Lehman Court Holds That Contractual Cross-Affiliate Setoff Rights Are Unenforceable In Bankruptcy

On October 4, 2011, the U.S. Bankruptcy Court for the Southern District of New York held in the SIPA proceeding of Lehman Brothers Inc. (“LBI”) that “a contractual right of setoff [in a swap agreement] that permits netting by multiple affiliated members of the same corporate family outside of bankruptcy may no longer be enforced after commencement of a [bankruptcy proceeding].” This decision is consistent with—but also broader than—the decision of the U.S. District Court for the District of Delaware in SemCrude, which addressed cross-affiliate setoff but not the effect of safe harbor provisions, and the decision of the U.S. District Court for the Southern District of New York in Swedbank, which addressed pre- and post-petition claims between the same entities and the effect of safe harbor provisions in that context. Unless overruled on appeal, the LBI court’s holding, when taken together with the decisions in SemCrude and Swedbank, would appear to provide a comprehensive determination that mutuality is required for setoff rights to be enforceable after commencement of a bankruptcy proceeding, even in the context of “safe harbored” contractual agreements. These decisions do not, however, affect the analysis of structured solutions—such as pledges of receivables—to achieve the goal of cross-affiliate setoff.