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 1 1 , 2020 )

Docket No. 18

- 1079

______________ I N R E : L EHMAN B ROTHERS H OLDINGS I NC

. ,
Debtor

.

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

L EHMAN B ROTHERS S PECIAL F INANCING I NC

. , Plaintiff

- Appellant ,

– v.
–

B RANCH B ANKING AND T RUST C OMPANY , S UCCESSOR IN I NTEREST TO S USQUEHANNA B ANK AND SBSI, I NC

. , U.S. B ANK N ATIONAL A SSOCIATION , C ONTINENTAL L IFE I NSURANCE C OMPANY OF B RENTWOOD T ENNESSEE , C OUNTRY L IFE I NSURANCE C OMPANY , D EUTSCH E B ANK T RUST C OMPANY A MERICAS , AS T RUSTEE , E LLIOTT I NTERNATIONAL , L.P., F IRST N ORTHERN

B ANK AND T RUST C OMPANY , G ARADEX I NC ., G ATEX P ROPE RTIES I NC ., G ENERAL S ECURITY N ATIONAL I NSURANCE , G ENWORTH L IFE AND A NNUITY I NSURANCE C O ., G OLDMAN S ACHS I NTERNATIONAL , G OLDMAN S ACHS & C O

. LLC, F / K / A , G OLDMAN , S ACHS & C O ., LGT B ANK IN L IECHTENSTEIN L TD ., T HE L IVERPOOL L IMITED P ARTNERSHIP , M AGNETAR C ONSTEL LATION F UND II L TD , M AGNETAR C ONSTELLATION M ASTER F UND III L TD , M AGNETAR C ONSTELLATION M ASTER F UND L TD , M ARINER LDC, M ARSH & M C L ENNAN C OMPANIES , I NC

. S TOCK I NVESTMENT P LAN , M ARSH & M C L ENNAN M ASTER

R ETIREMENT T RUST , MBIA, I NC ., M ODERN W OODMEN OF A MERICA , I N C ., M ONEY G RAM S ECURITIES , LLC AND ITS S UCCESSORS IN I NTEREST , M ORGAN2 S TANLEY & C O ., I NCORPORATED , M ORGANS F INANCIAL L IMITED , M ULBERRY S TREET CDO, L TD ., N ATIXIS F INANCIAL P RODUCTS LLC, PCA L IFE A SSURANCE C O

. L TD ., PHL V ARIABLE I NSURANCE C OMPANY , P HOENIX L IF E

I NSURANCE C OMPANY , P UTNAM D YNAMIC A SSET A LLOCATION F UNDS

– G ROWTH P ORTFOLIO , P UTNAM I NTERMEDIATE D OMESTIC I NVESTMENT G RADE

T RUST , P UTNAM S TABLE V ALUE F UND , RGA R EINSURANCE C O ., SBSI, I NC .,

SCOR R EINSURANCE C OMPANY , S ECURITY B ENEFIT L IFE I NSURANCE C O ., S H ENANDOAH L IFE I NSURANCE C OMPANY , S TATE S TREET B ANK A ND T RUST C OMPANY , AS T RUSTEE , S TATE S TREET G LOBAL A DVISORS , S TATE S TREET I NTERNATIONAL I RELAND L IMITED , S TRUCTURED C REDIT O PPORTUNITIES F UND II, L.P., S USQUEHANNA B ANK , T RICADIA C REDIT S TRATEGIES M ASTER F U ND , L TD ., F / K / A , M ARINER

- T RICADIA C REDIT S TRATEGIES M ASTER F UND , L TD

. , T RUSTEE U.S. B ANK T RUST N ATIONAL A SSOCIATION , U NI C REDIT B ANK AG, L ONDON B RANCH , Z AIS I NVESTMENT G RADE L IMITED X,
Defendants

- Appellees ,
C ITIBANK , N.A. , P RINCIPAL L IFE I NSURANCE C OMPANY , Defendants

. *

______________ B e f o r e :
J ACOBS , C ARNEY , and B IANCO , C ircuit 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 Leh man 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 paym ent priority to claims o f 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

. F or the reasons set forth below, we AFFIRM the judgment of the District Court.

A FFIRMED

.

