Lehman Brothers set for landmark appeal

By Anousha Sakoui FT, August 4 2009

Lawyers for the Lehman Brothers US estate will appeal against a decision by English courts that retail investors from Papua New Guinea, Australia and New Zealand should be paid ahead of the failed bank in the unwinding of a complex structured vehicle, according to people familiar with the situation.

The case over the ranking of creditors to a special purpose vehicle – SPV – called Dante, to which Lehman was a swap counterparty, is being closely watched for its potential implications for the securitisation and derivatives market.

It highlights the Lehman administrators’ fight to unwind 1.2m derivative contracts worth a net $40bn (€28bn) to which the bank was a counterparty, of which Dante is one such transaction. The gross notional value of derivative assets is $39,000bn for Lehman entities in Chapter 11.

Dante is one of a string of SPVs created that issued credit-linked notes to investors and to which Lehman is a swap counterparty. Swap counterparties are normally repaid ahead of other creditors, unless the counterparty is in default.

As Lehman is in default, investors in that SPV represented by Perpetual Trustee Company as trustee believe they should be paid out ahead of Lehman, as is set out under the English law documents governing the transaction. The Lehman estate is owed $100m, according to these people.

But lawyers for Lehman Brothers Special Financing believe the subordination of Lehman’s claim is contrary to US bankruptcy laws, which do not allow forfeiture of assets on bankruptcy.

While the English courts sided with the investors, unusually the judge stayed any enforcement of the collateral until any appeals have been heard.

“In staying the effect of his ruling, the judge both permitted Lehman to pursue its appeals in the English courts and, more importantly, recognised that the application of US bankruptcy law could compel a different result,” said a person with knowledge of the case.

The case could take years to resolve and highlights the difficulties lawyers face unwinding many structured vehicles, legacies of the credit boom, which were not set up with failure or insolvency in mind.

Analysts believe the case could have important implications for the securitisation market.

“A ruling against the investors would be hugely negative for the credit markets as the concept of bankruptcy remoteness will most likely not be value for any transaction if the swap counterparty has a US connection,” said analysts at Creditsights in a report. They believed such a decision could lead to further rating downgrades for similar collateralised debt obligations and could force rating sensitive investors to sell their holdings, pushing spreads up.