Lehman Brothers Finance SA v Sal. Oppenheim Jr. & CIE KGAA

Factual and Procedural Background

The Claimant initiated a claim for the balance of a sum alleged to be due from the Defendant following the early termination of four option transactions governed by an English law ISDA Master Agreement dated 6th September 2001. The transactions involved put and call options referencing the Nikkei 225 Stock Average Index. Early termination occurred automatically due to the Claimant's Credit Support Provider entering Chapter 11 bankruptcy proceedings on 15th September 2008, rendering the Claimant the Defaulting Party and the Defendant the Non-defaulting Party under the Agreement.

The Tokyo and Osaka stock exchanges were closed on the date of termination due to a holiday, reopening on 16th September 2008. During this period, the Nikkei Index fell substantially, increasing the value of the options. The parties had elected the "Market Quotation" method for payment calculation upon early termination.

The Defendant paid a sum in July 2009 based on certain calculations it provided, which the Claimant disputed as incorrect and an underpayment. The Defendant's payment was supported by valuations from three banks, but these valuations were dated prior to the Early Termination Date and not actual market quotations as required by the Agreement.

The Claimant went into liquidation in December 2008 and only later analyzed the Defendant’s calculations, challenging the basis and timing of the valuations used. The Defendant failed to provide evidence that it sought or obtained proper contemporaneous market quotations from four reference market-makers as mandated by the Agreement.

Legal Issues Presented

1. Whether the Defendant complied with its contractual obligation to determine the Settlement Amount by obtaining Market Quotations for Replacement Transactions on or as soon as reasonably practicable after the Early Termination Date.
2. Whether the Defendant was entitled to rely on valuations dated prior to the Early Termination Date as Market Quotations.
3. Whether either of the two gateways to apply the Loss method instead of Market Quotation was available to the Defendant, namely (a) that Market Quotation could not be determined, or (b) that Market Quotation would not produce a commercially reasonable result.
4. The appropriate calculation of interest on the underpaid sum, including the applicable Default Rate.

Arguments of the Parties

Claimant's Arguments

• The Defendant failed to obtain valid Market Quotations as required by the Agreement and instead relied on retrospective valuations dated before the Early Termination Date.
• The Market Quotation method requires "live" quotations obtained contemporaneously or as soon as reasonably practicable after termination, not backdated valuations.
• The Defendant's attempt to value the options based on prices before the Event of Default is contrary to the clear contractual terms and would result in an unjust windfall.
• The Defendant did not establish that Market Quotation was impossible or unreasonable, so the Loss method is not applicable.
• The Claimant seeks interest at the contractual Default Rate, supported by evidence of the Claimant’s cost of funding derived from its parent company’s credit default swaps.

Defendant's Arguments

• The Defendant contends that the Market Quotation can be determined using valuations as at the close of 12th September 2008, prior to the Early Termination Date.
• The Defendant argues that the Claimant seeks to benefit from a market rise following the Event of Default, which they would not have enjoyed absent the termination.
• The Defendant asserts that the Loss method should apply if Market Quotation is impractical or unreasonable, relying on hedging transactions and the timing of market closures.
• Regarding interest, the Defendant challenges the basis for the Default Rate claimed by the Claimant, arguing that the certificate relied upon is not contemporaneous with the relevant period and that a lower rate would be appropriate.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began with the undisputed fact that Early Termination occurred on 15th September 2008 and that the parties selected the Market Quotation method for calculating the Settlement Amount. The Defendant was obligated to obtain contemporaneous price quotations from four Reference Market-makers for Replacement Transactions, either on the Early Termination Date or as soon as reasonably practicable thereafter.

Evidence demonstrated that the Defendant did not obtain such live quotations on or after 15th September but instead relied on retrospective valuations dated 12th September 2008, before the Early Termination Date. The court found no credible evidence that the Defendant requested or was refused proper Market Quotations from the requisite number of market-makers. The valuations used were not quotations for Replacement Transactions and thus did not comply with the Agreement.

The court interpreted the Market Quotation provision as requiring "live" quotations reflecting current market conditions at or shortly after termination, rejecting the Defendant’s argument for backdating valuations. The court relied on the ISDA User’s Guide and authoritative commentary to confirm that quotations must be contemporaneous and not hypothetical or retrospective.

Regarding the two gateways to apply the Loss method instead of Market Quotation, the court found no evidence that Market Quotation was impossible to determine or that it would not produce a commercially reasonable result. The Defendant’s hedging activities and choice to use earlier valuations did not satisfy the contractual threshold to depart from Market Quotation.

The court concluded that the Defendant breached the contract by failing to perform its obligation to obtain valid Market Quotations and that the Claimant was entitled to be placed in the position it would have been if the contract had been properly performed.

On the quantum of damages, the court preferred the Claimant’s expert evidence and data, concluding that the correct Market Quotation figure would have been approximately 6,549,000 (gross), translating to a net payment due of 2,963,081.18 after adjustments. The court rejected the Defendant’s suggestion to calculate the amount based on valuations dated before the Early Termination Date.

Regarding interest, the court accepted that the Claimant was entitled to interest at the contractual Default Rate from the date the correct payment should have been made. While the Claimant’s evidence on the Default Rate certificate was based on the parent company’s funding cost as of 12th September 2008, the court found this certificate was not contemporaneous with the relevant period. Instead, the court accepted a lower but reasonable funding rate of 12% per annum, recoverable as compound interest, reflecting available funding rates at the relevant time.

Holding and Implications

The court held that the Defendant breached its contractual obligations under the ISDA Master Agreement by failing to obtain valid Market Quotations on or as soon as reasonably practicable after the Early Termination Date and by relying on retrospective valuations dated prior to termination.

The court ordered that the Settlement Amount be recalculated in accordance with the Market Quotation method using contemporaneous market data as of 16th September 2008, resulting in a higher sum payable by the Defendant to the Claimant than previously paid.

The Defendant was also ordered to pay interest on the underpaid amount at a contractual Default Rate of 12% per annum compounded from the date the correct payment should have been made.

No broader legal precedent was established beyond the application and interpretation of the specific ISDA Master Agreement provisions and the proper conduct of Market Quotation calculations following Early Termination due to default. The decision emphasizes the strict contractual requirements for obtaining valid market quotations and the limited circumstances in which the Loss method may be invoked.