Lehman Brothers Holdings Inc. and its affiliated debtors (collectively, the “Debtors”) filed a motion in the bankruptcy court on Nov. 13, 2008, asking the court to approve procedures for (i) assuming (affirming) and assigning derivative contracts entered into before the Debtors commenced their bankruptcy cases, including resolving cure amounts; and (ii) entering into settlement agreements that may establish termination payments and the return of collateral under terminated derivative contracts.

Debtors’ Derivative Contracts

The Debtors estimate that as of Nov. 13, 2008, they are party to approximately 930,000 derivative contract transactions, of which approximately 733,000 are purported to have been terminated by counterparties after the Debtors commenced their bankruptcy cases. The Debtors believe that many counterparties to derivative contracts may not have yet exercised their termination rights because termination of their derivative contracts would result in a net payment to the Debtors. These “in the money” contracts (from the Debtors’ perspective) constitute significant assets of the Debtors’ estates, but the Debtors fear that movements in the financial markets could reduce the net amounts owed to the Debtors and destroy the value available to their estates.

To avoid losing value from “in the money” derivative contacts, the Debtors intend to assume and assign some or all of the contracts to third parties in exchange for consideration that will provide realizable value to the Debtors. While many of the derivative contracts require the counterparty’s consent as a condition to assignment, the Debtors believe that the Bankruptcy Code authorizes them to assume and assign the derivative contracts over a counterparty’s objection if they satisfy certain requirements.

Proposed Procedures for Assuming and Assigning Derivative Contracts

The Debtors propose the following procedures for assuming and assigning pre-petition derivative contracts:

  1. The Debtors will give at least five business days’ notice to the counterparty of any derivatives contract to be assumed and assigned. The notice will state (i) the names and addresses of the counterparties; (ii) identify the derivative contracts to be assumed and assigned; (iii) either (x) that any assignee or its credit support provider will have a Standard & Poor’s or Fitch credit rating equal to or higher than A- or a Moody’s credit rating equal to or higher than A3, or any equivalent thereof (a “Qualified Assignee”), or (y) the identity of any proposed assignee and its credit support provider, if any, if neither is a Qualified Assignee; and (iv) any amount proposed by the Debtors to be paid to cure existing defaults (“Cure Amounts”).
  1.  If a derivative contract requires the Debtors to return posted collateral as part of a Cure Amount, the Debtors will either return the collateral or, if the collateral is no longer in the Debtors’ possession, the Debtors will pay an amount equal to the value of the collateral as of the business day before service of the assignment notice based upon independent third-party pricing services. This payment will be considered to be full satisfaction of the obligation to return posted collateral. The Debtors’ proposed manner of returning any such collateral, including any amount proposed to be paid for collateral no longer in the Debtors’ possession, will be included as a Cure Amount in the assignment notice.
  1. If a counterparty wishes to object to the assumption and assignment of its derivative contract, it must serve a written objection so that it is actually received no later than five business days after the Debtors served the assignment notice.
  1.  Unless the Debtors solicit bids from at least four potential assignees and select the highest or best bid received within a reasonable time period from such potential assignees, the Debtors will request consent from the creditors’ committee to assume and assign the derivative contract under the court-approved procedures. If a derivative contract is memorialized by a master agreement, the Debtors must assume and assign collectively all of the derivative contract transactions under the master agreement.
  1. If no objection is timely served by a counterparty, or a counterparty affirmatively consents to the assignment and any required consent from the creditors’ committee is received, the Debtors will be authorized (but not required) to assume and assign the derivative contract.

Proposed Procedures for Resolving Termination Payments

Alternatively, the Debtors seek authority to enter into termination agreements with derivative contract counterparties. If the motion is approved, the termination agreements may provide for any of the following:

  • Resolution and fixing of amounts owing between a Debtor and a counterparty
  • Counterparty releases
  • Liquidation or return of collateral or margin held by a Debtor or a counterparty in accordance with a derivative contract, applicable master netting agreement, or termination agreement

Approval of Motion

A hearing by the Bankruptcy Court on the motion has been scheduled for Dec. 3, 2008, at 10 a.m. (EST). Objections to the motion must be filed and served by 4 p.m. (EST) on Nov. 28, 2008.

A copy of the motion can be accessed here.