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In re Lehman Brothers Holdings Inc.

August 27, 2010


(On appeal from Bankr. No. 08-13555)

The opinion of the court was delivered by: Richard J. Holwell, District Judge


This case has a more complex posture than those a trial court is accustomed to seeing. Appellants are various entities associated with SunCal,*fn1 a now bankrupt California housing development consortium. Their core concern is that the automatic stay emanating from the Lehman Brothers bankruptcy in New York not limit their options in the SunCal bankruptcy in California. Because of the interplay between two ongoing bankruptcy proceedings on opposite coasts, matters bearing on that concern have already been heard before a California bankruptcy court, a bankruptcy appellate panel of the Ninth Circuit Court of Appeals, and the Bankruptcy Court for the Southern District of New York; and an appeal is currently pending before the Ninth Circuit Court of Appeals. Moreover, this Court previously denied a motion for emergency relief arising from similar issues.

Before this Court today are appeals from two orders in the Lehman Brothers bankruptcy proceeding before the Southern District Bankruptcy Court. Both are brought by SunCal entities in the midst of their own bankruptcy proceeding in California. The first appeal is from the Bankruptcy Court's order approving a compromise between Lehman, Fenway Funding, Fenway Capital, Hudson Castle, and Deutsche Bank (the "Compromise Order"). That compromise included the transfer of certain loans on which SunCal is a debtor. SunCal was not a party to the settlement. However SunCal objected to it out of fear that the transfer would bring the SunCal loans within the scope of the Lehman automatic stay, prejudicing its efforts with respect to those debts in its California bankruptcy proceeding. The second appeal concerns whether those loans, and the claims arising from them, should be excepted from the Lehman automatic stay-SunCal moved for relief from the Lehman stay, but the bankruptcy court denied that request (the "Stay Relief Denial Order"), and SunCal now appeals. That second appeal is from a denial without prejudice: the Bankruptcy Court deferred a final ruling on the relief from stay motion in light of the fact that a related request-which could moot the motion here-is currently pending before the Ninth Circuit Court of Appeals.

For the reasons stated below, the orders of the Bankruptcy Court are affirmed and both appeals are denied.

I. Factual and Procedural Background

The Court assumes the parties' familiarity with the facts and proceedings below. The following factual and procedural history is provided for background purposes and does not constitute findings of fact by the Court. Where appropriate disputes are noted in the margin.

Between 2005 and 2007 the California housing market was good, and entities associated with Lehman Brothers made several loans, totaling over $1.5 billion, to various SunCal entities, which used the proceeds to aggressively develop real estate projects in California. Subsequently, "market conditions slowed.." (SunCal Stay Mem. 4.)*fn2 In September of 2008 one of the loaning Lehman entities, Lehman Brothers Holdings ("LBHI"), filed for bankruptcy in New York. In October of 2008 another of those entities, Lehman Commercial Paper ("LCPI"), filed for bankruptcy in New York. In November 2008 the SunCal entities filed for bankruptcy in California.

In August 2008, just prior to the bankruptcy filings, the Lehman entities engaged in a complicated debt transaction that involved, in part, the SunCal loans. LCPI and Fenway Capital, LLC ("Fenway Capital") entered into a master repurchase agreement ("MRA" or "Repo") through which a number of assets, including some SunCal loans, were sold by LCPI to Fenway Capital subject to being transferred back to LCPI in the future. (Lehman Compromise Opp. 5-6.) In turn Fenway Capital issued a Variable Funding Note to Fenway Funding, which issued commercial paper notes to LBHI. (Id.) LBHI then executed a guaranty of LCPI's repurchase obligations under the MRA/Repo, and pledged the commercial paper to JPMorgan. (Id.) As appellees explain it, the ultimate exchange was "effectively between Lehman entities, with Fenway Funding and Fenway Capital serving as mere conduits with no economic interest in any outcome." (Id.; Appx. 7, 511.)*fn3 Because of that structure however, Lehman "had to seek consent from Fenway, among others, before taking actions concerning the Repo Assets." (Id.)

