18-1079

Lehman Brothers Special Financing Inc. v. Bank of America N.A.

In the

United States Court of Appeals

For the Second Circuit ______________ 

August Term, 2018

(Argued: June 26, 2019 Decided: August 11, 2020)

Docket No. 18-1079

______________ 

IN RE: LEHMAN BROTHERS HOLDINGS INC.,

Debtor.

-----------------------------------------------------------------

LEHMAN BROTHERS SPECIAL FINANCING INC.,

Plaintiff-Appellant,

–v.–

BRANCH BANKING AND TRUST COMPANY, SUCCESSOR IN INTEREST TO 

SUSQUEHANNA BANK AND SBSI, INC., U.S. BANK NATIONAL ASSOCIATION,

CONTINENTAL LIFE INSURANCE COMPANY OF BRENTWOOD TENNESSEE,

COUNTRY LIFE INSURANCE COMPANY, DEUTSCHE BANK TRUST COMPANY 

AMERICAS, AS TRUSTEE, ELLIOTT INTERNATIONAL, L.P., FIRST NORTHERN 

BANK AND TRUST COMPANY, GARADEX INC., GATEX PROPERTIES INC.,

GENERAL SECURITY NATIONAL INSURANCE, GENWORTH LIFE AND ANNUITY 

INSURANCE CO., GOLDMAN SACHS INTERNATIONAL, GOLDMAN SACHS & CO.

LLC, F/K/A, GOLDMAN, SACHS & CO., LGT BANK IN LIECHTENSTEIN LTD., THE 

LIVERPOOL LIMITED PARTNERSHIP, MAGNETAR CONSTELLATION FUND II LTD,

MAGNETAR CONSTELLATION MASTER FUND III LTD, MAGNETAR 

CONSTELLATION MASTER FUND LTD, MARINER LDC, MARSH & MCLENNAN 

COMPANIES, INC. STOCK INVESTMENT PLAN, MARSH & MCLENNAN MASTER 

RETIREMENT TRUST, MBIA, INC., MODERN WOODMEN OF AMERICA, INC.,

MONEYGRAM SECURITIES, LLC AND ITS SUCCESSORS IN INTEREST, MORGAN 
2

STANLEY & CO., INCORPORATED, MORGANS FINANCIAL LIMITED, MULBERRY 

STREET CDO, LTD., NATIXIS FINANCIAL PRODUCTS LLC, PCA LIFE 

ASSURANCE CO. LTD., PHL VARIABLE INSURANCE COMPANY, PHOENIX LIFE 

INSURANCE COMPANY, PUTNAM DYNAMIC ASSET ALLOCATION FUNDS –

GROWTH PORTFOLIO, PUTNAM INTERMEDIATE DOMESTIC INVESTMENT GRADE 

TRUST, PUTNAM STABLE VALUE FUND, RGA REINSURANCE CO., SBSI, INC.,

SCOR REINSURANCE COMPANY, SECURITY BENEFIT LIFE INSURANCE CO.,

SHENANDOAH LIFE INSURANCE COMPANY, STATE STREET BANK AND TRUST 

COMPANY, AS TRUSTEE, STATE STREET GLOBAL ADVISORS, STATE STREET 

INTERNATIONAL IRELAND LIMITED, STRUCTURED CREDIT OPPORTUNITIES 

FUND II, L.P., SUSQUEHANNA BANK, TRICADIA CREDIT STRATEGIES MASTER 

FUND, LTD., F/K/A, MARINER-TRICADIA CREDIT STRATEGIES MASTER FUND,

LTD., TRUSTEE U.S. BANK TRUST NATIONAL ASSOCIATION, UNICREDIT BANK 

AG, LONDON BRANCH, ZAIS INVESTMENT GRADE LIMITED X,

Defendants-Appellees,

 CITIBANK, N.A., PRINCIPAL LIFE INSURANCE COMPANY,

Defendants.*

______________ 

B e f o r e : 

JACOBS, CARNEY, and BIANCO, Circuit Judges.

______________ 

Lehman Brothers Special Financing Inc. (“LBSF”) appeals from the March 15, 

2018 district court judgment affirming the Bankruptcy Court’s grant of defendants’ 

motion to dismiss. This case grows out of the Chapter 11 bankruptcy of Lehman 

Brothers Holdings Inc., considered to be the largest bankruptcy proceeding to date in 

U.S. history. The Bankruptcy Court held that, in the context of synthetic collateralized 

debt obligations, certain “Priority Provisions” that subordinated LBSF’s payment 

priority to claims of the Noteholder defendants are enforceable by virtue of section 560 

* The Clerk of Court is directed to amend the caption to conform to the above.
3

of the Bankruptcy Code (“the Code”). Section 560 exempts “swap agreements” from the 

Code’s prohibition of “ipso facto clauses.” The District Court affirmed, and LBSF 

appealed. For the reasons set forth below, we AFFIRM the judgment of the District 

Court. 

AFFIRMED.

______________

PAUL R. DEFILIPPO (William F. Dahill, on the brief),

Wollmuth Maher & Deutsch LLP, New York, NY, for

Plaintiff-Appellant Lehman Brothers Special Financing, 

Inc.

CARMINE D. BOCCUZZI (Emily J. Balter, on the brief),

Cleary Gottlieb Steen & Hamilton LLP, New York, 

NY, for Defendants-Appellees Goldman Sachs 

International and Goldman Sachs & Co. LLC., f/k/a, 

Goldman, Sachs & Co.

Joshua Dorchak, Morgan, Lewis, & Bockius, LLP, 

New York, NY; John C. Goodchild, III, Rachel Jaffe 

Mauceri, Morgan, Lewis, & Bockius, LLP, 

Philadelphia, PA, for Defendant-Appellee Branch 

Banking and Trust Company, Successor in Interest to 

Susquehanna Bank and SBSI, Inc.

