In Re: Lehman Brothers Holdings Inc.

Citation: Not availableDocket: 12-2322-bk (L)

Court: Court of Appeals for the Second Circuit; August 5, 2014; Federal Appellate Court

Original Court Document: View Document

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James W. Giddens, as Trustee for the SIPA Liquidation of Lehman Brothers Inc. (LBI), appeals a district court decision concerning asset entitlements in the liquidation process. The dispute centers on two types of assets: the "Margin Assets," which are cash and cash equivalents held by third parties for LBI's exchange-traded derivatives, and the "Clearance Box Assets" (CBAs), valued at approximately $1.9 billion, consisting of unencumbered securities at the Depository Trust Clearing Corporation. The bankruptcy court initially ruled that Barclays had not purchased the Margin Assets or the Rule 15c-3 Assets but was conditionally entitled to the Clearance Box Assets. The district court, however, reversed this in part, awarding Barclays the Margin Assets and CBAs, while also conditionally granting access to the Rule 15c-3 Assets, a matter now settled. The appeal from Giddens seeks to challenge the rulings on the Margin Assets and CBAs, while Barclays' cross-appeal regarding the Rule 15c-3 Assets is moot due to the settlement. The appellate court affirms the district court's decision.

On September 15, 2008, Lehman Brothers Holdings Inc. (LBHI) and its broker-dealer subsidiary, Lehman Brothers Inc. (LBI), filed for bankruptcy, leading to a SIPA liquidation of LBI. An emergency sale of LBI to Barclays Capital Inc. was executed under Section 363 of the Bankruptcy Code, described as the largest and most expedited asset sale in bankruptcy history. This transaction preserved thousands of jobs and mitigated estimated losses in the hundreds of billions. Although the sale posed significant risks for Barclays, it was viewed as the best option to minimize economic loss.

On September 16, 2008, Lehman and Barclays signed an Asset Purchase Agreement (APA) specifying assets to be purchased, including retained cash, deposits, and exchange-traded derivatives, while excluding certain cash items and assets related to derivative contracts. Barclays's board required a capital buffer of $5 million for the deal, which was to be achieved through a repurchase agreement.

On September 18, Barclays provided LBI with $45 billion in cash to repay a loan from the New York Federal Reserve, with the expectation of receiving collateral of equal or greater value. However, LBI later informed Barclays it could not deliver the promised assets, prompting Barclays to request alternative assets for the deal's closure. This led to what the bankruptcy court termed the "asset scramble," wherein LBI sought to identify transferable assets, resulting in the Margin Assets and Customer Accounts (CBAs) being the focus of the current appeal. During the Sale Hearing on September 19, it was acknowledged that a deal was reached in principle, though amendments to the APA were necessary due to LBI's inability to deliver the anticipated assets.

A significant change addressed at the Sale Hearing involved the treatment of "cash" under the Asset Purchase Agreement (APA). Initially, Barclays was to acquire $1.3 billion in "retained cash," but this amount was later reduced to $700 million and ultimately eliminated by the Sale Hearing date. It was clarified that no cash from Lehman would be transferred to Barclays. Barclays' counsel stated that all material changes were disclosed, and the bankruptcy court indicated that any modification exceeding $500 million would be deemed material. Due to the urgency from the economic crisis, key stakeholders including Lehman, the bankruptcy court, the Trustee, Barclays, the Securities Investor Protection Corporation (SIPC), and the government supported the Sale despite incomplete documentation of the assets involved. A "Clarification Letter" was promised to formalize necessary changes.

Following the Sale Hearing, the bankruptcy court approved the transaction via a Sale Order, which allowed flexibility for changes to the APA. The Sale Order authorized the parties to take necessary actions to implement the agreement, reflecting the complexity and time constraints of the acquisition. Over the weekend, the parties created the Clarification Letter to document changes discussed at the Sale Hearing, which revised definitions of Purchased and Excluded Assets. This letter was filed with the bankruptcy court and served on interested parties, but court approval was not sought, as the parties claimed it merely documented changes rather than altering the APA. The deal closed on September 22, 2008.

