Almost five years after Lehman Brothers Holding Inc. filed for bankruptcy and set off the global financial crisis, managers of the bank’s estate are demanding millions of dollars from retirement homes, colleges and hospitals.
After selling most of its assets, Lehman now says it was shortchanged by scores of nonprofits that were forced to pay to exit derivatives that were unwound after the firm filed for Chapter 11 protection.
The Buck Institute for Research on Aging in Novato, California, gave Lehman $2 million in October 2008 to cancel a swap contract used to manage fluctuating interest rates. Lehman says it wants $12.1 million more and has assessed at least an additional $4.7 million in interest, the research center said in its most recent financial statement. The amount Lehman is seeking is more than half of what Buck spent last year researching Alzheimer’s, Parkinson’s and other diseases.
“Lehman is sort of a zombie-like bankruptcy entity: Instead of looking for brains, it’s looking for cash,” said Chip Bowles, a bankruptcy lawyer with Bingham Greenebaum Doll LLP in Louisville, Kentucky.
“Lehman doesn’t care. They have a duty to maximize their return to their bankruptcy creditors. If you’re Mother Teresa, they’ll go after you,” he said.
Mary McEachron, Buck’s chief administrative officer and general counsel, declined to comment, except to say the dispute hasn’t been settled. Kim Macleod, a spokeswoman for Lehman in New York, declined to comment about the talks.
Before the financial crisis, Wall Street banks and insurers peddled financial derivatives known as interest-rate swaps to governments and nonprofits that bet they could lower the cost of borrowing. There were as much as $500 billion of the deals done in the municipal-bond market before the credit crisis, according to a report by Randall Dodd, a senior researcher on the Financial Crisis Inquiry Commission, published by the International Monetary Fund in 2010.
After Lehman filed for bankruptcy and the market for some municipal bonds collapsed, nonprofits and state and local governments paid more than $4 billion to Wall Street banks to exit the swaps, according to Bloomberg News. Some officials said they weren’t aware of the risks involved in the trades.
In Lehman’s case, the battle over swaps shows how far it will go to collect money for creditors, including public pension funds and municipalities that held its bonds. The disputes are taking place in confidential mediation sessions set up by the bankruptcy court in 2009. The aim is to settle disagreements faster, without costly litigation.
Once the world’s fourth-largest investment bank, Lehman filed the biggest bankruptcy in U.S. history on Sept. 15, 2008, after suffering billions in losses on subprime mortgages. It had more than 1.7 million derivative trades with thousands of banks, hedge funds, companies, municipalities and sovereign nations when it filed for protection from creditors.
A derivative is a security whose price is dependent upon one or more underlying assets. Common types include futures contracts, options and interest-rate swaps.
Lehman tacks on interest of almost 14 percent annually on unpaid swap debts, said Phil Weeber, director of risk management at Kennett Square, Pennsylvania-based Chatham Financial, who is advising corporate clients in mediation with the bank’s estate. The rate is based on Lehman’s cost of funds, which is the London Interbank Offered Rate plus 13.5 percent. Lehman’s claims are now almost double the original amount, based on the interest they’re charging, he said.
“Lehman, from the very beginning, said they were going to use an assertive legal strategy to protect the estate,” Weeber said. “That’s what they’re doing, and they’re very good at it.”
Harvey Miller, the Weil Gotshal & Manges LLP partner who has been Lehman’s lead lawyer since the bankruptcy, also declined to comment on the negotiations. The New York-based law firm was paid $3.9 million in February, or about $140,000 a day.
Under bankruptcy law, lawyers and managers of a failed company have a duty to raise as much money for creditors as they can.
Lehman exited bankruptcy in March 2012 and is still liquidating. It has distributed about $47.2 billion and wants pay creditors $65 billion by about 2016. Creditors will get an average of 18 cents on the dollar.
Some of Lehman’s former clients have stopped fighting. Colorado’s Housing and Finance Authority settled a dispute over swaps with Lehman as of March 2012 for an undisclosed sum, according to its most recent financial report.
