In a long-awaited decision released on February 22, 2011, Judge James M. Peck of the United States Bankruptcy Court for the Southern District of New York ruled in favor of Barclays Capital in Lehman Brothers Holding Inc.’s multi-billion-dollar lawsuit arising out of the sale of Lehman’s investment banking and brokerage assets, which occurred in September of 2008. Lehman sought relief from the Section 363 sale order,1 contending that Barclays secured a “sweetheart” deal in connection with the tumultuous sale of the now-defunct investment bank’s North American business platform based on an alleged undisclosed, or secret, discount for Lehman’s assets.
The primary issue before the court was whether sufficient special circumstances were present to justify relief from the sale approval order entered at the outset of the bankruptcy cases, which permitted Lehman to sell its U.S. brokerage business under Section 363 of the Bankruptcy Code. Lehman argued that alleged misrepresentations and failures to disclose key terms of the deal allowed Barclays to receive literally billions of dollars more in value than it was entitled to under the transaction. Indeed, Lehman argued in court filings that “one deal was disclosed to the court while a very different deal was closed.” Despite what the court described as a “glaring problem of flawed disclosure” in terms of the appropriate value of Lehman’s business assets, the court found that relief from the sale order was not warranted given that full disclosure would not have changed the outcome of the sale process. In reaching its decision, the court noted that final sale orders entered under Section 363 of the Bankruptcy Code are “worthy of greater protection” from later reopening.
The facts surrounding the Lehman filing and sale at the height of the financial crisis are well-publicized, but, as the court made clear, “context matters,” and a brief overview of the pertinent facts sheds light on this important decision. On September 15, 2008, Lehman Brothers filed its historic Chapter 11 petition in the United States Bankruptcy Court for the Southern District of New York, and 22 of its affiliates filed bankruptcy petitions thereafter. Lehman Brothers immediately sought judicial approval to effectuate a sale of its assets to Barclays, the only prospective purchaser for its brokerage business. In a stunning display of speed, the Bankruptcy Court approved the proposed sale to Barclays, valued at nearly $2 billion, within the first week of the Chapter 11 case.
A critical aspect of the dispute was the enforceability of a “clarification letter” finalized after entry of the sale order, which sought to make major changes in the structure of the sale transaction. Importantly, the clarification letter was filed on the case docket several days later, but its approval was never sought or secured from the court. Notwithstanding this lack of judicial imprimatur, the court held that the clarification letter was “deemed approved” due to that fact that the 363 sale order anticipated that such a document would be drafted, it was filed on the docket, no party objected to it, and the conduct of the parties demonstrated unequivocal reliance thereon.
Demonstrating a profound case of “seller’s remorse”, the Rule 60(b) motion filed by Lehman (which had the support of, among others, the creditors’ committee), sought to overturn the 363 sale, positing that Barclays had achieved a tremendous “windfall” as a result of acquiring Lehman’s business assets at a deep discount, without disclosing material information relating to both the value of the assets being sold and the means for implementing the transaction. Barclays countered that Lehman was content to support the sale during “Lehman Week” – the tumultuous time period between the bankruptcy filing and finalization of the clarification letter – and should not be permitted to obtain such extraordinary relief more than one year after the fact. (Ironically, Lehman itself had vigorously defended against various objectors’ efforts to overturn the sale process, something the court noted on several occasions in its opinion.) At the time of the sale the court believed that the transaction benefitted all interested parties, mitigated systemic risk, and avoided an even greater economic catastrophe. None of the new evidence presented to the effect that these hard-to-value securities were marked down by as much as $5 billion dissuaded the court from that fundamental perception.2 Even though Barclays failed to make important disclosures to the court in respect of the 363 sale process, as borne out by the evidence presented during the 34-day trial, such failure was more than offset by the fact that the sale was the best alternative; indeed, it was the only viable option to preserve thousands of jobs and allow the brokerage unit to remain intact.
Barclays’ board of directors instructed its senior management to proceed with the Lehman acquisition only if it was “capital accretive.” Despite the relevance of this fact, it was never disclosed to the court. In particular, Barclays failed to inform the court of both the existence of a $5 billion discount in the value of the acquired assets and of a substantial change to the transaction involving an agreement by Barclays to “take out” Lehman’s obligations to the New York Federal Reserve Bank, which may have allowed Barclays to achieve an additional $5 billion monetary gain.
The evidence at trial established that Barclays negotiated a value for the purchased assets that was discounted from Lehman’s marks by approximately $5 billion. Consequently, the sale allowed Barclays to realize an undisclosed $5 billion gain upon closing, representing the spread between the value negotiated for the assets and book values ascribed to the assets by Lehman.
