The Death of Precedent

I reject the need to talk about the debt ceiling issue today. If Republicans want to show their commitment to fiscal responsibility by forcing massive hikes to the interest on U.S. sovereign debt — and the spiraling spending it entails — let the bastards. Statesmanship, apparently, is dead. As world powers discover when attempting to negotiate with non-state terrorists, one simply cannot have a rational discussion with an opponent who’s motivated solely by ideology, and has nothing left to lose.

Now. Moving on to more interesting things…

A year and a half ago, a federal bankruptcy judge stunned most of the legal world by invalidating a term basic to most structured financial transactions: the “waterfall flip,” which provides that in the event of bankruptcy, non-defaulting junior noteholders, unlikely to otherwise see payout, receive senior status. Basically, instead of having their payout come last (if at all), non-defaulting parties get the first and therefore most likely shot at cashing out from a limited pool. It’s a way of obviating counterparty risk — but Judge Peck was having none of it. He set aside the “waterfall flip” provision, essentially holding that Lehman Brothers, the defaulting party, would never have to pay out.

Bank of New York Mellon, the party on the losing side of this… event, pledged to take it up on appeal. What followed was one of the most bizarre and delicate courtroom dances of the new century. In a series of conferences, Judge Peck refused to enter a final order declaring Lehman’s victory (a necessary predicate to any appeal), putting BNY Mellon in the strange position of begging the Court to enter a disfavorable order, just so they could try to overturn it on appeal.

This lasted months. But eventually, BNY Mellon took their appeal, and the case settled, which is probably what Judge Peck wanted all along. Expedient, out-of-court settlement is clearly best for the parties, and especially best for the bankruptcy estate.

But is it best for the law? Because of the BNY/Lehman settlement, lawyers in the nation’s busiest, most influential bankruptcy court have to deal with an opinion that, because it was never vacated or corrected on appeal, remains controlling, but is arguably (and maybe clearly) wrong. Essentially, the settlement ended the New York courts’ potential to authoritatively resolve an open legal issue and imbue it with the force of precedent. Settling benefited Lehman and BNY, but stalled the development of the law, depriving litigants and judges of the answer to an open question.

As courts get busier — and so, more willing to force a settlement, even during the appellate process — this could become an increasingly serious problem, especially if high-risk, cutting-edge issues continue to evade review.

There’s little that lawyers can do to correct what is (no doubt) an old and periodically recurring problem. Federal judges cannot issue “advisory opinions”; instead, they have to wait for a live controversy. But here’s a situation where law firms and large banks, as institutions, potentially help the machine run more smoothly. Larger firms often represent many clients, all facing similar issues; and larger banks typically engage in many superficially similar transactions. The potential for repeat transactions means both face face incentives to value predictable, settled rules of law, over expedient resolution of individual disputes. Ideally, those rules will benefit the rest of us, too.


  1. A judge outright refusing to make a ruling in a case sounds like a pretty bizarre idea to me. Wouldn’t that in itself be subject to review by a higher court – could BNY for instance have asked for a mandamus or something like that to force the judge to make the order?

  2. Bankruptcy law is WEIRD. And mandamus is definitely an option, but you risk (1) pissing off the judge, which is a problem if you have more cases before him and (2) Peck had a basis for it. I just personally thought it was a smokescreen :)

  3. Judge Peck’s ruling isn’t binding precedent on anyone, and personally I think he got it right. Betting that you can enforce an ipso facto clause in bankruptcy is about like betting that Sisyphus is going to get that rock up the hill. Or that the Cubs will win the World Series before the sun burns out.

  4. It is binding, isn’t it, in SDNY? He sure thinks it is; in another case, from the bench, he referenced it as at least authoritative.

    And yeah. BNY had an uphill battle. But what I’ve heard from people here is that it’s not what they were expecting. Is that wrong?

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