## Facts

- Lehman Brothers Special Financing Inc. (LBSF) acted as swap counterparty in 44 synthetic CDO transactions structured through special-purpose issuers that sold notes to investors.
- Note proceeds purchased collateral securities held by a trustee; collateral income funded payments on the notes.
- Each transaction consisted of an indenture (issuer–trustee–noteholders) and a swap (issuer–LBSF) that cross-referenced each other and functioned as a single deal.
- The indentures included “flip clauses” that gave LBSF priority to collateral proceeds unless an event of default occurred with respect to LBSF (including a bankruptcy of Lehman Brothers Holdings Inc. (LBHI) as credit support provider), in which case priority shifted to noteholders.
- LBHI filed for Chapter 11 on September 15, 2008, triggering an event of default under the swap documentation.
- The trustee terminated the swaps, liquidated the collateral, and distributed proceeds pursuant to the flipped priority; the collateral was insufficient to pay both noteholders and LBSF, leaving LBSF unpaid despite being in the money on the swaps.
- LBSF later sued to recover the distributions, arguing the flip clauses were unenforceable bankruptcy-triggered provisions and that the distributions violated the automatic stay and related Bankruptcy Code limits.

## Issues

1. Whether the flip clauses were unenforceable bankruptcy-triggered provisions under the Bankruptcy Code’s anti-ipso-facto rules and/or barred by the automatic stay.
2. Whether 11 U.S.C. § 560’s safe harbor for “swap agreements” nevertheless permitted termination, liquidation, and application of collateral pursuant to the flip clauses.
3. Whether priority-shifting terms located in the indentures (rather than only in swap forms) were part of, or connected to, “swap agreements” for purposes of § 560.

## Decision

- The Second Circuit affirmed dismissal of LBSF’s complaint.
- The court held that the trustee’s termination of the swaps, liquidation of collateral, and distribution of proceeds pursuant to the flip clauses were protected by the § 560 safe harbor.
- The court concluded that, even if the flip clauses could be characterized as ipso facto provisions in another setting, § 560 permitted their enforcement in connection with swap termination and liquidation notwithstanding the automatic stay and general anti-ipso-facto provisions.
- The court treated the indentures and swaps as integrated transactions and held the priority-shifting terms were within the rights exercised “under or in connection with” swap agreements.

## Legal Principles

- Under 11 U.S.C. § 560, a swap participant may exercise contractual rights to liquidate, terminate, or accelerate swap agreements based on specified conditions, notwithstanding the automatic stay and general anti-ipso-facto restrictions.
- “Swap agreement” and related protected rights under § 560 are construed broadly, including rights embedded in integrated transaction documents that govern how collateral is applied upon swap termination and liquidation.
- Contractual priority shifts in collateral distributions can fall within § 560 when they operate as part of the contractual mechanism for liquidation and settlement of the swap following a specified default.
- Where § 560 applies, a debtor cannot recharacterize safe-harbor-protected termination/liquidation steps as prohibited post-petition conduct, avoidable transfers, or improper depletion of estate property.

## Conclusion

The Second Circuit held that, in integrated synthetic CDO structures, flip clauses reallocating collateral proceeds upon a bankruptcy-related default were enforceable because § 560 shields the termination, liquidation, and collateral application steps connected to swap agreements from the automatic stay and general anti-ipso-facto limits.


Lehman Bros. Special Fin. Inc. v. Branch Banking & Tr. Co. (In re Lehman Bros. Holdings Inc.), 970 F.3d 91 (2d Cir. 2020)