Franklin H. Top III, Chapman and Cutler LLP, 

Chicago, IL, for Defendants-Appellees U.S. Bank National 

Association and Trustee U.S. Bank Trust National 

Association.

Joshua Dorchak, Morgan, Lewis, & Bockius, LLP, 

New York, NY, for Defendants-Appellees Continental Life 

Insurance Company of Brentwood Tennessee, Country Life 

Insurance Company, Marsh & McLennan Companies, Inc. 

Stock Investment Plan, Marsh & McLennan Master 

Retirement Trust, Modern Woodmen of America, Inc., 
4

PHL Variable Insurance Company, Phoenix Life Insurance 

Company, Putnam Dynamic Asset Allocation Funds –

Growth Portfolio, Putnam Intermediate Domestic 

Investment Grade Trust, Putnam Stable Value Fund, SBSI, 

Inc., and Susquehanna Bank.

Christopher M. Desiderio, Nixon Peabody LLP, New 

York, NY, for Defendants-Appellees Deutsche Bank Trust 

Company Americas, as Trustee, State Street Bank and 

Trust Company, as Trustee, State Street Global Advisors, 

State Street International Ireland Limited, and ZAIS 

Investment Grade Limited X.

Matthew J. Gold, Kleinberg, Kaplan, Wolff & Cohen, 

P.C., New York, NY, for Defendant-Appellee Elliott 

International, L.P.

William A. Slaughter, Ballard Spahr LLP, 

Philadelphia, PA; Leslie C. Heilman, Ballard Spahr 

LLP, Wilmington, DE, for Defendant-Appellee First 

Northern Bank and Trust Company.

John H. Thompson, McGuire Woods LLP, 

Washington, DC, for Defendants-Appellees Garadex Inc., 

Gatex Properties Inc., and Morgan Stanley & Co., 

Incorporated.

Scott Walter Reynolds, Chaffetz Lindsey LLP, New 

York, NY; Nicole E. Schiavo, Peter A. Ivanick, Hogan 

Lovells US LLP, New York, NY, for DefendantsAppellees General Security National Insurance and SCOR 

Reinsurance Company.

Nicholas P. Crowell, Alex R. Rovira, Andrew P. 

Propps, Sidley Austin LLP, New York, NY, for 

Defendants-Appellees Genworth Life and Annuity 

Insurance Co., Magnetar Constellation Fund II Ltd, 
5

Magnetar Constellation Master Fund III Ltd, Magnetar 

Constellation Master Fund Ltd., and UniCredit Bank AG, 

London Branch.

Gregory F. Hauser, Wuersch & Gering LLP, New 

York, NY, for Defendant-Appellee LGT Bank in 

Liechtenstein Ltd.

Matthew J. Gold, Kleinberg, Kaplan, Wolff & Cohen, 

P.C., New York, NY, for Defendant-Appellee The 

Liverpool Limited Partnership.

Thomas J. Fleming, Olshan Frome Wolosky LLP, New 

York, NY, for Defendants-Appellees Mariner LDC, 

Structured Credit Opportunities Fund II, L.P., and 

Tricadia Credit Strategies Master Fund, Ltd., f/k/a 

Mariner-Tricadia Credit Strategies Master Fund, Ltd.

Kevin J. Biron, Morgan, Lewis & Bockius LLP, New 

York, NY, for Defendant-Appellee MBIA, Inc.

Brian Dillon, Gray, Plant, Mooty, Mooty, & Bennett, 

P.A., Minneapolis, MN, for Defendant-Appellee 

MoneyGram Securities, LLC and its Successors in Interest.

Lewis J. Liman, Cleary Gottlieb Steen & Hamilton, 

New York, NY, for Defendant-Appellee Morgans 

Financial Limited.

Jack Yoskowitz, Seward & Kissel LLP, New York, NY, 

for Defendant-Appellee Mulberry Street CDO, Ltd.

Scott W. Reynolds, Chaffetz Lindsey LLP, New York, 

NY, for Defendant-Appellee Natixis Financial Products 

LLC.
6

Nicholas P. Crowell, Jon W. Muenz, Andrew P. 

Propps, Sidley Austin LLP, New York, NY, for 

Defendant-Appellee PCA Life Assurance Co. Ltd.

Emilio B. Nicolas, Jackson Walker LLP, Austin, TX, for 

Defendant-Appellee RGA Reinsurance Co.

David Adler, McCarter & English, LLP, New York, 

NY, for Defendant-Appellee Security Benefit Life 

Insurance Co.

Joseph J. Saltarelli, Hunton Andrews Kurth LLP, for 

Defendant-Appellee Shenandoah Life Insurance Company.

Madlyn Gleich Primoff, Timothy P. Harkness, David 

Y. Livshiz, Henry V. Hutten, Jill K. Serpa, on the brief, 

Freshfields Bruckhaus & Deringer US LLP, New York, 

NY, for Amicus Curiae Structured Finance Industry 

Group.

______________

PER CURIAM:

The Bankruptcy Code generally bars enforcement of “ipso facto clauses,” which 

trigger or modify payment obligations when a party seeks relief in bankruptcy. Lehman 

Brothers Special Financing Inc. (“LBSF”) seeks to recover payments made to defendant 

noteholders (the “Noteholders”) in connection with certain synthetic collateralized debt 

obligations. LBSF argues that “Priority Provisions” that subordinated its interests to 

those of the Noteholders were unenforceable ipso facto clauses because they were 

triggered as a result of the Chapter 11 bankruptcy of Lehman Brothers Holdings Inc. 
7

(“LBHI”).1 The Bankruptcy Court held (and the District Court agreed) that section 560 

of the Bankruptcy Code (the “Code”), which creates a safe harbor for the liquidation of 

swap agreements, allowed the distribution of proceeds according to the Priority 

Provisions whether or not those provisions are properly characterized as ipso facto 

clauses. For the reasons set forth below, we AFFIRM the judgment of the District Court. 

