Local councils drain Lehman's zombie coffers

After three years, an international paper chase and countless millions of dollars in legal fees, the 300 odd local councils, religious groups and charities burnt by the collapse of Lehman Bros finally are to have their day in the sun.

A settlement is likely to be offered to creditors as early as tomorrow that will deliver a full return of all funds lost by Australian institutions after the collapse of the ill-fated American investment bank.

The $250 million settlement offer, on what is known as the Dante Notes, represents 100 cents in the dollar and follows a previous settlement on another set of investments, the Federation Notes that delivered $125 million, or 103 cents in the dollar.

All the institutions were sold high risk investments by Lehman Bros, camouflaged as triple A rated securities, that turned toxic when the American housing market collapsed.

Fortunately, however, few of the synthetic Collateralised Debt Obligations sold to charities and local councils such as Wingecarribee Shire Council were based on sub-prime property mortgages. Most, in fact, were based on corporate debt that has recovered value in the three years since Lehman's demise.

In addition, the liquidator of the Australian arm of the collapsed investment bank, PPB Advisory, discovered a previously unknown insurance policy in the US, potentially holding close to $100 million.

The liquidator was also helped by a UK High Court decision that quarantined substantial funds from Lehman's beleaguered US parent and that were payable to noteholders including the Australian investors.

But it was no easy task. As complex as synthetic derivatives were to build and impenetrable to understand, winding up the organisation that created them has proven to be a Herculean effort that escalated into a conflict between US law, international insurance law and Australian law.

To further complicate matters, Wingecarribee Shire Council had launched legal action against Lehman Bros in December 2007, just as global stock markets were about to implode and almost a year before the investment bank collapsed.

It was joined later by Parkes Shire Council and the City of Swan, along with about 70 others, in a class action funded by litigation group IMF.

That left PPB effectively fighting legal battles on three continents. Unbeknown to those involved in the class action, however, a clause in the US insurance policy required a court decision in Australia for a valid claim to be launched.

The IMF funded litigants, growing ever more impatient with the liquidator's reluctance to settle, unwittingly were helping PPB get closer to a settlement on the insurance claim.

Late last year, however, the insurers pulled a rabbit from the hat. There had been some anomalies in the documentation from the insurance broker, and the insurers were standing their ground. A settlement finally was reached in May this year for what is believed to be about $45 million.

The Australian investors predominantly bought two types of CDOs from Lehman. There were the Federation Notes and the aptly named Dante Notes.

The Dante Notes, though, have turned out to be anything but duds. Fortunately the trustee, the Bank of New York Mellon, held $250 million in good collateral over the notes. Even more fortunate, the money was held in the London office.

Shortly after the collapse, US Federal Court judge Justice Peck ruled that Lehman's world wide assets were to be protected to be distributed to all creditors.

PPB began action in the US against the decision and at one stage had six different actions afoot. Ultimately it prevailed in July this year when UK courts ruled the noteholders had priority.

It was just as well. The $250 million in collateral over the nine CDOs covered by the Dante Notes had actually appreciated during all this action and now are worth an estimated $300 million.

Similarly, the Federation Notes, the only ones that included sub-prime deb, lifted in value to what is believed to 103 cents in the dollar. That would come as a bitter pill for Wingecarribee Shire Council. Shortly before Lehman collapsed, it forced the investment bank to buy back some of the Federation Notes at 20 cents in the dollar, crystallising a huge loss.

Those notes now are held by the liquidator as a Lehman Australia asset and the proceeds will be distributed to all creditors evenly. So Wingecarribee will share a portion of the spoils from its own notes.

All that remains is for those involved in the class action to sign off on a settlement which may prove to be every bit as problematic as the rest of the case.

Justice Rares of the Federal Court recently ruled that all creditors were entitled to the settlement, not just those involved in the class action against Lehman Australia. That, understandably, has put some noses out of joint among the litigants.

Ian Verrender is a senior contributor at Eureka Report.