Lehman Brothers International (Europe) v Exxonmobil Financial Services BV

Contractual termination notices under standard-form financial contracts are governed by ordinary principles of construction. A notice must substantially comply with the contract and clearly convey the decision being taken, but need not identify facts or use prescribed words unless the contract makes that an indispensable condition.

Under the 2000 GMRA, the Appropriate Market is determined for securities of the relevant description on a security-by-security basis. A contractual valuation discretion is constrained by honesty, good faith and rationality, rather than an objectively reasonable outcome. Where the discretion was not exercised, the court asks what the decision-maker would have decided honestly and rationally within the contract.

LBIE and EMFS entered into a repo transaction documented by the 2000 GMRA. Following LBIE’s administration, EMFS served a Default Notice, liquidated much of the collateral and sent a Default Valuation Notice.

The dispute concerned the validity and timing of those notices, the meaning of “Appropriate Market” and “close of business”, and the valuation of securities where the contractual valuation procedure had not been validly completed. The court also had to determine the appropriate counterfactual valuation approach.

1. Default Notice. The communication of 15 September 2008 was a valid Default Notice. Paragraph 2(l) required the notice to convey that an event was being treated as an Event of Default, but did not require identification of the specific event or any particular form of words. The contrast with the expressly worded requirements for a Special Default Notice supported that construction: Rennie v Westbury Homes (Holdings) Ltd [2007] 2 P & C.R. 12 and [2007] EWCA Civ 1401.
2. Service and timing. Although the DVN was sent to a fax number different from that specified in Annex 1, LBIE waived the requirement by receiving and logging it, taking no objection for several years and pleading on the basis that it was effective. The fax was received by a responsible employee at about 6.02 pm on 22 September 2008. “Close of business” did not mean 5 pm; on the evidence it was about 7 pm for commercial banks in London. The DVN was therefore effective when received.
3. Appropriate Market. The GMRA did not permit EMFS to designate a single global or US market for the whole portfolio. “Securities of that description”, the requirement to return equivalent securities, and the use of the Appropriate Market for obtaining quotations all required a security-by-security analysis. The DVN was consequently in time for the North American securities and certain UK and Irish securities, but late for the remaining securities.
4. Contractual valuation discretion. The applicable test was rationality, not an objectively reasonable valuation. The decision-maker had to act honestly and in good faith, with a logical connection between the evidence and the decision, and without arbitrariness, capriciousness or perversity. Where no valuation decision had been made, the question was what EMFS would have decided honestly and rationally at the relevant time: Socimer International Bank Ltd v Standard Bank London Ltd [2008] EWCA Civ 116 and WestLB AG v Nomura Bank International plc [2012] EWCA Civ 495.
5. EMFS could not rely on the earlier sale prices for the Appendix 1 equities as their fair market value at the Default Valuation Time. However, on the counterfactual exercise, it would rationally have adopted the lower-bound valuation produced by the hedging-period methodology. It could also have adopted the refreshed quotations for the Appendix 2 bonds.
6. The 40 per cent discount applied to the Appendix 3 bonds was irrational. The inability to obtain bids justified a discount, but did not justify applying 40 per cent uniformly, particularly to high-quality bonds. EMFS’s contemporaneous internal valuation using a 20 per cent discount materially contradicted the DVN valuation. Those bonds therefore fell to be valued under the Default Valuation Time provisions.
7. The court determined the high-level principles and left the net principal sum, interest and legal expenses for consequential consideration.

First-instance decision of the High Court (Commercial Court). The judgment records no prior appellate decision in this litigation.