NEW YORK - We’ve all heard of the flip clause case between BNY Mellon and Lehman Brothers, regarding a dispute over the order of a payment waterfall in the event of a counterparty default. Judge James E. Peck ruled the clause was unenforceable. An unfortunate turn for BNY Mellon, which would have to pay more on the swap, but an even more unfortunate turn for Lehman counterparties everywhere. Reason being, the decision carved out a payment provision connected to safe harbor provisions included in U.S. Bankruptcy Code. In doing so, the decision opened the door for Lehman to contest that other payment provisions, such as who has the right to calculate the value of a swap and how, were “ancillary” to safe harbor provisions and cannot be enforced.
Lehman is currently in the midst of litigation with the Michigan State Housing Development Authority over a swap wherein the investment bank is alleging that it should be given the right to calculate the value of the swap. Specifically, it is asking for USD23 million more than MSHDA paid in the weeks after Lehman’s default on a swap that was out-of-the-money for the end user at the time. The MSHDA had been given the right to terminate and calculate the price of the swap based on “market quotation” in the swap agreement if Lehman filed for bankruptcy. Lehman is now using the BNY decision to convince the courts that MSHDA’s right to price the swap in such a manner falls outside of the safe harbor provisions governed by the Bankruptcy Code and, in fact, Lehman should be given the right to price based on “mid-market methodology.”
MSHDA, a little bit like Oliver Twist asking for more gruel, has countered with a plea to move the case out of Bankruptcy Court and into District Court, where a Judge would decide whether or not the BNY decision should continue to stand. The decision to move the case over likely won’t be made for another few months, but one lawyer pointed out MSHDA’s argument could convince the District Court to pick up the case. Its argument is that BNY was granted special permission to appeal the flip clause case by the District Court before the case had even been closed, a rarity. Meaning? The Court recognized the decision’s importance, and the possibility that it could have adverse market implications. BNY’s appeal, which may have resolved this issue for the market one way or the other, was cut short when the two parties agreed to settle out of court.
Why would Lehman go after MSHDA for a measly $23 million? The answer, say lawyers, is that it has deemed the BNY decision as crucial to recouping efforts. Meaning this case is worth far more than USD23 million to Lehman.