JAMES M. PECK

Curtis, Mallet–Provost, Colt & Mosle, LLP, Joseph D. Pizzurro, Esq., Lynn P. Harrison, III, Esq., Cindi M. Giglio, Esq., Nancy E. Delaney, Esq., Peter J. Behmke, Esq., Michael Moscato, Esq., New York, NY, for Plaintiff Lehman Brothers Holdings Inc. Wachtell, Lipton, Rosen & Katz, Harold S. Novikoff, Esq., Paul Vizcarrondo, Jr., Esq., Amy R. Wolf, Esq., Marc Wolinsky, Esq., Douglas K. Mayer, Esq., New York, NY, for Defendant JPMorgan Chase Bank, N.A.
Quinn Emanuel Urquhart & Sullivan, LLP, John B. Quinn, Esq., Erica P. Taggart, Esq., Los Angeles, CA, James C. Tecce, Esq., Daniel P. Cunningham, Esq., Andrew J. Rossman, Esq., New York, NY, for the Official Committee of Unsecured Creditors.

MEMORANDUM DECISION GRANTING IN PART AND DENYING IN PART MOTION TO DISMISS BY DEFENDANT JPMORGAN CHASE BANK, N.A.

JAMES M. PECK, Bankruptcy Judge.

Introduction

The captioned adversary proceeding brought jointly by Lehman Brothers Holdings Inc. (“LBHI,” and, together with its affiliated debtor entities, “Lehman”) and its Official Committee of Unsecured Creditors (the “Committee,” and, together with LBHI, the “Plaintiffs”) seeks to recover $8.6 billion from JPMorgan Chase, N.A. (“JPMC”) for the benefit of Lehman's creditors. The litigation relates to transactions that occurred shortly before LBHI's bankruptcy filing and highlights various defensive actions taken by JPMC as part of the bank's efforts to limit the impact on JPMC of a default by Lehman. The litigation touches on and illuminates the safe harbor provisions of the United States Bankruptcy Code, 11 U.S.C. § 101 et seq. (the “Bankruptcy Code”).

The allegations and defenses present important questions as to what a lender can do in managing its exposure to potential losses and protect its interests at a time of intensifying concerns about systemic risk. Plaintiffs complain that JPMC abused the power of its position to improperly extract billions in incremental collateral and other concessions from Lehman before the LBHI bankruptcy, while JPMC contends that the litigation is baseless, that its credit and clearance services benefited Lehman and its customers and that, as a matter of law, its institutional conduct should be fully insulated from all ex post exposure.

This decision resolves a broad-based motion to dismiss (the “Motion”) brought by JPMC at the outset of the litigation. The Motion is quite ambitious in its scope and endeavors to preemptively dispose of all counts in Plaintiffs' First Amended Complaint (the “Amended Complaint”).

In terms of the trajectory of the litigation itself, while the Motion has been pending, the parties have largely discounted the prospects of a complete win by JPMC at the pleading stage and have moved forward diligently under a series of pretrial orders that outline a protocol of extensive and mostly cooperative pretrial discovery. This discovery has been pursued actively while the Motion has been pending and is scheduled to be concluded within the next few months.

As a result of these discovery efforts, the Court assumes that the parties have developed an intimate understanding of the facts. These facts are not presently available to the Court in its consideration of the Motion, but this accumulated information will serve as evidence to be offered at trial or in connection with any future dispositive motions that may be filed. And so the contours of the surrounding litigation have expanded while proceedings with respect to the Motion have remained constant with the exception of some supplemental briefing.

The ongoing discovery has resulted in a mismatch between the bare-bones motion practice on which this decision is based and the nuanced substance of the case that has been fleshed out through discovery. A prolonged procedural detour concerning the very authority of the bankruptcy court to decide the Motion has added more asymmetry to the mismatch between what is now being decided and the case as it has been experienced by the litigators. More time has elapsed between argument and this decision than is either typical or desirable.

Having considered the arguments of the parties, the Court grants the Motion to the extent that it relates to those counts that seek relief that is unavailable under terms of the applicable “safe harbor” sections of the Bankruptcy Code.

No relief may be granted with respect to these counts, and they are dismissed. The remaining counts of the Amended Complaint that are outside the scope of these immunities, described in section II, infra, and Exhibit A to this decision, shall survive the Motion for the reasons discussed in this decision and summarized in the exhibit.

In short, as a result of a count-by-count analysis, the Court has concluded that the safe harbors are applicable to all claims based on preference liability or constructively fraudulent transfers but that Plaintiffs are entitled to proceed with the remaining complex and fact-driven causes of action in the Amended Complaint. The safe harbors have trimmed the claims in the Amended Complaint but have not eliminated all of them. That seems appropriate: a regime that compels dismissal of certain claims based on express statutory exemptions should be receptive to allowing all non-exempt claims to proceed so that they may be judged on their merits. Claims subject to the safe harbors are being dismissed because strict application of the law requires it; claims not subject to the safe harbors are proceeding because informed discretion permits it.

Content and context have played an important part in this decision. This is a case that examines the conduct of a giant lender at a time when the financial markets were in turmoil. JPMC grabbed assets for itself at a critical time in its banking relationship with Lehman. The timing alone—weeks before bankruptcy—is reason enough to question the circumstances of what occurred. The issues presented are especially difficult ones that one day may help to define what constitutes acceptable conduct by major financial institutions during times of crisis. The case obviously also involves quite a lot of money. And with so much at stake, both in terms of issues and dollars, making a decision on the merits should occur after careful consideration of a full evidentiary record, and that will happen in time with respect to those counts that are not being dismissed.

The sections that follow this introduction provide a detailed discussion of the procedural background of the adversary proceeding, an analysis of the safe harbors as justification for dismissal of counts in the Amended Complaint for recovery of preferences and constructively fraudulent transfers, and a discussion of those counts that are surviving the Motion for adjudication at a later time. Before reaching those substantive sections, the Court will provide an overview of the litigation and offer some initial thoughts on the issues presented by the Amended Complaint and the Motion.

The multiple causes of action in the Amended Complaint are based on allegations that JPMC took unfair advantage of Lehman at a time when Lehman depended on JPMC as its main source of prepetition credit to sustain critical trading operations for customers. The claims all arise out of a series of actions taken by JPMC to mitigate the risks associated with advancing substantial liquidity each day to Lehman—measured in the tens of billions—during the months leading up to the bankruptcy of LBHI.

These actions included “take it or leave it” demands to a submissive Lehman that additional entities within the Lehman enterprise agree to be liable to JPMC and that Lehman turn over multiple billions of dollars in incremental cash, liens and additional collateral as conditions to preserving JPMC's essential lending relationship. In combination, Lehman accepted changes imposed on it by JPMC that are claimed to have vastly improved JPMC's position relative to other creditors. This all happened urgently at a time of growing concerns and heightened anxiety as to Lehman's deteriorating financial condition and viability as an enterprise. Events proved that these concerns were justified.

The actions of JPMC during the months leading up to LBHI's bankruptcy filing, according to the Amended Complaint, were wrongful, constituted a deliberate abuse by JPMC of its position as a trusted commercial lender to Lehman and contributed to the severe liquidity constraints that ultimately doomed Lehman to fail in so spectacular a fashion. The Amended Complaint rests on a multitude of legal theories, but, when boiled down to its essence, states, under one theory or another, that JPMC should be found legally responsible for having engaged in a form of actionable economic coercion that compelled Lehman to yield to its unreasonable demands, thereby further weakening an already vulnerable Lehman and precipitating LBHI's eventual bankruptcy and the disastrous consequences that followed.

JPMC has moved to dismiss all counts of the Amended Complaint, arguing that it acted reasonably and was justified in requiring a pledge of more assets from Lehman as a condition to providing ongoing clearance services and credit at a time of obviously greater financial risk and that its rights as a secured creditor must be fully protected under the documents executed by Lehman and the applicable language of the safe harbor provisions of the Bankruptcy Code that apply to all of the transactions described in the Amended Complaint.

JPMC submits that the safe harbors were enacted to provide needed incentives to lenders to extend credit without having to even consider the risk that a bankruptcy court might later review and order a “claw back” of assets that were transferred under any of these protected transactions. Because market participants rely upon the safe harbors, and this reliance promotes essential liquidity and market stability, JPMC also argues that covered transactions should be immunized from further scrutiny under any legal theory, including several theories of recovery arising under state law, because to allow the safe harbors to be circumvented by such indirect means would frustrate the central purpose of these protections.

Stated differently, JPMC submits that the safe harbors reflect a preemptive federal policy to protect the markets and eliminate the risk of ex post second-guessing and interference by the bankruptcy court in financial transactions that have been completed. Consistent with that policy, JPMC urges that the transactions in question should be exempt from challenges and not be subjected to collateral attacks of any kind.

The Court agrees with JPMC that the safe harbors apply here, and it is appropriate for these provisions to be enforced as written and applied literally in the interest of market stability. The transactions in question are precisely the sort of contractual arrangements that should be exempt from being upset by a bankruptcy court under the more lenient standards of constructive fraudulent transfer or preference liability: these are systemically significant transactions between sophisticated financial players at a time of financial distress in the markets—in other words, the precise setting for which the safe harbors were intended.

It is for that very reason that the Motion is being granted as to those counts seeking avoidance of the transfers made to JPMC as preferences or constructively fraudulent transfers during the months of August and September 2008. The safe harbors apply to these transactions and were designed to protect transfers from avoidance, but dismissal also is appropriate as to those counts seeking to avoid “obligations” even though that term does not appear in section 546(e) of the Bankruptcy Code.

Plaintiffs are correct that “obligations” are not specifically mentioned within the language of this safe harbor and that the term “obligations” has a different meaning from the word “transfers.” As such, the incurrence of obligations is neither exempt nor protected from challenge under section 546(e). What might seem to be grounds for a victory for Plaintiffs fails upon further examination. The obligations remain shielded from avoidance because they are connected by the same transaction to transfers that are protected by the safe harbor language of section 546(e).

To say that obligations incurred may be avoided but the related transfers made in connection with such obligations are shielded from challenge creates a conundrum for the Plaintiffs. The theoretical ability to possibly exclude obligations incurred by Lehman from safe harbor protection does not support a claim upon which relief may be granted because any successful avoidance of the obligations would not impair the protected validity of the related transfers made in connection with these obligations. It amounts to legal checkmate.

Although “obligations” may escape safe harbor protection and may be exposed hypothetically to claims for potential avoidance, that does not matter because the liens and other transfers made in connection with these obligations remain exempt from such claims. Thus, Plaintiffs' success in separating the term “obligations” from section 546(e) leads to a dead end for purposes of obtaining a recovery.

Claims based on obligations, at least in this case, do not yield a potential remedy because the obligations are tied to and support transfers that are connected to securities contracts and thereby exempt from further challenges. Allowing Plaintiffs to proceed with these claims would be a vain and wasteful exercise that also would inject needless uncertainty into a realm where predictability should reign.

Granting the Motion as to all counts based on constructively fraudulent transfers and preferential transfers is supported by the broad language of the Bankruptcy Code and helps to preserve market expectations, but denying the Motion as to all counts of the Amended Complaint that are not being dismissed (the “Remaining Counts”) also is consistent with these exemptions and does nothing to impair the effectiveness or purpose of these provisions of the Bankruptcy Code.

JPMC is a systemically-important financial institution that routinely does business with other such institutions, but that status does not shield JPMC from potential liability for any wrongful acts that may be proven under the Remaining Counts. The safe harbors provide incentives and protections to market participants, but they are not a license for major institutions to act in a commercially unreasonable manner.

