On April 19, 2012, the Lehman bankruptcy court handed down its decision on the long-pending motion to dismiss filed by JPMorgan Chase Bank, N.A., in response to Lehman Brothers Holdings Inc.’s $8.6 billion avoidance action against it. The action sought to recover the value of collateral taken by JP Morgan in its role as principal clearing bank to Lehman in the run-up to the Lehman insolvency.

JP Morgan asserted that much of the collateral was taken in connection with transactions that were safe-harbored under the Bankruptcy Code—principally securities contracts—and therefore was protected from avoidance under section 546(e) of the Code and parallel provisions applicable to other safe-harbored agreements. The bankruptcy court’s decision, on the one hand, offers a broad and supportive reading of the Code’s safe-harbor from avoidance, but, on the other hand, (i) limits the meaning of the word “transfer” in section 546(e) in a manner that could be more significant on other facts and (ii) endorses a generous standard of pleading “actual intent” to defraud that may allow an easy means of skirting the safe-harbor.

On the pro-safe-harbor side, the court held:

  • The definition of “securities contract” is “very broad in its application and encompasses virtually any contract for the purchase or sale of securities, any extension of credit for the clearance or settlement of securities transactions and a wide array of related security agreements and guarantee agreements.”
  • No specific language is required to connect related agreements for purposes of the safe harbor “in connection with” wording.
  • The “in connection with” language of section 546(e) permits collateral to be taken and applied against future exposure not yet existing at the time the collateral was taken.
  • Although the court held that the safe harbors protect transfers and not the incurrence of obligations, the “notional ability to assert that an obligation is not exempt from avoidance is not an acceptable means to … undermine … the safe harbors.” Thus, even if a guarantee may be avoided, transfers of security interests and collateral in connection with that guarantee are safe harbored, so long as the guarantee was in connection with securities contracts. (Note that this reading of “transfer” as distinguishable from incurrence would leave an unsecured guarantee wholly voidable.)

On the anti-safe harbor side, the bankruptcy court allowed a very liberal interpretation of what constitutes sufficient pleading of “badges of fraud” to maintain allegations of actual fraud by JP Morgan that could allow avoidance. The court’s conclusion that the usual strict pleading standard applicable to allegations of fraud “may be relaxed” in this “exceptional and distinguishable” case is striking, given the ability of such pleading to side-track expeditious treatment of safe-harbor cases. This aspect of the decision is in stark contrast to the court’s earlier endorsement of the proposition that prompt disposition of safe harbor cases is essential to the effectiveness of the safe harbors.