The Deal: Lehman Makes Its Mark on Bankruptcy's Landscape

NEW YORK (The Deal) -- In the minds of many, Lehman Brothers' collapse andsubsequent bankruptcy has served as a turning point in the country'sfinancial landscape.

And while five years have gone by since the epic Chapter 11 filing onSept. 15, 2008, its influence remains strong. For example, the movementbehind the possible creation of a Chapter 14 of the U.S. Bankruptcy Codethat would just be for financial institutions is a direct response toLehman.

Meanwhile, the Lehman petition was clearly the impetus behind at least onepiece of legislation, the Dodd-Frank Wall Street Reform and ConsumerProtection Act, designed to improve accounting transparency amongfinancial institutions and prevent future taxpayer bailouts of them.

Less clear is how "the skinniest Chapter 11 petition in history," asdebtor counsel Harvey Miller of Weil, Gotshal & Manges LLP called itrecently, inspired the speed at which bankruptcy sales were done in thecases of General Motors ( GM) and Chrysler, which filed within twomonths of each other in the spring of 2009 and were sold in aslightning-quick a fashion as Lehman's North American investment bank andbrokerage assets.

Without question, general market turmoil, an economic freefall andwidespread mistrust of the big banks and the regulators tasked withoverseeing them followed the brokerage's implosion.

" It was the biggest unplanned bankruptcy in the history of bankruptcylaw, period," said the person presiding over the Lehman case, Judge James Peck of theU.S. Bankruptcy Court for the Southern District of New York in Manhattan,during a Sept. 12 teleconference commemorating the five-year anniversaryof the filing.

"Anyone who was in my overcrowded courtroom the first day will rememberthe experience as absolutely one-of-a-kind, extraordinarily dramatic."

The judge, who said he felt an "enormous responsibility" when randomlyassigned the case, said the first few days of the case "will go down asthe most momentous week in bankruptcy history, full stop."Right off the bat, Peck approved a $1.29 billion sale of Lehman's NorthAmerican investment bank and brokerage assets to Barclays Capital ( BCS) onSept. 20, 2008, less than a week after the company's filing -- a moveWeil's Miller calls "courageous" given the alacrity in which it was done.

Chris Kiplok of Hughes Hubbard & Reed LLP, who represented SecuritiesInvestor Protection Act trustee James W. Giddens, stated that the Barclaystransaction was one of several early case developments that marked "theend, in my mind, of the triage phase. ... We paused and saw that we hadthe right professionals on the case in the case ... we knew we coulddrive the case instead of having the case drive us."

Daniel Y. Gielchinsky of Higer Lichter & Givner LLP said that critics ofthe swift nature of the sale are ignoring other instances of fast Section363 transactions.

"That does occur fairly routinely," he said. "It was imperfect in thatnot all the issues came to light before -- but the Lehman judge did whathe had to do under the time constraints in realizing the enormity infailing to act in an expeditious matter."

One lawyer whose firm represented one of the parties that had its servicescontract acquired by Barclays, Christopher A. Ward at Polsinelli ShughartPC, said that because the deal was approved quickly, it made it "hard todot all your i's and cross all your t's."

Ward says the debtor, the purchaser and the client were unclear at firston whether the contract would even be involved in the Barclays deal -- aposition that many found themselves in for some time after the deal closed.

Ultimately, the client Ward's firm represented was absorbed under theBarclays deal, but not before months of litigation and back-and-forth overthe details of the deal.

"It's what needed to be done, but the rules were definitely bent to getthere," he said of Peck's approval. "Getting something done in less thanfive days was definitely unheard of. It was just unheard of and absolutelyunprecedented. No one really knew how to handle it."

But he doesn't foresee the Lehman formula for a rapid sale of a majordivision of a bankrupt business will serve as a playbook for others.

"I don't think it has established a blueprint, because it went so faroutside the box to get things done at the outset," Ward said.

To be sure, Lehman's bankruptcy may not have set a framework for creativeinterpretations of the U.S. Bankruptcy Code, but it may trigger changes tothe law itself. Peck is co-chair of one of the advisory committees that isexploring adding a Chapter 14 which would include "code reforms that wouldbetter match the Bankruptcy Code to the needs of financial institutions,"the presiding judge said at the teleconference.

"One of the things that we are clearly taking a hard look at are the safeharbors themselves ... and whether they are too broad," Peck said,declining to elaborate because of the ongoing nature of the matter.

