Co-underwriters with Lehman Brothers Inc. don’t have so-called contribution claims against the liquidated investment bank related to offerings in which it was the lead underwriter in the sale of its own securities.
Also as the result of a Sept. 5 ruling by a federal district judge in New York, hedge funds in effect won’t have claims when Lehman, acting as a prime broker, failed to carry out trades in its own securities.
U.S. Bankruptcy Judge James M. Peck ruled in January that hedge fund manager Claren Road Asset Management LLC and underwriters ANZ Securities Inc. and USB Financial Services Inc. in substance didn’t have claims to be paid in the Lehman brokerage’s liquidation under the Securities Investor Protection Act. Peck’s opinion was upheld Sept. 5 by U.S. District Judge Shira A. Scheindlin in Manhattan.
The underwriters filed contribution claims, claiming that the bankrupt brokerage was liable to them for its share of costs of defense and settlement on being sued for misstatements when Lehman was the lead underwriter of its own securities. ANZ claimed $78 million, while UBS wanted $250 million.
Claren Road submitted an $8.5 million claim, contending Lehman was its prime broker and failed to execute a trade in Lehman securities.
Scheindlin said the appeal revolved around Section 510(b) of the Bankruptcy Code, which says a claim for damages arising from the purchase or sale of securities of a bankrupt “or of an affiliate” will be subordinated to claims of unsecured creditors.
The same section provides that claims for contribution are similarly subordinated.
Scheindlin rejected the creditors’ arguments based on a close reading of the statutory language. To uphold Peck, she focused more on the purpose of the subordination provision “to ensure that creditors receive their distribution ahead of investors.” Following the reference in the statute to affiliates’ securities, she said it didn’t matter that the securities being sold were issued by the Lehman parent, not by the brokerage.
Scheindlin said subordination under Section 510 isn’t limited to claims by shareholders for securities-law violations. She also said the creditor “need not be an actual security holder.” Similarly, she said subordination kicks in even in the “absence of an actual purchase or sale.”
In the Lehman brokerage liquidation, there’s little likelihood that unsecured creditors will be paid in full. Consequently, subordinating the claims to unsecured creditors functionally means they won’t be paid.
Lehman Brothers Holdings Inc. and the brokerage unit began separate bankruptcies in September 2008. The New York-based parent’s reorganization plan was approved in December 2011 and implemented in March 2012. In April, the company made a fifth distribution of $17.9 billion.
For details on Lehman’s most recent Chapter 11 distribution, showing how different groups of creditors receive different recoveries, click here for the March 28 Bloomberg bankruptcy report.
In the liquidation of the brokerage, the trustee has paid customers in full. The trustee also paid secured and priority creditors 100 percent. He won bankruptcy court approval to make a distribution on Sept. 10 of almost $3.5 billion to general unsecured creditors with $20.4 billion in approved claims.
Scheindlin’s opinion is In re Lehman Brothers Inc., 14- cv-1742, U.S. District Court, Southern District of New York (Manhattan).
The holding company Chapter 11 case is In re Lehman Brothers Holdings Inc., 08-bk-13555; the brokerage liquidation is Securities Investor Protection Corp. v. Lehman Brothers Inc., 08-01420, U.S. Bankruptcy Court, Southern District of New York (Manhattan).