Lehman debtors file six lawsuits to fight payment priority changes

By Caroline Salls

Pittsburgh, Sept. 15 - Lehman Brothers Financial Products Inc. and Lehman Brothers Special Financing Inc. filed six lawsuits Tuesday against myriad trustee and issuers in an attempt to protect valuable contractual rights to senior priority payments in derivatives transactions and prevent unenforceable clauses from improperly modifying its right to priority payment of more than $3 billion under credit default swap agreements.

Five of the complaints filed in the U.S. Bankruptcy Court for the Southern District of New York address the alleged senior priority payment rights, and one deals with the swap agreement payment.

According to the credit default swap complaint, Lehman Brothers Special Financing purchased credit protection from the issuers in question in connection with 43 collateralized debt obligation transactions (CDOs).

Lehman Brothers Holdings Inc. provided credit support and guarantees to Lehman Brothers Special Financing under the swap agreements.

Under the CDOs, the trustee is required to make termination payments owned to Lehman Brothers Special Financing upon any early termination of the swap agreements before paying interest and principal to CDO noteholders.

However, the company said the transaction documents also include clauses that modify its senior payment priority, making the payment right junior to the payment rights of the noteholders when Lehman Brothers Special Financing was the defaulting party.

Lehman Brothers Special Financing said it became a defaulting party because of its bankruptcy filing.

Since the company lost its right to payment priority, the trustee liquidated and distributed the CDO collateral that would have otherwise gone to Lehman to the noteholders, costing the bankruptcy estate and creditors more than $3 billion.

As a result, Lehman filed the swap agreement lawsuit in an attempt to restore its rights and interests in the swap agreements.

Lehman said the priority payment modification provisions are unenforceable because enforcement violates the automatic stay imposed by its bankruptcy filing.

Derivatives complaints

The Lehman entities said the other lawsuits stem from provisions in derivatives transactions, the application of which were conditioned on the filing of a bankruptcy case.

The plaintiffs said these provisions deprived them of property interest by taking senior payment priority from the companies, replacing it with junior payment priority and transferring the senior priority to noteholders.

In some cases, Lehman said their right to payment under the derivatives transactions was totally eliminated.

Under the transaction documents, when Lehman Brothers Special Financing and Lehman Brothers Financial Products have a claim against a particular issuer because the agreement is in the money, the claim has a senior priority to the noteholders' claim.

However, the occurrence of an event of default relegates the payment to junior priority or no payment status.

Like in the swap agreement, the Lehman debtors defaulted on the derivatives transactions when they filed for bankruptcy.

In these complaints, the companies are asking the court to rule that the priority changes violate the Bankruptcy Code and the automatic stay.

New York-based Lehman Brothers Holdings Inc. was the fourth-largest investment bank in the United States. The company filed for bankruptcy on Sept. 15, 2008. Its Chapter 11 case number is 08-13555.

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