Lehman Brothers Holdings Inc. et al v. Intel Corp.

FOR PUBLICATION
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
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In re 	Chapter 11 Case No.
08-13555 (JMP)
LEHMAN BROTHERS HOLDINGS INC., et al., 	(Jointly Administered)
Debtors.
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LEHMAN BROTHERS HOLDINGS INC. and 	Adv. Proc. No. 13-01340 (JMP)
LEHMAN BROTHERS OTC DERIVATIVES INC.,
Plaintiffs,
v.
INTEL CORPORATION,
Defendant.
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MEMORANDUM DECISION GRANTING MOTION TO DISMISS AND
DETERMINING THAT CONTRACT CLAIM IS NON-CORE
WILLIAMS & CONNOLLY, LLP
Attorneys for Intel Corporation
725 Twelfth Street, N.W.
Washington, D.C. 20005
John Buckley, Esq.
WILMER CUTLER PICKERING HALE & DORR LLP
Attorneys for Intel Corporation
1875 Pennsylvania Avenue, NW
Washington, D.C. 20006
Craig Goldblatt, Esq.
Daniella Spinelli, Esq.
JONES DAY
Attorneys for Lehman Brothers Holdings Inc. and Lehman Brothers OTC Derivatives Inc.
222 East 41 st Street
New York, New York 10017
Robert W. Gaffey, Esq.
Mahesh V. Parlikad, Esq.
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JAMES M. PECK
United States Bankruptcy Judge
Introduction
Defendant Intel Corporation (“Intel”) seeks dismissal of two counts of the adversary
complaint filed by Lehman Brothers OTC Derivatives Inc. (“LOTC”) and Lehman Brothers
Holdings Inc. (“LBHI,” and, together with LOTC, “Lehman”) and a determination that the sole
remaining count for breach of contract is a non-core count that may not be finally adjudicated by
the bankruptcy court under the authority of Stern v. Marshall, 131 S. Ct. 2594 (2011). The
complaint seeks damages from Intel in relation to the early termination and unwinding of a swap
agreement dated August 29, 2008 that was structured to enable Intel to acquire by indirect means
a significant quantity of its own publicly-traded securities before the end of the third quarter of
2008. In effect, LOTC undertook by contract to execute purchases of securities for Intel’s
account that Intel, as an entity in possession of vast quantities of material nonpublic information,
could not have obtained directly without exposing itself to potential claims under the securities
laws. LBHI’s only obligations under the swap agreement were as credit support provider.
To complicate matters, this complex transaction to enable Intel to acquire its own shares
was arranged only a few weeks before the bankruptcy of LBHI. Under the agreement, LOTC
was to purchase Intel shares during the period from September 2, 2008 through September 26,
2008 (the “Calculation Period”) for eventual delivery to Intel on September 29, 2008 (the
“Settlement Date”). The complaint alleges that approximately 50.5 million Intel shares were
supposed to have been delivered on the Settlement Date in accordance with an agreed formula of
volume-weighted average prices (“VWAP”) of the shares to be acquired during the Calculation
Period. Without mentioning any of the well-known market disruptions and volatility that
occurred in the aftermath of LBHI’s bankruptcy, the complaint goes on to allege that, as of the
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Settlement Date, LOTC had purchased approximately 39.7 million shares at a cost of
approximately $803 million but that the value on that date had fallen to approximately $686
million.
The architecture of the agreement provided for the transfer of $1 billion from Intel to
LOTC in exchange for the contemporaneous transfer of $1 billion from LOTC to Intel. The
funds transferred to LOTC served as a prepayment of the cash needed to clear periodic purchases
of the Intel shares during the Calculation Period. The reciprocal transfer of $1 billion from
LOTC to Intel constituted a posting of collateral by LOTC, and, under the Credit Support Annex,
Intel had the right to set off from this collateral amounts owed by LOTC in accordance with the
swap agreement. Thus, the $1 billion in cash collateral was property of LOTC that functioned as
security to protect Intel against the risk of default by LOTC.