______________
P AUL R. D E F ILIPPO ( William F. Dahill , on the brief ) , Wollmuth Maher & Deutsch LLP , New York, NY , for P laintiff

- A ppellant Lehman Brothers Special Financing, Inc

.
C ARMINE D. B OCCUZZI (Emily J. Balter , on the brief ) , Cleary Gottlieb Steen & Hamilton LLP, New York, NY , for D efendant s

- A ppel l ee s 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 Defendant s

- Appellee s 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 Tr ust, 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 S usquehanna Bank.
Christopher M. Desiderio, Nixon Peabody LLP, New York, NY, for Defendant s

- Appellee s 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 Mo rgan 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 Defendant s

Appellee s 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, Kle inberg, 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 Defendant s

- Appellee s Mariner LDC , Structured Credit Opportunities Fund II, L.P

. , an d 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, Sidle y Austin LLP, New York, NY, for Defendant

- Appellee PCA Life Assurance C o . Ltd.
Emilio B. Nicolas, Jackson W alker 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. Har kness, David Y. Livshiz, Henry V. Hutten, Jill K. Serpa, on the brief , Freshfields Bruckhaus & Deringer US LLP, New York, NY, for A micus C uriae Structured Finance Industry Group.

______________ P ER C URIAM : 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 connect ion 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 b ankruptcy 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. F or the reasons set forth below , we AFFIRM the judgment of the District Court

.

BACKGROUND 2
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, i n 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 I ndenture

1 The LBHI bankruptcy is considered to be the largest bankruptcy proceeding in U.S. history: When it f iled for bankruptcy, LBHI held consolidated assets of $639 billion and liabilities of $613 billion.

2 T h is fact ual 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 A greement. The Issuer then used the proceeds from sale of the N otes to acquire highly
rated securities ; those valuable securities, in turn, would serve as collateral (the “Collateral”). The Issuer use d income generated by the Collateral to make schedule d
in terest payments to the Noteholders.

The Issuer then entered into a “ swap agreement ” with LBSF, pursuant to an ISDA Master A greement 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
Issue r. ( 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 fr om the Collateral

. If, by contrast,
the transaction reache d 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 t he Collateral in trust for the benefit of the secured parties

— primarily LBSF and the Noteholders.

As described above , the two components of the synthetic CD O transaction

— the CDO and the swap

— were documented separately, but the swap and indenture agreements (the “Transaction Documents”) referenced each other. The I ndenture

3 An ISDA Master Agreement is a standard form, published by the International Swaps and Derivat ives Association, regularly used to govern over

- the

- counter derivatives transactions.9 A greement specified that , upon the occurrence of an “Event of Default,” the Trustees

we re empowered to issue a “Termination Notice,” which would accelerate payment due on the N otes 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 (“ Priorit y 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 . Th ose termination s , in turn, led to the liquidation of the C ollateral and to subsequent distributions. Because LBSF defaulted , it dropped in priority and was entitled to receiv e its portion of the disbursement only after the Noteholders received their portion

. When the earl y termination s 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 the y were drawn from to pay the
Noteholder s. 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 a s a putative defendant class action against certain of the Noteholders, t he Trustees, and the Issuers . It allege d 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. Hol dings Inc. v. BNY Corp. Tr. Servs. Ltd. , 422 B.R. 407, 415 (Bank r . S.D.N.Y. 2010) (“ BNY ”) (“It is now
axiomatic that ipso facto clauses are, as a general matter, unenforceable.”). It next
claim ed 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 yea rs later, defendants filed an omnibus motion to dismiss, which t he Bankruptcy Court (Chapman, J. ) grante d

. 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 , t he 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 o f 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 49 4

- 9 5. The Bankruptcy Court thus
concluded that Type 2 Transaction s did not contain ipso facto clauses and were therefore
enforceable

. Second, r uling 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 Provisi ons 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 u nder 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 Bankrup tcy 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 state

law property or contractual rights

. LBSF appealed to the District Court (Schofield, J. ), which affirmed. Lehman Bros. Special Fin. Inc. v. Bank of Am. N at’l A ss’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 t he 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, i n affirming ,
we largely adopt the cogent reasoning of the District Court

.

I. Standard of R eview Rule 7012(b) of the Federal Rule s of Bankruptcy Procedure incorporates Federal Rule of Civil Procedure 12(b)(6) and permits a bankruptcy court to dismiss an adversary proceeding whe n a complaint fails to state a claim. A district court’s judgment “in a ban kruptcy 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. d e C.V. , 651 F.3d 329, 333 (2d C ir. 2011) (internal quotation marks omitted) . Here, we review de novo the District Court’s statutory interpretation of section 560. See i d. at 334.13 II. The S ection 560 S afe H arbor
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 e ffect this prohibition.
S ection 365(e) ( 1 ) of the Code provides: [A]n executory contract . . . may not be terminated or modified, and any right o r 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 possessio n 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 dilige nce 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 har bor provision).

