"The Effect of Bankruptcy on an Out-of-the-Money Swap" by Timothy Lin

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August 6, 2012

The bankruptcies of Lehman entities around the globe have highlighted novel questions in the OTC derivatives market arising from the insolvency of a swap counterparty:

  • What happens if the non-defaulting counterparty is out of the money on a swap and upon termination would owe money to the debtor counterparty?
  • Can the non-defaulting counterparty strategically refuse to terminate the swap while at the same time refusing to perform its ongoing scheduled payment obligations?
  • Or can the estate of the in-the-money debtor compel the non-defaulting counterparty to either terminate or perform?

Courts in the U.S. and England have issued conflicting opinions on these questions. In the attached memorandum, a version of which was previously published in Derivatives Week, Richards Kibbe & Orbe LLP partner Timothy E. Lin examines the conflicting cases, the underlying differences in U.S. and English insolvency law and public policy, and proposed amendments by ISDA intended to provide greater clarity in light of the conflicting case law.

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