For nearly a year, both Barclays and the Trustee relied on the Clarification Letter while defending the Sale Order on appeal. Subsequently, Barclays sought delivery of certain assets, while the Trustee, LBHI, and the Official Committee of Unsecured Creditors filed motions for relief from the Sale Order regarding the transfer of Margin Assets, leading to a 34-day trial. On February 22, 2011, the bankruptcy court ruled that the Margin Assets were awarded to the Trustee with prejudgment interest, the CBAs were awarded to Barclays, and Barclays’ claim to the Rule 15c3-3 Assets was contingent upon the Trustee having sufficient customer property to satisfy allowed customer claims in the SIPA liquidation.

Each party appealed to the district court regarding key assets: Barclays concerning the Margin Assets and Rule 15c3-3 Assets, and the Trustee regarding the Customer Business Accounts (CBAs). On July 16, 2012, the district court reversed the bankruptcy court's ruling, awarding Barclays the Margin Assets and affirming its entitlement to the CBAs, while denying Barclays an unconditional right to the Rule 15c3-3 Assets. A subsequent appeal and cross-appeal ensued, with the cross-appeal on the Rule 15c3-3 Assets settled. The focus is now on the Trustee's appeal concerning the Margin Assets and CBAs.

The review of bankruptcy court orders is conducted independently, with legal conclusions assessed de novo and factual conclusions reviewed for clear error. The case involves New York contract law, where the parties' intentions govern, primarily determined by the contract itself. Ambiguity in contractual language is assessed based on its capability of multiple meanings to a reasonable person, allowing courts to consider extrinsic evidence when ambiguity exists.

The Margin Assets in question amount to approximately $4 billion, maintained by Lehman Brothers International (LBI) as collateral for its exchange-traded derivative (ETD) business. These assets, which LBI pledged to secure its trading obligations, include cash or cash equivalents linked to LBI's ETD positions. A key issue is whether these Margin Assets were transferred to Barclays along with the ETD business according to relevant contractual documents.

Several contractual provisions are pertinent to the Margin Assets. The Asset Purchase Agreement (APA) defines "Purchased" and "Excluded" assets, categorizing the ETD business as a "Purchased Asset." The APA stipulates that Barclays would acquire all assets used in connection with the ETD business, excluding specific excluded assets, and includes a warranty from the seller ensuring the transfer of all necessary assets and services for the business's operation.

Section 2.2 of the Asset Purchase Agreement (APA) stipulates that Excluded Assets remain with the Seller, including all cash and cash equivalents, except for $1.3 billion specifically noted. Exclusion (n) refers to assets related to the Investment Management Business and derivatives contracts, though the APA does not define "derivatives contracts." The Clarification Letter (CL) refines the definition of "Purchased Assets" to include all assets used primarily in the business, excluding Excluded Assets, and specifies "exchange-traded derivatives." It modifies the APA's Excluded Assets definition by removing the exclusion related to "Retained Cash" other than the specified $1.3 billion and retains Exclusion (n).

The bankruptcy court ruled that the APA's exclusions meant Margin Assets were not transferred. It considered the CL enforceable based on the parties’ reliance but only to the extent it aligned with the Sale Hearing record and Sale Order language. The court found ambiguity regarding the CL's reference to property securing obligations under derivatives, concluding that this did not include Margin Assets.

Conversely, the district court determined that the bankruptcy court's approval of the CL was decisive and uncontested by the parties. It deemed the CL's language as controlling, rejecting the bankruptcy court's reliance on extrinsic evidence regarding "no cash" representations at the Sale Hearing. The district court concluded that the CL's parenthetical provision transferred the Margin Assets to Barclays, despite Exclusion (n).

The urgency of executing the deal led to inevitable ambiguities, acknowledged by the bankruptcy court, which admitted it was unaware of certain significant Sale aspects.

Transfer 21 of the Margin Assets to Barclays was explicitly anticipated in the Asset Purchase Agreement (APA) and reiterated in the Closing Letter (CL). The inclusion of these Margin Assets does not constitute a material change to the APA, rendering the dispute regarding the bankruptcy court’s approval of the CL irrelevant. The APA clearly defines “exchange-traded derivatives” as part of the Purchased Assets, and the CL further clarifies this definition to include such derivatives and any related property securing obligations. 

