British court backs Aussie investors

Q: What was the Lehman Brothers court case about and who won the Supreme Court decision?

The case concerned whether collateral supporting Dante synthetic CDOs belonged to 22 Australian noteholders or to Lehman Brothers' creditors after Lehman's 2008 collapse. Seven judges of Britain’s Supreme Court unanimously dismissed Lehman’s appeal, ruling in favour of the Australian investors.

Q: What is a "flip" clause in CDO documents and why did it matter in this case?

A flip clause is a contractual provision that changes the priority of access to collateral in certain events, such as issuer insolvency. The investors argued the Dante flip clause gave them priority over the collateral when Lehman went bankrupt, and the Supreme Court agreed that the clause operated in their favour.

A GROUP of "hard-working Australian citizens" has won a landmark case in Britain's highest court over assets claimed by the bankrupt estate of the Lehman Brothers investment bank.

By InvestSMART · 29 Jul 2011

By InvestSMART ·
29 Jul 2011

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A GROUP of "hard-working Australian citizens" has won a landmark case in Britain's highest court over assets claimed by the bankrupt estate of the Lehman Brothers investment bank.

Seven judges of the Supreme Court unanimously dismissed Lehman's appeal against 22 Australian investors, including superannuation funds, charities and individuals, who put $250 million into complex financial products known as synthetic collateralised debt obligations, or CDOs.

Lehman's collapse in 2008 triggered a dispute over whether the investors, or Lehman's creditors, were entitled to the collateral supporting the CDOs, marketed under the name "Dante" notes.

The collateral, in the form of bank bills with the same face value as the CDOs, is held in a London bank by the trustee, The Bank of New York Mellon.

One of the judges, Lord Robert Walker, said: "In this case the noteholders were, as a matter of substance, the only parties who contributed any real assets - in many cases the pension funds of hard-working Australian citizens. [Lehman] contributed only promises, and then proved unable to perform them."

The dispute centred on a so-called "flip" clause in the Dante notes, which the investors said changed the priority of access to the collateral in their favour when Lehman filed for bankruptcy.

Lord Lawrence Collins said the case involved "a complex commercial transaction entered into in good faith" by non-bank investors and Lehman, the designer and marketer of the notes.

"There was evidence that the fact that the noteholders would have priority over the collateral in the event of [Lehman's] insolvency was a very material factor in obtaining AAA credit ratings, which enabled Lehman to market the notes," he said.

The Johnson Winter and Slattery partner representing the noteholders, Jim Hunwick, said it was "an emphatic and welcome" victory over Lehman's "cynical attempt to invalidate its own documents".

The immediate impact of the decision is unclear because Lehman is also challenging the effect of the flip clause in the United States, where it has won several rulings and the Australian investors have lodged an appeal.

"We can expect Lehman to try anything it can to stop the trustee and the English courts from giving effect to this win," Mr Hunwick said.

A Lehman lawyer, Locke McMurray, said the decision had "no impact" on the US rulings "which remain the law of the case within the consolidated Lehman bankruptcy proceedings".

A separate group of Australian noteholders represented by Perpetual Trustee Company settled similar US and British litigation with Lehman in December.

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Frequently Asked Questions about this Article…

What was the Lehman Brothers court case about and who won the Supreme Court decision?

The case concerned whether collateral supporting "Dante" synthetic CDOs belonged to 22 Australian noteholders or to Lehman Brothers' creditors after Lehman's 2008 collapse. Seven judges of Britain’s Supreme Court unanimously dismissed Lehman’s appeal, ruling in favour of the Australian investors.

Who were the Australian investors involved and how much did they invest in the Dante synthetic CDOs?

The group included 22 Australian investors — a mix of superannuation funds, charities and individuals — who together put about $250 million into complex financial products known as synthetic collateralised debt obligations (CDOs) marketed under the name "Dante."

What is a "flip" clause in CDO documents and why did it matter in this case?

A "flip" clause is a contractual provision that changes the priority of access to collateral in certain events, such as issuer insolvency. The investors argued the Dante flip clause gave them priority over the collateral when Lehman went bankrupt, and the Supreme Court agreed that the clause operated in their favour.

What collateral backed the Dante notes and who holds it?

The collateral consisted of bank bills with the same face value as the CDOs. Those bank bills were held in a London bank by the trustee, The Bank of New York Mellon (BNY Mellon).

Does the Supreme Court decision mean Australian investors will immediately recover their collateral?

The immediate impact is unclear. While Britain’s Supreme Court ruled for the investors, Lehman is also litigating the effect of the flip clause in the United States — where it has won several rulings — and the Australian investors have lodged an appeal in the US proceedings. That ongoing litigation affects how quickly collateral may be recovered.

What did the judges and lawyers say about the outcome and its significance for investors?

Lord Robert Walker noted the noteholders had provided real assets while Lehman provided only promises. Lord Lawrence Collins described it as a complex commercial transaction entered into in good faith. Jim Hunwick, the Johnson Winter and Slattery partner for the noteholders, called the result an "emphatic and welcome" victory, while a Lehman lawyer, Locke McMurray, said the decision had "no impact" on existing US rulings.

Were there other similar settlements involving Australian noteholders and Lehman?

Yes. A separate group of Australian noteholders represented by Perpetual Trustee Company reached settlements of similar US and British litigation with Lehman in December.

What does this ruling tell everyday investors about complex products like synthetic CDOs?

The ruling highlights that legal details in structured products — such as flip clauses and the way collateral is held — can materially affect investor rights in insolvency. In this case, the English Supreme Court found the contractual protections for noteholders were meaningful, but the final outcome can still depend on parallel proceedings in other jurisdictions.