Condition precedent - Expiry
Lomas and others v JFB Firth Rixson Inc and others; Lehman Brothers Special Financing Inc v Carlton Communications Ltd; Pioneer Freight Futures Company Ltd (in liquidation) v Cosco Bulk Carrier Company Ltd; and another appeal: Court of Appeal, Civil Division (Lord Justices Longmore, Patten and Tomlinson): 3 April 2012
The instant appeal concerned four separate appeals which were heard together as they raised common issues. The appeals raised a number of questions of construction in relation to derivatives in the form of interest rate swaps and forward freight agreements (FFAs) on the International Swaps and Derivatives Association Inc form of master agreement, which had been published in 1992 and in 2002 (the master agreement).
The first appeal had arisen out of the Lehman Brothers administration. Lehman Brothers International (Europe) (LBIE) had been a party to numerous interest rate swap transactions. Its administration had constituted an event of default under each of the transactions. The essential issue had been to the extent that the defendants in the first appeal, as the non-defaulting parties, had owed any sums to LBIE on and after the date of the event of default pursuant to such agreements, and whether the obligation to make any payments either had not come into existence or had ceased to exist, or had been suspended for the duration of the event of default that had continued while the administration had progressed. The claimant administrators in the first appeal had wished to collect the sums purportedly owed to LBIE pursuant to a number of transactions.
The non-defaulting parties had submitted that no sums had become due because their obligations to make the relevant payment under section 2(a)(i) of the master agreement had been at all material times, by virtue of section 2(c)(iii), subject to the condition precedent that no event of default had occurred and had been continuing. The judge held that although an obligation on the part of the non-defaulting party had come into existence on the due date for payment, it had been suspended and later extinguished at the end of the natural term of each transaction. The administrators appealed.
The second appeal concerned Lehman Brothers Special Financing Inc (LBSF), and two linked-rate swaps that had incorporated the terms of the 1992 master agreement, which had been entered into to enable the defendant in the second appeal, as the non-defaulting party, to hedge its fixed interest exposure. The parties had elected against automatic early termination and chose the 'second method and loss' assessment of loss pursuant to section 6(e) of the master agreement. At the date of the Lehman Group collapse only one payment date had remained under each of the swaps. LBSF’s parent company had entered bankruptcy followed by LBSF, with the result that there had been two relevant events of default that had continued until the last payment date.
As of that date, LBSF had been in money and, but for the operation of section 2(a)(iii) of the master agreement, would have been entitled to a payment from the non-defaulting party. LBSF commenced proceedings. The principle issue had been the effect of an event of default on the subsequent payment obligations of the non-defaulting party, and whether, on the maturity of the swaps, those payment obligations had been either extinguished of revived. There had been a further issue as to whether the operation of section 2(a)(iii) of the master agreement had engaged either the anti-deprivation principle or the operation of the pari passu rule of distribution. LBSF appealed.
The third appeal had concerned a series of FFAs entered into by Pioneer Freight Futures Limited (in liquidation) (Pioneer) that had incorporated the master agreement. The FFAs had been sub-divided into three groups, and following an event of default that had been triggered by Pioneer passing a resolution for its winding-up, each party had obligations to pay the other under the different groups. The issue in the proceedings had been whether certain FFAs had been subject to automatic early termination. If they had been, the effect of applying close out provisions, pursuant to section 6 of the master agreement, and the choice by the parties of the 'second method and loss' would have resulted in a balance due to Pioneer.
Pioneer had submitted that all of the FFAs had been subject to automatic early termination, whereas the non-defaulting party had submitted that the FFAs in issue had not because in each case the last date for performance had passed prior to the early termination date. The judge held that any unperformed obligation under such a transaction, including obligations that had accrued to the non-defaulting party but had not been paid by Pioneer, and obligations that would have accrued due to Pioneer but for the operation of section 2(a)(iii) upon Pioneer becoming subject to an event of default, were not to have been taken into account in arriving at the net sum payable under section 6(e) of the master agreement. Pioneer appealed.
In the fourth appeal, the issue had been whether, when an event of default had occurred so as to trigger an automatic early termination under the master agreement, the measure of loss under the 'second method and loss' provisions of the master agreement had required that it be assumed for the purposes of carrying out the relevant calculations that each applicable condition precedent had been satisfied. The judge in that appeal had found that it had to be assumed that each condition precedent had been satisfied. The defendant appealed.
