Lomas and Others v JFB Firth Rixson Inc. and Others (International Swaps and Derivatives Association intervening)
| Jurisdiction | England & Wales |
| Judge | Lord Justice Longmore |
| Judgment Date | 03 April 2012 |
| Neutral Citation | [2012] EWCA Civ 419 |
| Docket Number | Case No: A2/2011/0070, A2/2011/0070(A), A3/2011/1107, A3/2011/2106 & A2/2011/1059 |
| Court | Court of Appeal (Civil Division) |
| Date | 03 April 2012 |
and
and
The Right Honourable Lord Justice Longmore
The Right Honourable Lord Justice Patten
and
The Right Honourable Lord Justice Tomlinson
Case No: A2/2011/0070, A2/2011/0070(A), A3/2011/1107, A3/2011/2106 & A2/2011/1059
A2/2011/0070(A) & A2/2011/0070
A2/2011/1059
A3/2011/2106
A3/2011/1107
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION (COMPANIES COURT)
IN THE MATTER OF LEHMAN BROTHERS INTERNATIONAL (EUROPE) (IN ADMINISTRATION)
IN THE MATTER OF THE INSOLVENCY ACT 1986 &
ON APPEAL FROM THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
COMMERCIAL COURT
THE HONOURABLE MR JUSTICE BRIGGS & THE HONOURABLE MR JUSTICE FLAUX
[2010]EWHC 3372 (Ch) , [2011] EWHC 718 (Ch), [2011] EWHC 1692 (Comm) & [2011] EWHC 692 (Comm)
Royal Courts of Justice
Strand, London, WC2A 2LL
Mr William Trower QC & Mr Daniel Bayfield (instructed by Linklaters LLP) for the Appellants
Mr Mark Hapgood QC & Mr Henry Forbes Smith (instructed by MacFarlanes LLP) for the first and second Respondents, Mr Robin Dicker QC & Ms Joanna Perkins (instructed by Clifford Chance) for the Third Respondents, Mr Richard Fisher (instructed by Freshfields Bruckhaus Deringer) for the fourth Respondents
Mr Antony Zacaroli QC & Mr Jeremy Goldring (instructed by Allen & Overy LLP) for the Intervener
Mr Jonathan Nash QC (instructed by Weil Gotshal & Manges) for the Appellants
Ms Felicity Toube QC (instructed by Hogan Lovells International LLP) for the Respondent
Mr Antony Zacaroli QC & Mr Jeremy Goldring (instructed by Allen & Overy LLP) for the Intervener
Mr Charles Kimmins QC & Mr Luke Pearce (instructed by Herbert Smith LLP) for the Appellant
Mr Richard Jacobs QC & Mr Siddharth Dhar (instructed by Thomas Cooper) for the Respondent
Mr James Willan (instructed by Berwin Leighton Paisner LLP) for the Appellant
Mr Mark Phillips QC & Mr Stephen Robins (instructed by Watson Farley & Williams LLP) for the Respondent
Hearing date: 14 th, 15 th, 16 th, 19 th & 20 th December 2011
Approved Judgment
Introduction:
This is the judgment of the Court, to which all members have made a substantial contribution.
These 4 appeals, two from Briggs J and two from Flaux J, were listed for hearing together and raise a number of questions of construction in relation to derivatives in the form of interest rate swaps and forward freight agreements on the International Swaps and Derivatives Association Inc (formerly the International Swaps Dealers Association Inc.) ("ISDA") form of Master Agreement which was published in 1992 and again in 2002 ("the Master Agreement"). Derivatives have come to occupy the time of many Chancery and Commercial judges and it is necessary to understand what they are. Mr Simon Firth of Linklaters has published an important monograph on the topic which (while we have to bear in mind that Linklaters are the solicitors of the first appellants in these cases) we have found most useful in wrestling with the questions of construction which need to be decided for the purposes of these appeals. He defines a derivative as (para 1–004):—
"a transaction under which the future obligations of one or more of the parties are linked in some specified way to another asset or index, whether involving the delivery of the asset or the payment of an amount calculated by reference to its value or the value of the index. The transaction is therefore treated as having a value which is separate (although derived) from the values of the underlying asset or index. As a result, the parties' rights and obligations under the transaction can be treated as if they constituted a separate asset and are typically traded accordingly."
