in re lehman brothers holdings inc. from chaos to · pdf filein re lehman brothers holdings...

Weil, Gotshal & Manges LLP June 22, 2012

In re Lehman Brothers Holdings Inc. From Chaos To Consensus Harvey R. Miller Lori R. Fife Maurice Horwitz

Weil, Gotshal & Manges LLP 2

Background

￭  Lehman Brothers Holdings Inc. (“LBHI”) commenced its chapter 11 case on September 15, 2008

￭  22 of its affiliates subsequently commenced chapter 11 cases in the United States Bankruptcy Court for the Southern District of New York

￭  More than 100 of the Debtors’ foreign affiliates commenced insolvency proceedings throughout the world

￭  Following major asset sales to Barclays and Nomura, billions of dollars in “legacy” assets (Derivatives, Real Estate, Corporate Loans, Private Equity, Bank Platforms) remained to be managed and liquidated over time.

￭  Approximately 1.2 million derivatives transactions with approximately 6,500 counterparties

￭  Approximately 67,000 claims were filed totaling $1.2 trillion of claims ￭  $328 billion in claims based upon asserted intercompany guarantees were

filed against LBHI by affiliates ￭  $255 billion in claims based upon asserted guarantees were filed against

LBHI by non-affiliate third parties


Phases of the Chapter 11 Cases

￭  From: ￭  Melting asset issues ￭  Loss of accounting systems ￭  No inventory of assets ￭  Loss of operational support ￭  Loss of employees

￭  To: ￭  Installation of Alvarez & Marsal as administrators and new management

teams for the Debtors in Possession ￭  Stabilization of assets and administration to preserve value

￭  Disposition process established ￭  Cash realized from administration and sale ￭  Inventories of assets established ￭  Material restoration of accounting systems ￭  Established extent of liabilities


Phases of the Chapter 11 Cases (cont.)

￭  Implementation of a Multilateral Cross-Border Insolvency Protocol enabling commencement of meaningful dialogue with representative foreign affiliates

￭  Establishment of relationship with Official Committee of Unsecured Creditors

￭  Establishment of bar dates for filing of claims of varying types

￭  67,000 claims filed aggregating approximately $1.2 trillion

￭  Development of framework for derivatives contracts

￭  Commencement of claims reconciliation and adjudication process (claim objections, ADR)

￭  Commencement of actions to recover receivables – affirmative ADR process

￭  Crystallization of key legal issues affecting chapter 11 plan formulation

￭  Formation of creditor groups based upon legal and economic positions and objectives


Key Legal Issues

Substantive Consolidation ￭  Most highly controverted issue in chapter 11 cases – whether equitable doctrine

of substantive consolidation should be applied to Lehman, and certain or all of the Affiliates, to create a de facto single merged entity of pooled assets and liabilities (including foreign affiliates) effectively eliminating intercompany claims and guarantee claims

Recharacterization ￭  “Recharacterization (i.e., conversion of debt to equity) is appropriate where the

circumstances show that a debt transaction was actually an equity contribution ab initio.” Off. Comm. of Unsec. Cred. v. Bay Harbour Master Ltd. (In re BH S&B Holdings LLC), 420 B.R. 112, 157 (Bankr. S.D.N.Y. 2009)


From Competing Plans to Global Settlement ￭  Conflict among Lehman creditors with respect to these key issues resulted in

filing of two competing chapter 11 plans versus the Lehman plans ￭  One extreme: ad hoc group of senior bondholders with claims against LBHI, the parent

company (the “Ad Hoc Group”) proposed sub-con plan

￭  Other extreme: various creditors of subsidiary debtors and non-debtors (the “Non-Con Group”) proposed treatment of the Debtors as separate entities

￭  Lehman needed to assume an aggressive leadership role to reconcile the conflicting interests and competing plans ￭  Filed an amended plan on January 25, 2011 proposing economic resolution of key

legal issues. Not a sub-con plan, but accounted for the risk of sub-con through the reallocation of distributions based on implied 20% risk of substantive consolidation

￭  To account for risk of recharacterization, intercompany balances owed to LBHI on account of “intercompany funding” (as opposed to, e.g., derivatives contracts or repurchase agreements) were reduced by 20%


