The Second Circuit recently affirmed that provisions setting priority of payments in CDOs marketed by Lehman Brothers Special Finance, Inc. are enforceable, and dismissed LBSF’s attempt to claw back approximately $1 billion of distributions to the CDO noteholders that were made after Lehman Brothers Holdings Inc. commenced a bankruptcy case in 2008.  Crediting the arguments of the Structured Finance Industry Group—represented by Freshfields as amicus curiae [1]—the Second Circuit held that, even if the Priority Provisions functioned as ipso facto clauses that modified the rights of LBSF upon the filing of a bankruptcy case, the safe harbor established in Section 560 of the United States Bankruptcy Code would still exempt the priority provisions from the Code’s general prohibition on ipso facto clauses.  In the Second Circuit’s opinion, Section 560 protected payments made to the noteholders pursuant to the priority provisions because, inter alia, the term “liquidation” in Section 560—which protects the right of a “swap participant” to “cause the liquidation, termination or acceleration” of a “swap agreement” upon a counterparty’s insolvency—was broad enough to include the distribution of assets to satisfy the parties’ respective positions on termination of a swap agreement.

The Second Circuit’s decision provides comfort to parties to swap agreements that they can use priority-of-payment provisions to protect themselves from the risks associated with the bankruptcy of their counterparties or their counterparties’ guarantors.  Freshfields has published a more detailed analysis of the Second Circuit’s decision, including implications for swap participants, in our related client alert here.

[1] Madlyn Gleich Primoff, Tim Harkness, David Livshiz, Henry Hutten and Jill Serpa of Freshfields’ New York office represented SFIG.