LOTC alleges that it purchased Intel shares during the Calculation Period as
contemplated by the swap agreement, but no purchased shares were delivered on the Settlement
Date as a consequence of the bankruptcy filing by LBHI as Credit Support Provider on
September 15, 2008 and the resulting financial upheaval within the enterprises managed by
LBHI. Two weeks later, on the Settlement Date, Intel sent a letter to LOTC referring to the
bankruptcy of LBHI as an Event of Default and designating September 29, 2008 as the Early
Termination Date of the agreement. The following day, Intel exercised its remedies as secured
party and set off against the entire $1 billion in collateral of LOTC plus accrued interest. That
setoff was a prepetition act that occurred on September 30, 2008, just three days before
commencement of LOTC’s own chapter 11 case. Issues surrounding the proper characterization
of this setoff frame the procedural contest now before the Court.
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LOTC alleges that in setting off the collateral, Intel failed to make a reasonable, good
faith determination of its loss under the swap agreement and wrongfully seized all of the
collateral in its possession, thereby exercising control over debtor property in violation of the
automatic stay and exposing itself to a cause of action for turnover. The amounts claimed
allegedly exceed amounts that LOTC would have owed to Intel under provisions of the
agreement that govern the calculation of loss due to LOTC’s own default. LOTC asserts that this
loss, if determined based on the market value of the undelivered shares, would be $873 million,
not the $1 billion plus interest taken by Intel.
From the point of view of the plaintiffs, this adversary proceeding involves an alleged
improper seizure of collateral by Intel of amounts greater than what Intel could have recovered
under the terms of the agreement. The amount in dispute is not less than $127 million, although
as much as $312 million may be claimed by LOTC under an alternative damage calculation
based on future open market purchases of Intel shares when prices were depressed even further.
From the perspective of Intel, it acted reasonably in accordance with the agreement, has no
liability whatsoever and properly exercised prepetition setoff rights that converted the collateral
to Intel cash.
The motion practice before the Court raises the question of whether LOTC and LBHI
have remedies under the Bankruptcy Code or simply have claims for breach of contract that do
not arise within their bankruptcy cases. This question, while sophisticated, is actually one of
very limited substantive importance because plaintiffs will retain a cause of action for breach of
contract against a financially strong defendant regardless of how the Court decides Intel’s motion
to dismiss. When viewed in this practical light, the parties conspicuously are jockeying over the
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pleadings as a means to obtain what each side no doubt perceives to be an advantage in forum
selection.
If LOTC prevails, it is foreseeable that the bankruptcy court will retain control over all
counts of a complaint that was drafted with obvious attention to including causes of action
grounded in provisions of the Bankruptcy Code. That drafting was intentional and designed to
invoke the jurisdiction of this Court. However, if Intel is successful in obtaining dismissal of
Count II and Count III (seeking turnover and asserting a stay violation, respectively) and a
related ruling that Count I is non-core, the defendant will then have the option to move for
withdrawal of the reference, thereby possibly enabling it to press contractual defenses in the
district court. The tactical aspects, thus, are undeniable and transparent to any experienced
observer.
That having been noted, the above procedural backdrop does not affect the merits of this
decision, although it does diminish the real importance of what is at stake here. Regardless of
the outcome of Intel’s motion, LOTC and LBHI will have their opportunity to challenge the
propriety of Intel’s loss calculation, and Intel will have the ability to defend itself and claim that
it acted strictly in accordance with the requirements of the contract governing the VWAP
purchases of its shares.
As described in this decision, the Court grants Intel’s motion to dismiss. Even after
accepting the truth of all allegations of the complaint, LOTC is unable to maintain claims for a
stay violation or for turnover. The undisputed prepetition setoff by Intel conclusively forecloses
all property interests of LOTC in the collateral. LOTC may have a claim against Intel for taking
more collateral than was proper, but that claim is simply a claim for breach of contract. That
claim for damages due to the alleged failure to set off in accordance with the loss provisions of
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the contract arose before commencement of the LOTC chapter 11 case, does not arise within the
bankruptcy cases of either LOTC or LBHI and is non-core.
Discussion
Rule 12(b)(6) Standard
Federal Rule of Bankruptcy Procedure 7012(b), which incorporates Federal Rule of Civil
Procedure 12(b)(6) (“Rule 12(b)(6)”), permits a bankruptcy court to dismiss an adversary
proceeding if a plaintiff’s complaint fails to state a claim upon which relief may be granted. In
reviewing a motion to dismiss under Rule 12(b)(6), the Court accepts the factual allegations of
the complaint as true and draws all reasonable inferences in the plaintiff’s favor. Ashcroft v.
