The trustee overseeing the liquidation of Lehman Brothers Holdings' broker dealer has sued Citibank to recover more than $1.3 billion in cash and other assets.

The assets include a $1 billion deposit that Citibank demanded to continue providing foreign exchange settlement services to broker-dealer Lehman Brothers Inc (LBI) after its parent filed for Chapter 11 bankruptcy protection, according to a complaint filed in U.S. bankruptcy court in Manhattan on Friday.

Citibank, part of Citigroup Inc , also froze more than $300 million in additional deposits, according to the complaint filed by Lehman Brothers trustee James Giddens.

When Lehman requested the return of the $1 billion deposit, Citibank said it had set the deposit off against other obligations Lehman owed to Citibank, according to the lawsuit.

The case centers on negotiations held during the frantic week of Lehman's bankruptcy filing on September 15, 2008, the largest ever, and its scramble to keep LBI functioning through the ensuing financial crisis.

In a statement, Citigroup said it demanded the deposit to cover any losses it suffered in settling LBI's trades during the panic caused by its parent's bankruptcy filing.

It called the trustee's claims unjustified and without merit and said it will vigorously defend its right to recover its losses, which amounted to more than $1 billion for helping settle the Lehman trades.

Citigroup had said in a filing last month that it could face up to $3 billion in claims from Lehman's bankruptcy proceedings. In addition to the $1 billion deposit from LBI for forex clearing, it said Lehman could also try to recover a $2 billion deposit it made with Citigroup in June 2008 before its collapse.

TRUSTEE SAYS LBI COERCED

LBI did not file for bankruptcy court protection with its parent but remained in business to protect its customers while its pending transactions were wound down.

According to the lawsuit, Citibank representatives attended meetings held the weekend of September 13-14, 2008, at the Federal Reserve Bank in New York and at Lehman Brothers Holdings and knew LBI would not be able to remain a viable business without access to foreign exchange settlement services.

Citibank had considerable leverage -- and knew that it had considerable leverage -- to extract concessions from LBI for its benefit and to the detriment of LBI's customers and other creditors, the complaint said.

On the morning of September 15, 2008, Citibank notified LBI it was cutting off its settlement services and then agreed to continue them only if it received a $1 billion deposit in a new Citibank account, the complaint said.

LBI, at a time of increasing financial distress, found itself in the coerced position of facing a demand for funds that it could not refuse, the complaint said.

In its statement, Citigroup said it is reviewing the complaint.

LBI directly benefited from Citi's extension of credit to facilitate LBI's foreign exchange trades, Citigroup said. The LBI Trustee now wants to go back on the agreement and to claw back the security Citi used to partially cover its losses.

In a statement, Giddens said he and his staff had discussed the return of the assets at length with Citibank, but good faith disagreements exist over the proper sums to be returned.

The case is In Re: Lehman Brothers Inc vs Citibank et al, U.S. Bankruptcy Court, Southern District of New York, No. 08-01420.

(Reporting by Dena Aubin; Editing by Dave Zimmerman, Gary Hill and Richard Chang)

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