11, United States Code (the 'Bankruptcy Code'), which authorised such conduct, notwithstanding the Bankruptcy Code's automatic stay and general prohibition on enforcing bankruptcy termination (or ipso facto) clauses.
The court observed that although Bankruptcy Code section 365(e) generally prohibits the modification or termination of rights under an executory contract based upon a provision in such contract conditioned on the insolvency or financial condition of a debtor, or the commencement of a bankruptcy case, the transactions before the court were part of an integrated transaction that was subject to a 'safe harbour' exception that expressly permits the enforcement of rights under swap agreements, notwithstanding the automatic stay of Bankruptcy Code section 362(a).
The Lehman Brothers ruling should provide definitive guidance on complex issues that have been mired in uncertainty for more than ten years. The ruling provides clarity to participants in the financial markets and upholds Congressional intent in enacting the safe harbour provisions, namely, to protect financial markets from the disruption attendant to insolvency of financial market participants.