Lehman Brothers Finance AG v Klaus Tschira Stiftung GmbH & Anor

Under the 1992 ISDA Master Agreement, the non-defaulting party has flexibility to choose a method for determining Loss, but the method must be reasonable, rational and used in good faith. The party remains bound by the contractual meaning of Loss and cannot redefine the recoverable loss for itself.

Loss generally concerns the clean value of the terminated transaction, assessed by reference to a collateralised replacement transaction where collateral formed part of the transaction’s conditions. A later valuation date may be permissible in limited circumstances, but the resulting valuation must remain a rational measure of the loss of bargain. A hypothetical uncollateralised replacement transaction which could not realistically have been entered into does not provide a valid measure.

The claimant, Lehman Brothers Finance AG, challenged the defendants’ determination of Loss following automatic early termination of four collateralised equity derivative transactions under 1992 ISDA Master Agreements.

The defendants claimed €411.13 million, relying on indicative valuations of uncollateralised replacement transactions assessed as at 16 October 2008, after the collapse of Lehman Brothers and the delayed recovery of collateral held by Lehman Brothers International Europe.

The issues were whether the selected date and methodology complied with the contractual definition of Loss, whether the defendants’ determination was rational, and what amount would have resulted from a valid determination.

1. The Loss Calculation was invalid. The defendants’ determination was not made in accordance with the close-out provisions of the Master Agreements and was not binding on LBF.
2. The 1992 ISDA Master Agreement gives the non-defaulting party discretion and flexibility to choose a methodology for calculating Loss. That discretion is subject to rationality, good faith and the contractual limits of the Loss definition. The determining party cannot decide for itself what losses and costs the contract permits it to include.
3. The reference to determining Loss as at the Early Termination Date, or as soon thereafter as reasonably practicable, allows limited flexibility. A later valuation date may be used where, for example, the termination was discovered later or no replacement market was available earlier. The flexibility does not permit an abuse of the provision or an assessment unrelated to the contractual loss of bargain.
4. The common-law compensatory principle and rules of remoteness illuminate the meaning of Loss. The definition does not create an unrestricted indemnity for every financial consequence of termination. The additional cost said to result from inability to recover collateral from LBIE was a different type of loss, outside the parties’ reasonable contemplation, and was not recoverable.
5. The clean valuation principle required the terminated transactions to be valued on the assumption that contractual conditions, including the provision of collateral, continued to be satisfied. An uncollateralised replacement transaction would materially alter the risk and pricing of the original transactions. It was also irrational to rely on a transaction which the defendants could not realistically have entered into.
6. The Mediobanca and Goldman Sachs valuations obtained shortly after the Early Termination Date were collateralised valuations and could properly be used. Averaging the two valuations produced an aggregate Loss of €22.84 million before crediting the €100 million Independent Amount, resulting in a net figure of minus €77.16 million.

Not stated in the judgment.