If JPMC crossed the line of permissible conduct and did anything wrongful that damaged Lehman, Plaintiffs have recourse by means of those counts that involve intentional misconduct or that are based on other claims that are not expressly subject to the protections of the safe harbors. The safe harbors specifically address certain stated bankruptcy-related risks and remedies but do not offer protection against exposure that exists under these alternative theories of recovery. Plaintiffs are entitled to pursue the Remaining Counts based on these theories and will have their chance to prove them.

While the Motion has been pending, the parties have engaged in robust pretrial discovery

and also have briefed and argued questions concerning the authority of the bankruptcy court to render decisions in this litigation and perform its judicial functions in light of the holding of the United States Supreme Court in Stern v. Marshall, ––– U.S. ––––, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011) (“ Stern ”). These questions and related procedural steps taken to address them have contributed to the delay in deciding the Motion and, as explained in more detail in the next section of this decision, prompted the filing of a motion by JPMC to withdraw the reference that currently is pending in the United States District Court for the Southern District of New York (the “District Court”). JPMC confirmed at a pretrial conference in January that it does not object to having this Court issue this decision on the Motion.

That certainly is some progress, but regardless of this concession, the Court always has had the authority to decide the Motion.

Due to its procedural character and the fact that the Court in deciding any motion to dismiss functions as a non-final gatekeeper in assessing the legal sufficiency of allegations in a complaint, any judicial determination of such a motion at the trial court level involves no factual findings and always is subject to a de novo standard of appellate review. As such, the Supreme Court's analysis in Stern is inapposite to this decision.

Factual Background and Procedural History

JPMC served as the principal clearing bank for Lehman Brothers Inc. (“LBI”) as well as the agent for LBI's tri-party repurchase agreements. See First Am. Compl. ¶¶ 3, 18, 19. It is one of only two banks in the United States to provide tri-party repo agency services. See Wolf Decl.

Ex. 10 (Task Force on Tri–Party Repo Infrastructure, Report of Payments Risk Committee, dated May 17, 2010) at 3. In its capacity as LBI's clearing bank, JPMC facilitated the clearance and settlement of securities trades by LBI. See First Am. Compl. ¶¶ 3, 18. JPMC acted as agent and intermediary for LBI and its tri-party repo investors who purchased LBI's securities in the evening subject to LBI's agreement to repurchase those securities the next morning. Id. at ¶ 3.

In addition to providing clearing services, JPMC also had other significant business relationships with Lehman in the period before it filed for bankruptcy. It was the lead arranger and administrative agent for LBHI's $2 billion unsecured revolving credit facility, was one of Lehman's main depository banks for deposit accounts, and was one of Lehman's largest global counterparties for derivatives activity. See First Am. Compl. ¶ 16.

The Clearance Agreement

JPMC performed its clearing activities for LBI pursuant to a Clearance Agreement dated as of June 15, 2000. See Wolf Decl. Ex. 1 (Clearance Agreement between LBI and Chase Manhattan Bank, as predecessor-in-interest to JPMC) (the “Clearance Agreement”); First Am. Compl. ¶¶ 19, 20. The Clearance Agreement did not create any express obligation for JPMC to extend credit to LBI. Instead, section 5 provided that “[JPMC] may, solely at [its] discretion, permit [LBI] to use funds credited to the Account prior to final payment” and that “[a]ll loans, whether of money or securities, shall be payable on demand....” Wolf Decl. Ex. 1 (Clearance Agreement) § 5. Section 5 further expressly preserves JPMC's right to decline a request by LBI for an extension of credit upon providing notice: “we may at any time decline to extend such credit at our discretion, with notice....” Id.

To secure any advances of credit, the Clearance Agreement granted JPMC a lien on the assets held in LBI's accounts at JPMC, other than segregated customer accounts. Wolf Decl. Ex. 1 (Clearance Agreement) § 11(a) (“In consideration of any advances or loans we may extend to [LBI] pursuant to this Agreement ..., you hereby: (a) Grant to us a continuing security interest in, lien upon and right of set-off as to (i) the balance of every existing or future deposit, and account which you ... maintain with [JPMC] (except for any Segregated Account containing customer securities or funds)....”). Because JPMC was the primary clearing bank for LBI, virtually all of LBI's securities and cash used in its trading activities were on deposit with JPMC or in JPMC accounts at depositories. See First Am. Compl. ¶ 22. JPMC's security rights to LBI's collateral were limited, however, to the assets in those accounts subject to JPMC's lien and did not extend to the accounts of other Lehman entities. Id. at ¶ 23.

The Clearance Agreement could not be terminated without proper notice. Section 17 provided that either party could terminate the agreement by written notice if, inter alia, (i) the other party filed for bankruptcy; (ii) the other party failed to comply with any material provision of the agreement, which failure was not cured within 30 days after notice of such failure; or (iii) any representation or warranty made in the agreement by the other party shall have proven to have been, at the time made, false or misleading in any material respect. See Wolf Decl. Ex. 1 (Clearance Agreement) § 17. LBI also agreed to limit JPMC's liability by waiving any claim for consequential damages under the Clearance Agreement: “In no event shall [JPMC] be liable for special, indirect, punitive or consequential damages, whether or not [JPMC has] been advised as to the possibility thereof and regardless of the form of action.” Id. at § 13.

The initial term of the Clearance Agreement commenced on June 15, 2000 and ended on October 7, 2002. The parties continued to engage in transactions under terms of the Clearance Agreement from 2000 on, and did not amend it until 2008, as discussed in greater detail below. See First Am. Compl. ¶ 27.

The August Agreements

On or about August 18, 2008, JPMC presented LBHI with a set of documents that, once effective, materially changed the clearance relationship between the parties. See First Am. Compl. ¶ 28. The new documents were executed on or about August 26, 2008. They included an amendment to the Clearance Agreement (the “August Amendment”), a guaranty agreement (the “August Guaranty”), and a security agreement in favor of JPMC (the “August Security Agreement”) (collectively, the “August Agreements”). Id. The August Security Agreement and the August Amendment were signed by Paolo Tonucci (LBHI's treasurer), and the August Guaranty was signed by Ian Lowitt (LBHI's chief financial officer). See id. at ¶ 34; Wolf Decl. Ex. 3 (August Amendment); Wolf Decl. Ex. 4 (August Guaranty); Wolf Decl. Ex. 5 (August Security Agreement). In accordance with the August Agreements, LBHI posted collateral with JPMC to secure JPMC's clearance exposure to LBI and other LBHI subsidiaries. See First Am. Compl. ¶ 30.

The August Amendment added LBHI and several LBHI subsidiaries as additional customers under the Clearance Agreement, which originally was between only JPMC and LBI. Wolf Decl. Ex. 3 (August Amendment) § 1 (“The Agreement is hereby amended by adding Lehman Brothers Holdings Inc., Lehman Brothers International (Europe), Lehman Brothers OTC Derivatives Inc., Lehman Brothers Commercial Bank and Lehman Brothers Japan Inc. as additional customers.”). The August Amendment further provided that the obligations of these affiliated entities to JPMC would be “several and not joint.” See Wolf Decl. Ex. 3 (August Amendment) § 2 (“Notwithstanding anything provided for herein to the contrary, except for the obligations of Lehman Brothers Holdings Inc. under the [August Guaranty and August Security Agreement], the obligations and liabilities of each of the Lehman entities which are a party to this Agreement under this Agreement shall be several and not joint and any security interest, lien, right of set-off or other collateral accommodation provided by any Lehman entity pursuant to this Agreement shall not be available to support the obligations and liabilities of any other Lehman entity pursuant to this Agreement.”).

The August Security Agreement granted JPMC a lien on certain LBHI accounts at JPMC in which LBHI had posted collateral “as security for the payment of all the Liabilities,” as defined in the August Guaranty. Wolf Decl. Ex. 5 (August Security Agreement) at 2 (“As security for the payment of all the Liabilities, the undersigned hereby grant(s) to the Bank a security interest in, and a general lien upon and/or right of set-off of, the Security.”).

To the extent that its collateral was no longer required to secure outstanding clearance obligations owed to JPMC, LBHI could transfer the collateral pledged under the August Security Agreement to a lien-free account at JPMC. See Wolf Decl. Ex. 5 (August Security Agreement) at 3 (“... at the end of a business day, if [LBHI] has determined that no Obligations (as defined in the Clearance Agreement) remain outstanding, [LBHI] may transfer to an account (the ‘Overnight Account’) any and all Security held in or credited to or otherwise carried in the Accounts.”); First Am. Compl. ¶ 31. Plaintiffs allege that because the intra-day clearance exposures between JPMC and the Lehman subsidiaries typically were reduced to zero at the close of business of each trading day, the “overnight account” provision of the August Security Agreement entitled LBHI to have access to substantially all of its collateral overnight. See First Am. Compl. ¶ 32.

Under the August Guaranty, LBHI guaranteed payment of all obligations and liabilities owed to JPMC under the Clearance Agreement of all of LBHI's subsidiaries that were parties to the Clearance Agreement, including LBI. See Wolf Decl. Ex. 4 (August Guaranty) § 1 (“The Guarantor unconditionally and irrevocably guarantees to the Bank the punctual payment of all obligations and liabilities (including without limitation the ‘Obligations' as defined in the Clearance Agreement) of the Borrowers to the Bank of whatever nature ... (all of the foregoing sums being the ‘Liabilities'), pursuant to the Clearance Agreement, dated as of June 15, 2000....”).

The liability of LBHI under the August Guaranty was limited to the value, adjusted on a daily basis, of the collateral held or requested to secure the August Guaranty. Id. (“The Guarantor's maximum liability under this Guaranty shall adjust each day and for each such day shall be equal to the dollar amount of cash and securities ... (i) held on such day in the accounts of the Guarantor subject to the Clearance Agreement and the Security Agreement and (ii) that the Bank has notified the Guarantor to be delivered to the Bank on such day in support of this Guaranty.”); See also First Am. Compl. ¶ 30.

The preliminary statement to the August Guaranty stated that LBHI as guarantor expected to derive significant financial benefit from the continued extension of clearance services provided by JPMC to LBHI affiliates in reliance on that agreement. See Wolf Decl. Ex. 4 (August Guaranty) at 1 (“The Guarantor derives, and expects to continue to derive, substantial direct and indirect benefits from the business of the Borrowers and the credit, clearing advances, clearing loans and other financial accommodations provided by the Bank to the Borrowers.”).

Plaintiffs allege that the August Agreements provided LBHI with neither actual nor reasonably equivalent value in exchange for granting JPMC significant legal rights. See First Am. Compl. ¶ 33 (“While the August Agreements purported to grant JPMorgan significant new rights against LBHI, they gave LBHI nothing of value in exchange ... [f]urther, LBHI did not even receive reasonably equivalent value....”).

JPMC's access to confidential Lehman information in September 2008

In the days before LBHI's collapse, JPMC was able to gain knowledge of Lehman's financial conditions and prospects. See First Am. Compl. ¶ 35. As Lehman's most significant relationship bank, JPMC officers attended meetings with high-level Lehman personnel in connection with its financial distress. Id. For example, on September 4, 2008, senior management of LBHI met with senior officers of JPMC, including its senior risk officer, Barry Zubrow, to discuss Lehman's upcoming third quarter results, including the expected significant asset write-downs from Lehman's commercial and residential real estate assets, and Lehman's plans going forward. See id. at ¶ 36. Similarly, JPMC offered to assist Lehman by providing feedback on its draft presentations to the rating agencies. For example, on September 4, 2008, LBHI treasurer Paolo Tonucci solicited comments from JPMC officials to a draft presentation scheduled to be made to one of the ratings agencies. See id. at ¶ 37.

