The United States Bankruptcy Court for the Southern District of New York entered an order on Sept. 17, 2009, granting a motion filed by Lehman Brothers Special Financing Inc. (“LBSF”) to compel Metavante Corporation (“Metavante”) to continue to make payments to LBSF under an ISDA Master Agreement. The court’s ruling provided that a non-defaulting swap participant that did not terminate its swap agreement following a bankruptcy proceeding by its counterparty must continue to make payments under such agreement (including past-due payments) in order to comply with the “safe harbor” provisions of the United States Bankruptcy Code (the “Code”).
Metavante and LBSF executed a 1992 ISDA Master Agreement (the “Master Agreement”) under which the parties entered into an interest rate swap. Lehman Brothers Holdings Inc. (“LBHI”) is the credit support provider under the Master Agreement. An event of default occurred under the Master Agreement when, on Sept.15, 2008, LBHI filed for bankruptcy. Since the event of default, Metavante has neither exercised its right to terminate the Master Agreement nor made any swap payments to LBSF. LBSF filed a motion to compel Metavante’s continued performance under the Master Agreement.
Metavante argued that it had no obligation under the Code to terminate the Master Agreement and no obligation under the Master Agreement to make swap payments following the event of default, citing Section 2(a)(iii) thereof, which states that an obligation to make a payment to a party is subject to the condition precedent that no event of default under the Master Agreement has occurred with respect to such party.
Unlike most commercial contracts, swap agreements like the Master Agreement are generally given “safe harbor” treatment under the Code, allowing non-debtor parties to terminate and liquidate such agreements after the filing of a bankruptcy petition by their counterparty. Each non-debtor party may then set off amounts due from and owed to the debtor counterparty under the swap agreement. According to the Hon. James M. Peck, the bankruptcy judge overseeing LBSF’s Chapter 11 case, Congress intended the safe harbor to allow counterparties to “promptly” liquidate their open positions following a bankruptcy. Judge Peck remarked that Metavante’s conduct of “riding the market for a period of one year” instead of terminating its swap agreement is not in the spirit of the safe harbor provisions.
The court thus held that neither the safe harbor provisions of the Code nor the Master Agreement permitted Metavante’s withholding of performance under the Master Agreement. Pursuant to the court’s order, Metavante must resume making quarterly payments under the swap agreement and pay LBSF over $6 million in missed payments, plus more than $300,000 in defaulted interest thereon.
Any swap counterparty that has suspended its payments to Lehman Brothers and has not terminated its agreement should review and consider carefully the court’s ruling when determining its course of action.