credit derivatives in bankruptcy
The ever insightful credit slips has begun a great series of posts on the treatment of derivatives in bankruptcy; a topic of great relevance to anyone who has been / is a counterparty to such an agreement with Lehman Brothers.
Seems like more and more of these cases are going to pop up. Almost all of them will address some very interesting legal questions. Helpfully, the post explores some of the relevant issues and arguments by detailing the current action brought by the Chicago Board of Education :
[For example], the Chicago Board of Education has filed an adversary proceeding to stop Lehman’s attempt to assume and assign an interest rate swap under which Lehman is currently owed (after netting) more than $1.1 million. The swap was one of several the Board entered into in connection with a debt offering, and was to have run until March 2034, with a declining notional amount after 2017. As interest rates have fallen since the swap was signed, the swap has become valuable to Lehman. If interest rates had risen, Lehman would have been subsidizing the Board’s debt payments…
Essentially the Board is trying to develop a form of early termination that is not recognized by the Master Agreement (the “no payment termination”). A fine common law argument, but for the contract itself.
This bears watching. A ruling in favor of the Board would give non-debtor counterparties a huge windfall – essentially an option to ignore bad bets on derivative contracts simply because of a bankruptcy filing. That is an even greater power than the option to end the deal,contained in an ipso facto clause and now clearly enforceable because of the safe harbors.
I think this series of posts will reap handsome dividends for those who pay attention to matters credit. Plenty of actionable insight to be gleaned from the good folks at CS.
Sorry for less frequent updates – I have had some major travel to hack through. No promises, but may be able to begin stepping up the posting tempo soon.
