14/03/2013

Lehman Brothers International (Europe) (In Administration) v Lehman Brothers Finance SA

This is an important decision on the ISDA Master Agreement. It is the first case in which any court has had to consider the provisions of the 2002 version of the Master Agreement dealing with the close-out amount payable on early termination. In essence, what the Court of Appeal decided was that the 2002 form is significantly different from the 1992 version.

Very broadly speaking, under the ISDA Master Agreement, when a transaction is terminated early, a close-out payment is made under which one party pays the other the value of the terminated transaction as at the date of the early termination. The LBIE v LBF case came before the courts in the wake of a number of recent decisions dealing with the proper method of assessing that close-out payment under the 1992 form, including, most recently, the Court of Appeal’s decision last year in Lomas v JFB Firth Rixson.

In all of those cases, it was held that the assessment of the close-out payment had to be made on the basis of a ‘clean valuation’ – that is, on an assumption that the terminated transaction would have run to term, even if in fact that was unlikely to happen. The question is LBIE v LBF was whether the same assumption had to be made under the 2002 form. The judge at first instance, Briggs J, held that it did. The case concerned a portfolio of derivatives transactions between two Lehman companies, which had all been terminated automatically when the Lehman group failed in September 2008. Applying the ‘clean valuation’ principle, the judge held that, when assessing the close-out payment, the parties had to ignore any possibility that the transactions would have terminated early – even though in fact, under a side letter agreement that the parties had made, early termination was bound to occur.

The Court of Appeal held that this was mistaken. Under the 2002 form, the party charged with valuing the terminated transaction must assess its value taking into account, first, all the payments that would have been made if the transaction had run to term – but then also taking into account any term of the terminated transaction that might have resulted in the transaction terminating early. This is the diametrical opposite of the conclusion reached by the Court of Appeal with respect to the 1992 form in ANZ v Societe Generale and it shows that the two forms can give rise to very different results.

Members of Chambers: Iain MIlligan QC and Julian Kenny for the Appellants (instructed by Linklaters LLP)