COMMODITIES IN FOCUS
Lomas and others v Burlington Loan
Management Limited and others 
This is the latest instalment in the Lehman "Waterfall"
litigation arising out of the collapse of Lehman
Brothers and looks at interest provisions on sums due
following early termination and close out of
The case centred on a surplus of approximately £7
billion that Lehman Brothers International Europe had
generated, despite having gone into administration
eight years previously. Various creditors were,
unsurprisingly, eager to obtain a share in this
surplus. A key issue was the interest payable on
debts owed by Lehman following close out of the
ISDA Master Agreement.
Section 9(h)(ii)(2) of the 2002 Master Agreement
provides for "interest" to be paid on a past-due Early
Termination Amount at the Default Rate. The Default
Rate is defined in section 14 as "a rate per annum
equal to the cost (without proof or evidence of any
actual cost) to the relevant payee (as certified by it)
if it were to fund or of funding the relevant amount
plus 1% per annum". The Default Rate may apply
both where a party pays a close-out amount late and
also on any defaulted payments.
The Court was asked to decide whether this cost of
funding was a borrowing cost or whether it could also
take into account the (higher) cost of raising equity.
It held that:
"cost of funding" means the cost of borrowing
the relevant amount under a loan transaction.
This did not include costs associated with wider
types of funding such as equity funding, which
was unfortunate as, following Lehman's collapse,
many banks raised equity at a cost well above
the 8% simple interest rate.
"cost" means the "transactional costs", i.e. the
price which is required to be paid in return for
the funding for the period it is required. Such
cost is effectively the rate of interest which was
incurred or would have been incurred by the
relevant payee for borrowing the close-out sum
over the period during which it remained
outstanding, at a daily compounding rate.
Accordingly, when the ISDA Master Agreement
refers to interest, it is referring to interest as the
price of borrowing money and it follows that the
cost of funding must be the cost of borrowing the
the Default Rate should be calculated only by
reference to Lehman's original contractual
counterparty's cost of funding, not by reference
to a third party to whom that original
counterparty has transferred its rights pursuant
to Section 7 of the 2002 ISDA Master
Agreement. As a matter of contractual
interpretation, only the original counterparty was
the "relevant payee". The Lehman debt,
including ISDA claims, had been heavily traded
following Lehman's entry into administration.
So transferees were entitled to the interest based
on the transferor's cost of borrowing, but not
interest based on its own costs.
In light of this decision, it is important for creditors to
think about what rate of interest they can certify (the
judgment sets out detailed guidance on this).
T + 44 20 7809 2329
+44 20 7809 2086