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High Court considers the meaning of Loss in 1992 ISDA Master Agreement


(1) Enasarco (2) ARIJ v. Lehman Brothers Finance S.A. [2011] EWHC 1822 (Ch)

On 15 July 2011 Mr. Justice Briggs gave judgment in two claims brought against Lehman Brothers Finance S.A. ("LBF") which raised issues of construction arising out of two complex structures forming part of a €10 billion secured medium term note programme devised by Lehman Brothers International (Europe). The primary issue concerned the meaning of Loss as defined by Sections 6(e) and 14 of the 1992 form of the ISDA Master Agreement. Given the Judge's observation that the ISDA Master Agreement is probably the most important standard market agreement used in the financial world, it is likely that the judgment will be of considerable interest to financial markets.

The claims involved two set of notes, with a principal value of approximately €780 million and €200 million and due to mature in 2017 and 2023 respectively, each issued by a single special purpose vehicle to a noteholder.

The notes had the benefit of principal protection provided by two derivative agreements, incorporating the 1992 ISDA Master Agreement and selecting the Second Method and Loss methodologies, whereby LBF granted cash settled put options to the issuers which ensured there would be sufficient funds to pay the noteholder at maturity not less than the original purchase price of the notes.

LBF suffered an event of default under the derivative agreements when on 15 September 2008 Lehman Brothers Holding Inc filed for bankruptcy protection in New York, resulting in automatic early termination of the derivative agreements. Thereafter, the issuers calculated their Loss, using market quotations for a replacement transaction, and claimed approximately US$61.5 million and €30 million respectively from LBF. LBF responded by denying those claims and claiming an entitlement to, or an amount equivalent to, approximately €43.74 million and €2.8 million respectively. This led to the commencement of the two claims against LBF.

Briggs J upheld the claimants' claims that they were entitled to determine their Loss under Section 6(e) of the derivative agreements by reference to the cost of a replacement transaction and rejected LBF's claim that it was entitled to claim the specified sums. Briggs J reached a number of general conclusions as to the legal principles applicable to Section 6(e) in the 1992 ISDA Master Agreement, including that the termination payment formulae under Section 6(e) are not in substance about the recovery of damages at common law for breach of contract; they provide a contractual formula for the determination by the non-defaulting party of a close-out payment where the derivative agreement terminates.

Recognising the complexity and importance of the matter, Briggs J granted LBF permission to appeal.

The judgment is here.

Mark Hapgood QC and Jasbir Dhillon appeared for Enasarco.