BACKGROUND2

On September 15, 2008, LBHI filed a voluntary petition for relief under Chapter 

11. Two weeks later, on October 3, LBSF, an indirect subsidiary of LBHI, began its own 

Chapter 11 proceeding. About two years later, in September 2010, LBSF initiated an 

adversary proceeding against 250 defendant noteholders, note issuers, and indenture 

trustees in connection with 44 synthetic collateralized debt obligations (“CDOs”) that 

Lehman affiliates structured, negotiated, and marketed (each, a “synthetic CDO 

transaction”). LBSF sought to recover roughly $1 billion that was distributed to the 

Noteholders after LBSF defaulted. 

I. The Transactions

In each of the synthetic CDO transactions, LBSF and its affiliates (collectively, 

“Lehman”) established a special purpose vehicle (the “Issuer”) through which it 

marketed and sold notes (the “Notes”) to the Noteholders pursuant to an Indenture 

1 The LBHI bankruptcy is considered to be the largest bankruptcy proceeding in U.S. history: 

When it filed for bankruptcy, LBHI held consolidated assets of $639 billion and liabilities of 

$613 billion. 

2 This factual statement is taken from the complaint and the documents incorporated therein. 

We accept it as true for purposes of reviewing the grant of a motion to dismiss. See Nicosia v. 

Amazon.com, Inc., 834 F.3d 220, 230-31 (2d Cir. 2016).
8

Agreement. The Issuer then used the proceeds from sale of the Notes to acquire highly 

rated securities; those valuable securities, in turn, would serve as collateral (the 

“Collateral”). The Issuer used income generated by the Collateral to make scheduled

interest payments to the Noteholders.

The Issuer then entered into a “swap agreement” with LBSF, pursuant to an

ISDA Master Agreement and other related contracts, including the Schedule and 

Confirmation.3 Under the swap agreement, the Issuer contracted to sell LBSF a credit 

default swap—credit protection against the potential default of certain “reference 

entities” or “reference obligations.” In exchange, LBSF made regular payments to the 

Issuer. (LBHI guaranteed LBSF’s obligations under the swap.) The Issuer used the flow 

of payments it received from LBSF to supplement the interest payments it made to the 

Noteholders. 

The swap agreement provided that if the reference entities experienced certain 

“Credit Events,” the Issuer could owe LBSF payment from the Collateral. If, by contrast, 

the transaction reached its scheduled maturity without a Credit Event occurring, then 

the Noteholders would be repaid the principal amount of their investment from the 

Collateral. The Trustees—a third party entity—held the Collateral in trust for the benefit 

of the secured parties—primarily LBSF and the Noteholders.

As described above, the two components of the synthetic CDO transaction—the 

CDO and the swap—were documented separately, but the swap and indenture 

agreements (the “Transaction Documents”) referenced each other. The Indenture 

3 An ISDA Master Agreement is a standard form, published by the International Swaps and 

Derivatives Association, regularly used to govern over-the-counter derivatives transactions. 
9

Agreement specified that, upon the occurrence of an “Event of Default,” the Trustees 

were empowered to issue a “Termination Notice,” which would accelerate payment 

due on the Notes and trigger early termination of the swaps. After issuing a 

Termination Notice, the Trustee could—but was not required to—liquidate the 

Collateral, and distribute the proceeds according to the stated priority of payments 

(“Priority Provisions”). Under the Priority Provisions, LBSF enjoyed payment priority 

over the Noteholders in certain circumstances. But in other circumstances—including in 

the case of LBSF’s default—LBSF’s payment was subordinated to that of the 

Noteholders.

LBHI’s bankruptcy filing in 2008 constituted an Event of Default under the ISDA 

Master Agreement, with LBSF as the defaulting party. LBSF’s default triggered the early 

terminations of the credit default swaps. Those terminations, in turn, led to the

liquidation of the Collateral and to subsequent distributions. Because LBSF defaulted, it 

dropped in priority and was entitled to receive its portion of the disbursement only 

after the Noteholders received their portion.

When the early terminations occurred, LBSF was “in the money”—that is, its 

swap position had value—but because it was also the defaulting party, the Noteholders 

received payment priority over LBSF. The proceeds from the Collateral were 

insufficient to make any payment to LBSF after they were drawn from to pay the

Noteholders. This precipitous drop in LBSF’s priority underlies the dispute between 

LBSF and defendants in this case. Specifically, at issue is the enforceability in 

bankruptcy of those contractual provisions—the Priority Provisions—that subordinated 

LBSF’s payment priority upon its default. 
10

II. Procedural History

In September 2010, LBSF commenced an adversary proceeding in Bankruptcy 

Court as a putative defendant class action against certain of the Noteholders, the 

Trustees, and the Issuers. It alleged first that the Priority Provisions are unenforceable 

ipso facto clauses—that is, clauses that modify a debtor’s contractual right solely because 

it petitioned for bankruptcy. See 11 U.S.C. § 365(e); Lehman Bros. Holdings Inc. v. BNY 

Corp. Tr. Servs. Ltd., 422 B.R. 407, 415 (Bankr. S.D.N.Y. 2010) (“BNY”) (“It is now 

axiomatic that ipso facto clauses are, as a general matter, unenforceable.”). It next 

claimed that the distributions to the Noteholders violated the automatic stay provision 

in the Bankruptcy Code.4 Finally, LBSF sought a claw-back of the distributions under 

various other provisions of the Code and asserted several common-law causes of action.

Five years later, defendants filed an omnibus motion to dismiss, which the Bankruptcy 

Court (Chapman, J.) granted. See Lehman Bros. Special Fin. Inc. v. Bank of Am. Nat’l Ass’n 

(In re Lehman Bros. Holdings Inc.), 553 B.R. 476 (Bankr. S.D.N.Y. 2016) (“Lehman I”).