Iqbal, 556 U.S. 662, 678 (2009); Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555-56 (2007);
E.E.O.C. v. Staten Island Sav. Bank, 207 F.3d 144, 148 (2d Cir. 2000). To survive a challenge to
the adequacy of a complaint under Rule 12(b)(6), the factual allegations in a complaint must be
supported by more than mere conclusory statements. Twombly, 550 U.S. at 555. The allegations
must be sufficient “to raise a right to relief above the speculative level,” and provide more than a
“formulaic recitation of the elements of a cause of action.” Id. (citations omitted).
A court may dismiss a complaint unless a plaintiff pleads “enough facts to state a claim to
relief that is plausible on its face.” Twombly, 550 U.S. at 570. “[O]nly a complaint that states a
plausible claim for relief survives a motion to dismiss.” Iqbal, 556 U.S. at 679 (citing Twombly,
550 U.S. at 556). Therefore, “[t]he appropriate inquiry is not whether a plaintiff is likely to
prevail, but whether [he] is entitled to offer evidence to support [his] claims.” Chance v.
Armstrong, 143 F.3d 698, 701 (2d Cir. 1998) (citation omitted).
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Turnover (Count II) and Declaratory Judgment – Stay Violation (Count III)
Counts II (for turnover) and III (for a declaratory judgment that Intel, by its actions,
violated the automatic stay) are based on the assertion that when Intel, on September 30, 2008,1
“set-off and applied the Posted Collateral held by [it] … consisting of Cash, in the amount of US
$1,001,966,256.00 … against the amount of US $1,001,966,256.00 payable by [LOTC] under
the [agreement],” it was not entitled to do so. Compl. ¶ 41; Compl. Ex. 7. Lehman alleges that
Intel’s “actual Loss” was less than the amount of the setoff. Compl. ¶ 47.
Lehman asserts a right to turnover under § 542(a) of the Bankruptcy Code of this
disputed portion of the collateral, claiming that Intel is “in possession, custody, or control of
property that the trustee may use, sell, or lease” under § 363 of the Bankruptcy Code “because
the definition of estate property includes all legal and equitable interests of a debtor in property
as of the commencement of the case.” Compl. ¶ 61. In Count III, Lehman claims that Intel’s
ongoing refusal to return the disputed portion of the collateral amounts to an “exercise of
control” over property of the estate, in violation the automatic stay imposed by § 362(a)(3) of the
Bankruptcy Code. However, these two counts of the complaint are based on the flawed premise
that Lehman retains the right to assert a property interest in the collateral after a prepetition
setoff.
Applicable case law clearly provides that where “a creditor sets off a prepetition debt
against a prepetition obligation prior to the bankruptcy case having been commenced, such setoff
… effectuate[s] a transfer that prevents the subject property from becoming property of the estate
1 The Court recalls its characterization of the commencement of the chapter 11 cases of LBHI and its affiliates as a
“singular event” in Lehman Bros. Special Fin. Inc. v. BNY Corporate Tr. Servs. (In re Lehman Bros. Holdings Inc.),
422 B.R. 407 (Bankr. S.D.N.Y. 2010) (“BNY Trustee”). That characterization was relevant for purposes of
interpreting the ipso facto language at issue in that proceeding, but is of no consequence here. See BNY Trustee, 422
B.R. at 420. In the complaint, Lehman has acknowledged the separateness of the LBHI and LOTC petitions and
points out that the setoff occurred prior to the filing date of LOTC’s own petition. Compl. ¶¶ 12, 41. Notably,
Lehman has not alleged that the setoff occurred post-petition, nor could it under the facts presented.
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… .” In re Quade, 482 B.R. 217, 229 (Bankr. N.D. Ill. 2012) (citations omitted). Prepetition
foreclosures, as a general matter, operate to transfer ownership to the foreclosing party. The
Second Circuit, in Rodgers v. County of Monroe (In re Rodgers), 333 F.3d 64 (2d Cir. 2003),
held that a debtor’s mere possession of title to a foreclosed property did not make it property of
the estate. Id. at 69. The court noted that a prepetition foreclosure sale of the property at issue
“effectively cut off [the debtor’s] legal title” in the property. Id. The debtor’s right of
redemption had expired, and so the property was not subject to the automatic stay. Id.
Weber v. SEFCU (In re Weber), 719 F.3d 72 (2d Cir. 2013) is a recent decision of the
Second Circuit that deals with a stay violation in relation to a repossessed motor vehicle.
