Sontchi, J.
The question before the Court is whether an (alleged) agreement to setoff amounts owed to affiliates of a counterparty (a so called "triangular setoff") is enforceable under the "safe harbor" provisions in sections 559-561 of the Bankruptcy Code. Prior to their bankruptcy, AHM Investment, one of the Debtors,
As set forth below, the Court finds that a contractual right of setoff that permits netting by multiple affiliates of the contract-counterparty outside of bankruptcy may not be enforced after the commencement of the debtor's bankruptcy cases. A triangular setoff lacks mutuality and is, therefore, not authorized under the Bankruptcy Code. As a result, Plaintiff has made plausible claims against Defendants. Herein, the Court denies the defendant's motion to dismiss the Amended Complaint.
Furthermore, the Court finds that Plaintiff has made plausible factual allegations that rebut the valid claim presumption established by Defendants. As a result, the
Plaintiff, Steve D. Sass, as Plan Trustee (the "Plan Trustee" or "Plaintiff") of the American Home Mortgage Plan Trust brought this adversary proceeding asserting both affirmative claims against Barclays Bank PLC ("Barclays Bank") and its affiliate Barclays Capital Inc. ("Barclays Capital" and with Barclays Bank, "Barclays" or the "Defendants") and objections to the claims filed by Defendants.
On August 6, 2007, the Debtors filed for relief under chapter 11 of the Bankruptcy Code. As of the petition date, the above-captioned debtors (the "Debtors") were authorized to continue to operate their businesses and manage their properties as debtors in possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code. On February 23, 2009, the Court entered the Confirmation Order. The Effective Date of the Plan (as defined therein) occurred on November 30, 2010. Pursuant to the Confirmation Order and the Plan, certain of the Debtors' assets were transferred to the Plan Trust upon the Effective Date.
Pursuant to the Plan and the Plan Trust Agreement, the Plan Trustee is permitted to, among other things, prosecute Causes of Action and object to Claims (each as defined in the Plan).
In April 2011, Plaintiff commenced this adversary action against Defendants by filing a complaint. Subsequently, Plaintiff filed an amended complaint
American Home Mortgage Investment Corp. ("AHM Investment") and Barclays Capital are parties to a Master Repurchase Agreement dated February 8, 2006 (together with all annexes, confirmations and schedules thereto and as amended, supplemented and/or modified, the "Repurchase Agreement").
The Repurchase Agreement provides that, among other things, AHM Investment, as seller, agrees to transfer to Barclays Capital, as buyer, various securities and other assets (including any Additional Purchased Securities transferred to Barclays Capital during the term of the Repurchase Agreement (the "Purchased Securities")) in exchange for the transfer of funds from Barclays Capital, with a simultaneous agreement by Barclays Capital to transfer to AHM Investment such Purchased Securities as a date certain or on demand in exchange for the transfer of funds from AHM Investment (the "Repurchase Price"). Barclays Capital and Plaintiff (for the most part) agree on the Repurchase Price (but not the value of the Purchased Securities).
On August 3, 2007 (the "Repo Termination Date"), Barclays Capital sent AHM Investment a letter captioned as "Declaration of Event of Default/Notice of Repurchase Date/Notice of Termination" (the "Repo Termination Notice"). Therein, Barclays Capital (i) asserted that AHM Investment was in default under the Repurchase Agreement; (ii) accelerated the obligations under the Repurchase Agreement such that AHM Investment was required to immediately repurchase all of the Purchased Securities in Barclays Capital's possession under the Repurchase Agreement as of August 3, 2007; and (iii) terminated the Repurchase Agreement. Because AHM Investment did not have the cash to buy back the Purchased Securities, Barclays Capital retained possession of the Purchased Securities and subsequently asserted a deficiency claim against AHM Investment for the alleged difference between the Repurchase Price and the value of the Purchased Securities.
