The Sears bankruptcy case made headlines this month in the complex world of credit default swaps (CDS). A credit default swap is a contract pursuant to which the seller receives payment from a buyer in exchange for which the seller must compensate the buyer in the event of a default or other specified credit event.

In the first article of this two-part series on sell-side opportunistic engineering in the CDS market, we surveyed a number of strategies that could be used by sellers of CDS protection to create sell-side gains. In this second part, we analyze two recent situations where a proposed refinancing dramatically affected the CDS market for the reference entity because of the reduction in the sell-side risk. Although these cases may or may not have been driven by CDS considerations, they illustrate how sell-side CDS strategies may be effectively implemented.

Part 1 of this series described the recent decision of the ISDA Americas Determinations Committee to declare that a “failure to pay” had occurred with respect to iHeartCommunications Inc., notwithstanding that the only non-payment had been to a wholly owned subsidiary. The non-payment was orchestrated to avoid a springing lien that would have been triggered had all the notes of a particular issue of iHeartCommunications debt been paid in full. It did not reflect on the creditworthiness of iHeartCommunications.

The bankruptcy court overseeing the Lehman Brothers chapter 11 cases rejected efforts by Lehman Brothers Special Financing Inc. (LBSF) to recover roughly $1 billion in payments made to numerous noteholder defendants from the liquidation of collateral originally pledged to secure both obligations under notes issued by special purpose entities and credit default swap (CDS) obligations to LBSF, holding that the termination of the swap and liquidation and distribution of the collateral were protected by the Bankruptcy Code’s safe harbor.

As attention shifts from the global financial crisis of 2008–2009 to the global sovereign crisis that currently is affecting much of Europe, lawmakers are scrambling to create new laws and regulations designed to stave off the next financial crisis.[1] Meanwhile, a different threat quietly has been growing in America's states, cities, towns, municipalities, and other political subdivisions.

On April 26, 2011, the Supreme Court of the United States adopted a completely revamped version of Rule 2019 of the Federal Rules of Bankruptcy Procedure to govern disclosure requirements for groups and committees that consist of or represent multiple creditors or equity security holders, as well as lawyers and other entities that represent multiple creditors or equity security holders, acting in concert to advance common interests in a chapter 9 or chapter 11 bankruptcy case.

On April 26, 2011, the Supreme Court approved a number of amendments to the Federal Rules of Bankruptcy Procedure. In particular, the Supreme Court amended Bankruptcy Rule 2019 to clarify the disclosure required of certain parties in interest in a chapter 9 or 11 bankruptcy case.1 These amendments were drafted by a panel of bankruptcy judges and restructuring experts and are intended to resolve a split in decisions concerning the proper application of the current Bankruptcy Rule 2019.

On April 26, 2011, the Supreme Court of the United States adopted amended Federal Rule of Bankruptcy Procedure 2019 (“Rule 2019”). Rule 2019 governs disclosure requirements for groups and committees that consist of or represent multiple creditors or equity security holders, as well as lawyers and other entities that represent multiple creditors or equity security holders, acting in concert in a chapter 9 or chapter 11 bankruptcy case.

In a decision entirely consistent with its ruling in the “Perpetual” adversary proceeding last year, on May 12, 2011, the United States Bankruptcy Court in the Lehman chapter 11 cases endorsed a strict interpretation of certain Bankruptcy Code provisions to the benefit of Lehman, which will result in Lehman having more leverage in its negotiations with derivatives counterparties. See Lehman Brothers Special Financing Inc. v. Ballyrock ABS CDO 2007-1 Limited and Wells Fargo Bank, N.A., Trustee, Adv. Proc. 09-01032 (Bankr. S.D.N.Y. May 12, 2011).

In Lehman Brothers Special Financing, Inc. v. Ballyrock ABS CDO 2007-1 Limited (In re Lehman Brothers Holdings, Inc.), Adv. P. No. 09-01032 (JMP) (Bankr. S.D.N.Y. May 12, 2011) [hereinafter “Ballyrock”], the United States Bankruptcy Court for the Southern District of New York held that a contractual provision that subordinates the priority of a termination payment owing under a credit default swap (CDS) to a debtor in bankruptcy, and which caps the amount of the termination payment, may be an unenforceable ipso facto clause under section 541(c)(1)(B).