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English High Court considers the meaning of Loss under the 1992 ISDA Master Agreement


Enasarco v. Lehman Brothers Finance S.A. [2015] EWHC 1307 (Ch)

On 12 May 2015, Mr. Justice David Richards gave judgment in an important case concerning the Loss methodology of determining the financial effect of an early termination of a derivative subject to the 1992 ISDA Master Agreement. The judgment will be of interest to financial markets because (as observed by the Court of Appeal) the ISDA Master Agreement is probably the most important standard market agreement used in the financial world.

In 2007, the Claimant, Enasarco (an Italian pension fund), invested €780 million in notes, due to mature in 2023, issued by Anthracite Rated Investments (Cayman) Limited (“ARIC”), an offshore special purpose vehicle, and part of a €10 billion note programme devised by Lehman Brothers International Europe. The notes were designed to provide Enasarco with exposure to hedge funds as an asset class.  The notes also had the benefit of a put option granted by Lehman Brothers Finance S.A., a Swiss company (“LBF”) which ensured there would be sufficient funds to pay the noteholder at maturity not less than the original purchase price of the notes.  The put option was contained in a derivative agreement which incorporated the 1992 ISDA Master Agreement and selected the Loss and Second Method methodologies.

On 15 September 2008 (“ETD”) Lehman Brothers Holding Inc filed for bankruptcy protection in New York.  This amounted to an event of default and resulted in automatic early termination of the derivative agreement.  On 16 September 2009, ARIC provided to LBF a calculation of ARIC’s Loss under the derivative agreement, which claimed from LBF a payment of US$61.5 million, using a quotation for a replacement transaction obtained from Credit Suisse dated as at 6 May 2009. Thereafter, ARIC assigned its claim under the derivative agreement to Enasarco.  LBF denied that it owed any sum to Enasarco under the derivative agreement and instead contended that ARIC owed to LBF an amount equivalent to US$42 million.

At the trial, LBF contended that ARIC’s calculation of its Loss was not valid and binding because ARIC did not determine its Loss in accordance with the Master Agreement for three reasons.

First, LBF contended that 6 May 2009 (the date of the Credit Suisse quotation) was not the earliest reasonably practicable date after the ETD, as of which ARIC could have determined its Loss on the basis of a quotation for a replacement transaction, as required by Section 6 of the Master Agreement. In dealing with this issue, the Court resolved two important points of law as follows: (1) in considering whether a non-defaulting party has reasonably determined its Loss that party is not required to comply with an objective standard of care, but must not arrive at a determination which no reasonable non-defaulting party could come to (a test of rationality as described in Associated Provincial Picture Houses Ltd. v. Wednesbury Corp. [1948] 1 K.B. 223); (2) Quotations within the meaning of Loss meant a real offer at which a dealer was willing to contract on the day of quotation, following a decision on the Market Quotation methodology, LBF v. Sal Oppenheim [2014] EWHC 2627 (Comm).

On the facts, the Court found that Enasarco did all that it reasonably could do to obtain a quotation for a replacement transaction and that, contrary to LBF’s contention, it was not reasonably practicable for Enasarco to obtain a quotation before the end of the 2008.  The Court was satisfied that even if it was practicable for Enasarco to have obtained a quotation earlier in 2009 than May it would have made no difference to the price of the replacement transaction.

Secondly, LBF contended that the terms of the Credit Suisse replacement transaction were so different from the LBF transaction that the price of the former could not be used to determine ARIC’s loss of bargain.   The Court rejected this criticism and held that LBF were not entitled to rely upon these factors to displace ARIC’s calculation of Loss.  LBF’s reliance on the fact that Credit Suisse had a better credit rating and stronger balance sheet than LBF was dismissed by the Court because it held that the definition of Loss in the Master Agreement did not require any quotations of relevant rates or prices from one or more leading dealers in the relevant markets to be obtained from a bank of an equivalent credit rating to the defaulting bank.  

Thirdly, LBF contended that the date of the calculation statement, 16 September 2009, was not as soon as reasonably practicable following the occurrence of the ETD, as required by section 6 of the Master Agreement. The Court accepted that the calculation statement could have been provided earlier than September 2009.  However, this lateness in the provision of the calculation statement, while amounting to a breach of contract, was held by the Court to have no impact on the validity or binding nature of the calculation of Loss.

Accordingly, the Court held that ARIC had validly calculated its Loss in accordance with the Master Agreement and Enasarco was entitled to payment of US$61.5 million, together with interest, from LBF.

The judgment is here.

Mark Hapgood QC and Jasbir Dhillon QC appeared for Enasarco, instructed by Sidley Austin LLP.