In March of 2006, AHM Investment created the securitization trust AHM Investment Trust 2006-1 (the "Trust") with Deutshe Bank National Trust Company acting as Indenture Trustee. Barclays Bank was chosen to underwrite the Trust's securitization of various adjustable rate mortgage loans (the "Trust Mortgages") whose rates were tied to the 1-year Treasury Index. The Trust issued floating rate notes (the "Trust Securities") based on these underlying Trust Mortgages.
The Trust Mortgages have an approximate average interest rate cap of 10%, with an effective interest rate cap of approximately 9% after netting out Trust expenses. The floating rate of the Trust Securities, however, is not capped. The lack of an interest rate cap on the Trust Securities means that an increase in market interest rates over 9% could lead to an inability to service the Trust Securities
As part of the underwriting of the Trust Securities, the Trust, Barclays Bank and AHM Investment entered into a series of interest rate cap transactions to hedge against the possibility that prevailing interest rates on the Trust Securities would increase over the effective interest rate cap on the Trust Mortgages. In order for the Trust Securities to be eligible for a AAA rating, the interest rate cap transactions were set up so that Barclays Bank— which was rated AAA at the relevant time—sold an interest rate cap option (the "Front Cap") to the Trust and AHM Investment simultaneously sold an interest rate cap option to Barclays (the "Back Cap").
The Front Cap would protect the Trust in the event that the interest rate on the Trust Securities increased beyond the interest rate of the underlying Trust Mortgages and the Back Cap would cover Barclays Bank's liability in the event that the Front Cap was exercised by the Trust. Barclays also entered into two interest rate cap options ("Hedge Cap 1" and "Hedge Cap 2," collectively the "Hedge Caps") with AHM Investment. These corridor cap transactions were intended to hedge AHM Investment's potential exposure relating to the Back Cap.
The Back Cap and Hedge Caps transactions were governed by the ISDA Master Agreement (Multicurrency-Cross Border), dated as of March 13, 2006 (the "Master Agreement"), the Schedule to the Master Agreement, dated as of March 13, 2006 (the "Schedule"), the ISDA Credit Support Annex (Bilateral Form) dated as of March 13, 2006 (the "Credit Support Annex"), and certain related Confirmations, and other related transactional documents, as amended, supplemented and modified (collectively, the "Swap Agreement").
The Swap Agreement, among other things, provides that margin protection in the form of cash collateral or securities be delivered to the Swap Agreement counterparty upon demand and under certain circumstances. During the term of the Swap Agreement, AHM Investment provided Barclays Bank with cash and certain securities (collective, the "Swap Collateral") pursuant to the requirements of the Swap Agreement.
On March 29, 2006, AHM Investment transferred various bonds with an aggregate value of $18,994,056 to Barclays Bank as Swap Collateral. The specific bonds held as Swap Collateral changed during the course of the Swap Agreement, as AHM Investment had the right to substitute bonds on an as-needed basis. On April 20, 2007, AHM Investment provided $5,336,536 in cash to Barclays Bank to be held as a portion of the Swap Collateral in exchange for the return of a certain bond (identified as JPMMT 2005-ALT1 2A1 (Cusip 466247XG3)).
The Schedule to the Master Agreement contains a broad setoff provision that purports to authorize Barclays Bank to perform cross-obligation setoffs and cross-affiliate setoffs. Part 5(b) of the Schedule to the Master Agreement (the "Setoff Provision") states, in pertinent part:
This Setoff provision, among other things, purports to permit Barclays Bank to effectuate a "triangular setoff" of its obligations to AHM Investment under the Swap Agreement against amounts AHM Investment allegedly owes to Barclays Capital under the Repurchase Agreement despite the fact that the debts are not mutual under the circumstances.
On August 2, 2007 (the "Swap Termination Date"), Barclays Bank sent AHM Investment a letter (the "Swap Termination Notice"), pursuant to which Barclays: (i) asserted that AHM Investment was in default under the Master Agreement; (ii) designated August 2, 2007, as the Early Termination Date with respect to all outstanding transactions under the Swap Agreement; and (iii) notified AHM Investment of Barclays Bank's exercise of its purported right under the Master Agreement to set off any amounts payable to Barclays Bank to AHM Investment against AHM Investment's unsatisfied obligations to Barclays Capital under the Repurchase Agreement.
