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The Bankruptcy Court for the Southern District of New York rejected yesterday afternoon a motion to dismiss a dispute over what could amount to billions owed to Lehman’s estate, according to a lawyer tracking the situation and wire reports.
At issue is whether Lehman or noteholders get paid first under one of the debtor’s credit-linked note CLN programs called Dante, Debtwire reports. CLN programs allowed Lehman and other banks to collect fees by selling bundled credit protection for loans held and already hedged on their books.
Most of the CLNs were sold to retail investors in Asia and Europe and were secured with collateral pools that are now the subject of pitched legal battles in multiple jurisdictions. The English High Court ruled provisionally last month that Dante’s collateral should go to CLN holders, prompting Lehman to appeal the decision in US bankruptcy court.
Bank of New York Mellon Corp – the trustee for the CLNs – filed a motion to dismiss Lehman’s complaint but New York Bankruptcy Judge James Peck decided today that he will hear the matter, the lawyer tracking the case said. Many of the CLNs traded following Lehman’s entrance into bankruptcy and are now held by distressed investors.
The litigation over Dante is being widely watched as it will set a precedent for how to treat waterfall claims built into securitization trusts when one counterparty files for bankruptcy. Collateral assigned to Lehman’s CLNs amounts to between USD 10bn and USD 16bn and the current litigation will determine whether that value goes to the note holders or general creditors of the estate.
The bankrupt investment bank claims it is owed USD 70m from the Dante trusts alone, according to court documents. Lehman’s bonds traded up one point today to around 19 in heavy volume on speculation about the outcome of the courtroom battle, according to a trader. The case is expected to be tried the same day as a similar dispute involving Lehman and insurer Aflac and will take place in September or later.
Lehman brought the claim against the Bank of New York Mellon in bankruptcy court as an appeal against the tentative decision reached in noteholders’ favor in the English High Court last month.
The English High Court ruled that investors in the CLNs hold senior claim on collateral posted to the structure because Lehman’s bankruptcy filing constituted an event of default. Under CLN indentures, which follow the rules of English law, an event of default flips the waterfall structure in noteholders’ favor, said both lawyers. If the CLNs had been whittled away by defaults of the credits they referenced, the collateral would have been paid to Lehman.
Lehman is now arguing that the US courts should have final say over the matter because terms of the CLNs run contrary to the anti-deprivation or ipso facto provisions of the Bankruptcy Code. These provisions stipulate that an agreement cannot be amended simply because of a bankruptcy filing by a party to the agreement, which contradicts the contract law set up under the Dante trusts, explained both lawyers.
The English court left open the question of whether it will permit the application of US bankruptcy laws to invalidate these subordination provisions via the appeals process. The court adjourned the proceeding to a date to be fixed no later than 1 October, said the second lawyer.
If Peck sides with Lehman, his ruling would fundamentally alter the assumption that CLN assets belong to noteholders first in the event of insolvency and could prompt rating agencies to downgrade similar CLN programs, said the first lawyer.
Lawyers for the Lehman Estate at Weil Gotshal and lawyers for BONY at Reed Smith did not return calls for comment.
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