In Lehman I, the Bankruptcy Court made three independent rulings on LBSF’s 

bankruptcy-law claims. First, Judge Chapman classified each of the 44 transactions as 

either a “Type 1” or “Type 2” Transaction, based on the specific contractual language in 

each of the Transaction’s Priority Provisions. The court determined that the Priority 

Provisions for the five Type 1 Transactions were unenforceable ipso facto clauses because 

they modified LBSF’s rights based on its filing for bankruptcy. By contrast, under the

4 Section 362(a) of the Code provides, in relevant part, that the filing of a petition under Chapter 

11 “operates as a stay, applicable to all entities, of . . . any act to obtain possession of property of 

the estate or of property from the estate or to exercise control over property of the estate.” 

11 U.S.C. § 362(a). 
11

remaining 39 transactions—the “Type 2” Transactions—LBSF never held a default 

priority right to payment, the Bankruptcy Court reasoned, and therefore LBSF’s 

bankruptcy did not modify its rights. Id. at 494-95. The Bankruptcy Court thus 

concluded that Type 2 Transactions did not contain ipso facto clauses and were therefore 

enforceable.

Second, ruling in the alternative, the Bankruptcy Court concluded that even if 

the Priority Provisions in the Type 2 Transactions modified LBSF’s rights, any 

“modification” of LBSF’s rights was effective upon early termination resulting from 

LBSF’s default, which, for all but two transactions, preceded LBSF’s bankruptcy. Id. at 

495-96. Because the prohibition on ipso facto clauses invalidates only those modifications 

of rights that occur after the filing of a bankruptcy petition, the transactions that were 

terminated before LBSF filed for bankruptcy did not involve ipso facto clauses.

Third, the Bankruptcy Court concluded that even if the Priority Provisions 

governing each of the transactions were ipso facto clauses, they nevertheless are 

enforceable under the “safe harbor” codified at section 560 of the Bankruptcy Code. Id.

at 500-01. That section creates a safe harbor for the termination and liquidation of swap 

agreements, exempting them from the Bankruptcy Code’s prohibition on the 

enforcement of ipso facto clauses.5

5 Because we ultimately agree with the Bankruptcy Court that the Priority Provisions were 

enforceable under the section 560 safe harbor, we assume without deciding that the Priority 

Provisions are ipso facto clauses. We therefore have no occasion to parse the Bankruptcy Court’s 

distinction between “Type 1” and “Type 2” Transactions, or to review the Bankruptcy Court’s 

conclusion that the Priority Provisions in “Type 2” Transactions are not ipso facto clauses.
12

Finally, the Bankruptcy Court dismissed LBSF’s state-law claims, reasoning that 

because the distributions were not improper, LBSF had not been deprived of any statelaw property or contractual rights.

LBSF appealed to the District Court (Schofield, J.), which affirmed. Lehman Bros.

Special Fin. Inc. v. Bank of Am. Nat’l Ass’n (In re Lehman Bros. Holdings Inc.), 17 Civ. 1224 

(LGS), 2018 WL 1322225 (S.D.N.Y. Mar. 14, 2018) (“Lehman II”). Resolving LBSF’s 

bankruptcy-law claims, the court rested its decision entirely on the Bankruptcy Court’s 

third ground—that the Code’s safe harbor provision in section 560 permits the 

enforcement of the Priority Provisions. The District Court also affirmed the dismissal of 

all of LBSF’s state-law claims. LBSF again appeals.

DISCUSSION

LBSF contends that the Priority Provisions that subordinated its claims and 

eliminated its priority upon its default are unenforceable ipso facto clauses. We disagree. 

LBSF has failed to identify any error in the District Court’s opinion, and, in affirming, 

we largely adopt the cogent reasoning of the District Court. 

I. Standard of Review

Rule 7012(b) of the Federal Rules of Bankruptcy Procedure incorporates Federal 

Rule of Civil Procedure 12(b)(6) and permits a bankruptcy court to dismiss an 

adversary proceeding when a complaint fails to state a claim. A district court’s 

judgment “in a bankruptcy case is subject to plenary review, meaning that this Court 

undertakes an independent examination of the factual findings and legal conclusions of 

the bankruptcy court.” Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329, 

333 (2d Cir. 2011) (internal quotation marks omitted). Here, we review de novo the 

District Court’s statutory interpretation of section 560. See id. at 334. 
13

II. The Section 560 Safe Harbor

A. Ipso facto clauses and the section 560 safe harbor

The Bankruptcy Code generally prohibits enforcement of ipso facto clauses—

contract clauses that modify or terminate an executory contract due to a debtor’s filing 

of a bankruptcy petition. A number of provisions in the Code effect this prohibition. 

Section 365(e)(1) of the Code provides: 

[A]n executory contract . . . may not be terminated or modified, and any 

right or obligation under such contract . . . may not be terminated or 

modified, at any time after the commencement of the case solely because 

of a provision in such contract . . . that is conditioned on— (A) the 

insolvency or financial condition of the debtor at any time before the 

closing of the case; (B) the commencement of a case under this title; or 

(C) the appointment of or taking possession by a trustee in a case under 

this title or a custodian before such commencement.

11 U.S.C. § 365(e)(1). In other words, section 365(e) curtails creditors’ ability to modify 

contracts with a bankrupt party. This general ban helps “deter the race of diligence of 

creditors to dismember the debtor before bankruptcy and promote equality of 

distribution.” Merit Mgmt. Grp. v. FTI Consulting, Inc., 138 S. Ct. 883, 888 (2018) (“Merit 

Management”) (internal quotation marks omitted) (discussing an analogous safe harbor 

provision).

Section 541 of the Code also effects the prohibition of ipso facto clauses by 

providing that a debtor’s interest in property

becomes property of the estate . . . notwithstanding any provision in an 

agreement, transfer instrument, or applicable nonbankruptcy law . . . 

that is conditioned on . . . the commencement of a case under this title . . . 
14

and that effects or gives an option to effect a forfeiture, modification, or 

termination of the debtor’s interest in property.

