Lehman debtor files lawsuit to protect $400 million credit default swap contract investment

By Caroline Salls

Pittsburgh, Feb. 3 - Lehman Brothers Holdings, Inc. debtor Lehman Brothers Special Financing, Inc. filed a lawsuit Tuesday against Ballyrock ABS CDO 2007 1 Ltd. and Wells Fargo, NA in an attempt to protect Lehman Special Financing's alleged contractual right to more than $400 million under a credit default swap agreement.

According to the complaint filed with the U.S. Bankruptcy Court for the Southern District of New York, Lehman Brothers Special Financing and Ballyrock entered into a credit default swap contract under which Ballyrock, a special purpose entity formed solely for the transaction, agreed to pay Lehman Brothers Special Financing if losses were incurred on underlying assets, mostly consisting of residential mortgage-backed securities.

In return, Lehman Brothers Special Financing agreed to pay a periodic premium to Ballyrock, and it purchased contractual protection that could potentially pay it hundreds of millions of dollars in case of losses connected to the specified residential mortgage-backed securities.

Lehman said the investors in Ballyrock stood to profit if there were few or no losses on the securities.

Because of the steep decline in the housing market and the ensuing poor performance of residential mortgage-backed securities, Lehman Brothers Special Financing alleges that its investment is now worth more than $400 million, "while investors in Ballyrock should be expected to receive little or none of their investment since the deal has turned out so badly for them."

As a result, Lehman Brothers Special Financing said it filed the lawsuit to protect its contractual right to more than $400 million from Ballyrock, and to enjoin trustee Wells Fargo from improperly distributing the more than $137 million in remaining assets to Ballyrock's investors because they are allegedly the property of Lehman Brothers Special Financing.

Lehman Brothers Special Financing said the credit default swap agreement in question is "in the money" to it by more than $400 million, but Wells Fargo is still looking to distribute the remaining assets to Ballyrock's investors instead of paying them to the plaintiff because of a default related to Lehman's bankruptcy filing.

"The investors in Ballyrock - who made a poor investment decision - will receive a windfall at the expense of LB Special Financing and its creditors," Lehman Brothers Special Financing said in its complaint.

New York-based Lehman Brothers Holdings is the fourth largest investment bank in the United States. The company filed for bankruptcy on Sept. 15. Its Chapter 11 case number is 08-13555.

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