Lehman Brothers Special Financing Inc v National Power Corporation & Anor

Factual and Procedural Background

This case concerns the calculation of the Close-out Amount under the 2002 ISDA Master Agreement following the early termination of a principal-only US dollar/Philippine peso forward currency swap ("the Transaction") entered into on 18 July 2007. The Plaintiff agreed to pay US$100 million to the Defendant in 2028, while the Defendant agreed to pay the US$ equivalent of PHP 4.4788 billion in 2028, with semi-annual fixed coupons payable by the Defendant to the Plaintiff. An option was granted allowing the Defendant to pay US$1 million instead of the PHP equivalent in 2028, which the Defendant did not exercise.

Following the collapse of the Plaintiff's corporate group in September 2008 and its subsequent bankruptcy filing, the Transaction was terminated early by the Defendant, who served notice of early termination on 17 October 2008, designating 3 November 2008 as the Early Termination Date. The Defendant was then obliged to determine the Close-out Amount payable, using "commercially reasonable procedures in order to produce a commercially reasonable result".

On 26 January 2009, the Defendant demanded US$3,461,590.93 as the Close-out Amount, but the Plaintiff contested the commercial reasonableness of the procedures and result. Subsequently, the Defendant withdrew its proof of claim in the Plaintiff's bankruptcy and served revised calculation statements in 2016, including a Primary Determination and an Alternative Determination, with disputed amounts ranging widely between the parties.

The Defendant is a government-owned entity of the Republic of the Philippines, and the Transaction was part of a hedging strategy related to a US$300 million bond issuance maturing in 2028. The Defendant transferred its rights and obligations under the Transaction to a successor entity, which is accepted as a proper party to the proceedings.

Legal Issues Presented

1. Whether the Determining Party under the 2002 ISDA Master Agreement is entitled to remake or revise a previously made determination of the Close-out Amount.
2. Whether the change in wording from the 1992 ISDA Master Agreement's "reasonably determines in good faith" to the 2002 ISDA Master Agreement's requirement that the Determining Party "act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result" imposes an objective standard of reasonableness rather than a mere rationality standard.

Arguments of the Parties

Defendant's Arguments

• The Defendant does not rely on its initial calculation annex but asserts that its Primary and Alternative Determinations represent valid exercises of its contractual right and obligation to determine the Close-out Amount.
• The initial calculation was flawed because it did not account for certain semi-annual fixed payments and thus was not in accordance with the Agreement.
• The availability of indicative quotations on 3 November 2008 justified a determination of the Close-out Amount as of that date rather than later dates.
• The initial determination was invalid and not binding, leaving the Defendant's obligation to make a valid determination unfulfilled until the revised calculations were served.
• The 2002 ISDA Master Agreement requires the Determining Party to make a determination, and the Defendant's revised calculations comply with this obligation.
• The standard of review under the 2002 ISDA Master Agreement is one of rationality, allowing the Determining Party discretion within rational limits.

Plaintiff's Arguments

• The Plaintiff contends that once a determination under Section 6(d)(i) of the 2002 ISDA Master Agreement is served, there is no contractual entitlement to withdraw or replace it unilaterally.
• The language and context of the Agreement suggest the determination statement should be provided once, with no provision for multiple attempts.
• Allowing the Determining Party to remake determinations years later during litigation would undermine contractual certainty and the interests of both parties.
• The standard imposed by the Agreement is an objective standard of commercial reasonableness, not merely rationality.
• The Defendant's Primary Determination, based on a single indicative quotation, does not meet the requirement of commercially reasonable procedures producing a commercially reasonable result.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by affirming that the 2002 ISDA Master Agreement requires the Determining Party to act in good faith and to use commercially reasonable procedures to produce a commercially reasonable result when determining the Close-out Amount. This imposes two objective standards: not only must the procedures be commercially reasonable, but the outcome must also be commercially reasonable.

The court rejected the Defendant's argument that the standard is merely one of rationality (analogous to Wednesbury unreasonableness), concluding instead that the wording of the 2002 ISDA Master Agreement explicitly raises the standard to an objective commercial reasonableness test. This standard is more exacting than the rationality test applicable under the 1992 ISDA Master Agreement.

Regarding the question of whether the Determining Party may remake a determination, the court held that once a valid determination has been made and notice served, the obligation is complete and the determination is binding. However, if the determination was invalid—such as being infected by a manifest error or misinterpretation of the Agreement—the Determining Party may be entitled to make a fresh determination. The court emphasized that repeated remittals or multiple attempts to make a compliant determination are not consistent with the parties' contractual intention, and that the court or tribunal is ultimately empowered to make the determination if the Determining Party fails to do so properly.

On the facts, the court found that the Defendant's initial determination dated 26 January 2009 did not account for the Accrued Amount, which was a manifest error. However, this error was subject to correction rather than a fresh determination. The Defendant's reliance on the UBS Transaction as the basis for the Close-out Amount was appropriate, and it was commercially reasonable to determine the Close-out Amount as of the date of the firm UBS quotation and the UBS Transaction, rather than the earlier indicative quotations.

The court rejected the Plaintiff's contention that the Primary Determination based on a single indicative quotation was commercially reasonable, favoring instead the Alternative Determination based on the actual UBS Transaction, excluding the option exercise price which the Defendant was not entitled to pass on.

Finally, the court recognized the importance of clarity and certainty in the ISDA Master Agreement and the value of the 2002 amendments introducing objective standards of commercial reasonableness, noting that these provisions impose a higher standard than the earlier 1992 Agreement.

Holding and Implications

The court held that the 2002 ISDA Master Agreement requires the Determining Party to act in good faith and to use commercially reasonable procedures to produce a commercially reasonable result, an objective standard exceeding mere rationality.

The court further held that a valid determination of the Close-out Amount, once made and notice served, is binding and not subject to unilateral withdrawal or replacement by the Determining Party. However, if the original determination was invalid due to manifest error or misinterpretation, correction is permitted either by agreement or by court order.

The court found that the Defendant's initial determination contained a manifest error by failing to include the Accrued Amount but that the use of the UBS Transaction as the basis for the Close-out Amount was commercially reasonable. The Alternative Determination excluding the option exercise price was appropriate.

DISPOSED OF accordingly with directions to address any consequential matters including interest and calculation details.

The decision clarifies the application of the 2002 ISDA Master Agreement's objective commercial reasonableness standard and reinforces the finality of determinations once validly made, thereby promoting contractual certainty. No new precedent beyond the interpretation of the 2002 ISDA Master Agreement was established.