Maverick Long Enhanced Fund, Ltd. v. Lehman Bros. Holdings Inc. (In re Lehman Bros. Holdings Inc.)

594 B.R. 564

IN RE: LEHMAN BROTHERS HOLDINGS INC.

Maverick Long Enhanced Fund, Ltd., Maverick Neutral Levered Fund, Ltd., Maverick Neutral Fund, Ltd., Maverick Fund USA, Ltd., Maverick Fund II, Ltd., and Maverick Fund, L.D.C., Appellants,

v.Lehman Brothers Holdings Inc., Appellee.

Case No. 08-13555 (SCC)

No. 17-CV-4203 (RA)

United States District Court, S.D. New York.

Signed September 30, 2018

Randall Lewis Martin, Solomon J. Noh, William Roll, J.F., III, Shearman & Sterling LLP, New York, NY, for Appellants.

Adam Michael Lavine, Garrett Avery Fail, Richard L. Levine, Weil, Gotshal & Manges LLP, New York, NY, for Appellee.

OPINION AND ORDER

RONNIE ABRAMS, United States District Judge:

Appellants, a collection of Maverick funds (collectively, "Maverick"), appeal from an order of the United States Bankruptcy Court for the Southern District of New York (Chapman, J. ) disallowing and expunging Maverick's claims against Lehman Brothers Holding Inc. ("LBHI"), a Chapter 11 debtor. For the reasons set forth below, the order of the bankruptcy court is reversed and this matter is remanded for further proceedings.

BACKGROUND

In 2005, each of the Appellant Maverick entities separately entered into a prime brokerage agreement ("Prime Brokerage Agreements") with Lehman Brothers Inc., which signed on behalf of itself and certain affiliates, one of which was Lehman Brothers International (Europe) ("LBIE," collectively with LBHI, "Lehman"). See App. 584. Pursuant to these agreements, LBIE was required, among other things, to maintain custody of Maverick's cash and securities, execute trades, and return Maverick's property, held as collateral, upon request. App. 574–80. The Prime Brokerage Agreements also contained provisions granting LBIE certain contractual rights in the event of a Maverick default. App. 575–76. At the same time, the Maverick entities were parties to a separate set of contracts with LBIE relating to the borrowing of securities to facilitate "short" trades and the provision of margin loans. Under the terms of these agreements, Maverick periodically owed LBIE various amounts.

Meanwhile, Maverick entered into a guarantee with LBHI (the "Guarantee") regarding all of the Maverick property custodied with LBIE. App. 646–49. Governed by New York law, the Guarantee was "absolute and unconditional." App. 647. The Guarantee also was for payment rather than collection, meaning that Maverick was under no obligation to pursue collection efforts against LBIE in the event of a default and could proceed directly against LBHI. App. 647. The purpose of the Guarantee was to protect Maverick if its property became trapped by virtue of an LBIE bankruptcy.

On September 15, 2008, LBIE commenced administration proceedings pursuant to the English Insolvency Act 1986. The same day, LBHI commenced Chapter 11 bankruptcy proceedings in the United States. App. 39. On September 22, 2009, Maverick timely filed claims against LBHI seeking to enforce the Guarantee in that entity's chapter 11 proceedings. App. 535. The bankruptcy court confirmed the Modified Third Amended Joint Chapter 11 Plan of LBHI and its affiliated debtors. App. 35–95. The Plan provides for partial payments to be made to holders of guarantee claims such as Maverick's, provided that the bankruptcy court allows them.

During this period, Maverick and LBIE engaged in negotiations concerning the resolution of their respective claims against one another in connection with LBIE's administration proceedings. On March 30, 2012, LBIE and Maverick entered into a Deed of Settlement ("Settlement Agreement"), which provided for a netting of certain amounts owed to Maverick on the basis of its property custodied by LBIE against amounts owed by Maverick on account of its margin loans and short positions. App. 249–281. The Settlement Agreement provided for Maverick to pay a net amount of $30 million to LBIE. App. 252.

On the basis of United Kingdom bankruptcy laws invoked by LBIE, the Settlement Agreement credited Maverick with the market value of its property at the time the agreement became effective, which was $101.9 million. This stands in contrast to the $118.1 million market value when both Lehman entities entered bankruptcy proceedings, the default date for assessing damages under Chapter 11. Therefore, Maverick contends, it has a claim against LBHI, the guarantor, for the difference between the amount with which it was credited under the Settlement Agreement and the market value of its securities on the day bankruptcy proceedings began.

