In In re Enron Creditors Recovery Corp.,^[1] the Second Circuit greatly expanded the settlement payment defenses of section 546(e) of the Bankruptcy Code (the “Code”)[2] by rejecting Enron’s attempt to avoid a repayment of debt, because the repayment was structured as a redemption. This case stemmed from a series of transactions in which Enron used a clearing agency—that merely acted as an intermediary and never took title to the commercial paper—to retire commercial paper before the maturity date. Enron later filed bankruptcy and sought to avoid the more than $1.1 billion it paid, in the 90 days prior to its bankruptcy filing, to retire the commercial paper.[3]

The Unenforceability of Flip Clauses in Swap Agreements

By: Piergiorgio Maselli

St. John's Law Student

American Bankruptcy Institute Law Review Staff

In Lehman Bros. Special Financing, Inc. v. Ballyrock (In re Lehman Bros. Holdings Inc.),[1] the United States Bankruptcy Court for the Southern District of New York held that a so-called “flip clause” in a swap agreement, which reordered the payment priorities in a collateralized debt obligation (“CDO”) transaction,[2] was an unenforceable ipso facto[3] clause of the type that is not protected by the safe harbor provisions of the Bankruptcy Code (the “Code”).[4] Lehman and Ballyrock’s swap agreement[5] provided that in the event of a party’s default, the non-defaulting party was entitled to terminate the agreement and alter the priority of payments under the agreement.[6] Since bankruptcy was an element of default, Lehman’s bankruptcy filing triggered the flip clause and placed it below CDO noteholders in the “waterfall” of termination payments. The flip clause, if enforced, would have eliminated Lehman’s right to receive funds that it would have received if not for its bankruptcy, and thus Ballyrock claimed that Lehman’s bankruptcy filing effectively deprived it of its right to collect termination payments.[7]