11 U.S.C. § 541(c)(1).

Section 363(l) further implements the Code’s ban on ipso facto clauses by 

preserving the right of the bankruptcy trustee to take certain actions using the property 

belonging to the bankruptcy estate6:

[T]he trustee may use, sell, or lease property . . . notwithstanding any 

provision in a contract, a lease, or applicable law that is conditioned 

on . . . the commencement of a case under this title concerning the 

debtor . . . and that effects . . . a forfeiture, modification, or termination 

of the debtor’s interest in such property.

11 U.S.C. § 363(l). These anti-ipso facto provisions strip non-bankrupt counterparties of 

certain contractual rights they otherwise have and prevent them from collecting debts 

due from the bankrupt party. 

Section 560 carves out an exception, however, and exempts swap agreements 

from the prohibition of ipso facto clauses by protecting a swap participant’s contractual 

right to terminate, liquidate, or accelerate a transaction upon a counterparty’s 

bankruptcy: 

The exercise of any contractual right of any swap participant or financial 

participant to cause the liquidation, termination, or acceleration of one 

or more swap agreements because of a condition of the kind in section 

365(e)(1) of this title [the prohibition on ipso facto clauses] or to offset or 

net out any termination values or payment amounts arising under or in 

connection with the termination, liquidation, or acceleration of one or 

6 Section 541 of the Code defines the bankruptcy estate to include, inter alia, “all legal or 

equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. 

§ 541(a)(1).
15

more swap agreements shall not be stayed, avoided, or otherwise limited 

by operation of any provision of this title or by order of a court or 

administrative agency in any proceeding under this title.

11 U.S.C. § 560. In other words, this safe harbor permits swap participants to modify or 

terminate an executory contract solely because of the commencement of a bankruptcy 

case. Originally added to the Code in 1990, section 560 was meant to protect the stability 

of swap markets and to ensure that swap markets are “not destabilized by uncertainties 

regarding the treatment of their financial instruments under the Bankruptcy Code.” See 

H.R. Rep. No. 101-484, at 1 (1990), as reprinted in 1990 U.S.C.C.A.N. 223, 223; see also 136 

Cong. Rec. S7534-01 (daily ed. June 6, 1990) (statement of Sen. DeConcini) (asserting 

that the “potential for disruption in the financial markets justified the creation of an 

exclusion for these contracts from the usual powers of a bankruptcy trustee”).

Congress amended section 560 in the Bankruptcy Abuse Prevention and 

Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23 (2005) (codified in 11 

U.S.C.) (the “2005 Act”). Relevant here, the 2005 Act broadened the definition of “swap 

agreement” to include virtually all derivatives. See 11 U.S.C. § 101(53B). The revised 

section 560 also clarifies that a swap participant’s contractual right to liquidate and 

accelerate a swap agreement—in addition to its right to terminate the swap—are 

protected under the safe harbor provision. See 11 U.S.C. § 560.

B. Application of the section 560 safe harbor

LBSF maintains that the Priority Provisions—which define the payment order for 

distributions of proceeds from the Collateral—are unenforceable ipso facto clauses

because they modify and downgrade LBSF’s right to receive proceeds. Defendants urge 

that the section 560 safe harbor authorizes enforcement of the Priority Provisions, even 

if they contain ipso facto clauses. The applicability of the safe harbor turns on whether, 
16

under section 560, the following conditions apply: (1) the Priority Provisions are “swap 

agreements”; (2) the distribution of the Collateral constitutes “liquidation”; and (3) the 

Trustees, in liquidating the Collateral and distributing its proceeds, exercised a 

“contractual right of a[] swap participant.” 

Like the District Court, we hold that, even if the Priority Provisions were ipso 

facto clauses, their enforcement was nevertheless permissible under the section 560 safe 

harbor.

1. Definition of “Swap Agreements”

Section 101(53B) of the Bankruptcy Code defines a “swap agreement” to include 

“any agreement, including the terms and conditions incorporated by reference in such 

agreement, which is” a swap. 11 U.S.C. § 101(53B)(A)(i) (emphasis added). A swap 

agreement also includes “a master agreement that provides for an agreement or 

transaction referred to in clause (i)[] [or] (ii), . . . together with all supplements to any 

such master agreement” and “any security agreement or arrangement or other credit 

enhancement related to any agreements or transactions referred to in [the above] 

clause[s] . . . , including any guarantee or reimbursement obligation by or to a swap 

participant . . . in connection with any agreement or transaction referred to in any such 

clause.” Id. § 101(53B)(v), (vi). 

Neither party disputes that the Code’s sweeping definition of “swap agreement” 

includes the ISDA Master Agreement, along with the related schedule and confirmation 

documents. LBSF contends, however, that the Priority Provisions—laid out in the 

Indenture Agreement—are not part of the swap agreement, and, therefore, are not 

protected under the section 560 safe harbor. We disagree: The ISDA Master Agreement
17

incorporates by reference the Priority Provisions, and, therefore, the Priority Provisions,

too, are swap agreements under section 560. 

The Schedule to the ISDA Master Agreement states: “all amounts, payable or 

expressed to be payable by [the Issuer] . . . shall be recoverable only from . . . the 

Collateral . . . , subject in any case to the Priority of Payments set out in the Indenture.” App’x 

1335, Schedule Part 5(i). The clause specifically identifies the referenced document—the 

Indenture and the relevant clause therein. See PaineWebber Inc. v. Bybyk, 81 F.3d 1193, 

1201 (2d Cir. 1996) (“[A] paper referred to in a written instrument and sufficiently 

described may be made a part of the instrument as if incorporated into the body of it.”

