Last September, Lehman Brothers
filed the biggest bankruptcy case in US history. Now, an upcoming decision by a US bankruptcy judge could set a precedent for how entities are paid when one of the parties in a collateralized debt obligation (CDO) becomes insolvent.
The case pits Lehman against Bank of New York Mellon (BK)
UK subsidiary BNY Corporate Trustee Services, acting on behalf of Australian asset manager Perpetual Investments
, who entered into a credit default swap with Lehman.
The contract, as written, provides for the investors to get paid before Lehman, since its bankruptcy constitutes a default. A UK judge upheld that interpretation and ruled in BoNY’s favor.
But Lehman petition the US bankruptcy court to intervene, citing the provision violates the US bankruptcy code’s anti-deprivation principle, which in essence protects a bankrupt entity from losing assets it would have normally have access, absent the bankruptcy.
The outcome of the case will have far-reaching effects that will go beyond the Lehman’s dispute. If the US judge rules in Lehman’s favor, it has the potential to affect all CDOs with US-based counterparties.
“If the court is to reject provisions of the documents as written, it will also put in question many aspects of structured finance deals, including ultimate recovery,” Moody’s Investor Services said in a recent Weekly Credit Outlook report.
This isn’t the first time Lehman’s has faced this issue during its bankruptcy. A similar transaction involving the Ballyrock CDO and its trustee, Wells Fargo (WFC)
is also making its way through the US bankruptcy court.
Write to Austin Kilgore