Stephen Foley: Lehmans battle with Barclays makes the case for bankruptcy reform

Click to follow
The Independent Online

US Outlook: We have been litigating the credit crisis for two years already, and will surely be litigating it for many more to come, but the Barclays boss, John Varley, and his investment banking chief, Bob Diamond, finally get their day in a US court next week. It is to be hoped that they triumph.

At issue are the events of that fraught week after the collapse of Lehman Brothers in 2008, when Barclays snapped Lehman's US brokerage business out of bankruptcy and at a stroke turned itself into the Wall Street powerhouse that Mr Diamond had been dreaming of. The trustees and creditors of the Lehman estate say Barclays diddled them, and that the cut-price acquisition should never have been approved by the bankruptcy court judge.

The British bank has $11bn on the line. But even more could be at stake for the workers and creditors of other companies that find themselves in bankruptcy in the future. Which business manager in their right mind would ride to the rescue of their operations, if they fear that any acquisition could be unpicked by the courts two years later?

It seems particularly unfair in the case of Barclays and Lehman because of the then chaos in the financial markets. It turns out to have been a remarkably lucrative purchase for the British bank, but fire sales often are.

The central allegation is that Lehman employees, in shock and fear for their jobs, cooked up a sweetheart deal with Barclays at the expense of creditors. The details are complex and various, but the most important, according to the trustees, is that Barclays received a windfall by pushing to have Lehman assets marked at a discount to what they were worth, thus reducing the purchase price.

But what was anything worth on Lehman's books? The market was suspicious all through 2008 that Lehman was overvaluing its assets, the participants in the failed rescue talks on its final weekend had argued on the subject, and frankly, Barclays needed to be compensated for the risk it took by buying an ailing brokerage in a collapsing market. If you are going to catch a falling knife, it makes sense to blunt the edges.

Now, one can hardly begrudge the Lehman estate using every legal lever in its attempt to wring more money for creditors. They are not likely to receive even 15 cents on the dollar, it would seem, so wresting a few more pennies from Barclays is material.

But the odds favour Barclays. The bankruptcy process, usually ponderous, allows parts of a collapsed business to be sold quickly if they are haemorrhaging value, in order to preserve something for creditors. In no industry is this more necessary than finance, where counter-parties can flee at any moment, but it can apply in almost any case where suppliers, customers and other trading partners are walking away. A victory for the trustee in this case could make such fire sales much harder to achieve, meaning longer periods of uncertainty for greater numbers of bankrupt businesses.

With the caveat that I have not been sitting through court proceedings myself, the journalists and lawyers who have say there has so far been no "smoking gun" proving Barclays pulled one over on the Lehman estate. The trustee, after all, supported the acquisition at the time in the teeth of opposition from a minority of creditors, for fear that the value of Lehman was collapsing.

We'll have to see what Mr Diamond can provide under examination on Monday, and Mr Varley the next day, but if they can take us back to the chaos and confusion of that week in September 2008 then they will be doing a favour to all of us who fear the consequences of rewriting history.

It is to be hoped, too, that this is the one and only time that the bankruptcy process will be used to manage the collapse of a broker-dealer, or indeed of any financial institution of systemic importance. The Lehman case is throwing up too many contradictions in bankruptcy law, and threatens to sprawl into a mess of Jarndyce v Jarndyce proportions. It stands as a monument to the need for a new resolution authority, so that financial giants can be wound up without their having to enter a "stop the clocks" bankruptcy filing.

The Wall Street reform Bill, which is moving closer to a presidential signature in the US, sets up just such a resolution authority. It can't come soon enough.

Comments