Bankruptcy Law

Credit Default Swaps Complicate Lehman Bankruptcy

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The trustee in the Lehman Brothers bankruptcy will likely have to make an effort to “chase people down” who owe money in credit default swaps, a type of insurance policy that protects against a corporation defaulting on its debt.

Lehman was one of the 10 largest parties participating in credit default swaps, the New York Times reports. The company’s most recent quarterly filing said it bought and sold $729 billion in derivatives with a fair net value of $16.6 billion.

Such derivative contracts are exempted from an automatic stay that prevents creditors from collecting debts during the bankruptcy case, and that could tempt some parties to try to evade their contracts, a bankruptcy expert told the Times.

“People who have a contract that looks dicey now would rather just wash their hands of it,” said law professor David Skeel Jr. of the University of Pennsylvania. “This sets up a circumstance where these people can try to slip away into the night. It is a waste of precious time for the bankruptcy trustee to have to chase people down.”

On the other hand, companies that are due money from Lehman in such contracts may try to collect outside of bankruptcy court, the Times story says.

Even if the company sells off its derivative contracts, it’s unclear just how much the investment bank will be able to recover, said law professor Frank Partnoy of the University of San Diego. “The really interesting question that no one knows the answer to is, if you were to go into liquidation and sell off all the derivatives contracts, what is the value?” he told the newspaper. “We are just learning that no one, not even the senior people within these banks, knows how much these contracts are worth.”

Lehman listed $639 billion in total assets in a Chapter 11 filing yesterday that prompted creditors to rush in to preserve their interests. Luc Despins, a partner at Milbank, Tweed, Hadley & McCloy, told the newspaper that speed is important. “The lesson generally from these cases in terms of companies that own financial assets is that time is of the essence,” he said. “If you want to recover the maximum value possible, you have to move really fast, because any value there now may be frittering away.”

Lehman is represented by Harvey Miller, a lawyer at Weil, Gotshal & Manges who represented Drexel Burnham Lambert in its 1990 bankruptcy filing.

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