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Brothers Holdings Inc. - No right to suspend swap payments indefinitely


18 September 2009

Lehman bankruptcy court rejects view that provisions of the ISDA Master Agreement allow an out-of-the-money counterparty to a bankrupt Lehman entity to suspend indefinitely its own performance to Lehman without actually terminating the ISDA Master.  

Ruling from the bench in a September 15, Lehman chapter 11 hearing intended by the counterparty, Metavante Corporation, to be an opportunity to seek an adjournment, Judge Peck rejected Metavante's position that it could rely on the conditions precedent section of an ISDA Master Agreement, section 2(a)(iii), to withhold its own performance from its defaulted Lehman counterparty without exercising its discretionary right to terminate the ISDA Master. Lehman was in the money under the ISDA Master and would have been owed a termination amount by Metavante. Although the judge issued a brief order today, September 17, the order relies on the transcript of the hearing for the judge's precise reasoning. We are in the process of obtaining the transcript and will write at greater length if broader discussion than that below is appropriate.

The essence of the court's position appears to be that section 2(a)(iii), as used by Metavante against a debtor in a US Bankruptcy Code proceeding, may be viewed as a penalty and hence unenforceable. The court also indicated that Metavante's safe-harbored right to terminate no longer exists, that there is a "use it or lose it" aspect to that safe-harbored right (hinted at in earlier rulings of the court in other contexts) and that Metavante is now subject to the court's stay. In today's order, the court also indicated that Metavante would have to now make past payments that it had withheld from Lehman at a default interest rate (presumably a reference to the ISDA Master's default rate, which the Lehman estate has presented in other contexts as in the neighborhood of 15 percent). Finally, an additional result for Metavante is that its ISDA Master is now viewed as an unterminated executory agreement, subject to the Lehman estate's decision as to assumption or rejection.

We note that this decision differs from that of the New South Wales court, in Enron Australia v. TXU, and may present an outcome different from that possible in still other jurisdictions (on "flawed asset" theory or otherwise).


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