Firth Rixson application (judgment of Hildyard J)

The court was asked to direct the construction and effect of Section 2(a)(iii) and related provisions (Sections 5 and 6) of the 1992 and 2002 ISDA Master Agreements, in particular whether various Events of Default in respect of Lehman Brothers International (Europe) (in administration) remained "continuing" so as to permit the non-defaulting counterparties, FR Acquisitions Corporation (Europe) Ltd and JFB Firth Rixson Inc, to suspend payment obligations. The judge held that the correct inquiry is whether the event or state of affairs giving rise to the Event of Default continues to subsist, not whether consequential legal effects on third parties or creditors continue.

Applying that test, the court concluded that:

• the payment-default Events of Default under Section 5(a)(i) in respect of the Sterling Swap ceased to be continuing by operation of insolvency set-off on 2 December 2009;
• an admission in writing of inability to pay is not a one-off event and should be corrected; the Administrators were directed to publish a notice that LBIE has a surplus and can pay its debts, which will dispel that Event of Default;
• the Scheme of Arrangement did not, in the court's view, constitute an "arrangement…with or for the benefit of its creditors" within Section 5(a)(vii)(3) as used in ISDA (that phrase being directed to insolvency-type arrangements); accordingly it did not give rise to a separate Event of Default;
• the Events of Default arising from LBIE's entry into administration under Sections 5(a)(vii)(4) and (6) will cease to be continuing when the administration itself is brought to an end (for example by termination of the Administrators' appointment under paragraph 79 of Schedule B1); and
• the Chapter 15 recognition and permanent injunction did not, in the court's view, give rise to a separate continuing Event of Default distinct from the Scheme.

Accordingly, once the "Relevant Steps" (including termination of the Administrators' appointments and publication of the proposed notice) have been taken, no Event of Default will be continuing under Section 2(a)(iii) and the counterparties will be contractually obliged to pay the sums owed under the Swaps.

Background and parties. The applicants were the joint administrators of Lehman Brothers International (Europe) ("LBIE"); the respondents were FR Acquisitions Corporation (Europe) Ltd and JFB Firth Rixson Inc (together "Firth Rixson"). LBIE was party to two interest rate swaps documented under the 1992 and 2002 ISDA Master Agreements. LBIE has been in administration since 15 September 2008. Firth Rixson relied on Section 2(a)(iii) of the ISDA Master Agreements to suspend payment obligations on the ground that Events of Default had occurred and were "continuing".

Nature of the application. The Administrators applied for directions on the construction and effect of Section 2(a)(iii) and related ISDA provisions, and whether various events (entry into administration, conversion to a distributing administration, the Scheme of Arrangement, Chapter 15 recognition and foreign exequaturs) constituted Events of Default and/or were "continuing" such that suspension of payment would remain effective.

Issues framed by the court. The principal issues were (i) how to construe the word "continuing" in the ISDA Master Agreements, (ii) whether the relevant events alleged by Firth Rixson constituted Events of Default under Sections 5(a)(i) and 5(a)(vii) (sub-paragraphs (2), (3), (4), (6), (8)), and (iii) if so, whether those Events of Default would cease to be continuing on termination of the administration and/or on publication of the Administrators' notice.

Court's reasoning and findings. The court emphasised that in interpreting a standard-form ISDA Master Agreement deference is to be given to the precise words chosen and to the commercial architecture of the form but that the operative question for "continuing" is whether the state of affairs comprising the Event of Default still subsists. Applying that test, the court found:

• Events of Default for failure to pay under Section 5(a)(i) in respect of the Sterling Swap were discharged by operation of insolvency set-off when the administrators gave notice under the insolvency rules (circa 2 December 2009) and were therefore no longer continuing;
• an earlier written admission of inability to pay is not necessarily a once-and-for-all event and should be corrected; the Administrators were directed to publish a notice that LBIE has a surplus and can pay its debts;
• the Scheme of Arrangement was a solvent measure directed to distribution of surplus and compromise of litigation; it was not the kind of insolvency-type "arrangement…with or for the benefit of creditors" contemplated by Section 5(a)(vii)(3) and therefore did not trigger a separate Event of Default;
• the Events of Default arising from LBIE's entry into administration under Section 5(a)(vii)(4) and (6) will cease to be continuing once the administration itself ends; the court rejected the argument that a distributing administration necessarily produces uncureable Events of Default because of permanent alterations to creditors' rights; and
• the Chapter 15 recognition and related injunction did not, in context, constitute a standalone Event of Default distinct from the Scheme.

Remedy sought and outcome of reasoning. The Administrators sought directions that, when the Relevant Steps are taken (including terminating the administration and publishing the proposed notice), no Event of Default will continue and the respondents will owe payment. The court directed the Administrators to publish the notice and concluded that upon completion of the Relevant Steps the respondents' suspensive defence under Section 2(a)(iii) will fall away and payment obligations will arise.

Wider context. The judgment notes the inherent tension between bright-line standard-form drafting and perceived unfairness in particular cases, but applies a textual/contextual approach adapted to the ISDA architecture. The court observed that the commercial function of Section 2(a)(iii) is protection against counterparty credit risk and that where that risk ceases the suspensory condition has no continuing justification.

The Administrators' application for directions was allowed. The court held that the correct test for a "continuing" Event of Default under Section 2(a)(iii) is whether the event or state of affairs giving rise to the Event of Default continues to subsist. Applying that test, the court found that payment-default Events of Default under Section 5(a)(i) were discharged by insolvency set-off, an earlier written admission of inability to pay should be corrected (the Administrators were directed to publish a notice that LBIE has a surplus and can pay its debts), the Scheme did not constitute an Event of Default under Section 5(a)(vii)(3), and Events of Default arising from LBIE's entry into administration will cease to be continuing upon termination of the administration; accordingly, when the Relevant Steps are taken no Event of Default will be continuing and the respondents will become liable to pay sums owing under the Swaps.