## Facts

- A special purpose issuer issued credit-linked synthetic portfolio notes to investors; the notes were backed by collateral held by a trustee.
- Lehman Brothers Special Financing Inc. (LBSF) entered swap agreements with the issuer, and LBSF’s swap-related rights were secured by the collateral.
- Transaction documents created competing claims to the collateral between noteholders and LBSF and set a payment “waterfall” for distributions.
- The documents included “flip” provisions that, upon specified events of default tied to Lehman insolvency/bankruptcy, changed priority from “Swap Counterparty Priority” (favoring LBSF) to “Noteholder Priority” (favoring investors).
- After Lehman’s chapter 11 filings, counterparties asserted that the flip provisions were triggered and that noteholders should be paid ahead of LBSF.
- Parallel proceedings in England addressed similar priority questions under English law, reaching conclusions favorable to enforcing the flip under English doctrines.
- LBSF filed an adversary proceeding in the U.S. bankruptcy court and moved for summary judgment seeking a declaration that the flip provisions were unenforceable and that LBSF retained priority.

## Issues

1. Whether the insolvency-triggered flip provisions were unenforceable ipso facto clauses under 11 U.S.C. § 365(e)(1) because they modified LBSF’s rights due to bankruptcy/insolvency.
2. Whether enforcing the flip provisions would impermissibly diminish the debtor’s interests in collateral constituting estate property based solely on bankruptcy-related events.
3. Whether comity or choice-of-law considerations required deference to the pending English litigation rather than applying U.S. bankruptcy law to the priority dispute.

## Decision

- The court granted LBSF’s motion for summary judgment.
- The court held the flip provisions unenforceable as ipso facto clauses under § 365(e)(1) to the extent they changed priority based on Lehman’s insolvency or bankruptcy filings.
- The court determined LBSF had a cognizable interest in the collateral that could not be subordinated solely because of bankruptcy-related events of default.
- The court declared that, with the flip provisions invalidated, the operative payment waterfall remained “Swap Counterparty Priority,” giving LBSF priority over noteholders in distributions from the collateral.
- The court declined to let foreign-law conclusions override the Bankruptcy Code’s effect on the debtor’s contractual rights and estate property.

## Legal Principles

- Section 365(e)(1) renders unenforceable contractual provisions that terminate or modify a debtor’s rights under an executory contract solely because of insolvency or the commencement of a bankruptcy case.
- A priority-shifting “flip” triggered by the debtor’s insolvency or bankruptcy is a prohibited modification when it reallocates value away from the estate based on an ipso facto condition.
- In administering estate property and applying Bankruptcy Code protections, a bankruptcy court may apply U.S. bankruptcy law notwithstanding parallel foreign proceedings that would enforce the same provisions under foreign law.
- When an ipso facto priority flip is invalidated, the pre-default contractual priority scheme remains in effect for purposes of distributions.

## Conclusion

The bankruptcy court held that insolvency-triggered flip clauses reallocating collateral payment priority away from LBSF were unenforceable under § 365(e)(1) and declared that swap counterparty priority governed distributions from the collateral notwithstanding contrary positions advanced in related foreign litigation.


Lehman Bros. Special Fin. Inc. v. BNY Corp. Tr. Servs. Ltd. (In re Lehman Bros. Holdings Inc.), 422 B.R. 407 (Bankr. S.D.N.Y. 2010)