Lehman Brothers Special Financing Inc v National Power Corporation and another  EWHC 487 (Comm) (12 March 2018): Can calculation statements under the 2002 ISDA Master Agreement be withdrawn and replaced once served?
- NPC was not entitled to replace its original determination of a Close-out Amount due under Section 6(e) of a 2002 ISDA Master Agreement which it had made in error.
- Where a manifest numerical or mathematical error has been made, correction would need to be made by way of mutual agreement or in some cases by court or tribunal rather than a fresh determination.
- There may be a basis for replacing an original determination where it was not a determination within the meaning of the Agreement. In the context of the 2002 ISDA Master Agreement, the test for this will be whether the requirement for using "commercially reasonable procedures in order to produce a commercially reasonable result" in respect of the Close-out Amount was complied with.
- The Close-out Amount determined on the basis of a replacement transaction satisfied the "commercially reasonable" requirement of the definition of Close-out Amount. The use of an indicative quotation when a firm quotation and actual transaction were shortly to be available would not have satisfied such a requirement. As such the original determination of the Close-out Amount had been made validly.
- Lehman Brothers Special Financing Inc. ("LBSF") and National Power Corporation ("NPC") had entered into a forward currency swap under a 2002 ISDA Master Agreement (the "Agreement"), whereby LBSF agreed to pay US$100 million to NPC in 2028 whilst NPC had to pay the US dollar equivalent of an amount in Philippine Pesos. Further NPC agreed to pay semi-annual coupons to LBSF at a fixed rate.
- An option was granted by LBSF to NPC under which NPC could choose to prepay US$1 million on 15 May 2008 instead of paying the US dollar equivalent of the specified Philippine Peso amount.
- After Lehman Brothers group collapsed in 2008, LBSF filed for bankruptcy, constituting an Event of Default under the 2002 ISDA Master Agreement and NPC served a notice on LBSF on 17 October 2008 designating an Early Termination Date of 3 November 2008 (the "ETD Letter").
- As Determining Party, NPC was required to determine the Close-out Amount under the Agreement using "commercially reasonable procedures in order to produce a commercially reasonable result" and sought on two occasions three third-party quotations for replacement transactions. On 3 November 2008 NPC received indicative quotations and on 7 November 2008 it received firm quotations. On 14 November 2014 NPC then entered into a replacement swap with UBS (the "UBS Replacement Swap").
- NPC calculated the Close-out Amount based on the cost of the UBS Replacement Swap, resulting in an amount payable by LBSF of around US$3.5 million (the "Original Determination"), which did not include an accrued amount representing a sum due to LBSF under the LBSF transaction from 15 May 2008 to 15 November 2008, which had accrued prior to the effective date of the UBS transaction (the "Accrued Amount"). NPC demanded such payment by LBSF on 26 January 2009, enclosing its calculations by way of an annex (the "Calculation Statement Letter").
- The Original Determination was challenged by LBSF which commenced legal proceedings against NPC based on mark-to-market valuations provided by LBSF from July and September 2008 which showed that NPC was out-of-the money.
- NPC then purported to withdraw the Original Determination and to replace it with a new determination dated 27 October 2016 (the "Replacement Determination") which included a "Primary Determination" of around US$10.8 million and an "Alternative Determination" of around US$2.1 million, both in NPC's favour.
- Whilst the "Primary Determination" was based on the indicative quotations by UBS for the replacement swap (which did not include a prepayment option), the "Alternative Determination" was based on the actual UBS Replacement Swap (which did include a prepayment option despite the fact that NPC's prepayment option in the LBSF transaction had already expired in 2008) but deducted the Accrued Amount.
The parties' views
- NPC argued, in summary, that:
- since the Original Determination did not account for the Accrued Amount, it was not calculated in accordance with the requirements of the Agreement and as such was invalid and not contractually binding as between the parties;
- the availability of an indicative quotation on 3 November 2008 made it commercially reasonable to determine the Close-out Amount as of that date instead of 7 November 2008; and
- the calculations described in the Calculation Statement Letter were not in accordance with the requirements of the Agreement and the determination of Close-out Amount by 26 January 2009 was invalid and not contractually binding as between the parties; it was only by making the later Replacement Determination and serving the revised calculation statement that it had complied with its obligation under Section 6 of the Agreement to make a valid and binding determination of the Close-out Amount.
