Anthracite Rated Investments (Jersey) Ltd v Lehman Brothers Finance SA

Automatic termination of an ISDA derivative agreement may constitute an early-redemption event in a structured investment, even where termination follows the counterparty’s default. The agreement’s wording must be construed in the context and commercial purpose of the structure as a whole, but the court cannot rewrite a carefully drafted scheme merely because its consequences appear rigid or unfair. Once the derivative agreement has terminated, a later mandatory-termination regime cannot generate a second termination or an additional contractual payment. Close-out loss under the 1992 ISDA Master Agreement is assessed using the contractual methodology, ordinarily on a clean valuation basis. The non-defaulting party may use the cost of a replacement transaction where that method is reasonable; subsequent arrangements between the issuer and investors are generally irrelevant to the contractual loss calculation.

Two related Part 8 claims concerned structured investment products issued by special purpose vehicles and supported by principal-protection put options granted by Lehman Brothers Finance SA, guaranteed by Lehman Brothers Holdings Inc. The relevant documents incorporated the 1992 ISDA Master Agreement.

Following Holdings’ Chapter 11 filing, automatic early termination occurred under the derivative agreements. The issuers claimed close-out loss calculated by reference to replacement transactions. LBF claimed entitlement to contractual early-termination compensation, or alternatively argued that the issuers’ loss calculation was unreasonable.

The court had to determine whether automatic termination triggered early redemption of the notes or bonds, whether a subsequent mandatory early-termination date and ETCSA arose, and how loss under the ISDA provisions should be calculated.

1. Early redemption. The phrase in Final Term 19 that the Principal Protection Agreement was terminated “in whole for any reason” included automatic termination caused by LBF’s default. The absence of a determination by the Calculation Agent did not prevent the contractual machinery from operating. The court could perform a necessary third-party function where the machinery had broken down: see Sudbrook Trading Estate Ltd v Eggleton [1983] 1 AC 444.
2. The passive wording “is terminated” did not restrict the provision to termination by notice. The documents used active and passive terminology inconsistently. The commercial purpose of the structure supported an automatic winding-up where principal protection had failed. The apparent conflict with the security priority provisions was resolved by reading the relevant provision subject to any priority flip following LBF’s default.
3. No ETCSA. Automatic Early Termination had already ended each derivative agreement. There could not be two successive terminations of the same agreement. Section 6(c)(ii) preserved provisions surviving termination, such as accrued premium, but not a payment triggered by a later termination which necessarily assumed that the agreement remained in existence. LBF therefore had no contractual entitlement to the ETCSA.
4. The issuer, investor and trustee were at liberty, subject to LBF’s security rights, to rearrange their affairs so that an early-redemption event did not result in actual redemption. The arrangements made in both structures did not invalidate the transactions or prejudice LBF’s security rights on the facts.
5. Close-out loss. Section 6(e) and the definition of Loss required a contractual close-out calculation, not ordinary damages for breach. The authorities supported a clean valuation of the lost transaction, assuming performance to maturity, and permitted replacement-transaction quotations where reasonable. The issuers’ calculations were not shown to be unreasonable. The ETCSA was directed to LBF’s loss on a different termination mechanism and was irrelevant to the issuers’ Loss.
6. Judgment was therefore given in accordance with the answers to the agreed issues: automatic termination triggered an early-redemption event, no mandatory early-termination date occurred, LBF was not entitled to the ETCSA, and the issuers’ replacement-transaction loss methodology was not unreasonable.