As a result of these and other meetings and correspondence, Plaintiffs allege that JPMC obtained access to confidential information, results, plans, and outlook. Id. at ¶¶ 35, 37. Tonucci himself warned JPMC that the draft presentation to the ratings agency contained “a lot of confidential info.” Id. at ¶ 37. Moreover, Plaintiffs allege that officials at JPMC knew by the morning of September 5, 2008 that the proposed transaction between Lehman and Korean Development Bank was unlikely to be completed. Id. at ¶ 38.

In addition, during this same time period, senior executives of JPMC attended meetings with officials in Washington D.C. in connection with Lehman's increasingly dire financial situation. For example, on September 9, 2008, Jamie Dimon, JPMC's chief executive, attended meetings with Chairman of the Federal Reserve Ben Bernanke and Secretary of the United States Treasury Henry Paulson in connection with the unfolding financial turmoil. Id. at ¶ 39.

According to Plaintiffs, JPMC abused its access to and knowledge of Lehman's internal struggles as well as the government's plans to address the growing crisis. After gaining this information, Plaintiffs allege that JPMC embarked on an effort to “capitalize on” an LBHI bankruptcy. See id. at ¶ 40. On September 9, 2008, a team of senior risk managers from JPMC arrived at Lehman's offices under the pretense of conducting due diligence on a potential acquisition, but Plaintiffs claim that in reality they were there to probe Lehman's confidential records and plans. See id. at ¶ 43.

The September Agreements

According to the Plaintiffs, JPMC exploited its access to nonpublic information about Lehman's financial condition to “maneuver to gain a preferred position over LBHI's other creditors.” First Am. Compl. ¶ 44. According to JPMC's own calculations, as late as September 4, 2008, JPMC believed it was more than fully collateralized for intra-day clearing risk. Id. at ¶ 45. Nonetheless, on the night of September 9, 2008, on the eve of the public release by Lehman of its earnings, JPMC requested that LBHI sign a new set of agreements. Id. at ¶ 46. Specifically, that night, JPMC executives pressed Lehman to enter into a guaranty (the “September Guaranty”), a security agreement (the “September Security Agreement”), a further amendment to the Clearance Agreement (the “September Amendment”), and an account control agreement (the “Account Control Agreement”) (together, the “September Agreements”). See id. at ¶ 46.

JPMC executives contacted their counterparts at LBHI and caused them to believe that if LBHI did not execute the proposed September Agreements immediately, JPMC would then immediately stop extending intra-day credit to and clearing trades for Lehman. Id. at ¶¶ 47, 48. During the course of the evening, JPMC's in-house counsel represented to Andrew Yeung of LBHI that Lehman's CEO Richard Fuld previously had agreed to the terms of the September Agreements. Yeung did not realize that this statement was untrue, and he was unable to verify its veracity at that time. Id. at ¶ 50. Yeung e-mailed Paolo Tonucci to advise him of the terms of the September Agreements, but ultimately was unable to reach him. Id. at ¶ 57. As a result, that night, neither Tonucci, Ian Lowitt, nor any other LBHI executive with the authority to bind LBHI to the September Guaranty reviewed or approved the September Guaranty or the other September Agreements. Id.

The next day, on September 10, 2008, LBHI agreed to the September Agreements. Id. at ¶ 59. Although Tonucci executed the September Agreements, Plaintiffs allege that he was not authorized to sign the September Guaranty. See id. at ¶¶ 59, 61. Plaintiffs further allege that JPMC was aware both that Tonucci lacked the authority to sign the agreements and that Lowitt, whose authorization was necessary, was unavailable. See id. at ¶ 61.

These agreements secured not only the exposure of JPMC in relation to clearing securities trades, but also essentially all exposure arising from other dealings of JPMC with LBHI's subsidiaries—principally derivatives transactions. Id. at ¶ 51. According to Plaintiffs, LBHI received “nothing in exchange” for the legal rights granted to JPMC under the September Agreements. See id. at ¶ 56. Nonetheless, LBHI acceded to JPMC's demands and entered into the September Agreements to ensure that JPMC did not discontinue availability to credit and clearing services and to avoid disruptions that would devastate Lehman's business operations. See id. at ¶ ¶ 49, 58, 68.

The September Amendment (together with the August Amendment, the “Amendments”) amended the Clearance Agreement by expanding the term “Obligations” to include all obligations, of whatever nature, of all Lehman entities to all JPMC entities, including clearance obligations, trading obligations, and derivatives obligations. See Wolf Decl. Ex. 6 (September Amendment) at 1; First Am. Compl. ¶ 51. The Account Control Agreement perfected JPMC's security interest in shares and related accounts of certain JPMC money market funds posted as collateral by LBHI. See Wolf Decl. Ex. 9 (Account Control Agreement) at 1; First Am. Compl. ¶ 54.

The September Guaranty (together with the August Guaranty, the “Guarantees”) expanded LBHI's liabilities (the “Obligations”) by defining the guaranteed “Liabilities” as all obligations of LBHI and any of its subsidiaries to JPMC and any of its affiliates or subsidiaries. See Wolf Decl. Ex. 7 (September Guaranty) § 1 (“The Guarantor unconditionally and irrevocably guarantees to the Bank the punctual payment of all obligations and liabilities of the Borrowers to the Bank of whatever nature ... (all of the foregoing sums being the ‘Liabilities')....”). The September Guaranty also expressly contemplated obligations arising from clearance, trading, and derivatives transactions. See Wolf Decl. Ex. 7 (September Guaranty) at 1 (“The Guarantor and each of the direct or indirect subsidiaries of the Guarantor ... desires to ... enter into derivative transactions with ... the Bank....”).

The September Guaranty also specified that it was “absolute and unconditional irrespective of ... any lack of validity or enforceability of ... [the September Agreements,]” and that LBHI “irrevocably waived the right to assert ... defenses, setoffs, or counterclaims in any litigation or other proceeding related to ... [the September Agreements].” Wolf Decl. Ex. 7 (September Guaranty) § 2. Similar to the August Guaranty, LBHI's maximum liability under the September Guaranty was capped at the value of the collateral pledged as security under that agreement. See id. at § 1 (“The Guarantor's maximum liability under this Guaranty shall be THREE BILLION DOLLARS ($3,000,000,000) or such greater amount that the Bank has requested from time to time as further security in support of this Guaranty.”); see also First Am. Compl. ¶ 52.

The September Security Agreement (together with the August Security Agreement, the “Security Agreements”) granted a lien on all of LBHI's accounts at JPMC or its affiliates and the assets contained therein (except for the Overnight Account created under the August Security Agreement), as security for payment of the “Liabilities.” See Wolf Decl. Ex. 8 (September Security Agreement) at 1–2 (“As security for the payment of all the Liabilities, the undersigned hereby grants to the Bank a security interest in, and a general lien upon ... the Security.”); First Am. Compl. ¶ 53.

Importantly, the September Security Agreement deleted the provision from the August Security Agreement that had given LBHI the right to transfer its collateral from the pledged accounts to the lien-free overnight account. See First Am. Compl. ¶ 55. Instead, the September Security Agreement provided simply that LBHI could access its collateral “upon three days written notice to the Bank.” See Wolf Decl. Ex. 8 (September Security Agreement) at 3 (“Notwithstanding anything provided for herein, the undersigned may upon three days written notice to the Bank transfer any Security....”); see also First Am. Compl. ¶ 55.

JPMC demands collateral pursuant to the September Agreements

JPMC promptly requested that LBHI deliver additional collateral under the September Agreements. See First Am. Compl. ¶¶ 62, 66. Plaintiffs allege that JPMC knew when making these requests that it already held sufficient collateral to secure its intra-day clearance risk, and used these agreements “as a pretext to improperly extract” additional collateral from LBHI. Id. at ¶¶ 62, 69. JPMC's demands were backed by the threat that if LBHI failed to comply, JPMC immediately would cease providing intra-day clearing services. Id. at ¶ 66. JPMC's collateral demands “contributed significantly” to LBHI's inability to meet the liquidity needs of its business. Id.

In response to these demands, on September 9, 2008 LBHI posted with JPMC $1 billion in cash and $1.67 billion in money market funds. Id. The next day, on September 10, 2008, LBHI turned over another approximately $300 million in cash. Id. Similarly, on September 11, 2008, LBHI posted additional cash collateral with JPMC in the amount of $600 million. Id.

That same day, on September 11, 2008, JPMC made demand for $5 billion more cash collateral and threatened that, if LBHI did not post that collateral by the opening of business the following day, “we intend to exercise our right to decline to extend credit to you under the [Clearance] Agreement.” Id. at ¶ 67. To further induce LBHI to accept this demand, Plaintiffs allege that Jamie Dimon of JPMC promised Richard Fuld that JPMC would return the $5 billion at the close-of-settlement on September 12, 2008. Id. at ¶ 70. LBHI had no choice but to post $5 billion in cash collateral the following day (together with the prior collateral transfers over the prior two-day period, the “Disputed Collateral Transfers”). Id. at ¶¶ 68, 71. Thereafter, JPMC transferred the cash component of the collateral (approximately $6.9 billion of the $8.6 billion in total collateral) out of the demand deposit account to which it had been delivered into a JPMC general ledger account (the “Funds Sweep”). Id. at ¶ 72.

JPMC retained the posted collateral after the close-of-trading on Friday, September 12, 2008, despite not having had any outstanding clearance exposure to Lehman. Id. at ¶ 73. Throughout that weekend, LBHI repeatedly requested that JPMC permit it access to its collateral to help it to stave off bankruptcy. Id. at ¶ 74. JPMC refused to grant LBHI access to its collateral, despite having concluded that it was overcollateralized with respect to clearance exposure by over $6 billion. Id. at ¶ 75. JPMC knew that Lehman was in danger of failing absent access to additional liquidity or collateral, and knew that any such failure would benefit JPMC's market share in trading and investment banking. Id. at ¶¶ 76, 77.

Lehman's chapter 11 cases

During the weekend of September 13–14, 2008, JPMC executives participated in meetings at the Federal Reserve Bank of New York (the “Federal Reserve”) with government officials and representatives of major financial institutions regarding a potential sale and/or rescue of Lehman. See First Am. Compl. ¶ 76. LBHI filed a petition for relief under chapter 11 of the Bankruptcy Code in the early morning hours of September 15, 2008. Id. at ¶ 78.

JPMC's post-petition advances and LBHI's comfort order motion

Notwithstanding LBHI's bankruptcy, JPMC continued to provide massive amounts of credit to LBI even after LBHI had filed its chapter 11 petition. Indeed, beginning on September 15, 2008, just a few hours after the filing by LBHI of the largest bankruptcy in history, JPMC made clearing advances to unwind LBI's outstanding tri-party repurchase agreements in the total amount of $87 billion. See Wolf Decl. Ex. 11 (Motion of Lehman Brothers Holdings Inc. for Order, Pursuant to Section 105 of the Bankruptcy Code, Confirming Status of Clearing Advances, Case No. 08–13555, ECF No. 29, (Bankr.S.D.N.Y. Sept. 16, 2008)) (the “Comfort Order Motion”) ¶ 9. These advances were made at the urging of the Federal Reserve to avoid a disruption of the financial markets. Id. The following day, JPMC advanced a “comparable amount” to unwind LBI's tri-party repurchase agreements. Id.

