Lomas (Together the Joint Administrators of Lehman Brothers International (Europe)) v JFB Firth Rixson Inc & Ors

Under the ISDA Master Agreement, section 2(a)(iii) suspends a payment obligation while the counterparty’s Event of Default continues; it does not permanently extinguish it. A suspended obligation does not, however, survive the natural expiry of the relevant transaction if the condition remains unsatisfied.

No term should be implied requiring the non-defaulting party to elect for Early Termination within a reasonable time, or at the transaction’s expiry. The election is exercisable in that party’s own interests. In the context of these net-basis interest-rate hedges, the condition precedent did not infringe the anti-deprivation rule. It was neither a penalty nor a forfeiture from which relief was available.

The joint administrators of Lehman Brothers International (Europe) sought directions concerning five interest-rate swaps governed by the 1992 or 2002 ISDA Master Agreement. After the company entered administration, its counterparties relied on section 2(a)(iii), which made their payment obligations conditional on there being no continuing Event of Default affecting the other party.

The administrators contended that the condition should operate only temporarily, that the counterparties should have terminated the swaps, and that the resulting non-payment offended the anti-deprivation rule, was a penalty, or was a forfeiture. The counterparties and the intervening International Swaps and Derivatives Association advanced competing constructions. The central issue was the effect and duration of the section 2(a)(iii) condition precedent.

1. The administrators’ construction, anti-deprivation, penalty and forfeiture arguments were rejected. Directions were given substantially in favour of the respondent counterparties.

2. Under the 1992 Master Agreement, a payment obligation prevented from falling due by section 2(a)(iii) is suspended, rather than permanently destroyed. If the relevant default is later cured, the obligation may arise. The same result was express under the 2002 form because of section 9(h)(i)(3). However, where the condition remains unsatisfied at the natural expiry of a transaction, section 9(c) means that the suspended obligation does not survive that expiry.

3. There was no basis for implying a reasonable time limit on section 2(a)(iii), a compulsory netting process at expiry, or a duty to designate an Early Termination Date. Those implications conflicted with the express scheme. Section 6(a) gave the non-defaulting party a contractual choice between remedies, exercisable in its own interests. The respondents’ decisions not to terminate were neither dishonest nor irrational.

4. Section 2(a)(iii), as incorporated into these net-basis interest-rate swaps, did not contravene the anti-deprivation rule. The contingent rights to future net payments were consideration for an ongoing hedge, not payment for performance completed before insolvency. An insolvency-related condition could therefore qualify those future rights from the outset without removing property that insolvency law required to be distributed pari passu. This conclusion was confined to the transactions considered and depended on the parties’ net-basis convention.

5. The penalty doctrine did not apply because entry into administration was not a breach of contract. Nor was section 2(a)(iii) a forfeiture: the relevant contingent contractual right to money was not property for which relief from forfeiture was available, and the clause was a condition precedent.

6. On the parties’ agreed net basis, the respondents had no present provable claim because LBIE was net in the money. The court made no decision on whether the condition precedent could be unilaterally waived.

not stated in the judgment.