U.K. Supreme Court Rules That Change in Priority over Dante CDO Collateral Triggered by Lehman Bankruptcy Does Not Violate Britain’s Anti-Deprivation Bankruptcy Rule

Belmont Park Investments PTY Limited was one of several Australian institutional investors (Noteholders) that purchased notes under the “Dante” collateralized debt obligation (CDO) program sponsored by Lehman Brothers Special Financing Inc. (Lehman).  The proceeds of the Dante notes were used by a Lehman special purpose vehicle to purchase AAA rated debt instruments that were held by BNY Corporate Trustee Services Limited as collateral to secure the parties’ obligations under the CDO and a related credit default swap.  Central to this dispute were CDO and swap provisions that shifted priority to the collateral from Lehman to the Noteholders in the event of Lehman’s bankruptcy.  In related cases involving Lehman, U.S. Bankruptcy Courts had previously ruled that the priority-shifting provision was a prohibited ipso facto clause, and ruled that Lehman retained first priority to the collateral.  In contrast, the U.K. Supreme Court has now ruled that the provision does not violate the United Kingdom’s anti-deprivation rule.  We summarize the Supreme Court’s decision.  For a discussion of a related U.S. Bankruptcy Court decision, see “Bankruptcy Court Holds That a Provision in a Derivative Contract Subordinating Payments to a Bankrupt Counterparty May Be an Unenforceable Ipso Facto Clause,” Hedge Fund Law Report, Vol. 4, No. 18 (June 1, 2011).  See also “Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act,” Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).

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