On September 16, 2008, the day after its bankruptcy filing, LBHI filed the Comfort Order Motion for the purpose of inducing JPMC to continue to extend credit to settle and clear securities transactions for LBI. See Wolf Decl. Ex. 11 (Comfort Order Motion) ¶ 19. In that motion, LBHI explained to the Court that “[JPMC] may, in its sole discretion, make advances to or for the benefit of the respective Lehman Clearance Parties [under the Clearance Agreement,] which are payable ... upon demand by [JPMC].” Id. at ¶ 6. LBHI emphasized that “[a]ny cloud on the guarantees vis-à-vis the Holding Company Collateral will inhibit [JPMC] from clearing advances to or for the benefit of the Lehman Clearance Parties to the detriment of public investors.” Id. at ¶ 19. The Comfort Order Motion was intended to assure JPMC that it could continue to make clearing advances knowing that such advances “will be allowed as claims under the Guarantee Agreements secured by the Holding Company Collateral.” Id. at ¶ 12. LBHI also acknowledged that the Amendments, the Guarantees, and the Security Agreements “are ‘securities contracts' within the meaning of section 741(7) of the Bankruptcy Code.” Id. at ¶ 17.

At the hearing on the Comfort Order Motion, counsel for LBHI stated that it was “completely understandable” that JPMC needed assurances before continuing to perform the “critical function” of performing its clearance services. See Wolf Decl. Ex. 12 (Comfort Order Motion Hr'g Tr., Sept. 16, 2008) at 27:9–12, 27:25–28:1. Thus, LBHI told the Court that “we believe that the guaranty and the collateral covers [sic] not only those transactions which have already occurred but as well the future transactions.” Id. at 28:6–8. The Federal Reserve supported the Comfort Order Motion, informing the Court that “the services that [JPMC] has been providing are critical to the smooth functioning of financial markets.” Id. at 34:12–15. The Court granted the Comfort Order Motion, finding it “entirely appropriate and consistent with the need to provide market liquidity for this debtor and its affiliates....” Id. at 35:1–2; Wolf Decl. Ex. 13 (Order Pursuant to Section 105 of the Bankruptcy Code Confirming Status of Clearing Advances, Case No. 08–13555, ECF No. 47 (Bankr.SDNY Sept. 16, 2008)) (the “Comfort Order”).

As described in proofs of claim filed with this Court, JPMC asserts claims against the LBHI estate in the total amount of approximately $30 billion. See Wolf Decl. Ex. 14 (Proofs of claim filed by JPMC) (the “JPMC Proofs of Claim”). The JPMC Proofs of Claim include secured claims under the Guarantees for approximately $25 billion in connection with extensions of credit under the Clearance Agreement. Wolf Decl. Ex. 14 Ex. B (LBI Claims Annex) at 2.

Adversary Proceeding and the Motion to Dismiss

On May 26, 2010, LBHI commenced this adversary proceeding (the “Adversary Proceeding”) by filing the Complaint. See Compl., ECF No. 1. That same day, LBHI and the Committee filed a joint motion to authorize the Committee's intervention in the litigation. The Court entered an order granting the intervention on June 24, 2010. See Order Authorizing Committee's Intervention, ECF No. 7. After an initial motion to dismiss filed by JPMC, the Plaintiffs filed the Amended Complaint on September 15, 2010. See First Am. Compl., ECF No. 19.

JPMC filed the Motion on October 19, 2010. See Mem. Supp. Mot. Dismiss, ECF No. 29. Extensive briefing ensued. See Pls.' Opp'n, ECF No. 41; Reply Br. Supp. Mot. Dismiss, ECF No. 53 (“Reply”); and Mem. Amici Curiae Supp. Mot. Dismiss, ECF No. 52 (“Amici Brief”).

The Court heard oral argument on the Motion on May 10, 2011 (the “Hearing”). See generally, Hr'g Tr., May 10, 2011, ECF No. 77.

The Stern v. Marshall Detour

During the month following the Hearing, the United States Supreme Court decided Stern. In Stern the Supreme Court ruled that a bankruptcy court, as a non-Article III court, “lacked the constitutional authority to enter a final judgment on a state law counterclaim that [was] not resolved in the process of ruling on a creditor's proof of claim.” Stern, 131 S.Ct. at 2620.Stern has led to a proliferation of litigation and procedural maneuvering nationwide as parties, especially defendants in adversary proceedings, have considered the impact of the decision on the authority of the bankruptcy courts to render final judgments. Many parties in pending adversary proceedings have taken steps to exploit some of the unsettled issues raised by Stern for procedural advantage.

A number of recent cases have clarified that the balance in workload between the bankruptcy court and district court due to the narrow ruling in Stern actually has not changed very much and that the bankruptcy system is continuing to function without as many disruptions as had been feared by some observers.

The standard order of reference in this district has been amended to resolve procedural issues in relation to the holding in Stern.

The recent developments that have helped stabilize the bankruptcy system and make it more predictable in the aftermath of Stern were not clearly foreseeable or understood in June of last year. In recognition that the holding in Stern might be applicable to the litigation, the Court asked counsel for Plaintiffs and for JPMC to submit papers addressing the effect of the decision on the claims asserted in the Adversary Proceeding. On August 5, 2011, the parties filed their position papers. See Pls.' Mem. Addressing Effect of Stern v. Marshall on Bankruptcy Court's Ability to Render Final J., ECF No. 89; Supplemental Mem. Supp. Mot. Dismiss, ECF No. 90.

The submissions of the parties reached totally different conclusions regarding the impact of Stern on the Adversary Proceeding and were not particularly helpful (one said the Court had the authority to do everything, while the other said that the Court could do nothing other than to dismiss the Amended Complaint). As a means to encourage further consideration of the issues, on August 15, 2011, the Court entered a case management order with respect to the unresolved questions raised by the parties' submissions (as subsequently amended on September 21, 2011, the “Case Management Order”). See Case Management Order in Relation to the Impact of Stern v. Marshall, ECF No. 93; Order Amending and Modifying the Case Management Order in Relation to the Impact of Stern v. Marshall, ECF No. 97.

Thereafter, in accordance with paragraph 4 of the Case Management Order, the parties filed additional briefs regarding the impact of Stern on each count of the Amended Complaint.

See Pls.' Statement in Accordance with Case Management Order in Relation to the Impact of Stern v. Marshall, ECF No. 98; JPMorgan's Submission in Resp. to Case Management Order, ECF No. 99. JPMC also filed a motion with the District Court for an order withdrawing the reference of the Adversary Proceeding to the United States Bankruptcy Court for the Southern District of New York (the “Withdrawal Motion”).

See JPMorgan's Motion to Withdraw the Reference to the Bankruptcy Court of the Above–Captioned Adversary Proceeding, ECF No. 100.

The Withdrawal Motion was assigned to the Honorable District Court Judge Richard J. Sullivan. After full briefing by the parties, a hearing on the Withdrawal Motion was held before Judge Sullivan on December 30, 2011. At the hearing, Judge Sullivan determined, and the parties agreed, that in order to avoid further delays in deciding the Motion, he would reserve decision on the Withdrawal Motion until after a ruling by the bankruptcy court on the Motion. See Withdrawal Motion Hr'g Tr. 76–77, Dec. 30, 2011, No. 11 CV 6760, ECF No. 34; Order of Judge Richard J. Sullivan, December 30, 2011, No. 11 CV 6760, ECF No. 33.

In January, a chambers conference was convened in the bankruptcy court to discuss further proceedings. During that conference, lead trial counsel for JPMC indicated that he had no objection to having this Court decide the Motion. In addition, due to the passage of time, the Court set a supplemental briefing schedule to allow the parties to address any legal developments since the close of briefing that were relevant to the Motion. Supplemental briefs were submitted on February 17, 2012. See Pls.' Br. of Supplemental Authorities in Further Opp'n to JPMorgan Chase Bank N.A.'s Mot. Dismiss, ECF No. 125; Supplemental Br. Addressing Recent Decisions Relating to JPMorgan's Mot. Dismiss, ECF No. 126.

Rule 12(b)(6) Standard

Federal Rule of Civil Procedure 8(a)(2) requires a complaint to contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” Fed.R.Civ.P. 8(a)(2). 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 can be granted. Fed.R.Civ.P. 12(b)(6). 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, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555–56, 127 S.Ct. 1955, 167 L.Ed.2d 929 (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 need to be supported by more than mere conclusory statements. Twombly, 550 U.S. at 555, 127 S.Ct. 1955. 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. In other words, “only a complaint that states a plausible claim for relief survives a motion to dismiss.” Iqbal, 556 U.S. at 679, 129 S.Ct. 1937.

Where a complaint alleges fraud, the pleading requirements imposed by Federal Rule of Civil Procedure 9(b) (“Rule 9(b)”), as incorporated in Federal Rule of Bankruptcy Procedure 7009, are even more demanding. The plaintiff “must state with particularity the circumstances constituting fraud or mistake,” including, at a minimum, “facts that give rise to a strong inference of fraudulent intent.” Fed.R.Civ.P. 9(b); Pereira v. Grecogas Ltd. (In re Saba Enters.), 421 B.R. 626, 642 (Bankr.S.D.N.Y.2009) (citations omitted).

In ruling on a motion to dismiss, the Court may consider documents omitted from the plaintiff's complaint but attached by a defendant to its motion to dismiss. See, e.g., Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47–48 (2d Cir.1991) (district court may consider exhibits omitted from plaintiff's complaint but attached as exhibits to defendant's motion papers because “there was undisputed notice to plaintiffs of their content and they were integral to plaintiffs' claim”).

It is important for the Court to rule on those counts of the Amended Complaint that implicate the safe harbor provisions of the Bankruptcy Code. See Amici Brief at 22 (“Prompt Disposition of Safe Harbor Cases is Essential to the Effectiveness of [Safe Harbor] Statutes”). Bankruptcy courts will enforce the safe harbor provisions of the Bankruptcy Code in appropriate cases by dismissing avoidance actions on the pleadings. See, e.g., Brandt v. B.A. Capital Co. L.P. (In re Plassein Int'l Corp.), 366 B.R. 318, 322–26 (Bankr.D.Del.2007) (granting a motion to dismiss claims seeking to avoid transfers protected under safe harbor section 546(e)).

Discussion

The Amended Complaint sets forth forty-nine separate counts seeking relief on multiple theories. See First Am. Compl. ¶¶ 87–369. These counts allege distinct causes of action that fit into a number of separate categories characterized by the underlying legal premises on which the claims are based— i.e., claims seeking (i) to avoid and recover actual fraudulent transfers under section 548 of the Bankruptcy Code; (ii) to avoid and recover constructively fraudulent and preferential transfers under sections 544, 547 and 548 of the Bankruptcy Code and applicable state law; (iii) relief under various common law legal doctrines; and (iv) relief under various other sections of the Bankruptcy Code, i.e., turnover of estate property under section 542, setoff under section 553, equitable subordination under section 510(c), and the disallowance of claims under section 502(d). For the reasons set forth below, the Court concludes that the claims for recovery of constructively fraudulent transfers and preferences under sections 544, 547 and 548 of the Bankruptcy Code should be dismissed.

I. The counts seeking to avoid and recover transfers made under the August and September Agreements as constructively fraudulent or preferential transfers are dismissed.