In September 2007, Barclays Bank sent AHM Investment a "Statement of Payment on Early Termination of ISDA Master Agreement" asserting that Barclays Bank's was entitled to $3,852,000 in damages under the Swap Agreement. Plaintiff asserts in the Amended Complaint that Barclays Bank's damages are only $478,352. Plaintiff asserts that on the Swap Termination Date, Barclays Bank held cash collateral plus unpaid accrued interest totaling $5,250,979 and three notes valued at $7,765,397—making the total value of collateral held by Barclays Bank on the Swap Termination Date $13,016,376. After using the Swap Collateral to setoff against the swap damages (whether using Barclays Bank's or Plaintiff's assertions regarding the value of the swap damages),
Barclays Bank notified AHM Investment of its intent to set off any amounts payable by Barclays Bank to AHM Investment under the Swap Agreement against AHM Investment's unsatisfied obligations to Barclays Capital under the Repurchase Agreement. Thereafter, Barclays Bank and/or Barclays Capital applied the Swap Collateral Surplus to amounts owed by AHM Investment to Barclays Capital under the Repurchase Agreement.
Barclays Capital filed proof of claim (the "Repurchase Claim") against AHM Investment regarding their (alleged) claims under the Repurchase Agreement, as identified by the Debtors as claim no. 8980, asserting a general unsecured claim in the total amount of not less than $45,064,682.
Pursuant to the Repurchase Claim, Barclays Capital calculated the Deficiency Claim portion of the Repurchase Claim as follows:
(i) calculating the difference between (a) the alleged market values of the Purchased Securities (minus Additional Purchased Securities) and one of the Swap Collateral Surplus positions (a portion of AHM 2006-1 1M6 Note)
(ii) Barclays Capital "credited" AHM Investment for the value of the Additional Purchased Securities that AHM Investment had provided to Barclays Capital as margin payments under the Repurchase Agreement.
(iii) Barclays Capital "credited" AHM Investment for the value of remaining Swap Collateral Surplus which included notes (AHM 2005-SD1 2M2, AHM 2005-SD1 and part of AHM 2006-1 1M6) and remaining cash.
(iv) Barclays Capital made other adjustments, such as a "credit" for principal and interest.
Plaintiff alleges that the value of the Purchased Securities (as discussed in more detail below) exceeds the AHM Repo Obligations on the Repo Termination Date and, thus, Plaintiff alleges that Barclays Capital does not have a Deficiency Claim (i.e. there are no damages under the Repurchase Agreement or other amounts owed to Barclays Capital). As a result, Plaintiff seeks to disallow the Repurchase Claim.
Plaintiff's alleged value of the Purchased Securities is comprised of the following: (i) Barclays Capital's own value of certain AAA-rated securities (not less than $100,736,438);
Plaintiff asserts that value of the sum of the Repurchase Price and all other allowed damages under the Repurchase Agreement (collectively, the "AHM Repo Obligations") is $148,562,568 on the Repo Termination Date. Plaintiff concludes that Barclays Capital has no deficiency under the Repurchase Agreement as the aggregate value of the Purchased Securities as of the Repo Termination Date exceeds the AHM Repo Obligation. Plaintiff continues that even if Barclays Capital had a deficiency claim—such deficiency claims cannot be reduced by the Swap Collateral Surplus.
Barclays Bank filed a proof of claim (the "Swap Claim") against AHM Investment regarding their (alleged) claims under the Swap Agreement, as identified by the Debtors as claim no. 8979, asserting a general unsecured claim in an amount not less than $10,830. The Swap Claim consists of the following: (i) $10,830 on account of legal expenses purportedly incurred by Barclays Bank in connection with the enforcement and protection of its rights under the Swap Agreement or by reasons of the early termination of the transactions contemplated by the Swap Agreement; and (ii) contingent claims for all indemnities of Barclays set forth in the Swap Agreement.