Although derivatives can be quite complex, the theory behind the ones in issue in these cases is simple. Under the interest rate swaps, one party is to pay a floating rate of interest on a notional sum (notional because there is no actual loan) over a period of ( say) 6 months. The other party is to pay a fixed rate of interest on the same notional sum over the same period. At the end of each six month period two calculations are done and one party will be "in the money" and the other "out of the money". That latter party will then pay the other the difference. This contract can be used as a pure speculation or (as in the present cases) be used as a hedge if one of the parties has a long term loan on interest.
Similarly the form of a forward freight agreement ("FFA") is that one party agrees to pay a fixed rate of notional freight while the other party agrees to pay a rate derived from an index published (normally) by the Baltic Exchange. The difference at the end of a set period is then payable by one to the other depending on the movement of the index as compared with the fixed rate. This can also be used by parties to protect themselves against fluctuation in shipping rates or as a means of trading in futures.
The first question which arises in the first three appeals is whether obligations to make payments pursuant to the agreements subsist after the party to whom payment is due has committed an Event of Default and, if so, for how long. The Master Agreement records that the parties have (or will have) entered into one or more Transactions governed by the Master Agreement and a "Confirmation" confirming the Transactions. There is set out in section 2(a)(i) of the Master Agreement an obligation on each party to make the payment specified in the Confirmation, followed by provisions in section 2(a)(ii) that such payment is to be made on the due date in the place specified in the Confirmation. Section 2(a)(iii) then provides as follows:—
"Each obligation of each party under Section 2(a)(i) is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing …"
In broad terms the dispute is whether, when there is a Event of Default on the part of the party due to receive a payment, there is any obligation at all on the counterparty to make a payment and, if so, whether such obligation is initially suspended but then disappears or revives (and, if so, the point at which it disappears or revives) or remains in suspense indefinitely.
These issues are determinative of the first appeal which is confined to questions of construction (including implied terms) relating to Section 2 of the Master Agreement. In the second appeal ("Carlton") the claimant also relies on an argument that the operation of Section 2(a)(iii) engages the anti-deprivation principle recently considered by the Supreme Court in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Securities Ltd [2011] UKSC 38; [2011] Bus. L.R. 1266.
The issue which arises in the third appeal also raises a question of construction concerning the rights of the parties in the event of Termination following an Event of Default. The Master Agreement will typically or often comprise a number of individual transactions which by Section 1(c) of the Master Agreement are deemed to form a single agreement. The Master Agreement gives to the Non-defaulting Party a right to terminate in certain circumstances consequent upon an Event of Default and the parties may opt for Automatic Early Termination ("AET") upon the occurrence of certain "Bankruptcy Events of Default". In the event of Termination the Master Agreement prescribes a regime of "close-out netting". The issue which arises on the third appeal is whether obligations which have arisen or would but for Section 2(a)(iii) have arisen under individual transactions whose natural term has expired prior to the occurrence of AET affecting the single agreement as a whole are subject to close-out netting. As will be seen that issue is in our view concluded by resolution of the issues determinative of the first appeal.
The fourth appeal raises a distinct point concerning the operation of the close-out netting provisions consequent upon AET. It concerns the question whether, in certain circumstances, the close-out netting provisions require an assumption to be made that the Defaulting Party would in fact have satisfied the conditions precedent to its entitlement to receive payment from the Non-defaulting Party.
The outline facts of the First Appeal
The problem has arisen in the Lehman Brothers administration. One of the Lehman companies, Lehman Brothers International (Europe) ("LBIE"), was a party to numerous interest rate swap Transactions and went into administration on 15 thSeptember 2008. That constituted an Event of Default under each of the agreements for the Transactions; to the extent that the counterparties owed any sums to LBIE on and after that date pursuant to such agreements, the obligation to make any payments either did not come into existence or ceased to exist or was suspended for the duration of the event of default which has continued while the administration is progressing. In the first of the cases under appeal the administrators wish to collect the sums purportedly owed to LBIE pursuant to 5 transactions made with
i) JFB Firth Rixson Inc ("JFB");
ii) FR Acquisitions Corporation (Europe) Ltd ("FRAC");...