The bulk of the Amended Complaint alleges that the liens granted under the Security Agreements, the Obligations incurred under the Guarantees, and the Disputed Collateral Transfers made under the September Agreements constitute constructively fraudulent transfers and preferential transfers. Specifically:

• Counts V, X, XXI, and XXII seek to avoid liens granted under the September Agreements as constructively fraudulent transfers and preferences;

• Counts VIII, IX, XV, XVI, XVII, XVIII, XIX, XX, XXIII, and XXIV seek to avoid and recover the Disputed Collateral Transfers, including the Funds Sweep, as constructively fraudulent transfers and preferences; and

• Counts V, VI, VII, X, XI, XII, XIII, and XIV seek to avoid LBHI's Obligations arising under the Guarantees as constructively fraudulent transfers and preferences, and, by extension, indirectly avoid the transfers made under the August Security Agreement and the September Agreements.

These counts are premised on the estate's avoidance powers under sections 547 and 548(a)(1)(B) of the Bankruptcy Code. Section 547(b) provides that the trustee of a bankruptcy estate may avoid as a preferential transfer any transfer made by an insolvent debtor in the ninety days preceding bankruptcy, where the transfer (i) was made to or for the benefit of a creditor; (ii) was made for or on account of an antecedent debt owed by the debtor; and (iii) enabled the creditor to receive more than it otherwise would have under the provisions of the Bankruptcy Code. See11 U.S.C. § 547(b). Section 548(a)(1)(B) provides that a trustee of a bankruptcy estate may avoid as a constructively fraudulent transfer any transfer or obligation incurred by a debtor within the two years before the date of the filing of the petition when made in exchange for “less than reasonably equivalent value” and that left the debtor insolvent. See11 U.S.C. § 548(a)(1)(B).

JPMC seeks dismissal of these counts, arguing that they fail as a matter of law because the transfers are fully protected from avoidance under section 546(e) of the Bankruptcy Code. See Mem. Supp. Mot. Dismiss at 22 (“The safe harbors of section 546 mandate dismissal of [P]laintiffs' claims to avoid transfers to [JPMC] based on theories of constructive fraudulent transfer or preference.”). The plausibility of the counts alleged in the Amended Complaint hinges on whether claims for avoidance are permitted given the language of section 546(e) that appears to effectively shield the agreements, transfers, and obligations from avoidance.

This Court most recently addressed section 546(e) in Official Comm. of Unsecured Creditors of Quebecor World (USA) Inc. v. American United Life Insurance Co. (In re Quebecor World (USA) Inc.), 453 B.R. 201 (Bankr.S.D.N.Y.2011). In Quebecor, the creditors' committee sought to avoid payments received by institutional noteholders in connection with the debtors' repurchase and subsequent cancellation of privately-placed notes. Relying on the Second Circuit decision in In re Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir.2011), the court granted summary judgment for the defendants, holding that the transfers of cash to complete a securities transaction were “settlement payments” that fall under the safe harbors. Quebecor, 453 B.R. at 206. While the definition of settlement payments—at issue in both Enron and Quebecor—has no direct bearing on this adversary proceeding, these decisions nonetheless are relevant precedents for the proposition that the language of the safe harbors is to be strictly interpreted even when the outcome may be prejudicial to the interests of the estate and its creditors.

In Enron, the Second Circuit “decline[d] to address Enron's arguments regarding legislative history” because it was able to reach a conclusion based on the plain language of the statute. Enron, 651 F.3d at 339 (citing Lamie v. U.S. Trustee, 540 U.S. 526, 534, 124 S.Ct. 1023, 157 L.Ed.2d 1024 (2004) (“It is well established that when the statute's language is plain, the sole function of the courts—at least where the disposition required by the text is not absurd—is to enforce it according to its terms.”) (internal quotation marks omitted)). In Quebecor, the Court noted the influence of Enron on its deliberations, applied the language of section 546(e) to the payments at issue, and found that they were, indeed, “settlement payments.” See Quebecor, 453 B.R. at 215. Consistent with its approach in Quebecor, the Court will strictly construe the plain meaning of section 546(e) in judging whether the claims set forth in the Amended Complaint are subject to the safe harbors of that section of the Bankruptcy Code.

Section 546(e) carves out an express exception to section 547(b) and 548(a)(1)(B):

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer ... that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract, as defined in section 741(7) ... that is made before the commencement of the case, except under section 548(a)(1)(A)

of this Title.”
11 U.S.C. § 546(e). Thus, section 546(e) exempts from avoidance “transfers” by or to “financial institutions” that are made “in connection with” a class of defined “securities contracts.” Once parsed, the language is clear, and, as further explained in the following paragraphs, prevents Plaintiffs from avoiding the August and September Agreements, the Disputed Collateral Transfers, and the Obligations on theories of constructively fraudulent transfer or preference.

A. JPMC qualifies for protection under section 546(e).

The Court first must consider whether JPMC is eligible for protection under section 546(e). That subsection, like the safe harbors generally, applies only to certain types of qualifying entities. Specifically, section 546(e) covers pre-petition transfers made by or to a “financial institution” or “financial participant” in connection with a “securities contract.” 11 U.S.C. § 546(e).

JPMC, as one of the leading financial institutions in the world, quite obviously is a member of the protected class and qualifies as both a “financial institution” and a “financial participant.” JPMC unquestionably fits the Bankruptcy Code's definition of “financial institution.” See11 U.S.C. § 101(22) (defining “financial institution” to include a “commercial bank”). JPMC also is a “financial participant” because it is a party to outstanding safe harbor contracts totaling at least $1 billion in gross notional or principal dollar amount. See11 U.S.C. § 101(22A) (defining “financial participant”). That JPMC fits the applicable definitions for safe harbor protection is not in dispute, and the Amended Complaint concedes this point. See First Am. Compl. ¶ 10 (identifying JPMC as a “financial institution”); ¶ 76 (identifying JPMC as a “national banking association chartered under the laws of the United States”); ¶¶ 66–67 (recognizing the extent of JPMC's derivatives obligations to LBHI and its subsidiaries).

B. The Clearance Agreement, the August Agreements, and several of the September Agreements constitute “securities contracts” for purposes of section 546(e).

Section 546(e) of the Bankruptcy Code protects from avoidance any transfer to a financial institution made in connection with a “securities contract.” 11 U.S.C. § 546(e). “Securities contracts,” in turn, are defined by section 741(7) of the Bankruptcy Code:

‘securities contract’—(A) means

(i) a contract for the purchase, sale, or loan of a security ... including any repurchase or reverse repurchase transaction on any such security ... (whether or not such repurchase or reverse repurchase transaction is a ‘repurchase agreement’ as defined in section 101);

...

(v) any extension of credit for the clearance or settlement of securities transactions;

...

(x) a master agreement that provides for an agreement or transaction referred to in clause (i)[or] ... (v) ... together with all supplements to any such master agreement, without regard to whether the master agreement provides for an agreement or transaction that is not a securities contract under this subparagraph, except that such master agreement shall be considered to be a securities contract under this subparagraph only with respect to each agreement or transaction under such master agreement that is referred to in clause (i) [or] ... (v); ... or

(xi) any security agreement or arrangement or other credit enhancement related to any agreement or transaction referred to in this subparagraph, including any guarantee ... by or to a ... financial institution, or financial participant in connection with any agreement or transaction referred to in this subparagraph....
11 U.S.C. § 741(7). The plain language of section 741(7) is very broad in its application and encompasses virtually any contract for the purchase or sale of securities, any extension of credit for the clearance or settlement of securities transactions, and a wide array of related contracts, including security agreements and guarantee agreements.

The Clearance Agreement (including the Amendments) constitutes a “securities contract” by virtue of being an “extension of credit for the clearance or settlement of securities transactions” under subsection (v) of section 741(7). See Wolf Decl. Ex. 1 (Clearance Agreement) at 1 (identifying JPMC as LBI's “non-exclusive clearance agent for securities transactions”); § 5 (“We may, solely at our discretion ... advance funds to you prior to final payment.”). As an agreement to extend credit to settle securities transactions, the Clearance Agreement constitutes a safe-harbored “securities contract.”

Notably, the definition in subsection (v) of “securities contract” is transaction-based, not agreement-based. Accordingly, in addition to the Clearance Agreement itself, subsection (v) includes within the definition of “securities contract” each individual extension of credit made to LBI under that agreement. Each such extension of credit under the Clearance Agreement is an independent “securities contract” under subsection (v). For this reason, the Clearance Agreement governs other securities contracts and functions as a “master agreement” for purposes of subsection (x) of section 741(7)(A). Indeed, the definition is replete with so many “belts” and “suspenders” that there can be no doubt as to the conclusion here: the relevant documents in reference to the transfers made from Lehman to JPMC in August and September all fit the definition of securities contracts.

The August Agreements and several of the September Agreements qualify as “securities contracts” under subsection (xi) of section 741(7)(A) because of their role as credit enhancements “related to” and “in connection with” other “securities contracts.” Subsection (xi) specifies that a security agreement is a “securities contract” to the extent that it secures debts “related to” another “securities contract.” Similarly, that subsection states that a guaranty is a “security contract” to the extent that it guarantees debts incurred “in connection with” another “securities contract.” See11 U.S.C. § 741(7)(A)(xi) (identifying as a “securities contract” any “security agreement or arrangement or other credit enhancement related to any [protected] agreement or transaction ... including any guarantee or reimbursement obligation ... in connection with any agreement or transaction referred to in this subparagraph....”) (emphasis added). Thus, under subsection (xi) of section 741(7)(A), the Security Agreements and the Guarantees are “securities contracts” to the extent that they secure debts related to (or guarantee debts incurred in connection with) safe-harbored contracts.

Close inspection of the plain text of each agreement reveals this to be the case. The August Guaranty and the August Security Agreement, for example, expressly contemplated obligations owing from LBI to JPMC under the Clearance Agreement (itself, a “securities contract”). See Wolf Decl. Ex. 4 (August Guaranty) at 1 (“[certain Lehman entities] desire to transact business with and/or to obtain credit, clearing advances ... from [JPMC] ... under or in connection with the Clearance Agreement....”); Wolf Decl. Ex. 5 (August Security Agreement) at 1 (recognizing that the lien granted is “[i]n consideration of one or more loans, letters of credit or other financial accommodation made ... by [JPMC]” pursuant to the Clearance Agreement).

The September Security Agreement and the September Guaranty also constitute credit enhancements in furtherance of “securities contracts” for purposes of subsection (xi) because they expressly contemplate “derivative transactions” and “clearing advances” between JPMC and LBHI subsidiaries. See Wolf Decl. Ex. 7 (September Guaranty) at 1 (granting guaranty “in order to induce the Bank from time to time ... to continue to extend credit, clearing advances, clearing loans, or other financial accommodations to the Borrowers....”); Wolf Decl. Ex. 8 (September Security Agreement) at 1 (“In consideration of [JPMC] ... extending credit to and/or transacting business, trading, or engaging in derivative transactions with the undersigned and/or its subsidiaries, the undersigned hereby agrees....”).

The fact that the references to safe-harbored transactions within the September Guaranty and September Security Agreement do not appear in substantively operative clauses does not matter for purposes of the definition set forth in subsection (xi) of section 741(7)(A) because all that is required is that agreements be related to one another. See Pls.' Opp'n at 45 (arguing that the September Agreements were not “securities contracts” under section 741(7) because “the operative language of the September Guaranty and September Security Agreement did not connect to any safe-harbored transactions ...”). There is no required language to connect agreements so that they will be deemed related, and the fact that these agreements recognize the otherwise safe-harbored derivatives transactions is sufficient for purposes of identifying a “securities contract” under subsection (xi) of section 741(7)(A).

