High Court Confirms Objective Standard Of Reasonableness In The Determination Of The Close-Out Amount Under The 2002 ISDA Master Agreement

In Lehman Brothers Special Financing Inc. v National Power Corporation and another [2018] EWHC 487 (Comm), the High Court ruled that the requirement to use "commercially reasonable procedures" to produce a "commercially reasonable result" in determining the Close-out Amount under the 2002 ISDA Master Agreement was to be assessed by reference to an "objective" standard of reasonableness. This decision emphasises the need for close scrutiny of the exact contractual wording in question in determining the ambit of any contractual discretion.

THE TRANSACTION

National Power Corporation (NPC) entered into a US dollar/Philippine peso forward currency swap with Lehman Brothers Special Financing Inc. (LBSF) (the Transaction) as part of a currency hedging strategy in connection with its issuance of certain US$ denominated bonds. A fixed rate premium was payable semi-annually by NPC to LBSF. The Transaction also included an option for NPC to extinguish the forward payment obligations arising in 2028 (the Option). The Transaction was made under a standard form 2002 ISDA Master Agreement (2002 ISDA MA).1

LBSF'S DEFAULT

With the collapse of Lehman Brothers in September 2008, LBSF filed for Chapter 11 bankruptcy relief in the United States on 3 October 2008, which constituted various events of default under the Transaction. NPC therefore served notice of early termination of the Transaction on 17 October 2008, designating an "Early Termination Date" of 3 November 2008.

It was common ground that it was then for NPC, as the non-defaulting party, to determine the Close-out Amount payable, and to do so using "commercially reasonable procedures in order to produce a commercially reasonable result".

NPC'S DETERMINATION OF THE CLOSE-OUT AMOUNT

On the Early Termination Date, NPC sought and obtained three indicative2 quotations for a replacement transaction from global investment banks. On 7 November 2008, NPC sought and obtained firm quotations from the same dealers and, on 14 November 2008, entered into a replacement transaction with the dealer offering the most favourable terms (the Replacement Transaction).

On 26 January 2009, NPC demanded US$3,461,590.93 from LBSF, which was based on the cost of the Replacement Transaction. LBSF contended that commercially reasonable procedures were not used to arrive at this figure and that it was not a commercially reasonable result. Instead, it contended that NPC owed LBSF US$12,826,887.

However, on 27 October 2016, by which time the proceedings in question had already been commenced, NPC served what it termed a "revised calculation statement" on LBSF, demanding from it a higher figure of US$10,778,943.12, based on the three indicative quotations it had received on the Early Termination Date.

NPC argued that its initial determination based on the Replacement Transaction had not accorded with the definition of Close-out Amount, since (among other things) it had failed to...