In the jargon of the secondary bank loan market, loans beneficially owned by participation may be "elevated" to direct assignments once requisite administrative agent and/or borrower consent is obtained. Such "elevations" customarily have been viewed as straightforward transactions -- when completed, the participant simply stands in the shoes of the grantor and becomes the lender of record of the loan on the books of the administrative agent.

Recent events in the Lehman bankruptcy proceedings raise questions about the effectiveness of elevations involving a standard form of participation agreement used in Europe and may result in monetary claims being brought by the Lehman estate against parties that elevated the pre-petition participations granted by Lehman, and, in some cases, the painstaking unwinding of chains of purchases and sales of bank loans that were once owned by Lehman.


Lehman Commercial Paper Inc. (“LCPI”), a subsidiary of Lehman Brothers Holdings Inc., recently brought proceedings seeking to unwind elevations of loan participations that occurred shortly after the holding company’s bankruptcy filing on September 15, 2008. LCPI alleges that such elevations constitute preferential transfers that should be avoided under the United States Bankruptcy Code and that payments received by the participants following the elevations should be returned to the Lehman estate.

Prior to their bankruptcy filings, LCPI and other subsidiaries of the holding company originated commercial loans to borrowers and sold participation interests in such loans to third parties in the ordinary course of their business. The participations at issue in the recent proceedings were documented on participation agreements that were substantially similar to those published by the Loan Market Association (“LMA”).1

Prior to LCPI’s own bankruptcy filing on October 5, 2008, certain participants requested elevations of the participation interests that they had purchased from LCPI. LCPI agreed to certain elevation requests and the elevations became effective in late September and early October 2008.


LCPI alleges that under LMA participations, participants have no contractual relationship with the underlying borrower, no ownership interest in the relevant loan and no legal right to pursue the borrower for principal or interest payments. Instead, LCPI asserts that LMA participants only have a creditor/debtor relationship with LCPI, in its capacity as the grantor of the participation.

These allegations regarding LMA participations are in contrast to participations that are documented on form agreements published by the Loan Syndications and Trading Association (“LSTA”). LSTA participations generally provide, among other things, that (i) the participant receives a beneficial interest in the underlying loan, with the grantor retaining only legal title to the underlying loan, (ii) the grantor receives and holds any principal or interest payments from the relevant borrower for the sole benefit of the participant, and (iii) the participation is intended to be treated as a sale by the grantor and a purchase by the participant.


LCPI asserts that the elevations in question meet the elements of avoidable preferential transfers under the Bankruptcy Code. Specifically, LCPI alleges that the elevations: (i) constituted transfers of LCPI’s interest in property; (ii) occurred within 90 days of LCPI’s bankruptcy filing; (iii) were to or for the benefit of the participants; (iv) were made on account of antecedent debts owed by LCPI to the participants under the LMA participations; (v) were made at a time when LCPI was presumed to have been insolvent;2 and (vi) resulted in payment in full of the debts and liabilities of LCPI to the participants, who are mere unsecured creditors of LCPI, enabling the participants to receive more than they would have received in a chapter 7 liquidation.

Further review and analysis of the underlying documents and facts regarding each participation will be necessary to see if there are any defects in or defenses to the claims made by LCPI (e.g. that the transaction was in the ordinary course of business or that the participant provided new value). To the extent the elevations are deemed to be preferences, LCPI also seeks to recover any payments of principal, interest and fees the participants received from the relevant borrowers subsequent to the elevations.


Under the Bankruptcy Code, LCPI had to bring proceedings to unwind elevations of LMA participations within two years of its bankruptcy filing. LCPI brought 58 such avoidance actions and also entered into tolling agreements with respect to more than 4,100 parties to preserve rights and to avoid the need to commence litigation. To the extent LCPI is unable to reach consensual resolutions with LMA participants that entered into such tolling agreements, it is likely that LCPI would commence proceedings to unwind the applicable elevations prior to the termination of the agreed upon tolling periods.

Prosecution of the avoidance actions that were brought were also stayed for a period of nine months, subject to certain conditions, pursuant to an order entered by the Bankruptcy Court on October 20, 2010 in order to permit the parties to engage in discussions to try to consensually resolve the disputes.3


The proceedings brought by LCPI to avoid the elevations of LMA participations and to claw back payments received by the participants implicate not only the individual defendants named in the complaints, but other participants that entered into tolling agreements with LCPI and potentially other parties that may have purchased elevated loans from such parties.

Until there is greater legal certainty about the novel issues raised by the LCPI proceedings, market participants should recognize that a "claw back risk" exists when elevating an LMA participation to a direct assignment when the grantor is potentially insolvent. Two practical lessons may be, (i) monitor the creditworthiness of the grantor and (ii) when the opportunity to elevate presents itself, do not delay.