(internal quotation marks omitted)). This evinces the parties’ assent to receive payment 

in accordance with the Priority Provisions. What is more, the only way to settle the 

Issuers’ obligations to LBSF and the Noteholders under the Swap and CDO was the 

liquidation of the Collateral and distribution of the proceeds. The reference to the 

Priority Provisions in the Schedule to the ISDA Master Agreement clarifies in what 

order the Trustees were to distribute the proceeds from the liquidated Collateral.

Seeking to avoid this straightforward conclusion, LBSF asserts that the phrase

“subject to” is ambiguous and that its meaning cannot be clarified on a motion to 

dismiss. We discern no ambiguity; and, indeed, LBSF does not provide any alternative 

interpretation of “subject to.” Accordingly, the Priority Provisions are incorporated by 

reference into the Swap Agreement, and thus, under the Code, are themselves part of a 

“swap agreement.”
18

2. Definition of the right to “cause the liquidation . . . of one or more swap 

agreements”

Section 560 affords safe harbor from the prohibition on ipso facto clauses when a 

swap participant exercises its contractual right “to cause the liquidation, termination, or 

acceleration of one or more swap agreements.” 11 U.S.C. § 560 (emphasis added). The 

question here is whether application of the Priority Provisions—and distribution of the 

Collateral according to those Priority Provisions—constitutes the “liquidation” of a 

swap agreement under section 560. 

The parties dispute the meaning of the term “liquidation” as used in section 560. 

Because the Bankruptcy Code does not define the term “liquidation,” we interpret the 

term according to its “ordinary, contemporary, common meaning.” Sandifer v. U.S. Steel 

Corp., 571 U.S. 220, 227 (2014) (internal quotation marks omitted). Considered in the 

abstract, to “liquidate” might plausibly mean “[t]o settle (an obligation) by payment or 

other adjustment” or “[t]o ascertain the precise amount of (debt, damages, etc.).” 

Liquidate, BLACK’S LAW DICTIONARY (10th ed. 2014). The term thus might refer to the act 

of ascertaining the precise amount of debt, as LBSF maintains. Alternatively, it could 

refer to the process of winding down a transaction, as defendants urge. Bearing in mind 

“the specific context in which that language is used,” Merit Management, 138 S. Ct. at 

892-93, we conclude that the term “liquidation,” as used in section 560, must include the 

disbursement of proceeds from the liquidated Collateral.

Section 560 operates as an exception to the Code’s prohibition of ipso facto

clauses. To understand the scope of the exception, we start with a brief overview of the 

ban on the enforcement of such clauses. The prohibition on ipso facto clauses prevents a 

non-bankrupt counterparty from modifying a contract simply because the counterparty 

declared bankruptcy. See 11 U.S.C. § 365(e). Similarly, the Code’s automatic stay 
19

provision prohibits the non-bankrupt party from terminating any executory contracts

where the debtor has a property interest in that executory contract. Id. § 362(a)(3).

While the non-bankrupt party is typically limited in its capacity to terminate an 

executory contract with a bankrupt counterparty, the debtor or bankruptcy trustee, by 

contrast, may “assume or reject any executory contract . . . of the debtor.” Id. § 365(a). If 

“the contract is a good deal for the [bankruptcy] estate,” then the debtor will “assume 

the contract, fulfilling its obligations while benefitting from the counterparty’s 

performance.” Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 

(2019) (“Mission Product Holdings”). If the contract is a bad deal for the debtor, the Code 

also enables the debtor to reject a losing contract, “repudiating any further performance 

of its duties.” Id. The Code explains that “the rejection of an executory contract . . . 

constitutes a breach of such contract,” 11 U.S.C. § 365(g), and thus the non-bankrupt 

counterparty “has a claim against the estate for damages resulting from the debtor’s 

nonperformance,” Mission Product Holdings, 139 S. Ct. at 1658. But the counterparty is 

likely to “receive only cents on the dollar” for such a claim.7 Id. Because the prohibition 

on ipso facto clauses bars a non-bankrupt counterparty from modifying or terminating 

an executory contract, a party’s bankruptcy exposes the counterparty to significant risk.

The upshot of all this is that the section 560 safe harbor exempts the non-bankrupt

swap participant from this regime. It specifically permits the non-bankrupt party to 

terminate, liquidate, and accelerate a swap agreement because of the counterparty’s 

7 That is so because the Code treats the debtor’s breach as occurring “immediately before the 

date of the filing of the bankruptcy petition,” and, therefore, the counterparty is treated like any 

other unsecured creditor. Mission Product Holdings, 139 S. Ct. at 1658 (brackets and internal 

quotation marks omitted) (quoting 11 U.S.C. § 365(g)(1)). 
20

petition for bankruptcy. Without the safe harbor provision, swap participants would be 

vulnerable to, inter alia, the automatic stay and the bankrupt counterparty’s assumption 

or rejection of the swap agreement. See 5 Collier on Bankruptcy § 560.01. By affording 

swap agreements special treatment, section 560 shields swap participants from some of 

the risks associated with a counterparty’s bankruptcy and enables them to unwind the 

transactions. This is what the statute means when it authorizes the exercise of a 

“contractual right . . . to cause the liquidation . . . of one or more swap agreements.” 11 

U.S.C. § 560. 

Because the statutory language in section 560 is “unambiguous,” we need not 

“consider legislative history.” United States ex rel. Wood v. Allergan, Inc., 899 F.3d 163, 171

(2d Cir. 2018). Nevertheless, we note that the congressional reports accord with this 

interpretation, which reads section 560 to protect a swap participant’s ability to unwind 

the swap transaction. See, e.g., 136 Cong. Rec. H2281-06, H2284 (daily ed. May 15, 1990) 

(statement of Rep. Schumer) (noting that section 560 will “bring a degree of certainty 

and finality to the resolution of troubled market participants”); 136 Cong. Rec. S7535 

(statement of Sen. DeConcini) (“[T]he swap provisions will . . . provide certainty for 

swap transactions and thereby stabilize domestic markets by allowing the terms of the 

swap agreement to apply notwithstanding the bankruptcy filing.”); see also Thrifty Oil 

Co. v. Bank of Am. Nat’l Tr. & Sav. Ass’n, 322 F.3d 1039, 1050 (9th Cir. 2003) (“The 

legislative history of the Swap Amendments plainly reveals that Congress recognized 

the growing importance of interest rate swaps and sought to immunize the swap 

market from the legal risks of bankruptcy.”).