The Trustee's argument that the APA's exclusions regarding cash and derivatives contracts prevent the transfer is rejected. Exclusion (b) about “cash” does not apply to assets defined as “Purchased,” which encompasses the Margin Assets. The general understanding of cash in this context excludes pledged collateral, which is not readily usable cash. It would be illogical for Barclays to acquire LBI's entire exchange-traded derivatives (ETD) business without the associated collateral, especially during a volatile economic period.

The conduct of both parties post-Sale supports the understanding that the Margin Assets were included in the Sale. On September 20, following the Sale Hearing, a Transfer and Assumption Agreement (TAA) was executed, confirming the transfer of all margin deposits linked to specific accounts, which contained significant portions of the disputed Margin Assets. The Trustee, on behalf of Lehman, affirmed the legality of the TAA, indicating the intent to transfer substantial proprietary cash and acknowledging nearly $1 billion in cash and over $2 billion in proprietary Margin Assets for transfer to Barclays. Communications from the Trustee to the Options Clearing Corporation (OCC) and Barclays reinforced this intent, recognizing Barclays as the owner of the relevant accounts and associated collateral.

The Clearance Box Assets (CBAs) consist of approximately $1.9 billion in unencumbered securities held in Lehman Brothers Inc. (LBI)'s clearance box accounts at the Depository Trust Clearing Corporation (DTCC). These assets served as collateral for open trading positions, allowing DTCC to cover potential liabilities in the event of LBI's default. Prior to the closing, two agreements were negotiated regarding the transfer of the CBAs: one in the Clarification Letter (CL) and the other in the DTCC Letter. The CL specified that the Purchased Assets included securities held in LBI's clearance boxes as of September 21, 2008, with 98% listed in Schedule B, while the DTCC Letter stated that LBI’s accounts at the Clearing Agencies were considered "Excluded Assets," potentially including the CBAs.

The bankruptcy court found the DTCC Letter ambiguous and treated it as extrinsic evidence, concluding that the intent of the parties was to transfer the CBAs to Barclays. The district court affirmed this ruling, noting that the provisions in the agreements conflicted but that the extrinsic evidence indicated an intent to transfer the CBAs. The apparent contradiction between the CL and the DTCC Letter was recognized, as the CL indicated that the CBAs were Purchased Assets, while the DTCC Letter suggested that LBI's accounts were Excluded Assets. However, it was determined that the DTCC Letter did not explicitly exclude the CBAs from being transferred, indicating that Barclays could receive assets from those accounts.

The distinction between CBAs, which were lien-free, and other accounts holding collateral assets was emphasized. The bankruptcy court concluded that the specific provisions in the CL regarding the CBAs took precedence over the general language of the DTCC Letter, as the Clarification Letter contained more detailed information about the CBAs than the DTCC Letter, which lacked an itemized list.

The Trustee's appeal arguing that the conflict between the Agreements should favor the DTCC Letter under APA Section 2.2 is unconvincing. Section 2.2 explicitly states that the Excluded Assets are not to be transferred to the Purchaser, but the DTCC Letter fails to mention the CBAs with the necessary specificity to override this provision. Consequently, any remaining ambiguities must be clarified using extrinsic evidence, which the bankruptcy court evaluated without clear error. Evidence supported both parties' positions, including testimony from the DTCC's Deputy General Counsel regarding negotiations where Barclays allegedly agreed to relinquish the CBAs. However, the bankruptcy court concluded that the evidence favored Barclays, particularly due to the parties' actions post-closing, which indicated an intent to transfer the CBA assets. This intent was further corroborated by testimonies from Barclays’s legal representatives and an email from DTCC’s counsel confirming acceptance of Barclays's $250 million guarantee in exchange for the CBAs. The court noted that the evidence aligned with the commercial context of the transaction, as DTCC's losses were significantly lower than the guarantee provided by Barclays, who assumed most of the risk. The court affirmed the district court’s decision. Additionally, the Trustee's assertion that Lehman’s lawyers were unaware of Barclays's exclusion of the CBAs contradicts the district court’s findings and the appeal record, which shows that Lehman’s lawyers were informed about the DTCC agreement and participated in drafting the relevant documents. The Trustee, having signed the CL and the DTCC Letter, cannot now dispute the clear language of the CL based on a claimed lack of knowledge.