The International Swaps and Derivatives Association, Inc. (ISDA) reacts to Mr Justice Briggs judgment handed down today in the case of Lomas and others v JFB Firth Rixson, Inc and others. Four out-of-the-money counterparties had declined to terminate their ISDA Master Agreements with Lehman Brothers International Europe (LBIE), relying on Section 2(a)(iii) of the ISDA Master Agreement to not make payments that they would, but for Section 2(a)(iii), have been required to make to LBIE. The Administrators sought directions as to the interpretation of Section 2(a)(iii) and its compatibility with the anti-deprivation principle of English insolvency law.
ISDA sought and was granted permission to intervene in the case to ensure that arguments reflecting the market’s understanding of the construction were made before the Court.
The Court rejected the Administrators’ argument that the condition precedent in Section 2(a)(iii) should be interpreted as being subject to a limitation that it may only be relied upon for a “reasonable time.” Nor did the Court accept that a Non-defaulting Party had any obligation to designate an Early Termination Date.
Crucially, the Court found that Section 2(a)(iii) is “suspensive” in effect, overturning the non-binding comments in the Marine Trade case that Section 2(a)(iii) is a once-and-for-all test. It was one of ISDA’s key goals in participating in the action to achieve this result.
The Court also held that there was no breach of the anti-deprivation principle under English insolvency law in the context of the swaps between the parties.
The Court’s finding that payments under certain types of transactions that have been suspended under Section 2(a)(iii) may be extinguished on the last date for payment under the transaction is surprising and is at odds with the market’s expectations. Nothing in the ISDA Master Agreement suggests that those suspended obligations would be extinguished at the end of the transaction’s term.
Even before the case had been brought, ISDA had started the process of preparing a form of amendment to Section 2(a)(iii) in response to concerns raised by supervisors, including the UK Treasury, as to the potential effect of Section 2(a)(iii) following the failure of a major financial institution. This process will continue, and whatever the ultimate outcome of this case after any appeals, ISDA will consult with its members to agree a form of amendment to Section 2(a)(iii) that ISDA will make available to market participants in order to enable them to amend their ISDA Master Agreements.
