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Lehman Brothers' ADR Procedures for Resolving Its Derivative Contracts in Bankruptcy

BY Andrew J. Olejnik
May 27, 2012

Lehman Brothers' bankruptcy case was the largest and most complex Chapter 11 case in history. Among other complexities, when Lehman filed for bankruptcy on Sept. 15, 2008, it was a party to approximately 1.2 million derivative transactions with approximately 6,500 counterparties. Lehman had entered into derivative transactions through a number of wholly owned subsidiaries, both in a trading capacity and as an end-user. No Chapter 11 debtor had had as many or as complex a collection of derivative contracts. Disputes relating to the contracts threatened to become a quagmire of extensive and costly litigation. However, Judge James Peck, overseeing the Lehman bankruptcy, approved alternative procedures, proposed by Lehman's bankruptcy counsel (Weil, Gotshal & Manges), to resolve these disputes. This approach to these issues undoubtedly contributed to Lehman's ability to resolve its bankruptcy case with a consensual plan in less than three-and-a-half years.

Assessing the Situation

Lehman's bankruptcy filing constituted an event of default under most (if not all) of its derivative contracts. As a result, the vast majority of its counterparties terminated their transactions with Lehman (by election or automatic termination), accelerated amounts owed, and exercised rights of setoff against collateral in their possession. Although Sections 362 and 365(e)(1) of the Bankruptcy Code generally prohibit the termination of contracts as a result of a bankruptcy filing, certain financial contracts are exempted by the “safe-harbor” provisions of the Bankruptcy Code. Some counterparties, however, did not exercise their termination rights.

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