Prior to its bankruptcy filing, Lehman Brothers (Lehman) was a global broker-dealer/investment bank that conducted trades and made investments on behalf of itself as well as its clients, including many hedge fund managers. As part of this business, Lehman entered into a large number of “derivatives” transactions – such as credit default swaps, interest rate swaps and currency swaps – both for speculative and hedging purposes. As of August 2008, Lehman held over 900,000 derivatives positions worldwide, in each case through one of its operating subsidiaries. In many instances, Lehman’s ultimate parent entity, Lehman Brothers Holdings Inc. (LBHI), guaranteed the obligations arising out of these derivatives positions. As of August 31, 2008, Lehman internally estimated that, on an aggregate basis, its derivatives positions had a positive net value of approximately $22.2 billion, representing a significant asset of the company. This substantial “in the money” position abruptly turned “out of the money” as the result of LBHI’s bankruptcy filing in the early morning of September 15, 2008. The commencement of LBHI’s bankruptcy case – the largest by far in U.S. history, with claims well exceeding $300 billion – provided a contractual basis for a large majority of Lehman’s derivatives counterparties to terminate their transactions with Lehman. As a result, more than 80 percent of Lehman’s derivatives positions terminated as of, or soon after, the date of the bankruptcy filing. Alvarez & Marsal, Lehman’s restructuring advisors, concluded in a three-month internal study that the losses from terminated derivatives trades cost the bankruptcy estate “at least” $50 billion. In a guest article, Solomon J. Noh, a partner in the Global Restructuring Group at Shearman & Sterling LLP, examines what may be one of the principal reasons why Lehman’s bankruptcy filing resulted in such an extraordinary loss in value for the Lehman estate and how Congress has proposed to address this problem in any future failure of a major financial institution. 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).