Section 541 of the Code also effects the prohibition of ipso facto clauses by providing that a debtor’s interest in property

b ecomes property of the estate . . . notwithstanding any provision in an agreement, transfer instrument, or applica ble nonbankruptcy law . . . that is condition ed 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 tr u stee to take certain actions using the property belonging to the bankruptcy estate 6 : [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 the m from collecting debts due from the bankrupt party.

S ection 5 60 carves out an exception , however, and e xempts 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, te rmination, 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
co nnection 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 c ommencement 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 unde r 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 p rotect 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 powe rs 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 d efinition 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 liquidat e and
accelerat e 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 s ection 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 s ection 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 “sw ap 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 pro vides 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 disp ute s 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 pa rt of the s wap a greement, and, therefore, are not protected under the section 560 safe harbor. We disagree : The ISDA Master Agreement17 incorporate s 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 Payme nts 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 t o 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 Prov isions. 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
P riority 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 clarifie d 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 Agree ment, and thus , under the Code, are themselves part of a “swap agreement

. ”18 2. Definition of the right to “ cause the l iquidation . . . of one or more swap agreements ”

S ection 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 agreement s
. ” 11 U.S.C. § 560 (emphasis added)

. T he question here is w hether 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.).”
L iquidate , B LACK ’ S L AW D ICTIONARY (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 w hich that language is used , ” Merit Management , 138 S. Ct. at
892

- 93, we conclude that the term “liquidation,” as used in section 560, must includ e the
disbursement of proceeds from the liquidated Collateral

. Section 560 opera tes 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 suc h 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 stay19 provision prohibits the non

- bankrupt party from terminating any executory contracts where the debtor has a property interest in th at executory contract

. Id. § 362(a)(3)

. While the non

- bankrupt party is typically limited in its capacity to terminate a n executory contract with a bankrupt counterparty, the debtor or bankruptcy trustee, b y contrast, may “assume or reject any executory c ontract . . . 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

o f 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. B ecause the prohibition

on ipso facto clauses bars a non

- bankrup t 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

- bankrup t 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. Missi o n 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 automa tic stay and the bankrupt counterparty’s assumption or rejection of the swap agreement. See 5 Collier on Bankruptcy § 560.01. By affording swap agreement s special treatment, s ection 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 t he statutory language in section 560 is “unambiguous,” we need not

“ consider le g islative 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 interpr etation , which reads section 560 to protect a swap participant’s ability to unwind the swap transaction

. See, e.g. , 136 Cong. Rec. H2281

- 06, H 2284 ( daily ed. May 15, 199 0 ) (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 certain ty 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. 200 3) (“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 “li quidation” of a swap agreement to include
distribution of the Collateral furthers the statutory purpose of protecting swap21 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 non

defaulting 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 13222 25, at *6

. The right to liquidate, in other words, would hardly protect swap counterparties if it me rely
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 agreement s : section 560 does not focus on “ unascertained

amounts and the need to ascertain them

. ” Lehman II , 2018 WL 1322225 at *6. I t 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 th ose 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 partie s 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 “dist ribution” 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,” i d. § 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 o f the estate’s property “suppl[ies] cue s 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 render ed 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 “avoidin g”

— 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 c onduit, 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 i d. 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.” Appe llant’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 bro ker, 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 “ S wap P articipant ” In a last attempt to avoid the consequences of the section 560 safe harbor, LBSF
contends that the Truste es who terminated the swaps and distributed the proceeds of
the Collateral were not “ swap participant s.” 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 Truste es 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 Swap s .” App’x 1601. And s ection 10.1 of the Indenture express ly grants to the Trus tee all of the

11 We ac knowledge 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 elim ination 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, t erminate 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 right s , 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 ” a ny swap participant, not by one. Special App’x 85 (emphasis added)

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

swa p 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.

N either 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 D ocumen ts

. B ecause of LBSF’s default, the Priority Provisions required them to distribute the proceeds of the Collateral pursuant to Noteholder priority.

In short: T he Priority Provisions are incorporated by reference into the swap agreements and thus, for the p urposes 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 th e proceeds of the sold Collateral. And, in doin g so, the Trustees exercised the rights of a swap participant.26 III. State L aw C laims and D eclaratory J udgment

LBSF brought a number of state

- law claims as well, alleging, for instance, that
defendants were unjust ly 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 Provision s constitute unenforceable penalties under New York law by depriving it of payments it was allegedly owed

. The penalty doctrine applies to liquidated damages clau ses 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 Court s thus correctly concluded that LBSF is not entitled to declaratory relief.

CONCLUSION

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