To continue reading
Request your trial
-
Monde Petroleum SA v Westernzagros Ltd
...or irrational manner 264 It may fairly be said that the facts of each of these cases are different in some respects from the present. Lomas and Greenclose were concerned with derivative contracts, which it could be argued are in a special category (though it should be noted that an ISDA Mas......
-
Belmont Park Investments Pty Ltd and Others v BNY Corporate Trustee Services Ltd and another (HM Revenue and Customs and another intervening)
... ... and Lehman Brothers Special Financing Inc (Appellant) [2011] UKSC 38 ... (Instructed by Hogan Lovells International LLP) ... Intervener (The Commissioners for Her ... Intervener (The Football Association Premier League Limited) ... Gabriel Moss QC ... In Lomas v JFB Firth Rixson Inc [2010] EWHC 3372 (Ch) ... of litigation relating to interest rate swaps, seems to have taken a similar view in Lomas v ... Rixson Inc (International Swaps and Derivatives Association Inc Intervening) [2010] EWHC 3372 ... ...
-
Pioneer Freight Futures Company Ltd v TMT Asia Ltd [QBD (Comm)]
... ... , following the decision of Briggs J in Lomas v JFB Firth Rixson [2010] EWHC 3372 (Ch) (" ... were fixed and floating interest rate swaps, all parties to the agreements invited the Court ... decision had received in Henderson on Derivatives, a textbook by Schuyler K Henderson, an eminent ... ...
-
Mayhew v King
... ... Handed Down Judgment of WordWave International Limited A Merrill Communications Company 190 ... inspired by observations of Briggs J in Lomas and Others v. JFB Firth Rixson, Inc and Others ... ...
-
High Court Finds No Continuing Event Of Default Under ISDA Master Agreements Once Administration Of Counterparty Terminates
...The court highlighted that, as per Pioneer Freight Futures Co Ltd v TMT Asia Ltd [2011] EWHC 778 (Comm) and Lomas v Firth Rixson Inc [2012] 1 CLC 713, the commercial function or purpose of the condition precedent to payment as set out in Section 2(a)(iii) is to mitigate counterparty credit ......
-
No implied duty of good faith in termination clause
...exercise of such a right are met, the party exercising that right does not have to justify its actions. In Lomas v JB Firth Rixson Inc [2012] EWCA Civ 419 the Court of Appeal characterised as “hopeless” the argument that a Non‑Defaulting Party’s express right under the ISDA Master Agreement......
-
BLG Monthly Update - June 2012
...50, which opted for the contextual approach, as informed by business common sense. But, on the facts of Lomas v JFB Firth Rixson Inc, [2012] EWCA Civ 419, the literal approach seems to make But first, a little Derivatives 101. Under an interest rate swap, one party pays a floating rate of i......
-
Proposals To Suspend Swap Termination Payments!
...suspend payments when the defaulting party is insolvent (see Section 2(a)(iii) and Lomas and others v JFB Firth Rixson Inc and others [2012] EWCA Civ 419 (3 April If the suspension period suggested in the letter were to be incorporated into the ISDA documentation, one of the issues that cou......
-
The treatment of ipso facto clauses in Canada.
...(223) See Wood, Bankruptcy, supra note 27 at 55; BIA, supra note 1, ss 2, 121. (224) See Belmont, supra note 4 at paras 100-101. (225) [2012] EWCA Civ 419, [2012] 1 CLC (226) See ibid at paras 88-92 where Lord Justice Longmore of the Court of Appeal refers to a quid pro quo test, which was ......
-
Contract Interpretation Regimes
...(1994) 13 Int’l FinL Rev 18, 18.76 ibid (‘permit the market to negotiate in a common language’).77 Lomas vJFB Firth Rixson Inc [2012] EWCA Civ 419.78 The ISDA participates with amicus briefs in a number of cases, see https://www2.isda.org/functional-areas/legal-and-documentation/amicus-brie......