In its Amended Complaint, Plaintiff argues that (i) triangular setoff is not allowable under the Bankruptcy Code and (ii) if it were allowed, triangular setoff is improper in this case as it violates the terms of the Swap Agreement. Plaintiff further asserts that Barclays Bank and/or Barclays Capital violated the automatic stay by performing a triangular setoff not permitted by either applicable law or the terms of the Swap Agreement. Barclays has moved to dismiss the Amended Complaint on the basis that (i) the terms of the Swap Agreement allow triangular setoff; (ii) the safe harbor provisions for swap and repurchase agreement, 11 U.S.C. §§ 559-561, do not require mutuality, thus, allowing for triangular setoff; and (iii) as a result, it did not violate the automatic stay.
As the Court finds (as set forth in detail below) that triangular setoff is not allowable under the Bankruptcy Code, the Court does not need to discuss whether triangular setoff is allowed pursuant to the terms of the Swap Agreement. In other words, even if triangular setoff was allowed pursuant to the terms of the Swap Agreement, the Bankruptcy Code does not allow parties to set-off non-mutual obligations, regardless of whether the agreements are incorporated in the safe harbor provisions of 11 U.S.C. §§ 559-661. As such, the Court will focus its opinion, almost entirely, on the issue of triangular set-off.
The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157 and 1334. Venue is proper in this District pursuant to 28 U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2). This Court has the judicial power to enter a final order.
A motion under Rule 7012(b)(6)
In Iqbal, the Supreme Court makes clear that the Twombly "facial plausibility" pleading requirement applies to all civil suits in the federal courts.
After Iqbal, the Third Circuit has instructed this Court to "conduct a two-part analysis. First the factual and legal elements of a claim should be separated. The [court] must accept all of the complaint's well-pleaded facts as true, but may disregard any legal conclusions."
The crux of the Amended Complaint (Counts I, II, III, IV, and VI) and the briefing on the motion to dismiss briefing is whether the Bankruptcy Code allows for triangular setoff in swap and repurchase agreements.
The "Bankruptcy Code does not establish an independent right to setoff, but section 553 does preserve any right of setoff that may exist under applicable non-bankruptcy law."
Although the Bankruptcy Code does not defined "mutuality," a majority of courts to consider the issue have held:
In SemCrude, Judge Shannon analyzed triangular set-off between three debtors and a supplier. The supplier was seeking to setoff a debt owed to one of the debtors versus a balance due to the supplier from another debtor. Judge Shannon held that "mutuality cannot be supplied by a multi-party agreement contemplating a triangular setoff."
In so holding, the SemCrude court held that there was no contractual exception to the mutual debt requirement.
As it is established that debts must be mutual to be setoff and parties cannot contract around this requirement, the Court must determine whether the safe harbor provisions of sections 559-561 alter that requirement.
Barclays argues that sections 559-561 create a safe-harbor for swap and repurchase agreements and that this safe harbor exempts these types of agreements from the mutuality requirements discussed supra.
Section 561 of the Bankruptcy Code provides, in relevant part, that:
Courts have faced the issue of the interplay between section 553 and these "safe harbor" provisions. The progression of the courts' rulings has assisted this Court's analysis and as such will be discussed below.
In Lehman/Swedbank, the bankruptcy court examined whether Swedbank could setoff a prepetition fund being held by the bank against postpetition deposits made by the debtors. Although clearly distinguishable from the case sub judice as the Lehman/Swedbank court was examining a setoff between pre and post-petition funds and this Court is examining setoff of prepetition amounts among affiliates, the Lehman/Swedbank court's analysis is persuasive in its analysis of section 553 and the safe harbor provisions in sections 559-61.
The Lehman/Swedbank court noted that "[p]lainly, the mututality requirement of section 553 precludes a creditor-bank from offsetting a debtor's prepetition obligations against funds deposited with the creditor-bank post-petition."
In so ruling, the Lehman/Swedbank court examined the language of the statute and relevant legislative history and found that the legislature intended to leave intact the mutuality requirements set forth in section 553.
On appeal, the district court affirmed the Lehman/Swedbank holdings and further expanded on the legislative history supporting sections 559-561.