The Formation of Creditor Groups and Crystallization of Key Legal Issues

Creditor Group(s) Key Legal Issues Ad Hoc Group Non-Con Group

• Substantive Consolidation • Recharacterization

LBT Noteholders (Really 2 groups)

• Substantive Consolidation • Structured Note Valuation Methodology

Big Banks / LBSF Creditors

• Derivatives Framework

Foreign Affiliates • Substantive Consolidation • Enforceability of Guarantee Claims • Intercompany Claims • Jurisdiction and Other Issues


Foreign Affiliates ￭  Highly contentious disputes existed with foreign affiliates as to nature and validity

of intercompany claims and the enforceability of asserted guarantee claims by affiliates against LBHI as the parent debtor and ultimate alleged guarantor

￭  To expedite the process and avoid a stalemate, Lehman engaged in bilateral negotiations with certain foreign affiliates for over two years

￭  A cross-border insolvency protocol established a baseline level of trust among the affiliates ￭  Affiliates met on a quarterly basis (sometimes more frequently) to discuss the status of

their proceedings, creating an environment of transparency ￭  Multilateral discussions focused on the Lehman chapter 11 plan and key issues in

dispute (e.g. substantive consolidation, validity and enforceability of guarantee claims)

￭  The “Global Close” – an accounting close that was conducted as of the last business day before LBHI’s bankruptcy – eliminated the potential for disputes among affiliates


Foreign Affiliates

￭  Through multilateral meetings among protocol members, a framework was developed and served as the basis for individualized bilateral settlement agreements ￭  Framework incorporated settlement of key disputed issues:

￭  Adoption of the Global Close for intercompany claims ￭  Validity and enforceability of guarantee claims ￭  Accounting for risks of substantive consolidation and recharacterization

￭  “Bilateral Settlements” ultimately executed with affiliates in Germany, UK, Netherlands, Curacao, Hong Kong, Japan, Luxembourg, and Singapore ￭  Resulted in 81% reduction of aggregate claims against Debtors (from $327.8B to

$61.4B), including a reduction in guarantee claims from $223B to $11.2B ￭  Mutual releases exchanged and foreign affiliates agreed to support the Plan


LBT Noteholders

￭  Lehman Brothers Treasury Co B.V. (“LBT”) – Lehman’s Dutch affiliate established for the purpose issuing notes to finance the general operations of the Lehman enterprise

￭  Primarily “structured notes” issued in Europe

￭  Structured notes pose special challenges; there was no precedent for how to deal with structured notes in any chapter 11 case or insolvency cases elsewhere

￭  LBT Noteholders represented one of the most significant creditor constituency in the chapter 11 cases ￭  LBT Noteholders represented approximately $34 billion in claims against LBHI,

the parent entity, based on LBHI’s guarantee of the LBT notes ￭  LBT held a $34 billion claim against LBHI


Big Banks / Derivatives

￭  Lehman engaged in negotiations with 13 of their largest derivatives counterparties (the “Big Banks”) each of whom had filed a very large claim against LBSF and LBHI – the aggregate claims amounted to approximately $22 billion.

￭  Lehman argued that the claims were grossly overstated and proposed a common methodology and settlement approach for the allowance of derivatives claims pursuant to standardized, uniform and transparent principles and methodologies (the “Derivatives Framework”)

￭  Lehman ultimately entered into settlements with 10 of 13 largest banks based on the Derivatives Framework, resulting in aggregate allowed claims of approximately $7.6 billion (and corresponding guarantee claims against LBHI) versus the approximately $26 billion that had been asserted prior to the application of the Derivatives Framework


Lehman Plan Negotiations

￭  In June 2011 the Debtors convened a series of summit meetings with all major global stakeholders

￭  Parties were required to stop trading for periods of two to three days - were subsequently “cleansed” through court filings

￭  As a result, Lehman’s second amended plan incorporated complex and interdependent settlement mechanisms that compromised key legal issues, including the risk of substantive consolidation through ￭  modifications to the chapter 11 plan that included reallocations of value among LBHI

and other subsidiary debtors ￭  agreements reached on methodology for valuation of structured securities ￭  settlements of “Big Bank” derivative claims occurred simultaneously


