Should Hedge Funds Purchase Unsecured Debt of Lehman Brothers Holdings Inc.? Key Legal Issues Impacting Returns
Hedge Fund Law Report
Before the ink was dry on the Chapter 11 bankruptcy filing of Lehman Brothers Holding Inc. (LBHI) last September 15, hedge funds – at least those with relatively strong stomachs – were evaluating LBHI debt as an investment opportunity. Many had in mind the Enron precedent, in which hedge funds and others bought the energy company’s debt for cents on the dollar, and in some cases enjoyed a par recovery based on lawsuits against the energy company’s banks. (However, the Enron precedent is distinguishable in important ways, as discussed in this article.) Others saw value in Lehman’s substantial derivatives book, in particular, in the opportunity to step into the shoes of Lehman’s derivatives counterparties. Over the months since the filing, an active market has developed in LBHI’s unsecured debt. Those on the long side of that market anticipate that value may reside in two primary sources: (1) recovery from JPMorgan Chase & Co. (JPMorgan) on the theory that the bank, acting as LBHI’s clearing bank with respect to repurchase agreements (repos) and as a significant derivatives counterparty, demanded and received more collateral than it was entitled to in the two weeks prior to the filing, thereby hastening or even causing the bankruptcy; and (2) that the Barclays PLC miscalculated the amount it should have paid for LBHI’s U.S. broker-dealer business, thus resulting in too little consideration being paid to the LBHI estate. With unsecured LBHI debt currently trading at around 15 cents on the dollar, hedge funds are taking a close look at the merits of these claims. To facilitate the evaluation by hedge funds of those claims, this article explores JPMorgan’s relationships with Lehman, the seizure by JPMorgan of LBHI collateral, potential remedies that may lead to recovery of some or all of that collateral, the relevance of the Enron precedent, the sale of the U.S. broker-dealer business to Barclays, the potential effects of various outcomes on the perception of finality of asset sales in bankruptcy and potential other sources of recovery for holders of unsecured debt of LBHI.