Lehman places considerable reliance on this decision in claiming a continuing property interest
in the collateral, but Weber is distinguishable. In Weber, although the vehicle in question was in
the possession of the debtor’s lender, the debtor still retained the “right … to redeem the vehicle
before sale.” Weber, 719 F.3d at 77 (citing N.Y. U.C.C. § 9-623). Therefore, retention of the
vehicle by the lender was a violation of the automatic stay. Id. at 83.
Exercising control over the vehicle violated the stay because the debtor’s right to
redemption was a property interest that was entitled to bankruptcy protection. See Weber, 719
F.3d at 77. No such right exists here. Cash collateral is not like a piece of tangible property.
Once taken by a secured party and applied to satisfy a prepetition obligation, both the obligation
and the cash collateral lose their separate character and are extinguished. The inescapable
problem for Lehman in asserting bankruptcy claims based on Intel’s ongoing possession of
debtor property is that the asserted property interest no longer exists and has evaporated. Setoff
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by Intel has transformed the once-segregated cash collateral account into fungible cash that is
now indistinguishable from the other cash held by Intel in its coffers.2
Here, the agreement expressly provides that Intel may, following an Early Termination
Date, set off the collateral against its losses, thereby eliminating “any claim or right of any
nature whatsoever of [LOTC]” in the Posted Collateral, “including any equity or right of
redemption.” Compl. Ex 4 ¶ 8(a)(iii)-(iv). Assuming the truth of the allegations in the complaint
that Intel has exceeded its authority and has not acted reasonably in calculating its loss on
account of declaring an Event of Default, Lehman is left with a breach of contract claim, not a
right of redemption or a right to reclaim a fund of segregated property held by Intel. The
disputed portion of the collateral is not property of the estate. Intel has not violated the
automatic stay and holds no property to turn over to Lehman.
Accordingly, for the reasons stated, Counts II and III of the complaint fail to state a claim
upon which relief may be granted and are dismissed.
Analysis of Core v. Non-Core Issues
Under 28 U.S.C. § 1334, district courts have “original but not exclusive jurisdiction of all
civil proceedings arising under title 11, or arising in or related to cases under title 11.” 28 U.S.C.
§ 1334(b). Pursuant to 28 U.S.C. § 157(a), Standing Order M-431 refers all such cases to this
2 Similarly, in a different Lehman-related adversary proceeding, the Court recently determined that a failure of a
secured party to return collateral that had been transferred to Barclays Capital gives rise to no more than a breach of
contract claim. See FirstBank Puerto Rico v. Barclays Capital, Inc., 492 B.R. 191, 200-201 (Bankr. S.D.N.Y.
2013). The court referred to the explanation by the Supreme Court in Hennequin v. Clews, 111 U.S. 676 (1884),
that a creditor who holds collateral is bound by its contract “to return it when its purpose as security is fulfilled; but
if [it] fails to do so, it is only a breach of contract … [.]” FirstBank, 492 B.R. at 200 (quoting Hennequin, 111 U.S.
at 682). This conclusion would not apply if the setoff by Intel had not occurred prepetition and if an identified fund
of cash collateral still existed. Under that hypothetical alternative, the holding in Weber would support a finding of
a stay violation by Intel and perhaps a count for turnover. The situation presented by Lehman in this adversary
proceeding also is distinct from the one that the Court confronted in Bank of America, N.A. v. Lehman Bros.
Holdings, Inc. (In re Lehman Bros. Holdings, Inc.), 439 B.R. 811 (Bankr. S.D.N.Y. 2010). There, a setoff occurred
in alleged reliance upon one of the safe harbor provisions of the Bankruptcy Code, but, in fact, that post-petition
setoff of debtor property violated the automatic stay.
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Court. See Amended Standing Order of Reference, dated January 31, 2012 (Preska, C.J.).
Typically, proceedings arising under title 11, and proceedings arising in a case under title 11 are
referred to as “core” proceedings, while proceedings “related to” a case under title 11 are
referred to as “non-core” proceedings. See Stern, 131 S. Ct. at 2605; Bank of America, N.A. v.
Lightstone Holdings, LLC (In re Extended Stay, Inc.), 418 B.R. 49, 55 (Bankr. S.D.N.Y. 2009),
aff’d, 435 B.R. 139 (S.D.N.Y. 2010) (citations omitted).
“Bankruptcy core jurisdiction extends to all civil proceedings arising under title 11 or
arising in a case under title 11.” Joremi Enters. v. Herskowitz (In re New 118th LLC), 396 B.R.