Higer Lichter's Gielchinsky said at its core, Chapter 14 would addressmatters that could affect relationships that are specific to the financialservices industry.

"When a large financial institution files for bankruptcy, the automaticmarket reaction is to make a run for it," Gielchinsky said.

When Lehman filed for bankruptcy, many of its customers tried to close outcontracts with the brokerage firm, which had a significant impact on thecompany's value as a going concern. (As a reference point, in the fivedays between when the Barclays deal was proposed and its approval, thedeal value dipped to $1.29 billion from $1.75 billion because of themarket's instability.)

Chapter 14, Gielchinsky explained, would establish a subsidiary tocontinue to do business with consumers when a major financial institutionfiled for bankruptcy, "and the market would understand that they are doingbusiness with a new nonbankrupt subsidiary that is adequately funded."

While Chapter 14 is still on the drawing board, the Dodd-Frank Wall StreetReform and Consumer Protection Act is a post-Lehman reality because of thefinancial instability the firm's bankruptcy helped usher in.

"Lehman was clearly the catalyst of the financial meltdown and therecession and people think of it as the start of the domino effect thatoccurred after that," said Mike Gottfried at Landau Gottfried & BergerLLP. "The whole world basically changed after Lehman in a lot of ways."

Dodd-Frank's purpose, effective as of July 21, 2010, is to "promote thefinancial stability of the United States by improving accountability andtransparency in the financial system, to end 'too big to fail,' to protectthe American taxpayer by ending bailouts, to protect consumers fromabusive financial services practices, and for other purposes."

Under Title II of Dodd-Frank, the Orderly Liquidation Authority has beencreated, allowing insured depository institutions and securities companiesto be liquidated under existing law by the Federal Deposit Insurance Corp.or Securities Investor Protection Corp. Other insurance companies andnonbank financial companies not covered elsewhere can be liquidated underthe act, too.

Bryan Marsal of Alvarez and Marsal Holdings LLC, who served as Lehman'sCEO after the company's filing until 2012, questioned whether Dodd-Frankwas the right way to deal with issues related to similar filings, addingthat we have "miles to go before we sleep" when it comes to the reform act.

"The bankruptcy process works well," Marsal said during theteleconference. "It continued to work well, so why we are moving to aregulator process is a mystery."

Marsal maintained that risk management should not simply be theresponsibility of the regulators, but has to start with the company.

Gielchinsky also questioned whether Dodd-Frank would cause more confusionmoving forward.

"Dodd-Frank raises questions in and of itself ... is the proper placewithin the Bankruptcy Code, or is it within Title II's orderlyliquidation?" Gielchinsky asked.

Polsinelli's Ward contended that Dodd-Frank has provided more clarity, buthasn't exactly accomplished the goals of its mission statement.

"It's provided more transparency in the system," Ward said. "It mayilluminate some of the issues, but I definitely don't think it has solvedthe problem."

Though questions around Dodd-Frank remain, there has been a consensus thata collaborative attitude from the parties involved has kept the biggestissues in Lehman's complicated case from dragging out even further than itcould have. (Though Peck on Dec. 6, 2011, confirmed a liquidation planthat would allow Lehman to unwind its remaining holdings, including realestate, commercial loans and private equity and principal investment overtime, Lehman is still disputing claims in the case.)

Peck pointed to the establishment of a protocol for dealing with Lehman'snumerous international affiliates ¿ 7,000 legal entities located in over40 countries ¿ as a key force binding the combatants.

"There was an extraordinary level of international cooperation andconsultation," Peck said during the teleconference. "It was a coalition ofthe willing."

Gielchinsky, who called it the first international protocol of its time,said that he has not yet seen an instance where a similar model has beenused but expects it'll rear its head again.

"I think that the testament to the collaborative process is the fact thatthe protocol worked," he said. "Everyone bought into it, the courtslargely abided by it, and it should become a model for how largebankruptcy cases should be handled in the future."

Miller, while outlining the biggest lessons learned from the case, said,"if parties are rational and if they examine the facts, they will worktogether to reach a conclusion that benefits everybody."

Peck concurred that the Lehman case shouldn't only be cast in a negativelight.

"While Lehman as an event is viewed with a sense of horror, Lehman as abankruptcy case was actually an effective and efficient way to deal withthat failure," Peck said. "I can't say that it can be easily replicated.It happened improvisationally."

-- Written by Kelsey Butler in New York

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