September 21, 2008 Following a week of unprecedented market upheaval, players in financial contracts got some reassurance from the bankruptcy judge presiding over the liquidation of broker/dealer Lehman Brothers Inc. (“LBI”) and the sale of a portion of its assets to Barclays Capital Inc. (“BCI”). In an order issued early Saturday morning after an extensive evidentiary hearing, the bankruptcy court affirmed that the order approving the LBI asset sale does not interfere with the exercise of contractual rights enjoyed by LBI counterparties under protected financial contracts such as securities contracts, repurchase agreements, forward contracts, commodity contracts, swap agreements, or master netting agreements (as each is defined under the Bankruptcy Code, “Protected Contracts”). Be cautioned, however: a companion district court order issued pursuant to the Securities Investor Protection Act imposes a stay of at least 21 days, during which counterparties to these agreements are prohibited from taking certain actions without permission of the SIPC Trustee.

The Bankruptcy Court Sale and SIPA Liquidation Orders

On September 20, 2008, Bankruptcy Judge James M. Peck of the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) entered an order (the “Sale Order”) approving an asset sale to BCI by chapter 11 debtors, Lehman Brothers Holdings, Inc. (“LBHI”) and LB 745 LLC (“745;” together with LBHI, the “Debtors”). The court emphasized that its decision was not to be treated as precedent for other transactions, given that it was issued under extraordinary circumstances in the absence of any real alternative due to the limited number of eligible purchasers and the potentially devastating consequences to the global economy of a failure to approve the sale.

On September 19, 2008, i.e., prior to the entry of the Sale Order, the Securities Investor Protection Corporation (“SIPC”) had commenced a proceeding under SIPA against LBI in the United States District Court for the Southern District of New York in which the district court had entered an Order Commencing Liquidation (the “SIPA Order”), appointed a trustee and referred the liquidation proceeding to the Bankruptcy Court.

The Bankruptcy Court, which now presides over all of these cases, has yet to be asked to rule on the interplay between the Sale Order, which preserves the exercise of rights with respect to Protected Contracts, and the SIPA Order, which stays the exercise of certain of those rights as detailed below.

The 21-Day Stay.

Subject to certain exceptions noted below, for a period of 21 days from the entry of the SIPA Order (a period subject to extension by the court), without first obtaining written consent from SIPC and the Trustee, creditors cannot take the following actions:

  • enforce liens or pledges against the property of LBI;
  • exercise any rights of setoff;2
  • foreclose on, or dispose of, securities collateral pledged by LBI, whether or not with respect to one or more [protected] contracts, securities sold by LBI under a repurchase agreement, or securities loaned under a securities lending agreement.3

Exceptions to the 21-Day Stay.

Among other things, the SIPA stay does not prohibit:

  • the exercise of a contractual right of an eligible counterparty to liquidate, terminate, or accelerate a Protected Contract, to offset or net termination values, payment amounts, or other transfer obligations arising under or in connection with one or more of such contracts, or to foreclose on any cash collateral pledged by LBI, whether or not with respect to one or more of such contracts; or
  • the exercise of a contractual right of any stockbroker or financial institution, as defined in section 101 of the Bankruptcy Code, to use cash or letters of credit held by it as collateral, to cause the liquidation of its contract for the loan of a security to LBI or for the pre-release of American Depository Receipts or the securities underlying such receipts; or
  • the exercise of a contractual right of any “repo” participant, as defined in 11 U.S.C. § 101, to use cash to cause the liquidation of a repurchase agreement, pursuant to which LBI is a purchaser of securities, whether or not such repurchase agreement meets the definition set forth in section 101(47) of the Bankruptcy Code. 

Many Questions Remain.

These exceptions may in fact raise more questions than they answer. For example, under what circumstances would SIPC consent to liquidation of non-cash collateral? What is the process for obtaining consent from the SIPC Trustee? How long will it take to obtain such consent? Is your contract protected? Is your firm an eligible counterparty such as a “financial participant” or “financial institution”?

In the past, SIPC has issued certain correspondence reflecting its position with respect to consenting to relief from the SIPA stay. Historically, consistent with this correspondence, SIPC would endeavor to grant consent relatively quickly, but given the far reaching implications of the current credit crisis and the magnitude of the task facing the SIPC Trustee and the Bankruptcy Court, SIPC’s practice in this case remains to be seen. More broadly given the potential adverse consequences of violating the automatic stay of the Bankruptcy Code, it is particularly important to vet all relevant issues prior to acting in reliance upon the foregoing exceptions to the 21-day stay.