UPDATE 3-BofA must return $500 mln seized Lehman deposits

Wed Nov 17, 2010 2:33pm EST

* Lehman bankruptcy judge says deposit seizure illegal

* Judge says Bank of America knew better

* Bank of America disappointed with ruling, may appeal

* JPMorgan also being sued by Lehman (Adds Lehman statement)

By Santosh Nadgir and Jonathan Stempel

BANGALORE/NEW YORK, Nov 17 (Reuters) - Bank of America Corp (BAC.N) was ordered by a U.S. judge to return $500 million of deposits it seized from Lehman Brothers Holdings Inc LEHMQ.PK shortly after Lehman's bankruptcy.

U.S. Bankruptcy Judge James Peck said Bank of America violated federal law when it "brazenly" seized the deposits after having taken advantage of Lehman's weakened condition in the summer of 2008 in obtaining the money.

"It is difficult to understand how Bank of America could have thought that taking the money was the right thing to do without first seeking permission from the court," Peck wrote in a Tuesday opinion filed in Manhattan bankruptcy court.

"The actions taken were surprising and, quite frankly, disappointing for a leading financial institution that should care a great deal about its reputation," he wrote.

The decision is a victory for Lehman as it tries to repay creditors still owed hundreds of billions of dollars following its Sept. 15, 2008 bankruptcy. [ID:n22239499]

Peck directed Lehman to draft an order calling for the return of the $500 million plus interest, and for the parties to meet to discuss "the amount of any further monetary award."

"We are disappointed with the court's decision, and we continue to believe that our actions were fully supported by well established New York law and the unambiguous language of the bankruptcy code," said Bank of America spokeswoman Shirley Norton. "We are considering our appellate options."

Martha Solinger, Lehman's co-general counsel, said the company is gratified by and fully agrees with the ruling.

Lehman is also seeking to recover $8.6 billion it said JPMorgan Chase & Co (JPM.N) extracted just before the bankruptcy, and an $11 billion "windfall" that Barclays Plc (BARC.L) got in acquiring a U.S. brokerage unit. Peck handles those cases as well.

ULTIMATUM

Like JPMorgan, Bank of America is a "clearing" bank that acts as a go-between in banks' dealings with other parties.

According to Peck's 46-page opinion, the Charlotte, North Carolina-based bank provided clearing services to Lehman for 16 years, but by the summer of 2008 was "particularly worried" about Lehman's health and sought to reduce its credit risk.

The judge said Bank of America gave Lehman an "ultimatum" that resulted in creation on Aug. 25, 2008 of an account in which Lehman posted the $500 million as security.

Bank of America still held these funds when Lehman went bankrupt, and seized them on Nov. 10, 2008, to offset alleged claims on unrelated derivative transactions. It then asked the bankruptcy court to approve the seizure.

But Peck said the Aug. 25 agreement gave Bank of America no right to offset its claims, and that both companies understood the purpose of that agreement given the "negative perceptions" then facing Lehman in the market.

He said Bank of America violated the "automatic stay" provision in U.S. bankruptcy law that halts actions to seize a debtor's collateral after a bankruptcy case begins.

"Bank of America brazenly elected to violate the stay with apparent disregard for the consequences of its actions," Peck wrote. "Bank of America, in the court's view, had a responsibility to approach the setoff issue with far more restraint than was shown here."

The case is Bank of America NA v. Lehman Brothers Holdings Inc et al, U.S. Bankruptcy Court, Southern District of New York, No. 08-ap-01753. The main bankruptcy case is In re: Lehman Brothers Holdings Inc in the same court, 08-13555. (Reporting by Santosh Nadgir in Bangalore and Jonathan Stempel in New York. Editing by Don Sebastian, Dave Zimmerman and Robert MacMillan)