Introduction
The issues concerning the interpretation and construction of Section 2(a)(iii) of the ISDA Master Agreement (the Master Agreement) which arose in Lomas v JFB Firth Rixson (see our briefing from December 2010) were re-considered by Briggs J in Lehman Brothers Special Financing Inc. v Carlton Communications Limited [2011] EWHC 718 (Ch). This note summarises the key areas for consideration by market participants.
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Alternative construction
Counsel for the claimant submitted that any construction of Section 2(a)(iii) which could permanently discharge the non-defaulting party from what would otherwise have been a payment obligation (whether immediately, or upon expiry of the agreement by effluxion of time (in other words, the suspended payment is no longer payable on the termination date of the swap transaction if the relevant event is still continuing at that time)) meant that Section 2(a)(iii) would be classified as a walk-away clause, contrary to the parties’ assumed intention. Counsel relied for his argument on the contention that the parties could not have intended the inclusion of “walk-away clauses” as they would have been aware that the capital adequacy requirements of most bank participants were such as to prohibit their inclusion. Briggs J rejected this argument on the grounds that it was by no means typical that both parties to a Master Agreement would be banks, let alone regulated banks. In a typical bank/customer swap transaction, it was unrealistic to suggest that non-bank customers as a class should be regarded as having the banks’ regulatory capital concerns as part of the background knowledge which was reasonably available for the purposes of construction. What Briggs J did not address in any detail, however, is whether he would find any differently in a scenario where both parties to the Master Agreement could be regarded as having such background knowledge (e.g. where both parties to the Master Agreement were banks).
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Anti-deprivation principle
Briggs J decided that the facts here were indistinguishable from those in Lomas v JFB Firth Rixson and therefore the anti-deprivation principle did not apply. The argument put forward by the claimant that Section 2(a)(iii) only operated on the last day of the transaction, with no continuing obligations on either side of the swap transactions after that date, did not change Briggs J’s view, as espoused in Lomas v JFB Firth Rixson, that the assets which the creditors had been deprived of were “flawed” due to the existence of the condition precedent in Section 2(a)(iii).
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Penalty
Despite spirited opposition from Counsel for the claimant, Briggs J maintained his position in Lomas v JFB Firth Rixson that Section 2(a)(iii) did not operate as a penalty where it was triggered by a bankruptcy Event of Default, as the event is not a breach of contract.
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Conclusion
Briggs J concluded that the claimant’s claim for payment which, but for the condition precedent in Section 2(a)(iii) of the Master Agreement would have been payable on the relevant date for payment, failed and had to be dismissed. This case and Lomas v JFB Firth Rixson, together with the recent case of Britannia Bulk plc (in liquidation) v Pioneer Navigation Limited and Ors [2011] EWHC 692 (Comm) shows that the courts are taking a consistent and fairly robust line in enforcing Section 2(a)(iii) generally in line with market expectations (although the question of whether suspended payments remain due after the termination date of a transaction remains subject to debate).
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