In November 2008, just after the bankruptcy filings, SunCal moved for relief from stay in the Lehman Commercial bankruptcy proceeding in the Southern District of New York. That motion sought blanket stay relief "to allow the [SunCal] Debtors to generally administer their California Chapter 11 cases." Lehman Commercial Paper, Inc. v. Palmdale Hills Property, LLC (In re Palmdale Hills Property, LLC), 423 B.R. 655, 660 (9th Cir. BAP 2009). Without mentioning the existence of the Fenway structure, Lehman opposed the request. (Appx. 21 ¶ 15.) The New York Bankruptcy Court denied the motion as overbroad, but did so without prejudice to SunCal refiling specific stay relief requests as needed. (Id.)

The dispute then moved to the West Coast. In a February 2009 response to claims filed by Lehman in the California Bankruptcy Court, SunCal argued that the Lehman Lenders' claims should be equitably subordinated. SunCal asserted that equitable subordination action could be used to defend against Lehman's claims without violating the Lehman/New York automatic stay, an uncontentious proposition. What's more however, SunCal contended that because it had raised equitable subordination as a defense, it could prosecute it to its conclusion without violating the Lehman automatic stay.

The question of whether a California equitable subordination action would violate the Lehman/New York automatic stay is a question of the scope or applicability of the automatic stay. Such questions as to the scope of the stay are subject to the concurrent jurisdiction of both the overseeing bankruptcy court (the New York court) and the court in which the litigation is to be stayed (the California court). See Erti v. Paine Webber Jackson & Curtis, Inc. (In re Baldwin-United Corp. Litig.), 765 F.2d 343, 347-48 (2d Cir. 1985). Accordingly by Order dated March 10, 2009 the California Bankruptcy Court determined the scope of the Lehman/New York stay. It found that the stay did not apply to any attempt by SunCal to equitably subordinate Lehman's claims. The California Bankruptcy Court thus found that SunCal could pursue equitable subordination in California.

Lehman appealed that decision to the Bankruptcy Appellate Panel of the Ninth Circuit (BAP). In an opinion dated December 15, 2009, Judge Hollowell writing for the panel reversed the scope-of-stay determination of the California Bankruptcy Court. See In re Palmdale Hills Property, LLC, 423 B.R. 655 (9th Cir. BAP 2009). Concluding that "equitable subordination seeks affirmative relief," the panel found that "adjudication of [SunCal's] equitable subordination claim violates [LCP's] automatic stay." Id. at 667. The panel thus found that SunCal could not pursue equitable subordination in California. The panel then noted that SunCal was not "hamstrung by this decision; [SunCal] may either seek relief from stay or initiate the equitable subordination action against Lehman Commercial in the New York bankruptcy case." Id. at 668. However SunCal did not then request relief from stay or initiate an equitable subordination action in New York, but rather appealed the decision of the appellate panel to the Ninth Circuit Court of Appeals. That appeal is pending.

Prior to the appellate panel's decision, SunCal had discovered the Fenway structure and taken the position that the Lehman stay is inapplicable to loans involved in the Fenway structure independent of whether equitable subordination is offensive or defensive. (See Appx. 21 at 1635 ¶ 5.) On October 2, 2009 the California Bankruptcy Court entered findings that certain disputed claims were in fact owned by Fenway, and that Lehman's filing of the claims as "creditors" was improper.*fn4 SunCal has since prosecuted the equitable subordination action "against Fenway, as the owner of the Disputed Claims" as if the stay did not apply to them for that reason. (SunCal Stay Mem. 7.) Lehman disputes that the Fenway structure has any effect on the stay, and maintains that LCPI has throughout been "required [by the MRA] to repurchase the Repo Assets, including the SunCal Loans," (Lehman Compromise Mem. 13), which were therefore always appropriately part of the Lehman Bankruptcy estate.

The dispute regarding the effect of the Fenway structure and that regarding the automatic stay have both since returned to New York. On March 24, 2010, Lehman moved in the New York Bankruptcy Court pursuant to Bankruptcy Rule 9019 for authority to enter into a compromise that, inter alia, unwound the Fenway structure and placed the SunCal loans in the possession of LCPI. SunCal filed a third party objection to that compromise. In that objection SunCal contended the compromise would bring loans not previously subject to the Lehman stay within its scope. Separately, SunCal moved before the New York Bankruptcy Court for relief from the Lehman stay in order to pursue equitable subordination back in California. The New York Bankruptcy Court disposed of both motions at oral argument on May 12, 2010. The Court approved the compromise and denied without prejudice SunCal's motion for relief from the automatic stay.

