On September 17, 2009, the U.S. Bankruptcy Court for the Southern District of New York granted Lehman Brothers Special Financing Inc.’s (LBSF, and collectively with its affiliates, Lehman) Motion to compel performance of Metavante Corporation’s (Metavante) obligations under an executory contract and to enforce the automatic stay (the Motion).1 The Order (available here) requires Metavante to make all payments to LBSF required under the ISDA Master Agreement (Master Agreement) between the parties, including payments suspended as a result of the bankruptcy filing, together with default interest on such payments. Metavante withheld its payments in reliance on § 2(a)(iii) of the Master Agreement, which imposes a condition precedent that no Event of Default exist before a party is obligated to make any payment or delivery. Metavante argued that Lehman’s bankruptcy filings constituted Events of Default and therefore allowed suspension of Metavante’s payment obligations. In an oral statement (available here) accompanying the ruling, the Court found that Metavante’s reliance on the condition precedent language in § 2(a)(iii) of the Master Agreement violated § 365(e)(1) of the Bankruptcy Code’s prohibition of any termination or modification of a contract due to the debtor’s bankruptcy filing, so-called ipso facto clauses.
Metavante argued that the Bankruptcy Code’s safe harbor statutes protected its contractual rights, but the Court rejected that argument. The Court stated that the safe harbor provisions of § 560 of the Bankruptcy Code protect a non-defaulting swap counterparty’s contractual rights solely to: (1) liquidate, terminate or accelerate one or more swap agreements under certain specified circumstances; or (2) offset termination or payment amounts in connection with the liquidation termination or acceleration of swap agreements. The Court noted that Metavante had not attempted to liquidate, terminate or accelerate the Master Agreement, nor offset amounts in connection with the termination of the Master Agreement.
While the Court’s decision is limited only to Metavante, it marks the first time that a court has ruled that the condition precedent language provided in § 2(a)(iii) of the Master Agreement violates the prohibition on unenforceable ipso facto clauses under the Bankruptcy Code. Nevertheless, the Court’s order in granting the Motion may have far-reaching implications in the Lehman bankruptcy case and insolvency proceedings involving transactions subject to an ISDA Master Agreement. Lehman has indicated that it has $24 billion of unpaid receivables under derivatives contracts, with approximately 4,000 counterparties. Lehman may now be able to use the Court’s order as a precedent to force other counterparties to surrender their § 2(a)(iii) rights and resume performance under other Master Agreements.
The question of the enforceability of § 2(a)(iii) of the Master Agreement is central to several other matters pending in the Lehman cases. A hearing is scheduled for October 14, 2009, in a similar motion against AIG CDS, Inc. (AIG). In its responsive pleadings, AIG has argued that § 365(e)(1) of the Bankruptcy Code is inapplicable to the inquiry because, rather than modifying the contract, its actions were entirely in accordance with the terms of the contract.
It should be noted that the Court indicated that it granted the Motion, in part, because Metavante did not make a sufficient commitment to timely settle the dispute. LBSF had proposed a settlement agreement in its Motion and Metavante did not respond. This may allow counterparties who actively engage in settlement discussions with Lehman to avoid being forced to perform under an ISDA Master Agreement. Conversely, Lehman may have significant leverage in forcing counterparties to agree to settlements to avoid being forced to perform and pay default interest.