On December 16, 2008, the United States Bankruptcy Court overseeing the Lehman Brothers bankruptcy proceedings entered an order establishing procedures for the assignment and termination of certain Lehman Brothers swap and other derivative transactions. The order is in response to a motion to establish such procedures filed by Lehman on November 13, 2008. There were numerous objections to that motion, including an objection from the Creditors Committee.1
The order sets forth procedures for both assignments and terminations of swaps and reflects a compromise between what Lehman initially sought and issues raised in objections to the motion.2 As a general matter, the order gives Lehman the right to assume and assign swaps that have not been validly terminated and the right to effect terminations and settlements of certain swaps. This client update speaks to the assumption and assignment process for borrowers (“counterparties”) whose Lehman swaps remain outstanding.
In its motion, Lehman sought the right to assume and assign swap agreements on a very brief time frame (five business days) as well as the right to assign a swap agreement to any “qualified assignee”, defined as an entity holding at least an A3 rating from Moody’s or an A- rating from either Standard & Poor’s or Fitch. Most objections to the motion focused on the time frame and the fact that Lehman’s counterparties could not object to any “qualified assignee”, regardless of its identity.
The order includes a somewhat expanded time frame for objections (depending on the number of transactions subject to the agreement, either ten or twenty business days between receipt of notice and filing of an objection). It also creates greater transparency with respect to possible assignees, and does not permit the “as of right” assignment to a “qualified assignee” originally sought by Lehman.
The order permits Lehman to deliver a notice (an “Assignment Notice”) to one or more counterparties giving them ten business days notice of proposed assignment of their swaps.3 Each Assignment Notice must contain: (1) the names and addresses of the affected counterparties; (2) identification of the derivative contracts in question4; (3) the identity of as many as 12 proposed assignees and/or their guarantors and their ability to perform under the contracts proposed to be assigned; and (4) if applicable, any amounts proposed to be paid by Lehman to cure existing defaults and compensate for actual losses by a counterparty related to the defaults.
For swaps in which Lehman has payment obligations to the counterparty, the assignment process requires that the counterparty be paid a cure amount. In addition, to the extent that Lehman had been given collateral by the counterparty, that collateral either must be returned or its value paid as part of the cure amount on the business day prior to the Assignment Notice being delivered.
Counterparties may object to the Assignment Notice on several bases: (1) the proposed cure amount; (2) the need to cure a default or early termination event (other than a default relating to the Lehman bankruptcy filing); (3) the proposed assignment does not result in adequate assurance of future performance (unless, following payment by Lehman of the cure amount, the assignee could have no ongoing payment or delivery obligations for the remaining term of the contract or upon termination); (4) the counterparty believes it had validly terminated the contract; or (5) the identity of the assignee (or the guarantor), including an objection that the assignment would either give the assignee the right to terminate the contract or impose additional obligations on the counterparty. Objections must be received no later than ten business days after delivery of the Assignment Notice.5
Objections must specify the counterparty’s basis for objecting, including, as applicable: (1) what the counterparty believes the cure amount is; (2) any defaults or termination events which must be cured in order for the assignment to proceed (or which cannot be cured); (3) the basis on which the counterparty believes the contract was validly terminated; or (4) the reasons why the counterparty objects to an assignment of the contract to any of the proposed assignees/guarantors.
A counterparty’s failure to deliver a timely objection will waive any objections that otherwise might have been raised to either actions and events that occurred prior to the assignment or the proposed assignee. More specifically, the order provides that a non-objecting counterparty will be deemed: (1) to have consented to any cure amount and the assumption and assignment of the swap; (2) to have agreed that the assignee will provide adequate assurance of future performance; (3) to have agreed that all outstanding defaults prior to the assignment have been cured, so that neither Lehman nor the assignee will have any liability for any pre-assignment default or obligation, and the contract will remain in full force and effect following its assignment; (4) to have agreed that the order applies to the assignment; and (5) to have waived any right to either terminate the contract or designate an early termination date under the contract as a result of any default that occurred or was continuing prior to the assignment.6
If an objection is filed, and Lehman and the counterparty are unable to resolve their differences, the assignment may nevertheless proceed if the court enters an order to that effect or, if the dispute relates only to the cure amount, Lehman pays the undisputed amount and creates an escrow for the disputed amount.
If: (1) a counterparty does not file a timely objection to the Assignment Notice (or agrees to the proposed assignment); (2) the dispute relates solely to the cure amount (and Lehman makes the required payment/escrow); or (3) the court authorizes the proposed assignment, then Lehman may proceed to assign the contracts identified in the Assignment Notice.7
Upon assignment of a contract, the assignee or guarantor will assume the contract with all defaults having been waived or cured, and with Lehman having no more claims against the counterparty. However, to the extent that Lehman had either defenses or counterclaims against the counterparty, those will survive the assignment. Within five business days after an assignment is consummated, Lehman must provide the counterparty with notice of the effective date of the assignment, any cure amount that has been paid, and the identity and contact information of the assignee (and its guarantor, if applicable). The notice must include an instrument executed by the assignee assuming all obligations under the assigned contract and, if applicable, a guarantee of the assignee’s obligations.
With assumption and assignment procedures having been approved by the court, it is expected that Lehman will begin seeking to assign its existing swaps in the near future. Consequently, counterparties with Lehman swaps need to be diligent about dealing expeditiously with the receipt of an Assignment Notice in order to best protect their rights under their swap contracts.
[1] Some objections by specific parties remain outstanding, and are scheduled for hearing on January 14, 2009.
[2] The order resolved approximately two-thirds of the objections to the original motion.
[3] Twenty business days notice must be given to counterparties with 100 or more derivative transactions or 50 or more Fully Paid Contracts (defined as contracts in which the assignee, after payment by Lehman of any cure amounts, could have no ongoing payment or delivery obligation for the term of the contract).
[4] In the case of contracts subject to a master agreement, Lehman must assign the entire master agreement and all transactions under that master agreement to a single assignee.
[5] Except for the contracts identified in footnote 3, with respect to which counterparties have twenty days to deliver the objection.
[6] The order does not, however, affect the rights of counterparties under the Bankruptcy Code to exercise certain liquidation, termination, acceleration, and setoff rights prior to the consummation of an assignment. In order to terminate a derivative contract based on a pre-assignment default, the counterparty must deliver the termination notice to Lehman so that it is received prior to the consummation of the assignment.
[7] Although Lehman is authorized to proceed, the order makes it clear that Lehman is not obligated to do so. In order to actually assign a contract, Lehman either must solicit bids from at least four potential assignees and select the highest or best bid or receive the consent of the Creditors Committee to the proposed assignment. As a general matter, if Lehman does not