Others, such as Simmons College in Boston and Havenwood-Heritage Heights, which runs a retirement community in Concord, New Hampshire, are balking at Lehman’s demands.
Simmons, a 5,000-student liberal arts institution, paid Lehman $5.5 million to exit three swaps in January 2009. It held back $800,000 for out-of-pocket expenses, the college reported in its June 30, 2012, financial statement.
Lehman disagreed with the amount, and more than three years later notified the college that it wanted to negotiate a settlement through mediation.
Havenwood-Heritage Heights paid a termination fee of about $420,000 in 2009. The nonprofit disclosed that Lehman wanted another $1.9 million as of Dec. 31 -- an amount equal to what the retirement community spent on food and utilities that year, according to its financial statement.
Havenwood has 409 independent-living units, 55 assisted-living units and 95 skilled-nursing-facility beds.
Kalimah Redd Knight, a spokeswoman for Simmons College, declined to comment on the negotiations. Michael Palmieri, president of Havenwood, didn’t respond to telephone calls requesting comment.
“Counsel for the community continues to be of the view that there is strong legal basis for the community’s position that it properly terminated its Lehman Swap on Sept. 16, 2009,” Havenwood said in notes accompanying its financial statement.
Many of the disputes are based on differences of opinion on the value of the contract when it was terminated, Weeber said. Nonprofits, municipalities and companies argue that they would get less favorable terms from new counterparties than they did from Lehman and therefore should owe Lehman less, he said.
“A lot of it goes to what is the value of the replacement trade,” he said.
When the disagreements can’t be settled out of court, Lehman has sued. On April 17, one of its units sued the Federal Home Loan Bank of Cincinnati, demanding the bank pay it an additional $63.9 million related to 87 interest-rate swaps.
Even as Lehman seeks to maximize the value of profitable derivatives contracts, the former investment bank is working to reduce what it owes others.
Lehman is trying to lower the claims of New York state’s Tobacco Settlement Financing Corp. and California’s Golden State Tobacco Securitization Corp. by more than $115 million and $107 million, respectively, according to March 14 bankruptcy court filings.
The entities, set up to issue bonds backed by a 1998 settlement with major tobacco companies, invested reserve funds in agreements with Lehman, allowing them to earn a guaranteed annual rate of return.
Municipalities and nonprofits typically issued floating-rate bonds and entered into a contract where they received a floating-rate that was meant to approximate the rate on their debt while paying a so-called synthetic fixed rate that was lower than the cost of borrowing with traditional bonds.
When Lehman filed for Chapter 11, many counterparties that had swaps and other derivatives with the bank ended their transactions. Depending on the terms, the client either owed Lehman money or was owed money on the date the contract was unwound.
The Buck Institute, about 30 miles (48 kilometers) north of San Francisco, entered into a swap with Lehman in December 2003 to manage interest-rate swings on about $56 million of bonds. Buck issued the debt to finance an 180,000-square-foot research complex designed by renowned architect I.M. Pei.
Buck Institute scientists research and use stem-cell technology to detect, delay, prevent and treat diseases such as Alzheimer’s, Parkinson’s and Huntington’s.
One of Buck’s researchers, Xianmin Zeng, is leading a global charge to get a stem-cell treatment for Parkinson’s disease ready for clinical trials.
In October 2008, Buck wired a $2 million termination payment to Lehman with a detailed explanation of the method it used to determine the amount, according to a court filing and Buck’s financial statements.
Typically, that method involves seeking quotes from at least three banks to determine what it would cost to replace the swap.
Since it was difficult, if not impossible, to find a new counterparty after the credit markets seized up after Lehman’s collapse, some nonprofits, municipalities and companies hired financial advisers to calculate how much it would cost to get into a replacement contract.
The talks may drag on for months.
“Welcome to Bankruptcyland,” said Bowles, the attorney. “Even though you thought I don’t exist, I do.”