PROCEDURAL HISTORY

On June 22, 2016, LBHI filed its objection to Maverick's claims. ECF No. 282. The bankruptcy court heard argument on March 24, 2017, at which point it issued an oral ruling, followed by a supplemental written order, disallowing and expunging Maverick's claims. ECF No. 1. Maverick timely filed its notice of appeal with this Court. ECF No. 1, After briefing was complete, the Court held oral argument. ECF No. 15.

LEGAL STANDARD

District courts have appellate jurisdiction over "final judgments, orders, and decrees" of bankruptcy courts under 28 U.S.C. § 158(a)(1). "A district court reviews a bankruptcy court's findings of fact for clear error and reviews its legal conclusions de novo. " Davidson v. AMR Corp. (In re AMR Corp. ), 566 B.R. 657, 663 (S.D.N.Y. 2017) (citation omitted). "A finding of fact is clearly erroneous when ‘the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.’ " Adler v. Lehman Bros. Holdings Inc. (In re Lehman Bros. Holdings Inc. ), 855 F.3d 459, 469 (2d Cir. 2017) (quoting Anderson v. City of Bessemer , 470 U.S. 564, 573, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985) ). By contrast, "[h]armless error, meaning an error not inconsistent with substantial justice or that does not affect the parties' substantial rights, is not grounds for reversal." McNerney v. ResCap Borrower Claims Trust (In re Residential Capital, LLC) , 563 B.R. 477, 485 (S.D.N.Y. 2016). "A district court may affirm, modify, or reverse a bankruptcy judge's judgment, order, or decree or remand with instructions for further proceedings." Margulies v. Hough (In re Margulies) , 566 B.R. 318, 328 (S.D.N.Y. 2017) (citation omitted).

DISCUSSION

The bankruptcy court relied on two independent bases for concluding that Maverick's claims against LBHI should be disallowed and expunged: (1) Section 562 of the Bankruptcy Code applies to any damages sustained by Maverick thereby extinguishing, directly or indirectly, the claims asserted against LBHI and (2) even if Section 562 does not apply, Maverick's claims fail because Lehman avoided liability by virtue of two exculpation clauses contained in the Prime Brokerage Agreements. The bankruptcy court further denied Maverick leave to amend in order to assert claims for lost profits.¹ The Court addresses each of these issues in turn.

I. Section 562

Enacted in 2005 as part of the Bankruptcy Abuse Prevention and Consumer Act, Section 562 is related to a number of preceding provisions, colloquially termed safe harbors because they exempt certain actions from aspects of the Bankruptcy Code, primarily the automatic stay and the ban on ipso facto clauses. See 11 U.S.C. §§ 555 – 56, 559 – 61. The rationale underpinning these provisions is that parties may be irreparably harmed if certain contractual rights, such as termination, cannot be exercised because one of the signatories has entered bankruptcy proceedings. Indeed, contractual rights of this sort are often meant to be exercised precisely because a counterparty has defaulted. Section 562(a) specifies the relevant date for purposes of assessing damages:

If the trustee rejects a swap agreement, securities contract (as defined in section 741), forward contract, commodity contract (as defined in section 761), repurchase agreement, or master netting agreement pursuant to section 365(a), or if a forward contract merchant, stockbroker, financial institution, securities clearing agency, repo participant, financial participant, master netting agreement participant, or swap participant liquidates, terminates, or accelerates such contract or agreement, damages shall be measured as of the earlier of —

(1) the date of such rejection; or

(2) the date or dates of such liquidation, termination, or acceleration.

11 U.S.C. § 562(a) (emphasis added).

Relying on this language, Lehman argues that damages should be measured as of the date the Settlement Agreement became effective, which operated, it contends, to terminate all of the relevant agreements, including the Guarantee. This argument runs contrary to a well-established principle of bankruptcy law— Section 562 being a codified exception—that damages should be measured as of the date on which bankruptcy proceedings began. See 11 U.S.C. § 502(b). The answer is of great import because, as previously noted, from the commencement of Chapter 11 proceedings to the date the Settlement Agreement became effective, Maverick's property declined in value by approximately $16.2 million.

Lehman asserts, in essence, two theories under which Section 562 applies: (1) any liability of LBHI was directly extinguished because the Guarantee was terminated by the Settlement Agreement and (2) any liability was indirectly extinguished because Section 562 similarly applies to the termination of the Prime Brokerage Agreements, which had the practical effect of negating any claims against LBHI on the basis that a guarantor has no liability once all claims against a primary obligor have been satisfied. The Court will assess these theories in tandem because, as it will explain, they suffer from the same flaw.²

As an initial matter, Lehman rightly notes that in issuing its ruling the bankruptcy court did not have the benefit of considering certain arguments now advanced by Maverick on appeal. The Court will consider these arguments, however, because waiver is a prudential, rather than jurisdictional, doctrine and they "pre...