885, 890 (Bankr. S.D.N.Y. 2008) (citing 28 U.S.C. § 157(b)(1)) (additional citations omitted). A
core proceeding, as a general matter, is one that invokes a substantive right under the Bankruptcy
Code or that could arise only in the context of a bankruptcy case. See New 118th, 396 B.R. at
890 (citing Binder, 372 F.3d at 162-63) (additional citation omitted).
“A proceeding is related to a case under title 11, and falls within its non-core jurisdiction,
if the outcome might have a conceivable effect on the estate.” New 118th, 396 B.R. at 890
(citing Publicker Indus. Inc. v. United States (In re Cuyahoga Equip. Corp.), 980 F.2d 110, 114
(2d Cir. 1992)) (additional citations and internal quotation marks omitted). The breach of
contract count discussed below unquestionably is related to the Lehman chapter 11 cases.
Breach of Contract (Count I)
Intel classifies the breach of contract count of the complaint as a “paradigmatic non-core
matter,” one that arises under New York law and could have been brought outside the context of
the Lehman bankruptcy. Reply Supp. Mot. Dismiss 3-4. Lehman disagrees, maintaining that
Count I is core because it “is inextricably tied to the bankruptcy context” and “arose only as a
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result of the Lehman bankruptcy,” relying on the “arising in” hook to core jurisdiction. Br.
Opp’n 19.
However, as this Court previously has held, a claim “arises in” a case under the
Bankruptcy Code only if the claim “would have no existence outside of the bankruptcy.”
Extended Stay, 418 B.R. at 58 (quoting Rednel Tower, Ltd. v. Riverside Nursing Home (In re
Riverside Nursing Home), 144 B.R. 951, 955 (Bankr. S.D.N.Y. 1992) and citing Geruschat v.
Ernst Young LLP (In re Seven Fields Dev. Corp.), 505 F.3d 237, 260 (3d Cir. 2007)). These are
the sort of “claims that by their nature, not their particular factual circumstance, could only arise
in the context of a bankruptcy case.” Seven Fields Dev. Corp., 505 F.3d at 260.
Without a doubt, the LBHI bankruptcy case was the event of default cited by Intel when
it declared an early termination of the agreement, but the consequences of that default – allegedly
unreasonable loss calculations in accordance with a contract for purchasing shares under a
VWAP formula leading to a demand for payment of excess amounts taken by Intel – have no
direct connection to the bankruptcy of either LBHI or LOTC other than as a possible claim to
augment the estates with cash now held by Intel.
Given the foregoing, and based upon the very same reasoning stated in Extended Stay,
Count I of the complaint is non-core. See generally, Extended Stay, 418 B.R. 49. The thrust of
Count I is that Intel breached the agreement by unreasonably computing its loss and seizing more
cash than it deserved. Regardless of the merits of that proposition, the claim against Intel to
recover contractual damages for the cash wrongfully taken does not arise in any bankruptcy case.
The commencement of the LBHI case was the triggering event for early termination but is not a
relevant factor for determining whether claims are core or non-core. This is unmistakably clear
where all material liability-creating conduct actually took place a number of days before the
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bankruptcy filing of LOTC. Plainly, a cause of action based on a prepetition breach of contract
is not one that can arise only in a bankruptcy case or that can only be pursued in a bankruptcy
court.
Notwithstanding the determination that Count I is non-core, the Court has a concern
about the “gaming” of bankruptcy jurisdiction that is evident both in the allegations of the
complaint and in Intel’s motion to dismiss. Regardless of whether a particular count is core or
non-core, it is most efficient and eminently sensible for all disputes involving swap agreements
where Lehman and its affiliates are counterparties to be handled in this Court. See, e.g., In re:
Lehman Brothers Holding[s] Inc., No. 13 Civ. 0748(LGS) (S.D.N.Y. Dec. 17, 2013) (granting
motion to withdraw the reference, but referring proceeding to this Court for a Report and
Recommendation in light of this Court’s familiarity with the issues). In the interest of orderly
case management, the Court proposes that Intel agree to an adjudication of this adversary
proceeding in the Lehman bankruptcy court.
Conclusion
For the reasons stated, the Counts II and III of the complaint are dismissed, and Count I is
non-core. Intel shall submit a proposed order consistent with this Memorandum Decision.
SO ORDERED.
Dated: New York, New York
December 19, 2013
/s/ James M. Peck
___________________________
Honorable James M. Peck
United States Bankruptcy Judge
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