## Facts

- Michigan State Housing Development Authority (MSHDA), a Michigan public authority, entered into an ISDA Master Agreement and related swap confirmations with Lehman Brothers Derivatives Products Inc. (LBDP) to execute interest-rate swaps.
- The documentation included standard close-out terms using “Market Quotation” under the “Second Method,” and additional “Trigger Events” that could permit termination using a “Mid-Market” valuation.
- After Lehman Brothers Holdings Inc. (LBHI) filed for chapter 11 in September 2008, the swaps were assigned from LBDP to Lehman Brothers Special Financing Inc. (LBSF) through an Assignment and Amendment Agreement.
- The amendment added a “Liquidation Paragraph” that tied the close-out valuation method to the reason for termination:
  - If MSHDA terminated due to LBSF’s bankruptcy or nonpayment, Market Quotation applied.
  - If termination occurred for any other reason, Mid-Market applied.
- LBSF filed for chapter 11 in October 2008, and MSHDA terminated the swaps post-petition.
- Applying Market Quotation under the Liquidation Paragraph, MSHDA calculated and paid approximately $36 million as the termination amount.
- LBSF later argued the Liquidation Paragraph was an unenforceable ipso facto provision and sought to revalue the close-out using Mid-Market, which it contended would reduce the amount payable.

## Issues

1. Whether the Liquidation Paragraph’s bankruptcy-contingent choice of valuation method was an unenforceable ipso facto modification under 11 U.S.C. § 365(e)(1).
2. Whether contractual provisions that specify the close-out valuation methodology are protected as part of the safe-harbored rights to liquidate, terminate, and determine settlement amounts under 11 U.S.C. §§ 560 and 561.

## Decision

- The court granted summary judgment in favor of MSHDA on the enforceability of the Liquidation Paragraph.
- The court held the Liquidation Paragraph was part of the contractual liquidation mechanics of a swap agreement and fell within the Bankruptcy Code’s swap safe harbor.
- The court ruled that § 365(e)(1) did not invalidate the provision because §§ 560 and 561 permit enforcement of swap liquidation rights even when triggered by bankruptcy.
- MSHDA’s Market Quotation close-out calculation and the approximately $36 million termination payment were upheld, and LBSF’s revaluation claim was rejected.

## Legal Principles

- The swap safe harbor in 11 U.S.C. § 560 protects not only the right to terminate and liquidate a swap agreement upon bankruptcy-related conditions, but also contractually specified methods used to calculate and settle the termination amount.
- A close-out provision that conditions valuation methodology on the cause of termination can be treated as part of the bargained-for economic terms governing liquidation, rather than as a prohibited bankruptcy penalty.
- The general ipso facto invalidation rule in 11 U.S.C. § 365(e)(1) is displaced for swap agreements to the extent §§ 560 and 561 protect contractual liquidation and settlement provisions.

## Conclusion

The bankruptcy court held that a swap agreement’s close-out valuation clause switching between Market Quotation and Mid-Market based on a bankruptcy-related termination trigger was enforceable under the Bankruptcy Code’s swap safe harbors, so the post-petition termination payment calculated using Market Quotation stood and could not be recalculated under § 365(e)(1).


Mich. State Hous. Dev. Auth. v. Lehman Bros. Derivatives Prods. Inc. (In re Lehman Bros. Holdings Inc.), 502 B.R. 383 (Bankr. S.D.N.Y. 2013)