Thereafter, the court in Lehman/UBS faced the identical issue now raised by Barclays—whether setoff of prepetition accounts among affiliates that is (or in this case may be) provided for in the Swap and Repurchase Agreements is allowable. In Lehman/UBS, the trustee for the debtors sought to enforce the automatic stay (among other stays issued by court order) against UBS AG ("UBS") and recover excess collateral that had been held by UBS since the date of the termination of a swap agreement between the parties.
Barclays' position urges the Court to disagree with the Lehman/UBS court—however, the Court is not inclined to do so. This Court agrees with Judge Peck's analysis—nothing in section 561 of the Bankruptcy Code can preserve or protect a right that that does not exist, inclusive of the mutuality requirement demanded in section 553.
Furthermore, the Court finds that the policies set forth in the Bankruptcy Code supports the mutuality requirement for setoff. The policy argument advanced by Judge Shannon in SemCrude (and as agreed with by Judge Peck in Lehman/UBS) is equally as pervasive in the facts sub judice:
The identical policy issue holds true here—when a debtor is owed money and collects less due to offsets claimed by affiliates of its named contract-counterparty, the debtor's creditors are impacted by the reduction in amounts to be realized by the debtor's estate.
Defendant asserts that the automatic stay does not apply to interfere with the (alleged) set-off rights in the respective contracts. As this Court holds that a triangular set-off is not permissible, Plan Trustee has asserted plausible claims that Defendants have violated the automatic stay. As such, the motion to dismiss Counts V and VII will be denied.
As set forth above, this Court holds, in keeping with its sister courts, that (i) parties cannot contract around the mutuality requirements for the exercise of the right to setoff in bankruptcy as required by section 553, (ii) the safe harbor provisions exceptions to the automatic stay embodied in sections 559-561 cannot be interpreted as implicitly removing the mutuality requirement for setoff; and (iii) without moving for relief from stay, the non-debtor counterparty to swap and repurchase agreements cannot exercise control over property of the estate by retaining funds in exercise of its alleged triangular setoff rights. As a result, Plaintiff asserted plausible claims against Defendants. Therefore, Defendants' motion to dismiss will be denied as to Counts I-VII of the Amended Complaint.
Barclays has also moved to dismiss Plan Trustee's objections to Defendants' Repurchase Claim and Swap Claim. Each claim is discussed below:
In the Amended Complaint, Plan Trustee objects to the Swap Claim on the grounds that the Swap Claim should be disallowed in its entirety because Barclays Bank has offset the Swap Damages against the Swap Collateral in full satisfaction of any amounts owed to Barclays under the Swap Agreement. Plan Trustee asserts that Barclays Bank has no amounts owed to it under the Swap Agreement.
Barclays asserts, in its motion to dismiss, that Plaintiff's objection to the Swap Claim only has merit if the use of the entirety of the Swap Collateral Surplus to set-off against deficiencies in the Repurchase Agreement was improper.
The Court has held that the setoff was, in fact, improper. As such, Plan Trustee's objection to the Swap Claim is plausible
In the Amended Complaint, Plan Trustee objects to the Repurchase Claim on the grounds that the Repurchase Claim should be disallowed in its entirety because the total value of the Purchased Securities as of the Repo Termination Date exceeds the AHM Repo Obligation. Plan Trustee asserts that Barclays Capital has no deficiency claim or other amounts owed to it under the Repurchase Agreement.
In its motion to dismiss, Barclays asserts that Plaintiff fails to provide results from the DCF Analysis of the Purchased Securities, which is approximately one-third of Plaintiff's value of the Remaining Notes. Barclays claims that the mere reference of a DCF Analysis to dispute the Repurchase Claim is not enough to rebut the valid claim presumption.
