By Nick Brown

NEW YORK (Reuters) - Lehman Brothers' defunct brokerage told an appeals court on Wednesday it was entitled to billions of dollars in cash it says was wrongly included in its 2008 sale to Barclays Plc .

The arguments in federal appeals court in New York renewed a murky, years-old court battle with huge implications for the brokerage's creditors, including Lehman affiliates and hedge funds.

"It was made very clear" in the asset purchase agreement "what was going to Barclays and what was staying behind," said the brokerage's lawyer, William Maguire. "The deal didn't exclude just some cash, it excluded all cash."

The dispute has its roots in the hectic sale of the brokerage's assets to Barclays in the days following the $639 billion bankruptcy of parent company Lehman Brothers Holdings Inc in September of 2008.

The brokerage contends the $250 million deal did not include the brokerage's cash assets. But Barclays says otherwise, relying on a so-called clarification letter signed after the deal was approved.

The disputed assets include margin to support exchange-traded derivatives, which could top $5 billion. They also include roughly $2 billion in so-called "clearance box" assets, which facilitate the clearance of securities trading. And they include $769 million promised to Barclays if Lehman's customers were paid in full.

U.S. Bankruptcy Judge James Peck approved the deal in 2008. Days later, the sides signed a "clarification" letter on the cash assets.

In 2011, Peck ruled that the clearance box assets should go to Barclays and the margin assets should stay with the brokerage. Then in June 2012, Judge Katherine Forrest in federal court in New York partially reversed Peck's ruling, assigning both the margin and the clearance assets to Barclays.

The focus of Wednesday's arguments was on the margin assets, over which the sides presented drastically diverging narratives.

Attorney David Boies, representing Barclays, said the clarification letter merely identified and quantified the assets already agreed to by the parties as a way of validating that the deal would boost Barclays' assets.

It did not change the terms of the deal, Boies argued.

But according to Maguire, Peck's initial approval of the deal specifically excluded cash assets. The clarification letter, far from mere explication, represented a fundamental change to the deal, amounting to an asset grab by Barclays.

Barclays currently holds about $2 billion of the margin assets and $786 million of the clearance box assets, with the Lehman brokerage holding the rest. The appeals court could grant both to one party, or divvy them up. In a less likely scenario, it could unwind the sale altogether.

After the hearing, a spokesman for James Giddens, the trustee winding down the Lehman brokerage, said the trustee's "position from day one has been that no cash was included" in the sale.

"That means billions of dollars in cash rightfully belong to the" brokerage's estate, spokesman Jake Sargent said.

Because customers of the brokerage are slated to get paid in full regardless of the outcome, it is general creditors whose recoveries depend on the appeals process.

They include roughly 12,000 claims from hedge funds, former employees, counterparties such as pension funds, banks and Lehman affiliates. Some of them were present on Wednesday in a packed courtroom on the 17th floor of a federal courthouse in New York. Security staff asked some standing spectators to move to an adjoining room with a video feed.

Judges Peter Hall, Gerard Lynch and Ralph Winter asked pointed questions of both lawyers. Winter suggested that Barclays' aim - to acquire the collateral of the exchange-traded derivatives business it bought - was only natural.

"Why would anyone expect someone to buy an ETD business and not buy the margin assets?" Winter asked Maguire. "You must have been delighted to pull off that economic coup."

Maguire countered that, for Barclays to essentially pay cash to acquire cash would have been a circular transaction and that it should have used its own assets to secure the derivatives business. Including cash, he said, would have handed Lehman's business, as well as billions of dollars in cash, to Barclays for only $250 million.

"That would skew the economics," he said.

Boies said the no-cash provision applied only to retained or unencumbered cash, but clearly excluded margin.

Boies faced his own helping of skepticism from the panel, including from Judge Hall, who suggested that a "no-cash" rule should be taken at face value.

"I would have taken that to the bank," Hall said.

The case is No. 12-2322, U.S. Court of Appeals for the Second Circuit.

(Reporting by Nick Brown; Editing by Eddie Evans and Andre Grenon)

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