HK Lehman minibond resolution may be approved despite bond-holder dissent

Published online only

Author: Viren Vaghela

Source: Asia Risk | 11 Apr 2011

Categories: Counterparty Credit Risk

Topics: Lehman Brothers, Asia, Hong Kong, HSBC, Allen & Overy, Minibonds
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Despite objections submitted to the US bankruptcy court from the holders of Lehman Brothers minibonds, the latest resolution effort to reach settlement on the sale of credit-linked notes to retail investors in Hong Kong may still be approved, as the 75% threshold required will predominantly consist of the banks themselves, who agreed to repurchase many of the so-called bonds, say lawyers.

On April 5, minibond holders applied to the Southern District of New York bankruptcy court requesting it not make an order that would allow collateral to be released under a derivatives procedures order (DPO). These holders of credit-linked notes, dubbed ‘minibonds', are fearful their rights to further litigate would be compromised if the bankruptcy court agrees to the resolution. They are still seeking the full return of their investments, despite distributing banks sweetening their offer of compensation in late March.

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But lawyers at Allen & Overy (A&O), which advises PricewaterhouseCoopers (PWC), one of Lehman Brothers' bankruptcy trustees, believe this latest resolution from banks and trustees will receive approval as part of a settlement agreement put forward on March 27 by the 16 distributing banks in Hong Kong. This agreement would result in more than 65% of outstanding minibond holders receiving back at least 80% of their collateral, according to PWC. The resolution is contingent on approval from the US bankruptcy court, and at least 75% of minibond holders in each eligible series approving the resolution.

"In July 2009, the 16 Hong Kong banks that distributed the minibonds to the retail investors made an offer to eligible customers to buy back the minibonds. The vast majority of these eligible customers accepted the buyback offer, resulting in the distributing banks owning a significant percentage of the outstanding minibonds," says David Kidd, head of A&O's Asia-Pacific restructuring practice in Hong Kong. "The distributing banks have indicated... that they intend to vote in favour of the extraordinary resolution."

Eligible minibond holders that settled in 2009 will also see a higher amount of their original investment returned to them, as the banks have agreed to make ex-gratia payments to all eligible individuals.

Some minibond holders, however, believe they should receive their entire investment back, and many have protested with placards outside Hong Kong bank office buildings since the demise of Lehman Bothers in 2008.

One of the reasons for this could be the existence of the ‘flip clause' in many of the minibond contracts. This affects the priority of claims against the underlying collateral underpinning the minibonds structure. The collateral that underpins each series consist of securities issued under the Dante Finance Limited secured note programme.

In normal circumstances, Lehman Brothers Special Financing (LBSF), the counterparty of the underlying notes, has priority to the underlying collateral underpinning the minibond structure. However, the minibond structure also provides that the priority claim flips to the minibond note holders - meaning the minibond note holders have a claim to the underlying collateral - in the event of default caused by LBSF, which occurred when it filed for bankruptcy.

As Lehman Brothers did in fact default, the flip clause should have been triggered in favour of the minibond holders. The English courts, which govern the swap contracts, recognise the validity of the flip clause as a matter of English law. However, Lehman Brothers filed for bankruptcy under Chapter 11 in the US, and the US courts administering the bankruptcy do not recognise the flip clause under US bankruptcy law.

It is this judicial stalemate which has restricted the options available to the receiver, PWC. The prospect of pursuing the case through the UK and US courts for a determination on the status of the collateral and whether or not it is distributable could prove costly and time-consuming.

According to lawyers at A&O, the next Lehman Brothers omnibus hearing is scheduled for April 13 in New York, but parties are still awaiting confirmation whether the minibond matter will be heard at that time.

"The receivers have received approximately 200 calls from noteholders since the announcement of the conditional settlement agreement with Lehman Brothers on March 27, 2011. To date, feedback has been generally positive as to the outcome created from the unwinding of the collateral as well as the release and the ex-gratia payment," says a spokesperson at PWC.

According to a statement by the banks, approximately 97% of total minibond investors who purchased relevant minibonds from the distributing banks have already received offers to repurchase their minibonds, and 96% in total have accepted these offers, either under the repurchase scheme or under other terms.

When asked about the chances of the resolution receiving approval in the US bankruptcy court, US lawyers Chadbourne & Parke, which represents the US trustee HSBC, decline to comment.

Read more: http://www.risk.net/asia-risk/news/2042417/hk-lehman-minibond-resolution-approved-despite-bond-holder-dissent#ixzz1K3nr0cLz
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