Lehman Plan Negotiations

￭  By and prior to the plan confirmation date, December 6, 2011, creditors who asserted more than approximately $450 billion in aggregate claims against the Debtors had executed and delivered Plan Support Agreements (“PSAs”) to the Debtors

￭  After PSAs had been executed, parties could continue to trade, but any claims subject to PSAs could only be transferred subject a joinder that would bind the transferee to the terms of the PSA

￭  Proponents of the Ad Hoc Plan and the Non-Con Plan agreed to suspend prosecution of their alternative plans, subject to confirmation of the Debtors’ plan


A Closer Look

￭  Certain elements of the Lehman cases are emblematic of a changing chapter 11: ￭  Proliferation of ad hoc committees and groups ￭  Underlying premise of chapter 11: to reach a consensual plan and limit litigation

and delay while reorganizing. ￭  US restructurings tend to be litigation prone:

￭  As the parties convened for the intensive summit meetings in June, Lehman made it clear that if the parties in interest wanted to litigate the issues, Lehman would accommodate them

￭  Discovery protocol – took four months to negotiate – 58 law firms, each representing multiple parties, opted to participate in discovery

￭  Requests for documents were astounding – almost beyond the ability to respond ￭  Burden placed on Lehman to create a data room


Unique Aspects of The Plan Negotiations

￭  Truly global creditor base: LBT Noteholders, foreign affiliates, derivatives counterparties ￭  All needed to work through their US attorneys and work within a US framework

(chapter 11) ￭  Coordination with foreign administrations and administrators facilitated by the

Bankruptcy Court’s recognition of the need to have a fully global settlement

￭  Different from typical chapter 11 plan negotiations because no other forms of consideration were available other than cash distributions from the “pot” – potentially a zero-sum game

￭  Legal issues needed to be translated into a realization of the economic facts and objectives of the impaired parties ￭  Factual disputes required extended discovery and costs ￭  A single judge who had experienced the complexities of the case from the beginning


Unique Aspects of The Plan Negotiations

￭  Creditor Groups – A Misnomer? ￭  Did creditors deliberately position themselves as “groups” through purchases of

claims? ￭  Many members of “Creditor Groups” held cross-holdings (necessitated simultaneous

involvement of all creditors) and potential conflicts ￭  Many creditors who had not purchased their claims (e.g. Big Banks who had actually

traded with Lehman) later participated their claims to third parties

￭  What motivated creditors to threaten litigation, negotiate and settle? ￭  A considered view of their legal entitlements? ￭  Just a numbers game? (Claims purchased at substantial discounts) ￭  More likely a dynamic interplay of legal risk analysis and each party’s economic

interests in the face of projected and extended chapter 11 case administration and aggravating litigation consuming Lehman assets and, finally deprivation of all economic benefits of receiving distributions


Critical Role of the Bankruptcy Judge

￭  Deeply involved, while at the same time not privy to negotiations, was the Court whose only knowledge resulted from proceedings on the record that were described as the “tip of the iceberg”

￭  Nevertheless, the Bankruptcy Judge probed into the state of the estate and was instrumental in creating an atmosphere inducing the parties to proceed in a mature, consensual way to avoid unnecessary legal fireworks and self-indulgence

￭  “Whether their claims are monstrous or moderate, everybody is encouraged to behave as gownups in our enlightened economic self interest to produce outcomes in this remarkable case…” August 30, 2011 Hr’g Tr. at 54:11-16

￭  “[W]e are dealing in a completely uncharted territory using plan support agreements, whether or not Court approved, that are achieving a highly desirable purpose, orderliness in lieu of unnecessary litigation.” August 30, 2011 Hr’g Tr. at 54:2-5


Impact of Claims Trading

￭  Debt is a commodity – freely tradable and creating a casino-like environment ￭  Distressed debt traders and others trade in claims against debtor companies

both for profit and often to gain control over the bankruptcy case and possibly to acquire a debtor

￭  Claims against Lehman US debtors are among the most heavily traded in the secondary market – a condition that has continued post the confirmation of the plan