The September Guaranty in particular expressly guarantees all obligations of LBI to JPMC “ of whatever nature ”—an open-ended phrase that further confirms its status as a credit enhancement “related to” other “securities contracts” for purposes of subsection (xi). See Wolf Decl. Ex. 7 (September Guaranty) § 1 (guaranteeing to JPMC the “punctual payment of all obligations and liabilities of the Borrowers to the Bank of whatever nature....”). The term “all” self-evidently encompasses safe-harbored derivative obligations to JPMC. This is especially pertinent given that most of JPMC's exposure to Lehman related to clearing advances and derivatives transactions. See 5/10/11 Hr'g Tr. 43:12–17 (JPMC counsel noting that “more than ninety percent of the collateral was used to pay what are obviously safe harbor claims....”).

C. The grant and perfection of liens under these “securities contracts” constitute “transfers” for purposes of section 546(e).

(Counts V, X, XXI, and XXII of the Amended Complaint)

Section 546(e) bars the avoidance of “transfers” made by or to eligible financial institutions in connection with a “securities contract.” The term “transfer” includes the grant of a lien for purposes of section 546(e). See11 U.S.C. § 101(54) (definition of “transfer” expressly includes “the creation of a lien”). Moreover, courts uniformly have treated a pledge or the attachment and perfection of a security interest as a “transfer” of an interest in property. See Permanent Mission of India to the United Nations v. City of N.Y., 551 U.S. 193, 198, 127 S.Ct. 2352, 168 L.Ed.2d 85 (2007) (liens are “interests in property”).

The liens granted under the September Agreements, therefore, are “transfers” pursuant to safe-harbored “security contracts.” For example, the September Security Agreement granted liens to secure all “Liabilities” (as defined in the September Guaranty) in consideration of, inter alia, JPMC's “trading or engaging in derivative transactions.” Wolf Decl. Ex. 8 (September Security Agreement) at 1. Similarly, the September Amendment to the Clearance Agreement expanded the scope of the lien granted by section 11 of the Clearance Agreement to secure all of the “existing or future indebtedness, obligations and liabilities of any kind,” including “arising in connection with trades, derivative transactions, settlement of securities [under the Clearance Agreement] or any other business....” See Wolf Decl. Ex. 6 (September Amendment to Clearance Agreement) § 1.

The Amended Complaint includes counts to avoid these liens that are barred under section 546(e) of the Bankruptcy Code. These counts are Count V (“Avoidance of September Agreements as Constructively Fraudulent Under Section 548 of the Bankruptcy Code”), Count X (“Avoidance of September Agreements as Constructively Fraudulent under Section 544 and Applicable State Fraudulent Conveyance or Fraudulent Transfer Law”), and Count XXI (“Avoidance of Preferential Transfer of September Security Agreement Under Section 547 of the Bankruptcy Code”). They request relief to avoid the grant of liens under the September Security Agreement and the September Amendment, but such relief may not be granted as a matter of law because the challenged “transfers” are exempt from avoidance under section 546(e) of the Bankruptcy Code.

Similarly, the perfection under the Account Control Agreement of liens granted by certain other September Agreements constitutes a safe-harbored “transfer in connection with a securities contract.” The Account Control Agreement confirms the perfection of the liens granted to JPMC under the other September Agreements. See Wolf Decl. Ex. 9 (Account Control Agreement) at 1 (Preamble ¶¶ 2, 3) (acknowledging that LBHI “has granted” JPMC a security interest under a separate agreement and stating that the parties are entering into the Account Control Agreement in part to perfect that security interest).

Such “perfection” of a lien constitutes a “transfer” for purposes of the Bankruptcy Code. See In re Badger Lines, Inc., 202 F.3d 945, 946 (7th Cir.2000) (describing the perfection of a lien as a “transfer”). In fact, the Amended Complaint recognizes that perfecting a lien is a transfer. See First Am. Compl. ¶ 210 (pleading that the Account Control Agreement “was a transfer made by LBHI to or for the benefit of JPMorgan”). Although the Account Control Agreement itself is not a “securities contract” for purposes of section 741(7) of the Bankruptcy Code, the perfection under that agreement of liens granted by other “securities contracts” is a transfer “in connection with” protected securities contracts.

In seeking to avoid the perfection of liens under the Account Control Agreement, Count XXII of the Amended Complaint seeks to avoid a safe-harbored “transfer in connection with a securities contract.” See First Am. Compl. Count XXII (“Avoidance of Preferential Transfer of Account Control Agreement under Section 547 of the Bankruptcy Code”). As a result, Count XXII of the Amended Complaint seeks relief that may not be granted as a matter of law.

D. The Disputed Collateral Transfers, including the Funds Sweep, were made “in connection with” safe-harbored “securities contracts.”

(Counts VIII, IX, XV, XVI, XVII, XVIII, XIX, XX, XXIII, and XXIV of the Amended Complaint)

Several counts in the Amended Complaint seek to avoid the Disputed Collateral Transfers made by LBHI to JPMC in September 2008 as preferential and constructively fraudulent transfers. See First Am. Compl. Count VIII (“Avoidance of Collateral Transfers as Constructively Fraudulent under Section 548 of the Bankruptcy Code”); Count XV (“Avoidance of Collateral Transfers as Constructively Fraudulent Under Section 544 and Applicable State Fraudulent Conveyance or Fraudulent Transfer Law”); Count XVII (“Avoidance of Funds Sweep as Constructively Fraudulent Under Section 548 of the Bankruptcy Code”); Count XIX (“Avoidance of Funds Sweep as Constructively Fraudulent Under Section 544 and Applicable State Fraudulent Conveyance or Fraudulent Transfer Law”); and Count XXIII (“Avoidance of Preferential Transfer of September Transfers Under Section 547 of the Bankruptcy Code”). On this basis, Plaintiffs seek to recover the value of certain of the Disputed Collateral Transfers under section 550 of the Bankruptcy Code. See First Am. Compl. Counts IX, XVI, XVIII, XX, and XXIV.

Plaintiffs argue that the Disputed Collateral Transfers are not protected from avoidance by section 546(e) because they “had nothing to do with” any JPMC “exposure” under the Clearance Agreement or its various derivatives transactions and were not made “in connection with” a safe-harbored securities contract. See First Am. Compl. ¶ 62 (transfers “were not made in connection with exposure under the 2000 Clearance Agreement”); Pls.' Opp'n at 51 (“[N]either the September Agreements nor the $8.6 billion of collateral transfers acted as credit support for clearance and trading activity under the 2000 Clearance Agreement” because “JPMorgan had already determined that it had sufficient credit support in place....”).

Plaintiffs dispute the significance of the fact that much of the collateral posted with JPMC in September 2008 ultimately was applied by JPMC to cover exposure arising from safe-harbored transactions. See 5/10/11 Hr'g Tr. 100:18–24 (counsel for Committee) (“... it's not the law that you can look back retrospectively and sanitize fraudulent transfer after the fact. Whether it's a fraudulent transfer and whether the safe harbor applies ... should be decided at the time the transfer takes place....”).

Plaintiffs question the legitimacy of these JPMC claims and contest the calculation of these amounts purportedly owing. See Pls.' Opp'n 59; but see 5/10/11 Hr'g Tr. 42:10–13 (counsel for JPMC) (confirming that “an overwhelming amount of JPMorgan's exposures and ultimate claims ... were the clearance advances and derivatives claims”), 43:13–17 (“more than ninety percent of the collateral was used to pay what are obviously safe harbor claims ... [and, therefore, it is] glaringly obvious that the September Agreements related to JPMorgan's safe harbor claims”). Plaintiffs submit that JPMC should not be able to exploit the recognition of this subsequent liability to “retroactively cloak” the collateral demands under the shelter of section 546(e). See Pls.' Opp'n at 59.

Plaintiffs have focused on whether the transfer of collateral related to exposure under a safe-harbored contract that existed at the time of the collateral demand. See 5/10/11 Hr'g Tr. 106:9–11 (“It's not entered into in connection with a protected contract because they had zero exposure at that time under the safe harbor contracts.”); First Am. Compl. ¶ 62 (alleging that JPMC had enough collateral at that time to cover its intra-day clearing risk); id. at ¶ 69 (JPMC demanded the collateral not to cover then-existing exposure but rather to serve as an “extra cushion”); id. at ¶ 268 (“[The Disputed Collateral Transfer] was posted by LBHI at a time when JPMorgan did not have the contractual right to demand collateral under the derivatives or other contracts.”) (emphasis added).

The “in connection with” requirement of section 546(e) does not contain any temporal or existential requirement that a transfer must be “in connection with” then-outstanding legal exposure. Indeed, section 546(e) does not include any language that refers either to exposure or timing. The formulation is quite simple: a transfer is safe-harbored if it is “in connection with” a securities contract. And the words “in connection with” are to be interpreted liberally.

It is proper to construe the phrase “in connection with” broadly to mean “related to.” See Interbulk, Ltd. v. Louis Dreyfus Corp. (In re Interbulk, Ltd.), 240 B.R. 195, 202 (Bankr.S.D.N.Y.1999) (interpreting the plain language of section 546(g), an analogue to section 546(e), and concluding that “a natural reading of ‘in connection with’ suggests a broader meaning similar to ‘related to’ ”); In re Keller Fin. Servs. of Fl., 248 B.R. 859, 879 (Bankr.M.D.Fl.2000) (citation omitted) (interpreting section 329 of the Bankruptcy Code and noting that “the scope of the phrase ‘in connection with’ is broad”); In re Powell, 314 B.R. 567, 571 (Bankr.N.D.Tex.2004) (interpreting section 330(a) of the Bankruptcy Code and liberally construing the phrase “in connection with”).

Given this liberal interpretation of “in connection with,” the Disputed Collateral Transfers necessarily “relate to” safe-harbored securities contracts. For example, the Amended Complaint itself points out that JPMC demanded the Disputed Collateral Transfers under the September Agreements. See First Am. Compl. ¶ 62 (noting that the September collateral requests were “made pursuant to [the September Agreements]” but arguing that such a purported connection to clearance activity was a pretext and sham); id. at ¶ 82 (alleging that JPMC “demanded and received” $8.6 billion in collateral “pursuant to the September Agreements”). Furthermore, the agreements themselves expressly reference safe-harbored “derivative transactions” and safe-harbored “clearing advances.” See Wolf Decl. Ex. 7 (September Guaranty) at 1; Ex. 8 (September Security Agreement) at 1. Without doubt, the disputed transfer of collateral “related to” the safe-harbored Clearance Agreement, the September Security Agreement, and the September Guaranty.

Additionally, the suggestion that there should be demonstrable exposure as a condition to satisfying the “in connection with” language of section 546(e) advocated by Plaintiffs would make it difficult to assure safe harbor protections without making an impractical and burdensome inquiry as to the status of countless derivatives positions at arbitrary points in time in the multiple dealings between counterparties. Such a focus is not well-suited to analyzing liabilities under complex financial relationships with exposures that change materially and rapidly with movements of the markets. Therefore, the Court concludes that the Disputed Collateral Transfers are within the scope of section 546(e) and that Counts VIII, XV, and XXIII should be dismissed.

Counts XVII and XIX adopt the same approach and seek to avoid the Funds Sweep from the LBHI deposit account to JPMC's separate general ledger account in the week prior to LBHI's bankruptcy. See Pls.' Opp'n at 60 (arguing that Counts XVII and XIX state plausible claims for relief because “JPMC's subsequent unauthorized transfers [of the Funds Sweep] would not qualify for safe harbor status because they were not made as part of, or to facilitate, any securities contract....”).

These counts fail as well because the transfer of funds at issue constitutes a transfer “in connection with” a securities contract and is fully protected from avoidance by the language of section 546(e). The Funds Sweep involved the internal movement of funds deposited as collateral pursuant to JPMC's requests in September 2008—transfers that fit within the scope of section 546(e). Because the original deposits were made “in connection with” safe-harbored securities contracts, the subsequent transfers within JPMC of those funds likewise are safe-harbored under section 546(e).