The issues for determination were: (i) on the first appeal, whether an event of default had had the effect that no amounts had ever become due and payable from the non-defaulting party to the defaulting party; if such amounts had become due, but had not been payable by virtue of the event of default, whether they had never become payable or whether they would have become payable if the event of default had been cured; if the amounts had become due and payable but had been suspended by reason of the event of default, whether the suspension ended and the payment obligation revived by the implication of a term of reasonable time; or, conversely, if the suspension had not so ended, whether the obligation to pay had been extinguished at the expiry of, or the maturity of, the transaction(s); and if the obligation had revived and had not been extinguished at the end of the transaction, whether it had lasted for ever, and if not, at what point it had ceased to exist; (ii) on the second appeal, whether the operation of section 2(a)(iii) of the master agreement had engaged either the anti-deprivation principle or the operation of the pari passu rule of distribution; (iii) on the third appeal, whether obligations that would have accrued to the defaulting party were to have been taken into account in arriving at the net sum payable under section 6(e) of the master agreement; and (iv) on the fourth appeal, whether it had to be assumed for the purposes of carrying out the relevant calculations under the 'second method and loss' provisions of section 6(e)(i)(4) of the master agreement that each applicable condition precedent had been satisfied.
The court ruled: (1) Section 2(a)(iii) of the master agreement focused on the payment obligation of the parties, but underlying any payment obligations had always been a debt obligation. Section 2 had been all about the payment obligation and had not touched upon the underlying indebtedness obligation. The underlying debt obligation had not been undisturbed by the event of default; it had merely been the payment obligation that was barred if there had been an event of default. The payment obligation had been suspended while the condition precedent had remained unfulfilled. To have treated the payment obligation as extinguished was altogether too drastic a remedy in favour of the non-defaulting party, because the possible event of default and potential events of default had been so many and various.
If the defaulting party had been able to remedy the position his rights against the non-defaulting party had forever gone and could never have been revived. Accordingly, it had been more natural to find that the obligation to pay had been suspended while the event of default had continued. Accordingly, the payment obligation of the non-defaulting party had been suspended, rather than extinguished, during the currency of an event of default under the master agreement, and would have been revived if the event of default had been cured at any time before the outstanding transactions had been terminated.
Contrary to the arguments advanced, to the effect that there had been implied terms to the effect that the obligation to make payments by the non-defaulting party had been revived after a reasonable time or at the maturity of the transaction(s), the judge had been right to have rejected those arguments. The only act required of the non-defaulting party had been to make payment, the time for doing so had been set out in the contract which had also provided that payment need not have been made while an event of default was continuing. There had been no just reason for any implied term that the non-defaulting party was to have done any other act within any particular time.
Further, there had been no reason to impose and implied term regarding the revival of the obligation to pay on the maturity of the agreement since the contract had worked well without it. Where there had been more than one transaction it would have been unjust if, at the maturity of the first transaction, the non-defaulting party had been required to pay whatever might have been due. The judge had however been wrong to have found that the payment obligation of the non-defaulting party had been suspended during the currency of the transaction, the suspension had ended on maturity and had then been extinguished. In determining what the contract, read with the relevant background, would reasonably have been understood to have meant, the contracts had not meant that the suspended payment obligation had disappeared on the maturity of the transaction.
None of the documents had expressly stated so and the parties had made no provision on the topic. Accordingly, it had still been possible for the non-defaulting party to terminate early if he had wished to do so. In the result therefore, there had been no terminus, either by way of extinction or revival, on the condition precedent. The condition had continued in force until the event in default had been cured. If it had never been cured then there had continued to be no obligation on the non-defaulting party to make payment (see , , , , , , , [57, ,  of the judgment).
The first appeal would accordingly be dismissed (see  of the judgment). Pioneer Freight Futures Co Ltd (in liq) v TMT Asia Ltd  All ER (D) 23 (Apr) approved; A-G of Belize v Belize Telecom Ltd  2 All ER 1127 applied; Marine Trade SA v Pioneer Freight Futures Co Ltd BVI  All ER (D) 30 (Nov) doubted.
