Fondazione Enasarco v Lehman Brothers Finance SA & Anor

Factual and Procedural Background

The principal dispute concerns the Loss arising from the automatic early termination of a put option following the insolvency of the Lehman Brothers group on 15 September 2008. The Loss is defined and to be calculated pursuant to the ISDA Master Agreement (1992 edition).

The claimant, a pension fund established in Italy ("Plaintiff"), had invested approximately 780 million in Series 26 Principal Protected Notes issued by a special purpose vehicle ("Company A") under a structured programme designed by Lehman Brothers International Europe ("Company B"). The notes were linked to a portfolio of hedge funds, with capital protection provided by a put option granted by Lehman Brothers Finance SA ("Defendant 1") and guaranteed by its ultimate holding company ("Defendant 2").

The put option was automatically terminated upon the insolvency filing of Defendant 2 on 15 September 2008, triggering the dispute over the calculation of Loss. The Plaintiff entered into substitute arrangements with Credit Suisse International ("Company C") on 6 May 2009, which formed the basis for calculating Loss.

The Defendant 1 contested the Plaintiff's calculation, asserting that if proper procedures had been followed, the Loss would be lower and potentially payable by the Plaintiff to the Defendant 1. The Plaintiff and Company A commenced proceedings seeking payment of the Loss and declarations regarding payment obligations. The Defendant 1 counterclaimed for declarations and payment based on an alternative Loss calculation.

The Master Agreement is governed by English law and jurisdiction was confirmed in the English courts. A prior application by Defendant 1 to stay proceedings in favour of Swiss proceedings was rejected.

Evidence at trial included factual witnesses from the Plaintiff, Company A, and Defendant 1's liquidators, as well as expert evidence on the calculation of Loss and market conditions.

Legal Issues Presented

1. Whether the Plaintiff and Company A reasonably determined their Loss in accordance with the ISDA Master Agreement following the automatic early termination of the put option.
2. Whether the date of 6 May 2009, when the Plaintiff entered into a replacement transaction with Company C, was the earliest reasonably practicable date for obtaining a quotation for a replacement transaction.
3. Whether the terms of the replacement transaction with Company C were sufficiently comparable to the original put option to be used in calculating Loss.
4. Whether the delay until 16 September 2009 in providing the calculation statement was justifiable under the Master Agreement.

Arguments of the Parties

Plaintiff's and Company A's Arguments

• The Loss was properly calculated by reference to the cost of a replacement transaction obtained on 6 May 2009, which was the first reasonably practicable date after the early termination date.
• The replacement transaction with Company C, though complex, was necessary due to the collapse of the Lehman Brothers group and the need to restructure the entire investment.
• The delay in providing the calculation statement was due to dependence on information from the Plaintiff and was reasonable under the circumstances.
• The replacement transaction's different terms, including maturity, did not materially affect the Loss calculation.
• The Plaintiff acted under significant pressure and urgency to secure replacement protection, demonstrating reasonable efforts.

Defendant 1's Arguments

• A quotation for a replacement transaction could have been obtained earlier, within weeks after the early termination date and in any event by the end of October 2008.
• The terms of the replacement transaction with Company C were materially different from the original put option, making it unsuitable for determining Loss.
• The delay until 16 September 2009 in providing the calculation statement breached contractual obligations under the Master Agreement.
• The Plaintiff's approach to obtaining replacement protection was unnecessarily complex and delayed.
• The market for such replacement transactions was sufficiently active after the early termination date to have allowed earlier quotations at more favorable prices.
• The Loss calculation should reflect a hypothetical replacement transaction as of the earliest practicable date, not the actual transaction concluded in May 2009.

Table of Precedents Cited

Court's Reasoning and Analysis

The court analysed the contractual framework under the ISDA Master Agreement, focusing on the definition and calculation of Loss following the automatic early termination of the put option triggered by Defendant 2's insolvency.

The court recognized that Loss may be determined by reference to the cost of a replacement transaction, provided the non-defaulting party reasonably and in good faith determines its total losses and costs.

Regarding the timing, the court held that the earliest reasonably practicable date for obtaining a quotation must be assessed on the facts, considering the complexity of the transaction and the market conditions after the Lehman collapse. The court found it was not reasonably practicable to obtain a firm quotation for a replacement transaction before 6 May 2009.

The court accepted that the Plaintiff undertook extensive and urgent efforts to find replacement protection, negotiating with multiple banks and restructuring the investment due to the involvement of multiple insolvent Lehman entities. The complexity and illiquidity of the underlying hedge fund portfolio further supported the timing.

The court rejected Defendant 1's submission that a quotation could have been obtained earlier, finding the evidence of market activity and pricing insufficient to establish this. The expert evidence supporting earlier quotations was found to be inadequate or based on hearsay.

The court addressed the differences in terms between the original put option and the replacement transaction, concluding that these differences did not materially affect the Loss calculation and that the replacement transaction was a valid reference point.

On the delay in providing the calculation statement, the court found that although the statement could have been given earlier, the delay did not invalidate the Loss calculation itself.

The court applied the rationality standard from precedent, concluding that the Plaintiff's determination of Loss was within the range of reasonable outcomes and thus valid.

Holding and Implications

The court held that the Loss was validly calculated by Company A in accordance with the Master Agreement and that the Plaintiff is entitled to payment of US $61,507,902 plus interest from Defendant 1.

Consequently, no sums are payable by either Company A or the Plaintiff to Defendant 1. The court rejected the alternative Loss calculation advanced by Defendant 1 and dismissed criticisms of the Plaintiff's approach and timing.

No broader precedent was established beyond the application of existing principles concerning Loss calculation under the ISDA Master Agreement and the assessment of reasonable timing and market conditions in such complex financial transactions.