FML Timeline: Lehman Brothers Finance S.A. (in liquidation) (Claimant) v Sal. Oppenheim jr. & Cie. KGAA (Defendant)

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The parties entered into an ISDA Master Agreement and elected for the Market Quotation measure rather than the Loss Payment measure to apply in the event of a default.

On 15 September 2008, the Claimant defaulted due to Lehman Brothers Holdings Inc., the Claimant’s Credit Support Provider (as defined in the ISDA Master Agreement), entering Chapter 11 bankruptcy.

The Defendant, as the non-defaulting party, applied the Market Quotation payment measure and determined that the amount to be paid to the Claimant in respect of the outstanding transactions was €1,849,968.99. This was on the basis of quotations predating the default.

The Claimant claimed that the figure was wrongly calculated and was a substantial underpayment.

Decision

When should quotations be obtained?

Examining the language concerning the Market Quotation payment measure in the ISDA Master Agreement itself, the User Guide to the 1992 ISDA Master Agreements (1993 edition) and academic writings on the subject, the Court held that the Market Quotation measure should be the price of a replacement transaction “on or after the Early Termination Date, and certainly not before it.” On the basis that the requirement is for live quotations which are capable of being taken up, quotations cannot be backdated.

The Defendant attempted to justify quotations prior to the Early Termination Date on the basis of the “value clean principle” (Australia and New Zealand Banking Group Ltd v Societe Generale [2000] 1 All ER (Comm) 682). This principle holds that the existence of the termination event and the Early Termination Date must be disregarded when valuing a transaction. The Defendant sought to extent this principle by submitting that the transactions “be valued not only on the basis that the Event of Default and Termination have not occurred but on the basis that any effect on the market, if there has been any, should be disregarded or ruled out.”

This submission was rejected by the court for a variety of reasons, including: (1) that it is wholly contradictory to the language of the ISDA Master Agreement; (2) the Market Quotation measure puts the non-defaulting party back in the same position in any event, whether or not the market moves; and (3) the precise impact of the collapse of Lehman Brothers on the market was unascertainable.

What is a “commercially reasonable result”?

The court considered s.14 of the ISDA Master Agreement, which provides that even in circumstances where the parties have elected to use the Market Quotation measure, the Loss measure should be used if the Market Quotation measure “would not (in the reasonable belief of the party making the determination) produce a commercially reasonable result.”

The court held that the relevant test is not whether an alternative measure was reasonable, but rather whether complying with the agreed Market Quotation measure would be unreasonable in the circumstances.

Noteworthy/ Novel points

The High Court was asked to consider the definition of the Market Quotation payment measure contained in the ISDA Master Agreement. Under this payment measure, quotations for replacement transactions should be obtained as soon as reasonably practicable after the Early Termination Date (as defined in the ISDA Master Agreement). It is not possible to use quotations prior to the Early Termination Date.

In addition, even where parties elected that the Market Quotation measure applied, the ISDA Master Agreement permitted the Loss payment measure to be used in the event that the Market Quotation measure would not produce a commercially reasonable result. The court held that the correct test was not that the Loss measure was reasonable but rather that the Market Quotation measure was unreasonable.