Reading section 560’s reference to “liquidation” of a swap agreement to include 

distribution of the Collateral furthers the statutory purpose of protecting swap 
21

participants from the risks of a counterparty’s bankruptcy filing by permitting parties to 

quickly unwind the swap. On LBSF’s reading of “liquidation,” by contrast, the nondefaulting counterparty’s rights under the safe harbor are hollow: simply calculating 

amounts due “provides no security to swap participants if they will not be able to 

collect,” as the District Court aptly concluded. Lehman II, 2018 WL 1322225, at *6. The 

right to liquidate, in other words, would hardly protect swap counterparties if it merely 

sheltered their ability to determine amounts owed, but not to distribute the proceeds 

from the sold Collateral.8 The District Court’s reading of “liquidation” is thus grounded 

in the statutory text and purpose of the section 560 safe harbor.

LBSF, by contrast, appears to take its understanding of “liquidation” from the 

particular context of “unliquidated”—that is, uncalculated—claims. See Appellant’s Br. 

33 (citing In re Dow Corning Corp., 215 B.R. 346, 355 (Bankr. E.D. Mich. 1997)). That is a 

far cry from liquidating swap agreements: section 560 does not focus on “unascertained 

amounts and the need to ascertain them.” Lehman II, 2018 WL 1322225 at *6. It is, 

instead, concerned with unwinding swap agreements. 

LBSF urges on appeal that (1) Chapter 7 of the Bankruptcy Code, which governs 

liquidation, undermines the Bankruptcy and District Courts’ reasoning; and (2) the 

Supreme Court’s recent decision in Merit Management undercuts those courts’ analysis 

of section 560. We disagree on both counts. First, Chapter 7, if anything, supports 

8 That the Trustees in several instances retained the Collateral, but did not distribute the 

proceeds until they received indemnification from the Noteholders does not upset our analysis. 

The scope of the term “liquidation” does not turn on whether immediate distribution is 

required (contractually or legally). The issue instead is whether distribution of proceeds is a 

“contractual right” to “liquidate” under the section 560 safe harbor. Here, distribution of the 

proceeds was the sole means by which the parties could obtain the economic benefit of the 

synthetic CDO upon termination. 
22

defendants’ more capacious reading of “liquidation.” LBSF contends that Chapter 7 

refers to “liquidation” and “distribution” as distinct concepts and specifically uses the 

word “distribution” to describe an estate’s payment of proceeds to creditors. See 11 

U.S.C. § 726 (“Distribution of property of the estate”). Chapter 7, however, lends some 

support to the notion that “liquidation” is a process by which the bankruptcy trustee 

first “collect[s] and reduce[s] to money the property of the estate,” 11 U.S.C. § 704(a)(1), 

and next, ensures that the “property of the estate . . . [is] distributed,” id. § 726(a); see 

also 6 Collier on Bankruptcy § 700.01 (“Liquidation is a form of relief afforded by the 

bankruptcy laws that involves the collection, liquidation, and distribution of the 

nonexempt property of the debtor . . . .”). The fact that Chapter 7 is entitled 

“Liquidation” and discusses distribution of the estate’s property “suppl[ies] cues as to 

what Congress intended.”9 Merit Management, 138 S. Ct. at 893 (internal quotation 

marks omitted). 

Second, we reject LBSF’s suggestion that Merit Management, a Supreme Court 

decision rendered after the Bankruptcy Court issued its ruling, invalidates the 

reasoning of either the Bankruptcy Court or the District Court. Merit Management

analyzed a different safe harbor provision, 11 U.S.C. § 546(e), which prevents 

9 In addition, Amicus Curiae the Structured Finance Industry Group cites to a number of 

industry-specific dictionaries, which use the term “liquidation” to refer to distribution of assets. 

See Amicus Br. 16-18 (citing Dictionary of Business and Economic Terms (5th ed. 2012) (“To 

liquidate often means to pay”); Dictionary of Finance and Investment Terms (9th ed. 2014) 

(“Dismantling of a business, paying off debts in order of priority”); Dictionary of Banking 

Terms (6th ed. 2012) (“When an obligation is paid off it is said to be liquidated.”)). Although we 

rely primarily on the plain meaning of section 560, we may also look to the way the term is used 

“in the context of the securities industry.” Enron Creditors Recovery Corp., 651 F.3d at 333

(internal quotation marks omitted).
23

bankruptcy trustees from “avoiding”—or clawing back—certain transactions.10 138 S. 

Ct. at 893. The Court ruled that the safe harbor did not apply where the transfer is 

between non-protected parties and the funds simply move through a protected 

institution (a financial institution), as a conduit, without benefitting it. The Court 

reasoned that to determine whether a transaction falls within the safe harbor, it must 

identify the relevant transfer—that is, the transfer that the trustee seeks to claw back.

See id. at 893-94.

LBSF contends that the Bankruptcy and District Courts ran afoul of Merit 

Management because they concluded that, as LBSF puts it, the safe harbor protected the 

“entire transaction[] merely because one component of such a transaction is safe 

harbored.” Appellant’s Br. 24. We reject that unfair characterization of the lower courts’ 

opinions. Both the Bankruptcy and District Courts focused on the challenged action—

transfers enforcing the Priority Provisions—and determined that the distribution 

according to the Priority Provisions constituted the exercise of a contractual right to 

effect liquidation. They undertook a careful analysis of the statute’s text, and concluded, 

10 Section 546(e) provides: 

[T]he trustee may not avoid a transfer that is a . . . settlement payment . . . made 

by or to (or for the benefit of) a commodity broker, forward contract merchant, 

stockbroker, financial institution, financial participant, or securities clearing 

agency, or 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 . . . commodity contract, . . . or forward contract, that is made before 

the commencement of the case . . . .

