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From Securities Regulation Daily, October 1, 2015

JPMorgan defeats Lehman suit over $8.6B ‘slush fund’

By Anne Sherry, J.D.

Lehman Brothers and its creditors’ committee lost their bid to recover $8.6 billion in collateral that JPMorgan Chase received from Lehman in exchange for clearing triparty repurchase agreements. The suit argued that JPMC abused its leverage over the broker to deprive it of liquidity and create a “slush fund” of collateral for the bank’s own use. The Southern District of New York decided the primarily contractual dispute in JPMC’s favor, concluding that the parties’ agreements did not require the bank to lend money or restrict its right to request collateral (Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank, N.A., September 30, 2015, Sullivan, R.).

Background. During the time period at issue, only two clearing banks (Bank of New York Mellon is the other) provided triparty repo clearing services to broker-dealers. The lawsuit argues that JPMC used its “life or death” leverage as Lehman’s primary clearing bank to extract virtually all of Lehman’s remaining liquidity and grab $8.6 billion in collateral. The crux of this argument is that because JPMC was contractually obligated to extend credit to Lehman, the bank was wrong to condition extensions of credit on the provision of additional collateral.

Contract terms. Analysis of the parties’ agreements contradicted the premise that JPMC was required to extend credit. On the contrary, the contracts unambiguously allowed JPMC to stop extending credit to Lehman on short notice. The court also found that the bank was allowed to request the collateral necessary to secure Lehman’s obligations and retained its lien of over $6.9 billion in cash collateral even after transferring the funds to a separate account from which only JPMC could make a withdrawal.

Other claims. Claims of conversion, unjust enrichment, and constructive trust required dismissal in light of the court’s holdings that the agreements (1) were valid, (2) contemplated the type of collateral transfers at issue, and (3) permitted JPMC to move collateral to a separate account. The court also dismissed the corresponding remedial claims. However, the plaintiffs’ claims of voidable setoff and violation of the automatic stay survived dismissal: the briefs were insufficient to determine whether the challenged transactions were protected by safe harbors. Similarly, judgment on the claims of equitable subordination was premature.

Counterclaims. JPMC had counterclaimed that Lehman fraudulently induced the bank to extend credit during the Lehman bankruptcy. The parties asked the court to consider JPMC’s counterclaims as well, but their dispute as to whether Lehman made misstatements that induced reliance precluded summary judgment. Finally, because the court could not enter summary judgment on the counterclaims, it also denied judgment on JPMC’s claim for indemnification as premature.

The case is No. 11-cv-6760.

Attorneys: Cindi Michelle Giglio (Curtis, Mallet-Prevost, Colt & Mosle LLP) for Lehman Brothers Holdings Inc. Andrew J. Rossman (Quinn Emanuel Urquhart & Sullivan, LLP) for the Official Committee of Unsecured Creditors of Lehman Brothers Holdings Inc. Alexander Lees (Wachtell, Lipton, Rosen & Katz) for JPMorgan Chase Bank, N.A.

Companies: Lehman Brothers Holdings Inc.; Official Committee of Unsecured Creditors of Lehman Brothers Holdings Inc.; JPMorgan Chase Bank, N.A.

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