On 15 September 2009, the US Bankruptcy Court for the Southern District of New York, in the Lehman Brothers chapter 11 cases, held that Metavante Corporation (Metavante), counterparty to Lehman Brothers Special Financing Inc. (LBSF) under an unterminated interest rate swap agreement (Swap Agreement), could not rely on the safe harbour provisions in the Bankruptcy Code to excuse its failure to perform its obligations under the Swap Agreement.

Further, the Court held that Metavante, by failing to exercise its rights to terminate the Swap Agreement, had waived those rights and the swap agreement was therefore to be regarded as a "garden variety executory contract."

LBSF and Metavante entered into the Swap Agreement on 4 December 2007, under the terms of a standard 1992 ISDA Master Agreement.

Under the Swap Agreement:

Lehman Brothers Holdings Inc. (LBHI) was the credit support provider for LBSF's obligations under the Swap Agreement.

As of May 2009, Metavante owed LBSF approximately US$6,640,138, representing net payments for the November 2008, February 2009 and May 2009 payment dates, as well as default interest in excess of US$300,000 on that amount.

Metavante refused to pay these amounts to LBSF, relying on Section 2(a)(iii) of the Swap Agreement. This provides that the obligation to make payments under the Swap Agreement is subject to the condition precedent that no event of default has occurred and is continuing.

Metavante argued that LBHI's bankruptcy filing had made LBSF an "ineffective counterparty," an essential item of value that Metavante had bargained for, and Metavante could not, therefore, be compelled to make its payment obligations under the Swap Agreement.

LBSF and LBHI argued that the Swap Agreement was an executory contract, as material performance (specifically payment obligations) remained due by both LBSF and Metavante. Therefore, Metavante was precluded from relying on Section 2(a)(iii) of the Swap Agreement, as this section amounted to an ipso facto clause. Ipso facto clauses are provisions in executory contracts and unexpired leases that automatically terminate the contract, modify a contractual right, or permit the other contracting party to do so, in the event of a bankruptcy. Such clauses are unenforceable against a chapter 11 debtor under section 365(e)(1) of the Bankruptcy Code.

LBHI and LBSF also pointed to section 365(a) of the Bankruptcy Code, which provides at the relevant part that a debtor in possession, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.

The debtors cited case law to support the proposition that while a debtor determines whether to assume or reject an executory contract, the counterparty to such contract must continue to perform its obligations under the contract.

LBSF and LBHI noted that the Bankruptcy Code contains "safe harbour provisions" that carve out an exception to the general rule that ipso facto clauses are void by permitting qualifying non-debtor counterparties to derivative contracts to exercise certain limited contractual rights in the case of a chapter 11 filing. LBHI and LBSF argued, however, that the safe harbour provisions are available to a counterparty only to the "narrow extent" that such counterparty seeks to liquidate, terminate, or accelerate its contracts with the chapter 11 filer, or offset or net out its positions under the derivative contract.

The Bankruptcy Court agreed that Metavante's refusal to perform its obligations under the Swap Agreement was not protected by the Bankruptcy Code's safe harbour provisions. The only rights of a swap counterparty that fell under the safe harbour were to "offset or net out any termination values or payment amounts arising under or in connection with the termination, liquidation or acceleration of one or more swap agreements."

Metavante had not attempted to liquidate, terminate or accelerate the Swap Agreement, or to offset or net out its position as a result of the events of default caused by the filing of bankruptcy petitions by LBHI and LBSF. Metavante had simply withheld performance, relying on the condition precedent language in Section 2(a)(iii) of the Swap Agreement.

This conduct, which the Bankruptcy Court described as "riding the market for the period of one year, while taking no action whatsoever," was "simply unacceptable and contrary to the spirit [of the safe harbour provisions] of the Bankruptcy Code."

The Bankruptcy Court pointed to the legislative history of the safe harbour provisions that indicate that the rationale for the enactment of these provisions was that "the immediate termination for default and the netting provisions are critical aspects of swap transactions and are necessary for the protection of all parties in light of the potential for rapid changes in the financial markets."

The Bankruptcy Court also relied on a decision in In re Enron Corp. that held that a counterparty's action under the safe harbour provisions must be made fairly contemporaneously with the bankruptcy filing, otherwise the contract will be rendered just another ordinary executory contract. The Bankruptcy Court found that Metavante's window to act promptly under the safe harbour provisions has passed, and that its failure to terminate the Swap Agreement by the date of the ruling constituted a waiver of that right.

The Bankruptcy Court held further that LBSF was entitled to continued receipt of the payments under the Swap Agreement and that Metavante's failure to make such payments constituted an attempt to control property of the debtors' estates, in violation of the automatic stay imposed by section 362 of the Bankruptcy Code.

Therfore, the Bankruptcy Court entered an Order directing Metavante to perform under the Swap Agreement until such time as LBSF and LBHI determine whether to assume or reject the agreement.

On 25 September 2009, Metavante filed a motion to amend the Order to provide clarification with regard to the debtors' future obligation to Metavante pending the debtors' decision to assume or reject the Swap Agreement.

Specifically, Metavante seeks, among other things:

Clarification of the assurances that the debtors will be required to provide if Metavante becomes a net payee under the transaction.

That the Bankruptcy Court order that the payments due from Metavante under the Swap Agreement be paid into an interest-bearing escrow account pending the debtors' decision to assume or reject the Swap Agreement.

The hearing on Metavante's motion is set for 18 November 2009 at 10:00 prevailing Eastern Time.