￭  Of the $36 billion in claims that were traded during 2011 in US markets, $32.4 billion consisted of Lehman claims1

￭  Ultimately in the Lehman cases, creditors organized into groups based upon asserted common economic interests and legal issues - these groups consisted primarily of creditors that held their claims as of the commencement of the cases (and had actually done business with the debtors prior to bankruptcy); and investors who had purchased their claims on the secondary market post bankruptcy

1 Source: Bloomberg


Material Non-Public Information

￭  While claims trading made it possible for creditor groups to organize around common economic interests and legal issues, it also impeded negotiations, because creditors could not trade if they became aware of material non-public information (“MNPI”) ￭  Trading with MNPI may violate US securities laws under section 10(b) of the Securities

Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder ￭  At least one court has held that negotiations themselves may be construed as MNPI,

and negotiating creditors may become temporary insiders. See In re Washington Mutual, Inc., Case No. 08-12229 (MFW), 2011 WL4090757, at *51-53 (Bankr. D. Del. Sept. 13, 2011)


Bankruptcy Rule 2019 ￭  Pursuant to Rule 2019 of the Federal Rules of Bankruptcy Procedure, entities

and committees that represent more than one creditor are required to file a verified statement with the court that discloses, among other things, ￭  the names and addresses of the committee’s members, ￭  the nature and amounts of claims or interests they hold, ￭  when such claims or interests were acquired, ￭  the amounts paid for such claims or interests, ￭  any disposition of such claims or interests, ￭  details regarding the formation of the committee, and ￭  a copy of the documents governing the committee

￭  Lehman sought to strictly enforce the requirements of Rule 2019 upon the Ad Hoc Group

￭  Ad Hoc Group later sought enforcement of Rule 2019 on all other groups – Non-Con Group claimed it was not a “group” and set up barriers to that determination that would have to be litigated


Time to Cash In

￭  The Plan was confirmed on December 6, 2011 – during that same month:

￭  trading in Lehman claims exceeded $3.6 billion out of the $3.8 billion of total bankruptcy claims traded that month

￭  Goldman Sachs – part of the Non-Con Group and one of the Big Banks – sold $500 million in claims

￭  Morgan Stanley, another Big Bank, sold $320 million in claims

￭  In January 2012, Goldman Sachs sold another $190 million in claims, and Paulson Credit Opportunities Master Ltd. sold more than $100 million

Source: Bloomberg


Judge Peck’s Closing Remarks

Closing Remarks of Judge Peck, LBHI, et al., December 6, 2011

My world changed when the Lehman cases were assigned to me and so did yours. For me, it has been a once in a lifetime experience. To have worked across the bench from so many outstanding professionals in promoting conflict resolution and helping to bring these truly extraordinary one-of-a-kind cases to this culminating substantive moment, superlatives abound. And we have heard them all and probably used them all. This is the biggest, the most incredibly complex, the most impossibly challenging international bankruptcy that ever was.

But the greatest superlative of all is reserved for today. This largest ever unplanned bankruptcy that started in chaos, accelerated the financial crisis and eroded confidence in the global financial system also has yielded the most overwhelming outpouring of creditor consensus in the history of insolvency law. What a difference three years can make. Never before have divergent holders of 450 billion dollars in claims recognized the benefits of pragmatic compromise and come together as one in support of a single chapter 11 plan. This is a monumental achievement in our field, awe-inspiring, really, that, to me, represents the highest and best use of chapter 11 in the public interest.


Judge Peck’s Closing Remarks (cont.)

For myself, I'm extremely proud to have presided over this transparent, fair and remarkably successful process that stands out as perhaps the finest example of the flexibility, power and utility of the United States bankruptcy system. Our system is not perfect. But together we have shown the world that it can work very well indeed. Lehman may once have been a too-big-to-fail systemically significant global financial institution. But it was not too big to resolve in chapter 11.

I congratulate each and every professional in every single law firm and advisory firm here and in foreign jurisdictions that contributed in ways recognized and unrecognized, large and small, to this historic confirmation of Lehman's plan. You should all feel great pride in what has been accomplished.

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