In this case, two Lehman subsidiaries traded with each other in derivatives on an ISDA Master Agreement, which included the close-out provisions of the 2002 form. Following the Lehman insolvency, all their transactions were terminated early and various issues arose as to how the close-out amount payable should be calculated.
In particular, there was an issue about the treatment of a side letter agreement which provided that in certain circumstances (which had not arisen), their transactions would terminate early and a special close-out amount would be paid. The Court was asked to decide whether the value of this side letter could be taken into account when calculating the close-out amount payable on the early termination that had occurred.
Briggs J held that the side letter was part of the terms of the Master Agreement, but it was not a term which could be taken into account for the purposes of close-out provisions. That, he said, was because the case-law had established that under the ISDA Master Agreement, the terminated transaction had to be ‘valued clean’. That meant that the calculation of the close-out amount had to be made on a ‘continuity assumption’ – i.e. an assumption that the original transaction would have continued for its full term and that there was no possibility of its terminating early.
This decision casts a controversial new light on the construction of the close-out provisions in the ISDA Master Agreement and on the question of what it means to ‘value clean’. It therefore forms an interesting but surprising companion piece to the Court of Appeal’s recent decision in Firth Rixson.