Lehman's 'flip' appeal flops in landmark ruling

A subsidiary of fallen Wall Street bank Lehman Brothers lost its final battle to overturn a key UK ruling over a swap dispute with Australian creditors in a decision dubbed a "game changer" by lawyers. The UK's Supreme Court unanimously upheld previous UK rulings that creditors should have priority in Lehman Brothers' $2.0 billion plus "Dante" programme of structured finance deals, which one judge described as "of a purgatorial complexity".
The closely-watched case, which comes at a time of rising litigation against banks over elaborate financial products sold before the credit crisis, hinges on whether a so-called "flip" clause can be enforced in the event of bankruptcy or default. Flip clauses, which are designed to separate the credit risk of swap counterparties from their investors, reverse the priority of termination payments if the swap provider defaults.
Elana Hahn, a lawyer at international capital markets law firm Morrison & Foerster, said more emphasis would be placed on the jurisdiction of counterparties in future asset-backed securities and structured products deals. "This ruling has resolved considerable market uncertainty but it is a 'game changer' in terms of global structured finance business," she said, adding that legal suits could be brought in the United States to re-examine the "flip" clause.
Dismissing the Lehman appeal in the A$91.1 million ($99.7 million) case, the Supreme Court said it relied, in part, on the 200-year-old "anti-deprivation rule" that in the event of a bankruptcy, property cannot be taken away from creditors. It was a principle Australian creditors Belmont Park Investors would have relied on before investing, it said.
"These transactions were designed, arranged and marketed by the Lehman group," judge Lawrence Collins stated on Wednesday. "The investors who bought the notes were in the main not banks. In the case of the Belmont noteholders they were Australian local authorities, pension funds, private investment companies and private individuals.
"There was evidence that the fact that the noteholders would have priority over the collateral in the event of LBSF's (Lehman Brothers Special Financing) insolvency was a very material factor in obtaining triple A credit ratings which enabled Lehman to market the notes." The Belmont group held credit-linked notes in the Dante CDO (collateralised debt obligation) programme, which had an overall value of around $12.5 billion when Lehman filed for bankruptcy in 2008.