- LBSF argued, in summary, that Section 6(d)(i) of the 2002 ISDA Master Agreement did not entitle NPC to withdraw and replace a determination once served without LBSF's consent. The natural meaning of the language of the Section suggested that such a statement would be provided only once.
The Court's decision
Robin Knowles J also drew attention to the Court of Appeal's findings in the case of Videocon Global Ltd v Goldman Sachs International  EWCA Civ 130,  2 All ER (Comm) 800 that the service of a notice designating an Early Termination Date and a calculation statement setting out the amount payable in respect thereof both give rise to legal obligations. The debt obligation in respect of an Early Termination Date "arises, or accrues due on, or as at" the Early Termination Date, and that the obligation to pay the relevant amount arises on the day on which notice of the amount payable, given in a manner described in Section 12 to the address or number provided in the Schedule, will be deemed effective in accordance with Section 12. Such obligations were therefore not reversible except by mutual agreement or in some cases by order of a court or tribunal.
Robin Knowles J noted that there were some circumstances in which the determination of an Early Termination Amount could be replaced by a subsequent determination. Where a determination was made that was not a determination within the meaning of the ISDA Master Agreement (for example, because it was based on a misinterpretation of the Agreement), a later determination provided by a party within the meaning of the ISDA Master Agreement could be said to be the first such determination.
However, he cautioned that a repeated remittance back to the Determining Party to make a compliant determination could not be the approach objectively intended under the ISDA Master Agreement. Additionally, the case of manifest numerical or mathematical error would require correction by way of mutual agreement or in some cases by court or tribunal rather than a fresh determination.
In light of the above, the Court approached the question of whether the determination under the Calculation Statement Letter was capable of being corrected by analysing the following factors: (a) whether the Accrued Amount should have been taken into account and (b) whether the requirement for "commercially reasonable procedures in order to produce a commercially reasonable result" was complied with, as required under the Agreement.
(a) The Accrued Amount
The parties did not dispute that the Accrued Amount should have been taken into account however Robin Knowles J found that the determination set out in the Original Determination was a valid determination for the purposes of the ISDA Master Agreement nonetheless. Robin Knowles J also disagreed with NPC's assertion that that its failure to take into account the Accrued Amount was a manifest error entitling it to make a fresh determination. He found that this was the type of error that could only be corrected by agreement between the parties or by court or tribunal and only in respect of which there was an error. As such, NPC's Replacement Determination would only be validly served if the second argument in (b) could demonstrate that the Original Determination was invalid.
(b) "Commercially reasonable"
The Court considered the question of whether the requirement to use "commercially reasonable procedures in order to produce a commercially reasonable result", as required by definition of Close-out Amount in the 2002 ISDA Master Agreement, was complied with.
The Court interpreted the above phrase as requiring the Determining Party to adhere to an objective standard of reasonableness. In comparison, the equivalent wording as set out in the definition of "Loss" in the 1992 ISDA Master Agreement, "an amount that party reasonably determines in good faith to be its total losses and costs" produced a different and lower standard of reasonableness, often referred to as "Wednesbury"8 reasonableness, and would require a rational decision with reference to the relevant decision maker i.e. a subjective standard. Additionally, the supporting user's guide for the 2002 ISDA Master Agreement explains that the change to the wording was specifically designed to achieve greater objectivity compared to the 1992 ISDA Master Agreement.
In considering the sequential indicative and firm quotations obtained by NPC, Robin Knowles J noted that NPC had intended to enter into a replacement transaction:
"NPC proposed to enter into a transaction and for that purpose would and did seek firm quotations a short while later. The indicative quotations were preparatory to that."
"Where a firm quotation existed from UBS it was appropriate to regard that as having superseded the indicative quotation from UBS."
Taking the foregoing into consideration, Robin Knowles J found that the Original Determination did satisfy the "commercially reasonable" requirement and as such was a valid determination for the purposes of the ISDA Master Agreement. As such, for the Replacement Determination to be valid, the consent of the parties would be required or otherwise the decision of a court or tribunal.
(c) Evidential value of a revised calculation statement
Robin Knowles J also noted that whilst the Replacement Determination could not substitute the Original Determination, it would nevertheless provide evidence for a commercially reasonable determination.
THE DELTA REPORT
8 — Associated Provincial Picture Houses Ltd v Wednesbury Corporation (1948) 1 KB 223
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