E. Section 546(e) also shields LBHI's Obligations from avoidance even though the word “obligations” does not appear in the text of section 546(e).

(Counts V, VI, VII, X, XI, XII, XIII, and XIV of the Amended Complaint)

In addition to claims to avoid the liens granted and the Disputed Collateral Transfers made under the August and September Agreements, the Amended Complaint seeks to avoid LBHI's Obligations under the Guarantees as constructively fraudulent transfers and preferences. See First Am. Compl. Counts VI, VII, XI, XII; Pls.' Opp'n at 19 (“The Guarantees themselves are not transfers covered by the safe harbors—they are incurrences of obligations.”).

Plaintiffs endeavor to distinguish the incurrence of obligations under the Guarantees from the transfers themselves and thereby to transform a claim that otherwise would be exempt into one that escapes the preclusive impact of section 546(e). Plaintiffs contend that avoiding LBHI's Obligations would effectively nullify the August and September Agreements by rendering them “meaningless.” See First Am. Compl. Counts XIII and XIV; Pls.' Opp'n at 19 (“Without those guarantees, JPMorgan has no valid lien on the LBHI deposits at JPMorgan....”). These counts of the Amended Complaint are creative efforts to craft theories of recovery that are outside the ambit of the safe harbors and are subject to more lenient standards of proof.

Because the language of section 546(e) as written includes no express references to the incurrence of obligations, Plaintiffs are correct that the incurrence of obligations is not exempt from avoidance, and the following paragraphs in this section confirm that analysis. Plaintiffs are not correct that this notional ability to assert that an obligation is not exempt from avoidance is an acceptable means to whittle away at or undermine the effectiveness of the safe harbors. Despite the linguistic exercise, the safe harbors still protect the transactions between Lehman and JPMC.

The exclusion of “obligations” from the statutory exemption, thus, becomes something of a Pyrrhic victory for Plaintiffs. The Guarantees are not transfers themselves, yet they are resistant to successful challenge because they connect so directly to transfers that are exempt and beyond reach. A transfer made in connection with a securities contract remains unavoidable regardless of whether the Guarantees could potentially be avoided.

In the Amended Complaint, Plaintiffs assert that section 546(e) cannot protect LBHI's Obligations from avoidance because that section does not refer to “obligations.” See First Am. Compl. ¶¶ 116, 123, 130, 147, 155, 163. Their argument is textual: because the word “obligation” is missing from section 546(e), “obligations” such as LBHI's Obligations under the Guarantees are not protected. See Pls.' Opp'n at 20 (“[O]ne need look no further than the plain and unambiguous text of [section 546(e) ] to determine that the section 546 safe harbors only shield from avoidance certain transfers and not the incurrence of obligations.”).

This choice of language in the statute may reflect an intentional decision by Congress to differentiate between transfers and obligations. See 5/10/11 Hearing Tr. 86:2–19 (counsel for Committee) (“The Code treats transfers and obligations differently.... Congress has separately and specifically included the words ‘incurrence of obligation’ in some statutes and not in others.”). It is difficult to know what Congress actually meant with any confidence, although given the purposes of section 546(e) to immunize the markets from certain bankruptcy risks and the seemingly boundless definition of the term “transfer,” this may be an example of a word that is supposed to transcend its ordinary meaning to include the incurrence of obligations.

Although the Bankruptcy Code does not define the term “obligation,” it does define “transfer” to include “each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing or parting with—(i) property or (ii) an interest in property.” 11 U.S.C. § 101(54)(D) (emphasis added). It follows, then, that section 546(e), in providing exemptions for “transfers,” plainly protects “each mode” of “disposing or parting with” Lehman's property or interests in property, including modes that are merely “conditional.”

Looking at this definition, the incurrence of an obligation by itself does not constitute a mode of “disposing or parting with” property. Instead, it is a preliminary aspect of a transactional process that must occur prior to or as a condition of transferring property or an interest in property. No doubt these two concepts—transfer and obligation—are very closely related, but they are not identical.

The parsing of English can be difficult, but even when the word “transfer” is given a most expansive meaning that encompasses every conceivable means of disposing or parting with property or an interest in property, it still fails to capture the meaning of the undefined term “incurrence of an obligation.” Becoming obligated to a counterparty is not the same as parting with property.

This conclusion is supported by several cases that have distinguished between “transfers” and “obligations” in other contexts not involving section 546(e), including sections 547 and 548. See Pls.' Opp'n at 19–35, citing, inter alia, In re Asia Global Crossing, Ltd., 333 B.R. 199, 203–204 (Bankr.S.D.N.Y.2005) (holding that a guaranty was not a transfer in the context of section 502(d)); Covey v. Comm. Nat'l Bank of Peoria, 960 F.2d 657, 661 (7th Cir.1992) (noting that a guaranty was an obligation and not a transfer in the implied fraudulent transfer context).

These authorities confirm that the words “transfers” and “obligations” have different meanings and may be distinguished in construing other sections of the Bankruptcy Code. The word “transfer” also happens to be one of those chameleon-like terms that may be interpreted differently depending on context. Courts interpreting section 547 have recognized that “what constitutes a ‘transfer’ under one subsection of § 547 does not necessarily constitute a transfer under a different subsection.” Hall–Mark Elecs. Corp. v. Sims (In re Lee), 108 F.3d 239, 240 (9th Cir.1997).

Regardless of these nuanced interpretations, the language used in section 546(e) uses the word “transfer” but omits any reference to the incurrence of obligations. The missing words may not be supplied by any reasonable construction. One possibility would be to blur the distinctions between “transfer” and “obligation” and find that the words are so closely tied together that they effectively merge into a single concept that fits into the open-ended definition of transfer in section 101(54)(D).

That does not work and would lead to the absurd articulation that to the incurrence of a contingent guaranty obligation is equivalent to a conditional mode of disposing of property or an interest in property—a kind of inchoate transfer from the moment that an obligation is incurred. The words themselves are distinct, however, and cannot be so easily merged. Just because an obligation has been incurred does not mean that any property or interest in property will ever be transferred. It simply means that the legal prerequisite for a possible future transfer has occurred.

This interpretation of the term “transfer” in section 546(e) is consistent with a decision issued last year by my colleague, United States Bankruptcy Judge Robert Drain. See Geltzer v. Mooney (In re MacMenamin's Grill Ltd.), 450 B.R. 414 (Bankr.S.D.N.Y.2011) (“MacMenamin's Grill ”). In MacMenamin's Grill, a trustee sought to avoid three payments made to individual owners of a bar and grill, the restaurant's incurrence of a loan obligation, and the grant of a security interest in favor of a bank, in connection with a private leveraged buyout. Both the bank and the shareholder defendants moved for summary judgment, conceding that the challenged payments, incurrence of obligation, and grant of security interest satisfied the requirements for a constructively fraudulent transfer but were nonetheless shielded from avoidance by section 546(e) as protected “settlement payments.” See11 U.S.C. § 546(e).

In denying the motions for summary judgment, Judge Drain also addressed the argument that section 546(e) applied to protect the loan obligation from avoidance. The court noted that within the Bankruptcy Code as a whole “[t]here clearly is a difference between making a transfer and incurring an obligation....” MacMenamin's Grill, 450 B.R. at 429.MacMenamin's Grill, therefore, supports the interpretation of the term “transfer” urged by Plaintiffs: “[i]t is clearly proper ... to presume that section 546(e) does not implicitly adopt a definition of ‘transfer’ that somehow includes the ‘incurrence of an obligation’.” MacMenamin's Grill, 450 B.R. at 430.

Despite the fact that the term “transfer” as used in section 546(e) does not explicitly encompass obligations such as those incurred by LBHI under the Guarantees, certain observations in MacMenamin's Grill confirm the logic of extending safe harbor protection for transactions that involve transfers that are connected to obligations. As Judge Drain noted “... any payments and any lien that the [bank] received in connection with the securities contract would not be avoidable, because they were transfers.” MacMenamin's Grill, 450 B.R. at 430.

Similarly, the transfers in question here are not avoidable because they were additional steps that took place in connection with the incurrence of obligations.

Although the Plaintiffs are correct that the obligations themselves are not shielded by section 546(e), they still are unable to prevail on these counts of the Amended Complaint and have failed to state claims upon which relief may be granted. The reason for this is that the liens and related collateral transfers remain independently immune from avoidance regardless of whether Plaintiffs can succeed in avoiding the Guarantees. Dismissal is appropriate because pursuit of these counts ultimately leads to safe-harbored transfers that may not be avoided.

II. The counts in the Amended Complaint seeking to avoid and recover actual fraudulent transfers survive the Motion.

(Counts I, II, III, and IV of the Amended Complaint)

Plaintiffs allege in Counts I, II, and III of the Amended Complaint that the September Agreements, the August Guaranty, the August Security Agreement, and Disputed Collateral Transfers constitute avoidable fraudulent transfers under section 548(a)(1)(A) of the Bankruptcy Code because they were made with the “actual intent to hinder, delay or defraud.” On this basis, Count IV asserts that the estate may recover the value of the Disputed Collateral Transfers under section 550 of the Bankruptcy Code. These counts state plausible claims for relief that survive the Motion.

Section 548(a)(1)(A) provides that:

(a)(1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—(A) made such transfer or incurred such obligation with actual intent to hinder, delay or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted ...
11 U.S.C. § 548(a)(1)(A). When alleging such an actual fraudulent transfer, a plaintiff must “state with particularity the circumstances constituting fraud.” See Fed.R.Civ.P. 9(b). To plead fraud with the required degree of particularity, a “party asserting an intentional fraudulent transfer claim under either the Bankruptcy Code [and/or New York state fraudulent conveyance law] must normally allege (1) the property subject to the transfer, (2) the timing and, if applicable, frequency of the transfer and (3) the consideration paid with respect thereto.” See In re Saba Enters., Inc., 421 B.R. at 640 (citations omitted).

“In contrast to the particularity requirement for pleading fraud under Rule 9(b), the intent element of an intentional fraudulent conveyance claim may be alleged generally so long as the plaintiff alleges ‘facts that give rise to a strong inference of fraudulent intent’.” In re Saba Enters., Inc., 421 B.R. at 642 (citation omitted); see also Sharp Int'l Corp. v. State St. Bank & Trust Co. (In re Sharp Int'l Corp.), 403 F.3d 43, 56 (2d Cir.2005) (citation omitted) (noting that, “[d]ue to the difficulty of proving intent ... [a plaintiff] may rely on ‘badges of fraud’ to support his case”). This strong inference of fraudulent intent, in turn, may be established either “(1) by alleging facts demonstrating that the Defendants had both the motive and the opportunity to commit fraud or (2) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.” See In re Saba Enters., Inc., 421 B.R. at 642 (internal quotation marks and citations omitted).

The following badges of fraud, when present in a complaint, may create a strong inference of fraudulent intent: (i) a close relationship among the parties to the transaction; (ii) a questionable or hasty transfer not in the ordinary course of business; (iii) the existence of an unconscionable discrepancy between the value of the property transferred and the consideration received therefor; (iv) the chronology of the events and transactions under inquiry; (v) the existence or cumulative effect of a pattern or series of transactions or course of conduct after the incurrence of debt, onset of financial difficulties, or pendency or threat of suits by creditors; and (vi) whether the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred. See, e.g., In re Kaiser, 722 F.2d 1574, 1582–83 (2d Cir.1983) (upholding an intentional fraudulent transfer claim based on the presence of multiple badges of fraud); In re Enron Corp., 328 B.R. 58, 73–75 (Bankr.S.D.N.Y.2005) (denying motion to dismiss where plaintiff alleged sufficient badges of fraud so as to satisfy pleading standard).