In reviewing the compromise, the Bankruptcy Court took a proffer of the testimony of a Mr. Fitts as to the business purposes for the transaction. (Appx. 25, 1801-1803.) Mr. Fitts would have testified that the compromise would eliminate delays and administrative fees associated with the Fenway structure and would eliminate further litigation regarding the Fenway structure. The Bankruptcy Court also heard SunCal's objections based on their fears that the compromise would prejudice their ability to pursue equitable subordination (in California). However the Bankruptcy Court disagreed that SunCal's fears would necessarily be realized:

THE COURT: I don't believe that there is anything in the motion before me that requires me to make any findings as to the consequences in the SunCal bankruptcy of my unwinding the structure. So part of what I don't understand is why you're spending all this time arguing about those consequences. (Appx. 25, 1818)

Mr. O'Keefe, representing appellants, responded to that prompt from the Bankruptcy Court:

MR. O'KEEFE: Your Honor, with that characterization, I'm more than willing to sit down. I just wanted to make sure, Your Honor, that in connection with the next motion, I didn't prejudice any rights in this motion. Otherwise, I wouldn't have said anything. But I appreciate Your Honor's clarification in that regard. (Appx. 25, 1818-1819.)

After that exchange, the testimonial proffer, and after an appearance from the creditors' committee supporting the settlement, the Court approved the compromise.

THE COURT: Okay. Having heard the argument presented by the debtors, the support of the creditors' committee and the opposition by the SunCal voluntary debtors, which appears to the Court to have been more in the nature of a reservation of right as to the potential consequences in the SunCal bankruptcy case in California to approval of the unwinding of the structure, I am satisfied that sufficient business justification has been presented to approve the motion and that the undoing of the structure results in a number of claimed benefits to the estate including the elimination of certain costs and the preservation of the rights of separate debtors so that the distribution rights of those creditors looking to particular members of the Lehman corporate family will [be] unaffected by the approval of a settlement. (Appx. 25, 1824-25.)

The Bankruptcy Court then turned to the SunCal appellants' motion for relief from stay. At the outset the Bankruptcy Court expressed concern that an appeal regarding the scope of the stay was already pending before the Ninth Circuit. (See Appx. 25, 1826 (asking at outset "what's the time horizon of briefing and adjudication in the Ninth Circuit?).) The Bankruptcy Court explained that it had originally expected SunCal's stay relief motions to be filed in New York, but that instead a related matter regarding the scope of the stay had been litigated in California and could potentially moot the stay relief motion.

THE COURT:. I couldn't have been clearer in January of 2009 that this was the Court that you needed to come to for purposes of getting stay relief, in that instance, relating to the use of cash collateral.

But it's now May of 2010. It's quite a long while after that. And one of the concerns I have is that Judge Smith and I are players in a cross-country game of gaming the system, of using courts to your particular purpose in order to gain strategic advantage. And speaking for myself, I don't like that. I suspect that Judge Smith would say the same thing if she were here. (Id. at 1835.).

THE COURT: Let me ask you a question. Assuming that you are successful in the Ninth Circuit whenever that happens, what's the consequence of that successful prosecution of the appeal of the BAP decision in the Ninth Circuit? What happens then? Does it moot my need to decide the pending motion? (Id. at 1836.)

MR. O'KEEFE: I would say yes [it could moot the pending motion], if it's before the ruling. Yes, because if they decide that the BAP is overruled, then at this point, Judge Smith[ is] ruling with concurrent jurisdiction.. So if she determines the stay doesn't apply and nobody comes back here than that's the law of our case and we proceed on that basis.. (Id. at 1837-38.)

After hearing appellants' other arguments at length, (Appx. 25 at 1838-1850), the Bankruptcy Court denied without prejudice their request for relief ...

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