Prior to the sale, the New York Fed had agreed to provide Lehman with financing through short-term funding agreements under which Lehman was required to post collateral in excess of the principal amount advanced (colorfully referred to as the “haircut”). When it learned of the planned asset sale, the New York Fed insisted that Barclays step into its role of providing short-term financing to Lehman. The parties entered into an agreement by which Barclays relieved the New York Fed by providing Lehman with $45 billion in cash in exchange for Lehman posting securities as collateral in the approximate amount of $50 billion, or a $5 billion “haircut” for Lehman. The court found that it had not been sufficiently informed of this repo transaction and Barclays retained the securities as part of the purchase, which permitted it to obtain an additional undisclosed gain of approximately $5 billion.
Furthermore, it was represented to the court at the sale hearing that Barclays would likely incur contract cure liabilities of an estimated $1.5 billion and the asset purchase agreement provided that Barclays would assume exposure of approximately $2 billion in employee-related claims, largely consisting of bonuses awarded in 2008 to former Lehman employees who were transferred to Barclays. However, Barclays ultimately paid only approximately $200 million in cure liabilities and $1.5 billion in employee bonus claims, amounts that were far less than the parties had indicated to the court.
In his 103-page decision, Judge Peck acknowledged that confusion, ambiguity and uncertainty prevailed during Lehman Week. Nevertheless, the expeditious sale of the brokerage unit as a going concern was paramount, as it ensured the continued survival of a multitude of otherwise imperiled jobs. In the face of the “melting” business, the court entered the sale order, cognizant of the fact that errors and omissions were bound to occur. While the need for speed was not deemed a valid excuse for inadequate disclosure, the court found it the best explanation for the lapses in disclosure that formed the basis of the litigation.
The court noted that the purchase was the “quintessential distressed sale” and that it was appropriate for Barclays to look after its own interests in its role as purchaser. Barclays did not take unfair advantage of Lehman and the failed disclosures did not compromise the transaction to the point where the court felt it appropriate to grant relief from the final sale order. At bottom, Judge Peck found that Barclays acted in good faith while protecting its own interests in negotiating the best deal possible.
Judge Peck also explained that he did not approve the sale based upon the concept of a “wash” or the reasonableness or accuracy of those values ascribed to the Lehman assets being acquired by Barclays. The asset purchase agreement contained no representations or warranties of value, and the court made no findings of specific valuations. Approval instead rested on the premise that a going-concern sale to Barclays would likely result in the highest value for the assets. Moreover, the court found that the estimates relating to cure liabilities and employee claims were just that, good-faith estimates. From the court’s vantage point, it was widely understood that compensation and cure figures were moving targets. The fact that they were not completely accurate was not cause for relief from the 363 sale order.
The court did rule in favor of Lehman in finding that Barclays was not entitled to $4 billion in cash and was required to return any such cash that it may have received, notwithstanding contradictory language in the clarification letter. The parties disagreed about whether cash was an “excluded asset” under the terms of the asset purchase agreement, as modified by the clarification letter. The court, however, stressed that at the sale hearing the parties were unequivocal in stating that cash was excluded from the transaction. Although Barclays argued that the clarification letter included cash as an acquired asset, the court would not countenance such an argument in the face of explicit oral representations to the contrary.
Although the court learned post hoc that the parties failed to disclose details fundamental to the evolution of the transaction over the course of Lehman Week, such failure was not sufficient cause for the grant of extraordinary relief under Rule 60(b). The court based such a conclusion on the finding that the parties negotiated in good faith and at arm’s length and that they did not knowingly conceal relevant facts. The asset mark down process used by Barclays was neither arbitrary nor unfair, the aggregate amount paid was reasonable, and the approved transaction was undoubtedly the best alternative. To be sure, the court would have preferred complete disclosure, but it nevertheless found the disclosure to be adequate under the circumstances because the court would have approved the sale even if it had knowledge of the undisclosed facts. Tellingly, the opinion provides in this regard: “The court still would have entered the very same sale order because there was no better alternative and, perhaps most importantly, because the sale to Barclays was the means both to avoid a potentially disastrous piecemeal liquidation and to save thousands of jobs in the troubled financial services industry.”
The Lehman opinion offers tremendous insight into the chaotic sale process that transpired during Lehman Week in September 2008, in addition to highlighting the extraordinary burden required to overturn a Section 363 sale to a good-faith purchaser under Federal Rule of Civil Procedure 60(b). Section 363 sales have been used in many recent bankruptcy cases, and have enabled companies such as General Motors Corp. and Chrysler LLC to reorganize their businesses. The court’s ruling in Lehman highlights the integrity of such sales and helps ensure that parties-in-interest can rely on the finality of sale orders.
Equally important to Lehman’s request to overturn the sale, the court undoubtedly considered the enormity of the undertaking in terms of unscrambling the eggs of a corporate omelet made in late 2008. While the opinion did not make specific mention of this issue, one can fairly assume that a reversal of the sale would pose an impractical – if not impossible – burden on Barclays in trying to unwind billions of dollars of securities, 72,000 customer accounts and countless contracts after such considerable time had passed since the acquisition. Given the sheer impracticality of reversing the consummated sale transaction, and the fact that the court was unwavering as to the propriety of approval of the sale notwithstanding the subsequent disclosures, it is not surprising that the court refused to overturn the final sale order.