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(Bloomberg) -- Three years into the bankruptcy of Lehman Brothers, Credit Suisse Group AG made a bold move.

It was around 2011 and most of its peers were settling claims that Lehman owed them billions of dollars from failed derivatives trades. Instead of joining in, Credit Suisse -- which had said Lehman owed it $1.2 billion from such trades -- decided to sell most of that claim to hedge funds, according to people with knowledge of the matter. The transaction gave Credit Suisse a shot of cash during a difficult period, while allowing it to forge ahead with a legal battle for the full amount it said it was owed.

Now, nearly a decade after Lehman’s collapse, the trade may be coming back to haunt the Swiss lender.

Credit Suisse is the last large holdout among banks in the derivatives dispute. Only one bank, Citigroup Inc., took its case to trial, but last month ended up settling for a fraction of what it sought. Unless Credit Suisse fares better, the trades with hedge funds leave it at risk -- in worst-case scenarios -- of having to pay back hundreds of millions of dollars with interest to the investors, said the people, who asked not to be identified because the transactions were private.

Representatives for the Zurich-based lender declined to comment, as did Lehman. Credit Suisse continues to press its case and could still prevail. But the hedge fund transactions, known as claim participation agreements, may complicate a resolution.

Rising Costs

Credit Suisse began selling off chunks of its derivatives claim in 2011 and 2012, just around the time that most of Lehman’s biggest trading counterparties settled their bankruptcy claims for undisclosed sums, the people said. At the time, the bank was under pressure from regulators to shore up capital and jettison risky assets. And lenders across Europe were facing potential losses from a sovereign debt crisis that was threatening the region’s common currency.

Among the firms that have bought these claims were Goldman Sachs Group Inc., Appaloosa Management, Oaktree Capital Group, Silver Point Capital, Fortress Investment Group and King Street Capital Management, the people said. Some of them exited their positions by trading in the secondary market, while others bought in. Representatives for all of the funds declined to comment.

The deals show how Credit Suisse’s creativity in dealing with crisis-era financial problems, which in separate transactions helped its investment bank turn a profit in 2011, can be a double-edged sword. While it’s unclear how Credit Suisse accounted for the Lehman claims trade and whether it took any gains or losses, the Swiss bank could end up owing money to investors that bought its claims. On top of that its legal costs and interest expenses from the trades keep mounting. 

Complicated Terms

While terms of each trade varied, at least some of the claims traded at around 37 cents on the dollar, the people said. And Credit Suisse agreed to pay interest on the proceeds until the litigation was resolved, they said. At 37 cents, the bank would have received about $340 million in cash.

In all, according to the people with knowledge of the transactions, the trades would have allowed Credit Suisse to hive off more than $900 million of its exposure to bankrupt Lehman. At the same time, the people said, the deals limited the Swiss bank’s upside while leaving it responsible for the principal, plus interest.

Under the terms of at least some of the trades, if Credit Suisse has its claim wiped out, it is still required to pay back investors the money it got upfront plus interest, said the people with knowledge of the transactions.

On the other hand, if the full claim is allowed, investors would earn the difference between their purchase price and the amount that’s ultimately received from the Lehman estate, the people said. If the claim is only partially allowed, investors get back what they paid upfront, plus interest, on the portion that is not allowed, and get distributions from the estate on the rest.

Vanishing Hopes

For investors that bought into the claim, hopes for a big payday have largely vanished, the people said, especially after Citigroup’s settlement, which was overseen by the same judge presiding over Credit Suisse’s case. Citigroup said it was owed around $2 billion, but it ended up with about $360 million.

The two parties settled after more than 40 days in court, in which Lehman presented evidence bolstering its argument that the U.S. bank was inflating its claim to profit from the failed brokerage’s misery. While it’s impossible to make direct parallels due to nuances in each bank’s claims, Lehman has similar arguments about inflation by Credit Suisse. The Swiss bank said in court filings that it didn’t inflate the claim, and doesn’t owe Lehman any money. 

‘Ringing the Register, Homey’: Read more about Lehman’s fight with Citi

Since the claims were sold, Lehman and Credit Suisse have been locked in slow-moving litigation. In a 2013 lawsuit, Lehman sued Credit Suisse, accusing it of having “inflated” its claim by over $1 billion, and saying that it actually owes Lehman money.

The judge who oversees the legal dispute in Manhattan bankruptcy court is pressing Credit Suisse and Lehman forward, saying a trial should be held by October 2018 and ordering the Swiss bank to produce documents. Until now, the legal case has been mired in disputes over what Lehman says is the bank’s refusal to produce documents.

The Swiss bank said in its defense that the fact that much data is from nine years ago poses “significant technical challenges.”

--With assistance from Jan-Henrik Förster

To contact the reporter on this story: Tiffany Kary in New York at tkary@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Dan Wilchins

©2017 Bloomberg L.P.

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