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Critical Time to Assess Exposure (Direct and Indirect) to “Troubled” Companies and Possible Steps to Minimize Losses

Article

Corporate & Finance Alert

October 1, 2008

It goes without saying that companies need to immediately and continually assess what actions might be available to mitigate any losses arising from Lehman Brother’s historic bankruptcy filing last week. Equally important is to identify and monitor direct and indirect exposure to Lehman and other “troubled” companies.

Recent events, such as the near collapse and dramatic credit rating downgrade of American International Group (“AIG”), have demonstrated that even behemoth companies, rich in standing and tradition, are not immune to failure, and a credit downgrade event can, in some instances, trigger a termination event or an additional collateral requirement that can have an effect on a transaction that is as serious as if there had been a bankruptcy filing.

In addition to assisting clients who are direct creditors of Lehman Brothers and clients who have been impacted by AIG’s credit downgrade, Gibbons is providing assistance in identifying and mitigating actual and potential exposure under credit default swap (CDS), interest rate swap (IRS) and other derivative transactions.

For example, as a result of the Lehman Brothers bankruptcy credit event, derivatives transactions in which Lehman is a dealer or a reference entity are being terminated, requiring cash settlement payments of a counterparty. Counterparties may have contractual rights, or may be able to negotiate a consensual arrangement, not contemplated by their existing contracts, that could help them (and others in the transaction) avoid monetizing current losses (for example by receiving physical delivery of underlying obligations), which would give the holder greater flexibility and possibly more control over the situation and the amount ultimately recovered in the bankruptcy. In case of exposure to an organization who has not filed for bankruptcy, companies need to evaluate what options may be available and whether it is appropriate to unwind the transactions that give rise to the exposure.

The Gibbons Corporate Department has been advising clients regarding their rights and obligations under CDS, IRS and other derivative arrangements arising out of the financial crisis. The department has been closely monitoring the developing “bail-out” legislation and will advise clients of the provisions created as a result of the new legislation. We will circulate additional alerts in the near term.