This judgement is important for participants in the structured products and derivatives markets and involves calculation of loss under the 1992 ISDA Master Agreement (the ’Agreement’).
The Claimant, an Italian pension fund, had invested in a structured product devised by Lehman. The details involved notes issued by an SPV (ARIC) the proceeds of which were indirectly invested in a managed pool of funds. The claimant also secured capital protection from Lehman which was documented under the Agreement. In September 2008 Lehman collapsed, the Derivative Agreement was terminated, and the claimant sought capital protection elsewhere, eventually securing this from Credit Suisse in May 2009. Due to general market turmoil, this transaction included terms which were different in a number of respects from the original agreement with Lehman.
This original agreement provided for calculation of a payment upon early automatic termination. The payment was to be the non-defaulting party’s (ARIC) loss, “loss” to be defined as the “amount that party reasonably determines in good faith to be its total losses and costs” and at the termination date or at “the earliest date thereafter as is reasonably practicable“. ARIC used the price for the replacement transaction as the basis for its calculation of loss and made a claim of $61m from Lehman in September 2009. Lehman countered that ARIC was only due $42m and that the loss had not been correctly calculated in accordance with the original terms :- May 2009 was not the earliest reasonable practicable date to assess loss, the Credit Suisse option was too different to the original option and so its price should not be used to assess the loss, the September 2009 calculation date was not “as soon as reasonably practicable” after the early termination date.
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The court found that the loss had been calculated reasonably and in good faith. Although conceding that the calculation statement ought to have been produced before September 2009, this had not affected the validity of the calculation.
The case is of wider interest because of the method of calculation of losses under a 1992 ISDA Master Agreement. First, the Judge used the “Wednesbury” test (cf Associated Provincial Picture House Ltd v Wednesbury Corporation [1948] 1KB 223) to decide whether the loss had been reasonably assessed. This is a test of rationality which requires only that the non-defaulting party does not take into account matters irrelevant to the calculation itself (and does take into account all matters that are relevant) and must not arrive at a conclusion which no reasonable non-defaulting party could reach. Notably, the test does not require the non-defaulting party to arrive at the most reasonable result, as it would in a negligence claim.
Secondly, he found that ARIC was entitled to calculate its loss with reference to the replacement security provided by Credit Suisse. Loss of bargain was more appropriately worked out with references to actual market quotations rather than financial models, even if the quotations were on slightly different terms to the original agreement.
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Link: Fondazione Enasarco v Lehman Bros Finance SA EWHC Ch [2015] 1307
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