“Do Nothing” Advice to Federation SCDO Holders Proves Correct

As reported in Amicus’ article published in August 2020, Lehman Brothers Holdings Inc (the ultimate parent company within the Lehman Brothers group (Lehman)) lost their recent appeal to the Second Circuit Court.  This appeal was of the judgement made against Lehman in the Bankruptcy Court in 2016 and Lehman’s subsequent unsuccessful appeal of that judgment to the District Court in 2018. 

The period allowed for Lehman to appeal the Second Circuit Court decision expired in November 2020.  Amicus understands one Australian investor sought a formal legal opinion from their lawyers who have confirmed no appeal by Lehman is now possible.  In further support of the conclusion the legal action is now over, Lehman confirmed in its quarterly financial report to creditors that their “SPV avoidance action” is no longer an active lawsuit.  This therefore brings to an end the lawsuit initiated by Lehman in 2010 against the former holders of Lehman issued SCDO globally and in particular holders of the Federation SCDO in Australia.

Reflecting on the facts of the case, it is easy with hindsight to see this was always a frivolous and vexatious lawsuit.  The case itself was summarily dismissed meaning the Bankruptcy Court would not even hear the case in 2016 as it thought it had such little merit. All subsequent failed appeals by Lehman to reverse this decision were simply to try to get the Bankruptcy Court to even consider the case let alone find in favour of Lehman.  When filing the case in 2010, Lehman immediately “stayed” it meaning they did not pursue it; hence the six year wait before the Bankruptcy Court summarily dismissed it.  This demonstrates Lehman had no confidence from the outset it was ever going to obtain a favourable judgement.  In summary, the primary purpose of filing the case was simply to pressure holders of SCDOs into out of court settlements to avoid years of potential legal actions hanging over their head until 2021.

Further had Lehman ever won the case, it would have meant no derivative contracts with US based banks were ever safe from dispute.  This would have put US banks at a severe disadvantage in financial markets as compared with European or non-US banks.  The US Congress had long recognised this issue and had set up “Safe Harbour” provisions to carve derivatives contracts out of the US bankruptcy process. It was on this basis the Bankruptcy Court dismissed the case.  In essence, Lehman was asking the US courts to essentially cripple the US financial markets by reversing a policy decision purposely designed to solve this issue it was raising.

Many holders of the Federation SCDO succumbed to pressures put upon them.  Some investors gave up all of the principal and interest Lehman claimed and others paid back 80%, 50% and 30% of principal in successive rounds of negotiations with Lehman.  This occurred because investors were fearful due to being uninformed, or they received poor advice that did not give primacy to the facts and arguments laid out in the two paragraphs above.

Investors were often not helped by their Trustees and Custodians some of whom implicitly encouraged Federation holders to settle with Lehman as the Trustees and Custodians themselves were being sued by Lehman as part of tactics to put additional pressure on investors.  This was an agency problem where Lehman cleverly created a situation where investors were being coerced to settle to reduce the Trustees and Custodians’ own liabilities.  Some Trustees and Custodians tried to enforce indemnities while simultaneously asking investors to pay the legal bills of their own lawyers who were acting in their interests rather than those of the investors.

Many (but not all) law firms involved encouraged their clients to settle.  For some investors where relatively small amounts of money were involved, this may have seemed justified to make the nuisance go away but, in reality, there was no need to do anything because in this case possession of the monies was not just nine tenths of the law, it was ten tenths.   

The course of action that proved to be the best, and the one which Amicus advised its clients to follow, was to do nothing.  Do not settle, do not spend money on legal advice, simply monitor the situation and wait. 

Lehman failed at every stage of the legal process and even if they had made progress, there were multiple layers of legal defences still available such as waiting to address the issue if and when the US Bankruptcy Court was forced to consider the actual case or at the various appeals afterwards and then beyond that when jurisdictional issues were considered for non US investors[1] and further beyond that when Lehman would be required to ask the Australian Courts to enforce any US Court decision in Australia.

The lesson of this case is that with conservative fixed interest investments seeking independent advice (rather than remaining uninformed or sourcing advice from those with a conflict of interest) can make a large difference to the substantial downside risks when loss of principal is involved.  Independent advice may also be necessary to resist pressures placed upon those with fiduciary responsibilities for the entrusted funds of others to alleviate their personal liabilities and give them the courage to pursue what they believe to be correct course of action.  

[1] One Custodian, ANZ Bank, informed its clients it was no longer seeking indemnities from them after it won a US Court case saying the US Courts had no jurisdiction over the sale of Federation as all actions had taken place in Australia rather than the US

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