05/26/2011 – Defendant’s Memorandum of Law in Support of Motion for Partial Dismissal filed in the Lehman Brothers Inc. Adversary Proceedings by Citibank, N.A. et al before Judge James M. Peck in the Southern District of New York (Manhattan).

Lehman Brothers, Inc. (“LBI”) liquidation Trustee seeks recovery of this $1 billion under almost every avoidance theory provided by the Bankruptcy Code. This 60 page motion to dismiss seeks to narrow the Trustee’s lines of attack by asserting multiple, independent grounds for dismissal of various counts of the complaint.

In its factual recitations, Citibank presents the avoidance proceedings as proof of the adage “No good deed goes unpunished.”  Citibank explains that in the face of the the 2008 financial meltdown, “urgently requested” Citibank to continue settling LBI’s foreign exchange (“FX”) trades through the Continuous Linked Settlement (“CLS”) system “to avoid catastrophic losses to LBI and its customers”. Citibank requested and LBI deposited with Citibank “$1 billion as security for any resulting exposure to LBI” and Citibank continued to settle LBI’s FX trades and, in the process “incurring losses of $1.26 billion”. On September 19, 2008, very shortly before LBI’s liquidation proceedings were commenced, Citibank applied the $1 billion deposit to set off the losses Citibank had incurred.

The Trustee attacks both a September 15, 2008 transfer of $700,000,000 by LBI to Citibank that provided part of the $1 billion deposit and Citibank’s application 4 days later of the $1 billion deposit to Citibank’s losses. Citibank raises six broad categories of defenses:

First, the Bankruptcy Code safe harbors for “swap agreements” protect the $1 billion setoff. The FX trades Citibank settled for LBI, the agreement under which Citibank settled those trades, and the letter agreements relating to the $1 billion cash deposit are all “swap agreements” within the plain language of the Bankruptcy Code safe harbor provisions… .

Second, the equitable doctrine of recoupment bars the Trustee’s claims. Recoupment applies where parties have obligations arising out of a “single integrated transaction” such that it would be inequitable for the debtor to enjoy the benefits of the transaction without satisfying its corresponding obligations…. .

Third, the facts alleged in the Complaint show that the Trustee cannot recover the $1 billion on multiple independent grounds, including:

• The Complaint fails to state a claim for violation of the automatic stay because Citibank set off the $1 billion deposit before commencement of LBI’s liquidation proceeding.

• The Complaint fails to state a claim under 11 U.S.C. § 553(a) because Citibank did not receive the $1 billion deposit for the purpose of obtaining a right to set off existing debt, but instead to secure Citibank’s future extensions of credit to LBI for CLS services.

• The Complaint fails to state a claim under 11 U.S.C. § 553(b) because Citibank did not “improve its position” as a creditor from September 15 to September 19, 2008, but instead increased its exposure to LBI.

• The Complaint fails to state a claim under 11 U.S.C. § 544 with respect to the September 15 and September 16 Letter Agreements (and an alleged “obligation” to deposit $1 billion and confer setoff rights) because LBI did not incur any such obligations under those Agreements and, even if it did, LBI received fair consideration in exchange for those Agreements.

• The Complaint fails to state a claim under 11 U.S.C. § 547 because, even assuming Citibank’s $1 billion setoff was a “transfer,” the parties intended a contemporaneous exchange of new value and a substantially contemporaneous exchange took place.

Fourth, the Trustee’s claims of actual fraud fail as a matter of law because LBI did not enter into the September 15 and September 16 Letter Agreements or create the $1 billion deposit with “an intent to hinder, delay, and/or defraud LBI’s creditors and customers”… .

Fifth, the Trustee’s claim for equitable subordination fails as a matter of law because the Complaint does not remotely allege the type of conduct—“egregious and severely unfair to other creditors,” “involving fraud, illegality or some other breach of a legally recognized duty”—required to support such a claim… .

Sixth, the Trustee’s claim that Citibank breached the September 15 and September 16 Letter Agreements “by exceeding the limitations contained therein with respect to setoffs” fails to state a claim because there is nothing in the Letter Agreements that purports to limit Citibank’s broad setoff rights.

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