JPMorgan’s $8.6 Billion Lehman Victory: A Deeper Dive | Practical Law

JPMorgan’s $8.6 Billion Lehman Victory: A Deeper Dive | Practical Law

The US District Court for the Southern District of New York, in In re Lehman Brothers Holding Inc., held that JPMorgan (JPM) did not exploit its position as the main clearing bank for Lehman Brothers in the days leading up to Lehman's 2008 bankruptcy. JPM was therefore entitled to retain $8.6 billion of Lehman’s collateral posted during this period.

JPMorgan’s $8.6 Billion Lehman Victory: A Deeper Dive

Practical Law Legal Update w-000-6816 (Approx. 7 pages)

JPMorgan’s $8.6 Billion Lehman Victory: A Deeper Dive

by Practical Law Bankruptcy & Restructuring and Practical Law Finance
Published on 22 Oct 2015USA (National/Federal)
The US District Court for the Southern District of New York, in In re Lehman Brothers Holding Inc., held that JPMorgan (JPM) did not exploit its position as the main clearing bank for Lehman Brothers in the days leading up to Lehman's 2008 bankruptcy. JPM was therefore entitled to retain $8.6 billion of Lehman’s collateral posted during this period.
On September 30, 2015, the US District Court for the South District of New York, in In re Lehman Brothers Holding Inc., held that JPMorgan Chase Bank, N.A. (JPM) did not exploit its position as the main clearing bank for Lehman Brothers Holdings Inc. and its related subsidiaries (collectively, Lehman) in the days leading up to Lehman's 2008 bankruptcy ( (S.D.N.Y. Sept. 30, 2015)). The court found that JPM was therefore entitled to retain $8.6 billion of Lehman’s collateral posted during the period.


Lehman filed this noncore adversary proceeding against JPM in the Lehman bankruptcy cases in 2010. Directly at issue in this matter was JPM's role as Lehman's main clearing bank and source of credit for its various tri-party repurchase agreements (providing up to $242 billion in intraday credit to Lehman at their relationship's peak).
Lehman and its creditors argued that a series of amendments to certain agreements between the parties made in the months immediately preceding its bankruptcy filing were improper.
The main agreement governing the relationship between the parties was a June 2000 “clearance agreement” between Lehman and Chase Manhattan Bank (Chase), JPM's predecessor in interest. Under the clearance agreement:
  • JPM could transfer funds from Lehman's clearing account to other accounts managed by JPM to allow itself to become fully collateralized for exposure to Lehman under the various transactions between them.
  • JPM had the right to decline Lehman's request for an extension of credit and immediately call all loans on demand with notice.
  • JPM held a lien over certain assets in Lehman's JPM accounts as security for its exposure on advances to Lehman.
JPM and Lehman operated under the clearance agreement (which expired in October 2002) until the parties agreed to a formal amendment to that agreement in May 2008.
In early 2008, acting on the advice of the Federal Reserve, which urged JPM to review its exposure in the clearing market, JPM began negotiations with Lehman in hopes of increasing collateralization against its exposures. In June 2008, Lehman pledged additional collateral to JPM in the form of securities valued at approximately $5 billion (June collateral).
In August 2008, JPM raised additional concerns about the value of the June collateral and its lien on that collateral, and the two parties entered into a series of agreements (collectively, the August agreements) which included:
  • An agreement by Lehman to transfer the June collateral to a securities account managed at and by JPM.
  • An amendment to the clearance agreement, in which JPM agreed to post collateral to continue to guarantee the intraday trading obligations of Lehman.
  • A guaranty on Lehman's obligations (guaranty agreement).
  • A security agreement that created a lien on Lehman's accounts in favor of JPM.
On September 9, 2008, Lehman's stock dropped 45% from its previous day's value. On that date, JPM informed Lehman that, without additional agreements in place, JPM would not be able to support Lehman's trading positions for the following day. The next morning, the parties executed amendments to the clearance agreement, guaranty agreement, and security agreement (collectively, the September amendments). Under the amendment to the clearing agreement, Lehman's obligations to JPM expressly enumerated all of Lehman's existing indebtedness, obligations, and liabilities.
On September 11, 2008, JPM again called Lehman to demand an additional $5 billion in cash collateral to secure Lehman's obligations under the September agreements. Lehman provided those funds the next morning.
In total, between September 9 and September 12, 2008, Lehman pledged $8.6 billion to JPM in collateral security, comprised of $1.7 billion in money market funds and $6.9 billion in cash collateral. These assets were deposited into a demand deposit account held by JPM. After the funds were deposited, JPM moved the cash collateral from the account into its general ledger.
On the morning of September 15, 2008, Lehman filed its Chapter 11 petition.

