Lehman Brothers’ bankruptcy and asset sales show the firm to be the beneficiary of some very clever legal advice. The particulars of the bankruptcy filing and asset liquidation show just how much. This is the second installment of a series on Lehman and its strategies.

Lehman’s bankruptcy filing had to take into account many major issues. We outline two major ones below:

First, Lehman’s most prized asset – its brokerage subsidiary – avoided potential forced sale under broker-dealer bankruptcy rules thanks in large part to smart corporate structuring.

Chapter 11 protection allows Lehman Brothers to liquidate assets in an organized fashion under Section 363 of the Bankruptcy Code, and installs a stay on creditor lawsuits for now. Filing under Chapter 11 also prevents creditors from forcing liquidation and protects seizure of Lehman’s overseas holdings.

Broker-dealers are not allowed to file for Chapter 11. Because of this, Lehman’s parent holding company filed under Chapter 11 -- not its subsidiaries. This choice allows the filing at the holding company level to act as a prophylactic from a forced Chapter 7 liquidation of the broker-dealer subsidiary. Had this not been done, a Chapter 7 liquidation would have left the company little wiggle room to negotiate better deals. Obviously the beneficiary of smart legal advice, Lehman’s holding company now acts as debtor-in-possession under Chapter 11, and can supervise its own asset sales.

Second, Lehman doesn’t get to realize the full range of protections under Chapter 11. In particular, the "automatic stay" that freezes creditors and preserves the value of the enterprise is carved back in Lehman’s case. This leaves the stay as somewhat less effective, because certain contract types may not be stayed in bankruptcy... and these happen to hold a central place in the Lehman bankruptcy:

• Terminated swaps; and
• Repo transactions

The absence of the full “stay” may make Lehman more of a depreciating asset than some realize.

These issues sit not only at the heart of Lehman's crisis, but at the heart of the credit crisis overall. Food for thought for the policy teams at the Fed and the SEC.

Of course, Lehman’s timing was unfortunate – and catalytic. It filed before the Treasury announced its bailout initiative which might very well have saved the bank. Of course, one can wonder whether, without Lehman failing, the Treasury might ever have put forth its ambitious bailout proposal…and on this, wise minds will differ.

In related resources, you will find several documents related to the Lehman Brothers bankruptcy and asset sale, all which are readily available in Westlaw Business.