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In the Matter of Lehman Brothers International (In Administration) (2013)


The "value clean" principle established in relation to the 1992 ISDA Master Agreement had not been preserved by the changes to the closing out provisions introduced by s.14 of the 2002 ISDA Master Agreement. The provisions of a side letter agreement entered into alongside certain Intercompany Transactions were therefore "material terms" which had to be taken into account within the definition of "Close-out Amount" in the 2002 ISDA Master Agreement.


The appellant administrators of Lehman Brothers International (Europe) (LBIE) appealed against a decision ([2012] EWHC 1072 (Ch)) that a letter agreement was not a material term of certain Intercompany transactions which they had entered into with the respondent Lehman Brothers Finance SA (LBF).

LBIE had laid off risks arising from its derivative trading by entering into back-to-back transactions (Intercompany Transactions) with LBF and signing a letter of agreement (the Side Letter). The terms of the agreement followed the 1992 ISDA Master Agreement, as modified to incorporate provisions of the 2002 ISDA Master Agreement dealing with the consequences of termination. The Side Letter provided for automatic termination of a back-to-back Intercompany Transaction if the related transaction terminated, and for LBIE to pay to LBF under any Intercompany Transaction only the amount recovered from the client under the related client transaction. Automatic early termination occurred, and compensation had to be determined by "closing out" the Intercompany Transactions in accordance with the Master Agreement. That involved determining gains or losses at the date of the closing out and replacing or providing the economic equivalent of the "material terms" of the Intercompany Transactions and assuming that all conditions precedent as to payment and delivery were fulfilled. The judge below held that the Side Letter was not a "material term" and should be left out of the determination. He found that taking the Side Letter into account would involve a radical departure from the "value clean" principle established in relation to the 1992 Master Agreement, namely the assumption that conditions precedent were deemed to have been fulfilled. The judge also held that "option rights" in the Master Agreements were restricted to options which did not amount to a right or early termination.

LBIE submitted that the provisions of the Side Letter were "material terms" of the Intercompany Transactions which had to be taken into account by virtue of the definition of "Close-out Amount" introduced in s.14 of the 2002 Master Agreement. LBF argued that they had to be left out of account because the valuation had to be carried out under the value clean principle.


The Side Letter had to be taken into account as a "material term" under the 2002 Master Agreement closing provisions. The value clean principle had a different effect in the 2002 Master Agreement from that which it had in a different context in the 1992 Master Agreement. The 2002 Master Agreement had to be interpreted according to its own terms and taking into account all the relevant background. The decision in Lomas v JFB Firth Rixson Inc [2012] EWCA Civ 419, [2012] 2 All E.R. (Comm) 1076 did not establish the value clean principle for the purposes of the 2002 Master Agreement, Lomas not applied. The value clean principle appeared in the 2002 Master Agreement in a very different context from that in which it appeared in the 1992 Master Agreement. The User's Guide to the ISDA 2002 Master Agreement (the User's Guide) suggested that the changes to the 2002 Master Agreement were regarded as more important than the preservation of the value clean principle in the form in which it existed in the 1992 Master Agreement (see paras 7, 51-64 of judgment). Where more than one meaning was possible, the court had to prefer that which was more consistent with business common sense. However, the judge's application of the value clean principle conflicted with business common sense. The effect of his decision was that a party might be overcompensated on the ascertainment of the Close-out Amount because the possibility of automatic termination had been left out of account. It was clear that the value clean principle in the 1992 Master Agreement could produce unreasonable results (paras 65-70). "Material terms" were those which impacted upon pricing. But for the judge's ruling on the value clean principle they would have included the terms of the Side Letter (paras 77-84). The judge's restriction on the meaning of "option rights" was not justified by the words used to describe option rights in the definition of "Close-out Amount" or by the User's Guide. The explanation in the User's Guide stated quite clearly that it was intended to make significant changes to the 1992 Master Agreement to meet the requirements of regulators and provide more flexibility. It was a reasonable inference that there would be a desire to remove artificiality. That would explain the introduction of option rights. The express inclusion of option rights was a pointer towards a wider meaning of "material terms" than simply conditions precedent as to payment and delivery. It was also an indication that the expression was intended to have some real content and meaning (paras 85-91). The inclusion in the Close-out Amount of permission to the determining party to take account of its own creditworthiness involved a clear departure from the value clean principle. That supported the argument that "material terms" and "option rights" were not to be interpreted on the basis that it was necessary to maintain the integrity of the value clean principle. The words "assuming satisfaction of the conditions precedent" in s.2(a)(iii) of the Master Agreements could not be taken to deprive the references to "material terms" and "option rights" of the weight that they would otherwise have (paras 92-112).

Appeal allowed

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14 Mar 2013

Court of Appeal
Sir James Munby (President Fam), Arden LJ, Aikens LJ

LTL 14/3/2013 : [2013] EWCA Civ 188

Practice areas
Commercial Disputes