11 U.S.C. § 546(e).
24

correctly, that the challenged action was safe harbored as part of the “liquidation” process, 

not bootstrapped in by the sale of the Collateral.11

3. Definition of “Swap Participant”

In a last attempt to avoid the consequences of the section 560 safe harbor, LBSF 

contends that the Trustees who terminated the swaps and distributed the proceeds of 

the Collateral were not “swap participants.” As a result, LBSF continues, the Trustees’ 

actions fall outside the ambit of section 560’s safe harbor, which expressly protects 

certain contractual rights of “swap participant[s]” only. 11 U.S.C. § 560. 

Section 101(53C) defines “swap participant” as “an entity that, any time before 

the filing of the petition, has an outstanding swap agreement with the debtor.” Neither 

party disputes that the Issuers, as parties to the swaps, were “swap participants” under 

the Bankruptcy Code. The Transaction Documents grant the Issuers the right to 

terminate the Swaps and liquidate the Collateral, and expressly permit the Trustees to 

exercise those rights. Section 7.7(c) of the Indenture, for instance, instructs that the 

“Issuer shall enforce all of its material rights and remedies under the Credit Swaps.” 

App’x 1601. And section 10.1 of the Indenture expressly grants to the Trustee all of the 

11 We acknowledge that this reading of section 560 conflicts with that adopted by Bankruptcy 

Judge Peck, who originally presided over the Lehman bankruptcy. In two earlier cases arising 

out of Lehman’s bankruptcy, Judge Peck ruled that the priority provisions were unenforceable 

ipso facto clauses that fell outside the section 560 safe harbor. See BNY, 422 B.R. 407; Lehman Bros. 

Special Fin. Inc. v. Ballyrock ABS CDO 2007-1 Ltd., 452 B.R. 31 (Bankr. S.D.N.Y. 2011) (“Ballyrock”). 

The court wrote that “a mandated elimination of a substantive right to receive funds that 

existed prior to the bankruptcy of LBHI should not be entitled to any protection under safe 

harbor provisions that, by their express terms, are limited exclusively to preserving the right to 

liquidate, terminate and accelerate a qualifying financial contract.” Ballyrock, 452 B.R. at 40. As 

set forth in this Opinion, we disagree with that statement: the term “liquidation,” as used in 

section 560, is in our view broad enough to include the subordination of LBSF’s payment 

priority and distribution according to the amended waterfall of payment priorities. 
25

Issuer’s rights, title, and interest in the Swap. Specifically, it provides that “[t]he Issuer 

shall enter into the Credit Swaps . . . and shall Grant its interest therein to the Trustee.” 

Id. at 1618.

The District Court correctly pointed out that section 560 requires the exercise of a 

contractual right “of” any swap participant, not by one. Special App’x 85 (emphasis 

added). Thus, the mere fact that the Trustees (rather than the Issuers) liquidated the 

swap does not place the transaction outside the safe harbor. Here, the Transaction 

Documents enabled the Issuers to grant their right to terminate and liquidate to the 

Trustees. The Trustees therefore exercised the contractual rights of a swap participant. 

Neither party disputes that the Issuers incurred obligations to LBSF and the 

Noteholders, both of which had recourse for satisfaction of the Issuers’ obligations 

against only the Collateral. App’x 1335, Schedule Part 5(i). As a result, the obligation to 

pay LBSF and the Noteholders from the proceeds of the Collateral was the Issuers’ 

obligation. Once the swap was terminated, the Issuers had to satisfy their obligations in 

accordance with the terms of the Transaction Documents. Because of LBSF’s default, the 

Priority Provisions required them to distribute the proceeds of the Collateral pursuant 

to Noteholder priority. 

In short: The Priority Provisions are incorporated by reference into the swap 

agreements and thus, for the purposes of section 560, are considered to be part of a 

swap agreement. The contractual right to liquidate included distributions made

pursuant to Noteholder priority. The Trustees exercised a contractual right to effect 

liquidation when they distributed the proceeds of the sold Collateral. And, in doing so, 

the Trustees exercised the rights of a swap participant. 
26

III. State Law Claims and Declaratory Judgment

LBSF brought a number of state-law claims as well, alleging, for instance, that 

defendants were unjustly enriched, breached their contracts with LBSF, and effected 

fraudulent transfers by distributing the proceeds to defendants. See App’x 272-83, 

Fourth Amended Complaint, Counts XIII-XVIII. All of LBSF’s state-law causes of action

require LBSF to allege plausibly that it was entitled to the payments. They therefore rise 

and fall with the disposition of the bankruptcy-law claims. Because we have already 

concluded that the Priority of Payments clauses are enforceable under the Code, LBSF’s 

state-law claims also fail.

In Count XIX, LBSF seeks a declaratory judgment that the Priority Provisions 

constitute unenforceable penalties under New York law by depriving it of payments it 

was allegedly owed. The penalty doctrine applies to liquidated damages clauses where 

the “damages [are] grossly disproportionate to the amount of actual damages.” 172 Van 

Duzer Realty Corp. v. Globe Alumni Student Assistance Ass’n, 25 N.E.3d 952, 957 (N.Y. 

2014) (internal quotation marks omitted). As both the Bankruptcy Court and District 

Court remarked, however, the Priority Provisions do not fix damages, but rather 

subordinate LBSF’s payment priority. The District and Bankruptcy Courts thus 

correctly concluded that LBSF is not entitled to declaratory relief.

CONCLUSION

For the foregoing reasons, the judgment of the District Court is AFFIRMED.