(2) In the second appeal, the suspension of the payment obligations of the non-defaulting party for the duration of the defaulting party's insolvency had done no more than prevent the non-defaulting party from having to make payments under the arrangement with the bankrupt defaulting party. There had been no suggestion that the arrangement had been formulated in order to have avoided the effect of any insolvency law or to have given the non-defaulting party a greater or disproportionate return as a creditor in the insolvent estate. The commerciality of the arrangements had had to be judged by considering the operation of section 2(a)(iii) of the master agreement throughout the life of the contract and not solely by reference to the point in time when it had come to operate.
Accordingly, it could not be said that the suspensory effect of section 2(a)(iii) had engaged the anti-deprivation principle; its purpose had been to protect the non-defaulting party from the additional credit risk that had been involved in performing its own obligations whilst the defaulting party had remained unable to meet its own. Further, in the circumstances, section 2(a)(iii) had operated at most to prevent the relevant debt which had been suspended by an event of default from becoming payable, and had accordingly not infringed the pari passu principle since there had been no property capable of distribution (see , ,  of the judgment). The second would accordingly be dismissed (see  of the judgment).
Pioneer Freight Futures Co Ltd v TMT Asia Ltd  All ER (D) 241 (Jul) approved; Belmont Park Investments PTY Ltd v BNY Corporate Trustee Services Ltd  1 All ER 505 applied.
(3) It followed from the findings in the first appeal, that all of the FFAs in the third appeal had been subject to automatic early termination since there had been no basis for excluding from the ambit of section 6(e) of the master agreement transactions in respect of which the last date for performance had passed prior to the automatic early termination taking effect. The judge had concluded that the close-out netting calculation under section 6(e) had excluded transactions that had already terminated at their natural expiry date.
However, that finding had been inconsistent in light of the previous findings, which had the result, properly understood in the context of the shape and nature of the transaction, that neither the terms of section 6(a) nor section 6(e)(iii) had carried any implication that transactions in respect of which the last date specified for performance had passed had been excluded from the close-out mechanics following early termination (see ,  of the judgment). The third appeal would accordingly be allowed (see  of the judgment).
(4) The identification of the non-defaulting party's loss of bargain that had arisen from the termination of the derivative transaction had required a clean rather than a dirty market valuation of the lost transaction. That meant that the assessment of loss of bargain pursuant to section 6(e)(1)(4) of the master agreement, where loss was defined in section 14, had had to be valued on an assumption that, but for automatic early termination, the transaction would have proceeded to a conclusion and that all conditions to its full performance by both sides would have been satisfied. Further, the termination payment formulae under section 6(e) were not to be equated with, or interpreted rigidly in accordance with the quantification of damages at common law for breach of contract (see  of the judgment).
The fourth appeal would accordingly be dismissed (see  of the judgment). Anthracite Rated Investments (Jersey) Ltd v Lehman Brothers Finance S.A. in liq; Fondazione Enasarco v Lehman Brothers Finance S.A  All ER (D) 171 (Jul) approved. Decision of Briggs J  EWHC 3372 (Ch) affirmed. Decision of Briggs J  All ER (D) 309 (Mar) affirmed. Decision of Flaux J  2 All ER (Comm) 1079 reversed. Decision of Flaux J  All ER (D) 122 (Apr) affirmed.
William Trower QC and Daniel Bayfield (instructed by Linklaters LLP) for the claimant in the first appeal; Mark Hapgood QC and Henry Forbes Smith (instructed by MacFarlanes LLP) for the first and second defendants in the first appeal; Robin Dicker QC and Joanna Perkins (instructed by Clifford Chance) for the third defendants in the first appeal; Richard Fisher (instructed by Freshfields Bruckhaus Deringer) for the fourth defendants in the first appeal; Antony Zacaroli QC and Jeremy Goldring (instructed by Allen & Overy LLP) for the International Swaps and Derivatives Association Inc as intervening party in the first and second appeals; Jonathan Nash QC (instructed by Weil Gotshal & Manges) for the claimants in the second appeal; Felicity Toube QC (instructed by Hogan Lovells International LLP) for the defendant in the second appeal; Charles Kimmins QC and Luke Pearce (instructed by Herbert Smith LLP) for the claimant in the third appeal; Richard Jacobs QC and Siddharth Dhar (instructed by Thomas Cooper) for the defendant in the third appeal; Mark Phillips QC and Stephen Robins (instructed by Watson Farley & Williams LLP) for the claimant in the fourth appeal; James Willan (instructed by Berwin Leighton Paisner LLP) for the defendant in the fourth appeal.
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