The Primary Clearing Agreement Between the Parties Did Not Obligate JPM to Lend or Restrict JPM's Right to Receive Collateral

Lehman claimed that JPM improperly used its leverage as Lehman's main clearing bank to extract virtually all of Lehman's liquid assets. Therefore, the first question the court analyzed was whether JPM was under any obligation to extend credit to Lehman indefinitely. If JPM did have such an obligation under the parties’ agreements, JPM’s conditional extensions of credit and to Lehman and extraction of collateral would have been wrongful.
The primary document governing the tri-party repo relationship among the parties was the clearance agreement. This was therefore the primary clearing agreement between the parties. The court noted at the onset that this agreement, by its terms, "clearly contemplates JPMC's ability at its discretion, and the right to decline, with notice, further extensions of credit regardless of any prior course of conduct." (, at *7) (emphasis added).

JPM Was Not Required to Extend Credit to Lehman Indefinitely

Under the relevant section of the clearance agreement:
Notwithstanding the fact that [JPM] may from time to time make advances or loans pursuant to this paragraph or otherwise extend credit to Lehman, whether or not as a regular pattern, [JPM] may at any time decline to extend such credit at [its] discretion... (, at *7) (emphasis added).
In spite of its strong drafting, Lehman nevertheless argued that "notice" in this capacity meant a commercially reasonable notice that would require anywhere from several months up to one year. In the alternative, Lehman argued that the "notice" JPM provided on September 9, 2008, when it warned Lehman it might not be able to continue funding obligations the following morning, was insufficient.
The court ruled that no ambiguity existed surrounding the contract language on notice. JPM could, and did, provide notice at any time. Furthermore, Lehman could not argue that the clearance agreement's termination provision (which provided for 30 days' notice in the event of a breach and 12 months' notice in the absence of a breach) would undermine the bargained for right that JPM received to stop extending credit at its discretion at any time. The nature of the financial industry and the sophistication of the parties factored against such an interpretation.

JPM Had Right to Request Additional Collateral

The court also noted that nothing in the clearance agreement restricted JPM's right to request collateral, or, as Lehman argued, prohibited Lehman from becoming "overcollaterilized."
The relevant language within the clearance agreement read:
[JPM] shall only permit transfers from the Clearing Account(s) to the Custody Account(s) or Segregated Account(s) to the extent that after such transfer [JPM] remain[s] fully collatereralized… (, at *10) (emphasis added).
The court held that "[t]he 'fully collateralized' language operates as a shield" and in the absence of express language to the contrary, Lehman could not impose a cap on JPM's collateral (, at *10). The court therefore declined to question JPM's $5 billion collateral demand based on any implied covenant of good faith or fair dealing.
Likewise, the court failed to find relief for Lehman in UCC Section 1-208 (which states that "at will" contractual terms governing collateral will only be honored if the requesting party acts in good faith), as that section's official comment expressly states that good faith shall not apply to express contractual obligations to the contract. Since JPM's rights to deny funding and request additional collateral were expressly stated in the clearance agreement, the court could not superimpose additional limits in the prospect of fair dealing simply because Lehman was upset with the terms it bargained for.

Hell or High Water: The Amendments Executed in Advance of Lehman's Bankruptcy Were Enforceable

While Lehman did not specifically attack the enforceability of JPM's actions under the August agreements, Lehman did attack the validity of the September amendments for lack of adequate consideration and lack of authority.
Similar to the court's reasoning above, it was the strongly drafted JPM protections in a so-called hell or high water clause included in the September amendment to the guaranty agreement that ultimately insulated JPM from liability. The relevant section read:
The liability of [Lehman] under this Guaranty is absolute and unconditional irrespective of . . . any lack of validity or enforceability of any . . . Facility Document [which is defined to include any agreement between Lehman and JPM] or . . . any other setoff, defense, or counterclaim whatsoever . . . which might constitute a legal or equitable defense available to . . . a guarantor; and [Lehman] irrevocably waives the right to assert such defenses, setoffs or counterclaims" (, at *13).The Second Circuit has held that, among sophisticated parties, hell or high water clauses are enforceable (see Wells Fargo Bank, N.A. v. BrooksAmeica Mortg. Corp., 419 F.3d 107 (2d Cir. 2005)).
The Southern District of New York itself has found that these clauses specifically bar claims for lack of consideration or authority (see Liberty Mut. Fire Ins. Co. v. Mystic Transp., Inc., (S.D.N.Y. Sept. 16, 2004)).
The court again noted that the parties were sophisticated and the terms of the relevant agreements and amendments unambiguous, despite the fast-paced nature of the September amendments.
Regardless, Lehman ratified the September amendments when it first brought its motion for a comfort order before the bankruptcy court, in which it failed to question the agreements or acts of JPM they later contended to be improper. As the court noted, when Lehman filed for bankruptcy, it was "put to a choice: either receive the benefits in its prior agreement with [JPM], most notably the extension of intraday credit, or argue that these agreements were invalid or had been breached…." (, at *14).

