Lehman Scraps in Dispute as Deutsche Bank Makes Legal Bid
(Bloomberg) -- More than 13 years after Lehman Brothers filed for bankruptcy, the fight for the last scraps of its carcass is still going on.
Deutsche Bank AG is leading a last-ditch legal bid to squeeze more from a bet it made on obscure notes issued by Lehman in the years before the U.S. bank’s collapse.
The German lender is appealing a decision made by a British court last year, hoping to gain more from its holding of “enhanced capital advantaged preferred securities” or ECAPS, a series of subordinated notes Lehman issued via one of its U.K. subsidiaries. The case started on Monday at the Court of Appeal in London, and the hearing is scheduled to last until the end of the week.
A ruling in Deutsche Bank’s favor could see the payout on the ECAPS rise, boosting the returns of other holders, which, according to public documents and a person familiar with the matter, include Barclays Plc, Farallon Capital Management and CarVal Investors. If all goes well for the holders it’s possible they could receive a windfall of 500 million pounds ($678 million) on notes that were deemed worthless and given away for next to nothing in the aftermath of Lehman’s bankruptcy.
That said, the case isn’t without its risks, and it’s possible that holders could be cut out of the money altogether. Another Lehman entity is also appealing, potentially diverting money away from ECAPS holders, according to separate court documents.
“There are many hundreds of millions of pounds that investors are still looking to try and fight over” said Ed Macnamara, a London-based partner at PricewaterhouseCoopers who is a joint administrator on a number of Lehman’s U.K. subsidiaries. PwC has handled the administration of Lehman’s European business since 2008.
A spokesperson for Deutsche Bank declined to comment. Spokespeople for CarVal, Farallon and Barclays also said they wouldn’t comment.
Though Lehman’s demise on Sept. 15, 2008 is remembered as the darkest hour of a global financial crisis, it presented an opportunity for anyone willing to make bets on the bank’s discounted debt. In fact, hedge funds and institutions such as Deutsche Bank have been snapping up the securities for years. That’s led to a series of legal showdowns over how much they are owed, keeping a legion of lawyers, accountants and former Lehman employees busy for well over a decade. The ECAPS case is likely one of the last.
After the collapse of its parent, Lehman’s European arm went into administration owing creditors billions of dollars and at the time few imagined that they would receive more than a fraction of what they were due. But PwC has wrung more out of the firm than would have seemed likely in 2008. In fact, creditors ahead of ECAPS holders in the queue will be paid out in full with interest and, to the surprise of many, there will probably be money left over.
|Scenario||Outcome for ECAPS holders||Potential estimated payout|
|Deutsche Bank loses appeal||Holders receive payout from Lehman administrators, limited to around 14% of cash left over for subordinated debt holders.||38 million pounds to 70 million pounds|
|Deutsche Bank wins appeal||Holders move ahead of LBHI claim, and are first in line to receive money for subordinated creditors.||168 million pounds, 500 million pounds or even more|
|Appeal of other Lehman entity successful||Another possibility is that a different appealing Lehman entity could overturn a previous ruling. That might leave ECAPS holders out of the money altogether, regardless of the outcome of Deutsche’s appeal.||Likely nothing|
“It was quite some time before people realized that the U.K. Lehman administration had been hugely successful, and that value would flow right through the capital structure,” Macnamara said in a phone interview. “It’s now at a stage where the battle is in the court of appeal between the creditors of the ultimate U.K. entities.”
PwC estimated the surplus could be anything from 280 million pounds to 500 million pounds earlier this year, and that money will have to go to someone. In an update for Lehman’s European creditors in October 2017, PwC raised the possibility that money could end up in the hands of subordinated creditors, a group normally one of the last to get paid in insolvency proceedings.
The ECAPS were designed to help bolster Lehman’s capital, placing them at the bottom of a long list of other creditors. In the years following the collapse, they were largely forgotten. Some traded in 2017 for 1.5 cents on the euro and for even less before that, according to documents seen by Bloomberg and people familiar with the trades.
“Around 2015, we started to talk to Lehman holders about the trade but couldn’t really convince anyone to buy, but by 2018 interest increased,” said Robert Southey, the founder of London-based broker Southey Capital.
As it became clear that there was a surplus of money, distressed investors rushed to find a way in. The ECAPS were one way that hedge funds could establish a claim on the cash. Some of the notes traded at more than 20% of face value in mid-2020, according to data compiled by Bloomberg.
The June 2020 judgment from London’s High Court found that owners of the notes were due a payout, but a far smaller one than Deutsche Bank and many other holders would have hoped for. The judge ruled that investors should share 13.7% of whatever was left after paying higher-ranking creditors, with the rest going to Lehman Brothers Holdings Inc., or LBHI, the ultimate U.S. parent of the collapsed broker-dealer.
King Street Capital Management and Elliott Management teamed up with LBHI to form a joint venture called the Wentworth Group that would share claims based on loans that the U.S. parent made to its European subsidiary, according to another court filing. King Street is also a large ECAPS holder, according to a separate court document, and will likely receive a share of the pot either through the notes or the LBHI venture.
If Deutsche Bank, which is the largest holder of ECAPS, is successful in convincing the court that it should rank ahead of LBHI, the payout on its notes may balloon. Currently, assuming a 280-million-pound surplus from the wind-up of Lehman’s European arm, ECAPS holders would receive about 38 million pounds, according to PwC. But if they were to move ahead of LBHI and successfully claim interest, they might take the entire 280 million pounds.
The amount of money that Deutsche Bank is fighting for partly depends on a separate legal spat between Lehman’s European arm and U.S. bond insurer Assured Guaranty Ltd. Lehman Brothers International Europe is suing the bond insurance firm for $500 million, arguing Assured Guaranty mispriced credit default-swap trades in a case that is scheduled to start next month. Any money won in this case could make its way to ECAPS holders.
“We feel good about the Assured Guaranty claim,” Russell Downs, another London-based partner at PwC that is working on the administration of Lehman’s European arm, said. If the suit is successful “a large part of that money would flow to subordinated creditors.”
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