Plaintiff responds that the Repurchase Claim is not entitled to prima facie validity because Barclays failed to include any documents that actually support its determination of the alleged Deficiency Claim. In the alternative, Plaintiff argues that if the Court finds that the Repurchase Claim is prima facie valid, then the factual allegations in the Amended Complaint overcome the prima facie validity of the claim. Plaintiff asserts that the inquiry is whether the value that Plaintiff attributed to the Remaining Notes is appropriate under the circumstances and required a factual determination of, among other things, whether a commercially reasonable market existed for the Remaining Notes as of the Repo Termination Date and, if not, whether the DCF Analysis is a commercially reasonable determination of value.
Barclays replies that Plaintiff has not offered the facts necessary to conclude that the Purchased Securities exceeds the AHM Repo Obligation. Moreover, Barclays claims that the Amended Complaint fails to address the Repurchase Agreement's contractual requirements for valuing the Purchased Securities. Barclays alleges that the Repurchase Claim specifies that Barclays gave "the defaulting party credit for such Purchased Securities in an amount equal to the price therefore on such date, obtained from a generally recognized source or the most recent closing bid quotation from such a source."
The burden of proof regarding the allegations set forth in a proof of claim shifts:
Pursuant to Federal Rule of Bankruptcy 3001, where a proof of claim does not provide the facts and documents necessary to support the claim, it is not entitled to the presumption of prima facie validity.
The first inquiry the Court is in determining whether the Repurchase Claim establishes prima facie validity. The Repurchase Claim attaches a summary of the contracts between the parties and an explanation of the calculations comprising the claim, which includes citations to the Repurchase Agreement. The Repurchase Claim also attaches the "Master Repurchase Agreement" between Barclays Capital Inc. and American Home Mortgage Investment Corp., dated February 8, 2006; the termination letter dated August 3, 2007; a calculation of Barclays (alleged) Deficiency Claim, and a copy of the Margin Call.
Plaintiff urges that the Repurchase Claim has not established prima facie validity. In comparison, Plaintiff cites In re All-American Auxiliary Ass'n, wherein the court found that the insider-claimant did not establish prima facie validity of his claim because he did not provide written documentation of his employment or any corporate action authorizing the payment of salary or reimbursement of expenses, nor was there any evidence as to the amount of time the claimant spent on the debtor's affairs or the reasonable value of his services to the debtor.
The case sub judice is distinguishable as the Repurchase Claim attaches the Repurchase Agreement, a summary of the claim (including citations to the relevant sections of the Repurchase Agreement), the termination letter, a calculation of the amount of the claim and a copy of the Margin Call.
As the Court has determined that the Repurchase Claim (at this stage of the proceedings) is entitled to the presumption of prima facie validity, the Court must now determine whether it is plausible that the facts in the Amended Complaint, taken as true, rebut the prima facie validity of the Repurchase Claim.
Plaintiff claims that he met this burden by alleging that the aggregate value of the Purchase Securities is comprised of: (i) Barclays Capital's own valuation of the AAA Notes comprising a portion of the Purchased Securities; (ii) an independent DCF Analysis of the Remaining Notes comprising the Purchased Securities; (iii) July 2007 principal and interest payments received by Barclays Capital; and (iv) the Repo Cash Collateral. Plaintiff alleges that with respect to the aggregate value of the remaining Notes, no commercially reasonable market existed for these securities as of the Repo Termination Date, however a DCF Analysis is a commercially reasonable determinant of value with respect to the Remaining Notes under the circumstances
Barclays replies that as the non-defaulting party, Barclays is tasked with pricing the securities and determining the method it would use at termination. The Repurchase Agreement states:
It is not possible, at this stage, to determine whether there is an "absence of a generally recognized source" to value the Securities. This valuation is the subject of factual and expert evidence—and is inappropriate to decide on a motion to dismiss. Plaintiff need not rebut the valid claim presumption in the Amended Complaint, but must make plausible allegations that, taken as true, rebut the allegations set forth in the Repurchase Claim. Here, Plaintiff has alleged its theory of valuation of the Purchased Securities, the calculations comprising that valuation, and what the commercially reasonable source (or commercially reasonable determinant) of value
As stated above, the Court finds that "mutuality is an essential, definitional element of the right to setoff that must be strictly observed."
11 U.S.C. § 553(a).
