Scenario:

The recent case of In re Tousa, Inc. (Official Committee of Unsecured Creditors of Tousa, Inc., v. Citicorp North America, Inc., Adv. Pro. No. 08-1435-JKO (Bankr. S.D. Fla., October 13, 2009)) has attracted considerable attention – and dread – in the banking and legal communities.

Lehman Brothers Holdings Inc. (“LBHI”) and its affiliate and subsidiary debtors (collectively, “Lehman”) filed their proposed chapter 11 plan of reorganization in their jointly administered chapter 11 proceedings on Monday, March 15, 2010 (Docket No. 7572). Monday was the last day for Lehman to file a plan pursuant to section 1121(d) of the Bankruptcy Code in order for Lehman to maintain the exclusive right to file and obtain confirmation of a plan.¹

Anyone who obtains title insurance, whether as an owner or a lender, should be aware of a recent abrupt and significant change in title insurance practices across the country. Title companies have recently stated that they will no longer delete creditors’ rights exclusions from, or add affirmative creditors’ rights coverage as an endorsement to, any of their issued title policies.

Bankruptcy Rule 2019, an often ignored procedural rule in U.S. bankruptcies, has returned to the public eye with a vengeance in light of a recent ruling by the influential Bankruptcy Court for the District of Delaware¹ and controversial pending amendments to Rule 2019 proposed by the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States (the “Rules Committee”). The amendments will be the subject of a public hearing held in New York City on February 5, 2010.²

Courts are now being asked to examine transactions which were completed during the recent exuberant period. Despite the fact that the transactions in question may have been market standard at the time, because those transactions are being scrutinized during an unprecedented economic crisis, it appears that a disproportionate amount of finger pointing – and economic loss – is being directed at secured creditors. The result is a seeming erosion of secured creditors’ rights for the benefit of unsecured creditors.

Credit agreements typically provide that any amendment permitting the release of “all or substantially all” of the collateral requires the unanimous consent of the lenders. Many market participants expect that this provision provides protection against the agent and other lenders from consenting to the sale of the collateral and releasing the corresponding liens without the consent of all lenders.

The recent steady drumbeat of Chapter 11 bankruptcy filings is producing an equally persistent corollary: creditors receiving new securities issued by the reorganizing debtor or a related party in full or partial satisfaction of the creditors’ claims. Some of these creditors-cum-investors never planned to receive securities. The paradigmatic example is a creditor that enters into a normal business transaction resulting in an obligation that the debtor company hasn’t yet satisfied when it files for reorganization.

Nothing is certain in today's financial crisis - except that the legal system will be sorting out the rights and obligations of financial market participants for years to come. This is especially true for participants in the over-the-counter derivatives markets.

This memorandum provides an overview of the practical issues facing a sub-participant under a Loan Market Association ("LMA") English-law governed sub-participation agreement as the creditworthiness of grantor deteriorates.