JAMES COILEY<br />PARTNER, COILEY<br /><br />NINE months have passed since the collapse of Lehman Bothers. Yet many investors in its Special Purpose Vehicle (SPV) platforms are still waiting for their money. Disputes relating to these trades are now hitting the courts in earnest in both London and New York.<br /><br />The transactions are variations of &ldquo;repackaging&rdquo; structures. At the heart of each trade is a limited purpose company which issues notes carrying a tailored risk. The risk could be a slice of the credit risk on a pool of companies &ndash; ie, a synthetic Collateralised Debt Obligation (CDO) &ndash; or it might be inflation risk, the risk of a basket of hedge funds or a combination of risk classes. The SPV typically acquires assets such as highly-rated bonds, and enters into a derivative to exchange the bond cashflows for the required risk profile. <br /><br />Such transactions depend on a specified priority of payments, also known as a &ldquo;waterfall&rdquo;, to tell a third-party trustee how cash and assets in the SPV should be distributed in a given scenario. The operation of that waterfall is at the heart of the latest disputes. <br /><br />Typically, if a transaction is unwound early (eg, where there is a default of the repackaged bonds), the trustee and other deal expenses will be paid first. Then the derivative counterparty will be paid out before finally investors receive their cash. In rated transactions, however, the rules are reversed if the derivative counterparty is insolvent or otherwise in default. <br /><br />This was a requirement of the rating agencies that derivative counterparties were prepared to comply with, assuming that it wouldn&rsquo;t happen. If this regime applies, noteholders stand to receive their principal, or at least the value of the repackaged bonds less costs, whilst the defaulting derivative counterparty gets nothing.<br /><br /><strong>QUESTION MARK</strong><br />So far, so good for investors. However, there&rsquo;s a significant question mark over the enforceability of this arrangement under US bankruptcy laws prohibiting the surrender of assets &ndash; in this case, the right of the Lehman company to a priority share of the SPV&rsquo;s assets &ndash; on insolvency. <br /><br />So now the trustee on some of these transactions is being sued in the English courts on behalf of investors seeking the return of their cash &ndash; in line with the provisions of the English-law documentation &ndash; while simultaneously coming under attack from the insolvent Lehman entity in US proceedings. That is an uncomfortable position for an entity with little to gain in any case.<br /><br />Investors would in many cases be receiving a windfall if the documents were to operate as written, in that they would get much of their cash early without the cost of unwinding the derivative. Against that, Lehman, through various entities, marketed the trades and wrote the contracts. The sight of a company disclaiming terms that it has previously agreed is not appealing; investors are entitled to feel aggrieved. The outcome of the litigationProxy-Connection:keep-aliveCache-Control:max-age=0 though, is highly uncertain.<br /><br />Give or take the occasional insight, legal documentation evolves through experience&ndash; less charitably, maybe, by closing stable doors. This is just one of the issues which has come up, and new issuance platforms should be more robust in case of derivative counterparty default and other inconveniences. But while the market moves on, the investors in question are now in a state of limbo, out of pocket and ou