The Amended Complaint pleads sufficient “badges of fraud” to satisfy Rule 9(b) and create a “strong inference of fraudulent intent.”

Specifically, the Amended Complaint alleges the existence of the following factors: (i) LBHI was wholly dependent on JPMC for the conduct of its business, and JPMC was an insider with unparalleled access to information regarding LBHI's state of affairs and future plans (¶¶ 2, 4, 35); (ii) each transaction occurred on a rushed basis prior to LBHI's bankruptcy, with little or no negotiation, and was unprecedented in the prior course of business between the parties, and the industry generally (¶¶ 46–48, 58, 66–67); (iii) LBHI received no consideration in exchange for incurring billions of dollars in potential obligations pursuant to the agreements, or for transferring billions of dollars in LBHI assets to JPMC (¶¶ 5, 33, 56); (iv) these transactions resulted in a massive drain of LBHI liquidity and an unjustified transfer of property to JPMC prior to LBHI's bankruptcy petition (¶ 74); and (v) each transaction occurred at a time when LBHI was insolvent and/or undercapitalized (¶¶ 5, 30, 60, 66). See First Am. Compl.

JPMC argues that the Court may not apply the so-called “relaxed” pleading standards that would permit a complaint seeking to avoid an actual fraudulent transfer to survive a motion to dismiss based solely on allegations of circumstantial badges of fraud. See 5/10/11 Hr'g Tr. 55:13–56:13. JPMC argues that: (i) this approach ceases to be valid in light of the recent Supreme Court decisions of Twombly and Iqbal, and (ii) such an approach is not available to a debtor-in-possession. See Reply 34–5.

While Twombly and Iqbal together have toughened the pleading standards for purposes of judging the adequacy of a complaint under Rule 12(b)(6), those cases do not speak directly to questions as to the sufficiency of a complaint that alleges badges of fraud as a means to infer fraudulent intent for purposes of Rule 9(b). To support its position, JPMC relies on a single recent decision issued by a bankruptcy court in Texas. See Reply 34 (citing Airport Blvd. Apartments, Ltd. v. NE 40 Partners, Ltd. P'ship (In re NE 40 Partners, Ltd. P'ship), 440 B.R. 124, 127–8 (Bankr.S.D.Tex.2010) (declining to adopt a “more flexible approach” to Rule 9(b) when analyzing actual fraud claims asserted by third-party bankruptcy trustees in light of Twombly and Iqbal )); 5/10/11 Hr'g Tr. 55:13–21.

This isolated case is insufficient to cause the Court to break from other persuasive authority confirming that the Rule 9(b) standard may be relaxed in appropriate circumstances. See, e.g., Official Comm. of Unsecured Creditors of Fedders N. Am., Inc. v. Goldman Sachs Credit Partners L.P. (In re Fedders N. Am. Inc.), 405 B.R. 527, 544–45 (Bankr.D.Del.2009) (citation omitted) (post-Twombly and Iqbal,

recognizing that courts continue to relax pleading standards and allow plaintiff trustees to allege “badges of fraud” because “actual fraud is rarely proven by direct-evidence, as individuals are rarely willing to admit such an intent”); Chase Bank, U.S., N.A. v. Vanarthos (In re Vanarthos), 445 B.R. 257, 263 (Bankr.S.D.N.Y.2011) (Glenn, J.) (post- Twombly and Iqbal, concluding that a complaint alleging fraud and seeking non-dischargeability of debt under section 523(a)(2)(A) satisfied the “particularity” requirement of Rule 9(b) by alleging a number of “circumstantial factors”).

Pleading the badges of fraud has been found to satisfy the intent requirement of section 548(a)(1)(A). See, e.g., Enron, 328 B.R. at 73, 74 (denying motion to dismiss claims brought by a debtor-in-possession to avoid an actual fraudulent transfer, and concluding that those claims satisfied the “relaxed” pleading requirements of Rule 9(b), when the complaint alleged badges of fraud). Applying such a relaxed standard for Lehman also is appropriate in view of the enormous disruption caused by the bankruptcy filing and the immediate loss of so many senior level employees with institutional memory. See id. (finding that the debtor-in-possession was operating under “the same disadvantage” usually faced by a trustee with second-hand knowledge of the relevant facts because personnel and senior management with first-hand knowledge of the relevant facts departed the company early in the company's bankruptcy). Moreover, the transactions at issue are so extraordinarily complicated and intertwined that describing them with any further detail would pose a special challenge.

In this respect, the Lehman cases are exceptional and distinguishable from other cases that have declined to permit a relaxed pleading standard under Rule 9(b) because of the ability to take an examination pursuant to Federal Rule of Bankruptcy Procedure 2004 (“Rule 2004”) prior to the filing of a complaint. See Liquidation Trust v. Daimler AG (In re Old CarCo LLC), 435 B.R. 169, 191–92 (Bankr.S.D.N.Y.2010) (in dicta, noting that under the “circumstances of this case,” relaxed pleading standards under Rule 9(b) were inappropriate because, inter alia, the trust plaintiff had prior access to Rule 2004 discovery).

Under the circumstances presented here, it is sufficient for purposes of Rule 9(b) for the Plaintiffs to have alleged the badges of fraud in the Amended Complaint, and the Motion is denied with respect to those counts that seek to avoid and recover actual fraudulent transfers.

III. The twenty-five other counts survive the Motion.

In addition to the claims under Bankruptcy Code sections 544, 547, 548 and 550 discussed in this decision, Plaintiffs have pleaded twenty-five other counts under both the common law and the Bankruptcy Code (the “Other Remaining Counts”),

which, like Plaintiffs' claims related to section 548(a)(1)(A) of the Bankruptcy Code, are not protected by the safe harbors of the Bankruptcy Code and thus survive the Motion.

JPMC posits various theories pursuant to which the Other Remaining Counts should be dismissed including, among other arguments, that certain of Plaintiffs' common law claims are preempted by federal bankruptcy law, Plaintiffs fail to allege fraud with particularity, Plaintiffs have failed to plead sufficient facts to support their claims, and generally, that many of Plaintiffs' claims fail to state a claim upon which relief can be granted. None of these arguments, however, is sufficient to prevent Plaintiffs from pursuing the Other Remaining Counts.

For the purposes of the Motion, the allegations of the Amended Complaint must be accepted as true. It alleges that JPMC, using its “unique position as primary clearing bank to Lehman's broker-dealer business,” put a “financial gun to LBHI's head” by threatening to stop crucial clearing services to LBHI's subsidiaries, including LBI, and further used such threats to “extract extraordinarily one-sided agreements from LBHI literally overnight” and to “siphon billions of dollars in critically needed assets” in order to “leapfrog JPMorgan over other creditors....” See First Am. Compl. ¶¶ 1–8.

While the safe harbors of section 546(e) exist to protect the capital markets and should be strictly construed as written to carry out their salutary objectives, they are not so exalted as to trump and preemptively block every other legal theory that a creative adversary might choose to employ when seeking relief from conduct of a market participant that is outside the norms of ordinary market behavior and that is claimed to be egregious. Plaintiffs have made such claims here.

The Amended Complaint represents something of a laundry list approach to litigation. It identifies a wide-ranging variety of causes of action with the goal of obtaining redress for the harms allegedly suffered due to the actions of JPMC. This multi-pronged approach is what lawyers tend to do in complex disputes like this: they look for theories that may gain traction, but at the start of a case it is tough to predict which of the various theoretical constructs that may apply will prove in practice to be the most suitable means to remedy the alleged wrongdoing.

This expansive approach to identifying other workable theories of recovery is not impacted by the safe harbors. The safe harbors are not all encompassing and do not offer “fail safe” protection against every cognizable claim made in relation to transactions that may fit within the statutory framework. The safe harbors necessarily do not extend to the open waters of litigation and are not an impenetrable barrier to other claims against a market participant that has behaved in a manner that may expose the actor to potential liability. In sum, these important protections do not grant complete immunity from every conceivable claim made by Plaintiffs. Indeed, how could they?

The plain language of section 546(e), read literally, provides limited immunity but does not bar Plaintiffs from maintaining all common law claims, intentional fraud claims and any other claims not expressly embraced by section 546(e). As to these causes of action that are outside the scope of the safe harbors, Plaintiffs, for present pleading purposes, have adequately set forth claims that survive the Motion and that should proceed to a determination on the merits based on facts to be presented in any dispositive motions or at trial.

This is true not only as a general proposition but also based on a count-by-count assessment of the arguments made by the parties, as reflected in Exhibit A. This summary evaluates the Motion in reference to the Other Remaining Counts and shows that these claims survive because, in each instance, the Plaintiffs have given more persuasive arguments concerning the plausibility and viability of their legal theories, at least for purposes of moving ahead with their case against JPMC.

Without limiting the points made in Exhibit A, the Court is satisfied that the Amended Complaint pleads sufficient “badges of fraud” and complies with the requirements of Rule 9(b) for purposes of pleading fraudulent intent with particularity. Also, consistent with earlier comments in this section regarding the safe harbors, JPMC's argument that federal bankruptcy law preempts certain of the Plaintiffs' unjust enrichment and conversion claims falls short.

JPMC cites two cases in support of its argument, Contemporary Indus. Corp. v. Frost (In re Contemporary Indus. Corp.), 564 F.3d 981 (8th Cir.2009) and Official Comm. of Unsecured Creditors of Hechinger Inv. Co. of Del., Inc. v. Fleet Retail Fin. Group (In re Hechinger Inv. Co. of Del., Inc.), 274 B.R. 71 (D.Del.2002). In both of these cases, however, the unjust enrichment claims were identical to the plaintiffs' constructively fraudulent transfer claims under the Bankruptcy Code and also were based upon the same facts as these constructive fraud claims. See Contemporary Indus., 564 F.3d at 984, 988;Hechinger, 274 B.R. at 96.

This litigation is different. The claims that JPMC argues should be preempted by federal bankruptcy law are unlike classic avoidance claims for constructively fraudulent transfers. Instead, these claims have more in common with claims grounded in actual fraudulent intent. See 5/10/11 Hr'g Tr. 147:18–20, 148:4–10. These claims are not to be treated as replicas of claims to recover constructively fraudulent transfers, and, along with the rest of the Other Remaining Counts, they survive the Motion for further adjudication.

Conclusion

This decision enforces a blanket exemption taken directly from the language of section 546(e): notwithstanding the right that otherwise exists to avoid transfers under the Bankruptcy Code, no transfer may be avoided that is made by or to a financial institution in connection with a securities contract. That declarative statement is an overriding principle that mandates dismissal of those counts in the Amended Complaint that seek avoidance of such transfers made to JPMC.

The Remaining Counts survive the Motion to be resolved at a later stage of this adversary proceeding. The parties are directed to submit an agreed form of order that dismisses Counts V through XXIV and that denies the Motion as to the Remaining Counts.

Exhibit A

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Image 27 (8.42" X 6.24") Available for Offline Print

Image 28 (8.42" X 6.24") Available for Offline Print

Image 29 (8.42" X 6.24") Available for Offline Print

Image 30 (8.42" X 6.24") Available for Offline Print

Image 31 (8.42" X 6.24") Available for Offline Print

Image 32 (8.42" X 6.24") Available for Offline Print

Image 33 (8.42" X 6.24") Available for Offline Print