Lehman's Pledge of Collateral Was Not the Product of Fraud by either Lehman or JPM

Lehman also alleged that the collateral pledged on September 12, 2008 was the product of a fraudulent inducement by JPM. While the court noted that a genuine question of fact existed as to whether or not JPM ever promised to return the $5 billion, the contract itself was drafted so that, even if JPM did promise to return the collateral, Lehman could never have reasonably relied on that promise. Therefore, the fraud in the inducement defense was barred as a matter of law.
Lehman's creditors also sought to attack the September amendments as a fraudulent conveyance, based on actual fraud, under section 548 of the Bankruptcy Code. Since actual intent is difficult to prove, courts examine various "badges of fraud" to prove intent (In re Kaiser, 722 F.2d 1574, 1582 (2d Cir. 1983)). The Lehman creditors proffered that the following were badges of fraud:
  • JPM's failure to give adequate consideration for the September amendments. The court held on this point that JPM had no obligation to extend credit and therefore "the consideration for the $8.6 billion in collateral was the extension of credit in the tens of billions to [Lehman] at a time when its very survival required such infusions of credit." (, at *17).
  • JPM and Lehman's relationship could not produce an arm's length transaction due to JPM’s position as Lehman's main clearing bank. The court rejected this argument, holding that the terms of the contract were the product of strong negotiation by JPM rather than a desire for Lehman to provide JPM with a "sweetheart" deal.
  • The rapid, closed-door nature of the September amendments support a fraudulent attempt to conceal these agreements. The court noted that, in the absence of any indication that these negotiations were conducted in secrecy, the mere fact that they were done quickly could not support an inference of fraudulent intent.
  • Lehman's distressed nature at the time of these transfers. The court noted that this was insufficient to constitute fraud, and while outside of the normal course of business, "there is nothing unlawful about a company transacting business during unusually difficult financial times in an attempt to prevent its own collapse." (, at *18).

JPM Had a Valid Lien over Lehman's Collateral

Lehman's creditors also argued that JPM released its lien when it moved the $6.9 billion from the cash collateral account to its general ledger.
Also, under the terms of the September security agreement amendment, which granted JPM a broad security interest in the cash collateral account, Lehman was granted the right, upon three days' notice to JPM, to transfer any "Security," which included substantially all of Lehman's accounts at JPM, “and upon any such transfer the security interest hereunder shall be released," provided that JPM did not separately exercise any of its rights under the guaranty agreement, security agreement, or under an event of default with respect to any piece of collateral security (, at *18).
However, the court concluded that Lehman never provided written notice of its intentions to transfer any of the Security in the lead up to its bankruptcy and, similarly, JPM never expressly released its lien over the funds in question.
The court noted Article 9 of the NY UCC, which states that a security interest in collateral continues after a disposition until the secured party "authorize[s] the disposition free of the security interest" (N.Y. U.C.C. § 9-315(a)(1)).
Lehman's creditors argued that JPM's lien was extinguished when the cash was transferred from the collateral account to the general ledger account managed solely by JPM. The September security agreement amendment's definition of "Security" included "all proceeds of any and all of the foregoing security." The UCC's official comment to the definition of "proceeds" states that "a transfer of all funds maintained in an account subject to a security interest – and not just the interests or dividends accrued on those funds – is a cognizable transfer of 'proceeds'" (U.C.C. § 9-322, cmt. 2, ex. 2). Therefore, the Court reasoned that, when JPM transferred the $6.9 billion, its right of payment attached to that collateral in the original account transferred along with it.

Next Steps

The court dismissed several smaller common law claims against JPM such as conversion, unjust enrichment, and constructive trust in light of its holding that the agreements were valid and that the type and transfer of the collateral were permitted under the agreements. There were, however, several issues of material fact that existed for the remaining claims. With the latest decision, only six of the 49 counts found in the original 2010 complaint, and seven of JPM's counterclaims, remain before the court.

Practical Implications

This latest development in the Lehman bankruptcy saga demonstrates the importance that courts will give to express terms of an agreement (such as hell or high water clauses) and unambiguous drafting among sophisticated parties, regardless of the extreme duress under which they may have been negotiated.