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18 Mar 2019

High Court clarifies its approach to determination of "Loss" under the 1992 ISDA Master Agreement


Under the 1992 ISDA Master Agreement, following an event of default, there is either an automatic termination or the non-defaulting party can serve a notice designating an Early Termination Date.  There then has to be a determination by the non-defaulting party of the compensation that is owed by one party or the other.  This is done by closing out the transactions, which involves determining gains or losses in replacing or providing the economic equivalent of the terminated transactions.  Once that is done, a statement is served setting out the calculations.

In Lehman Brothers Finance AG (in liquidation) v Klaus Tschira Stiftung GMBH & Anor [2019] EWHC 379 (Ch) Snowden J held that the defendants' Loss Calculation was not in accordance with the close-out provisions of the 1992 ISDA Master Agreement, and that it was not binding upon Lehman.

This case provides further clarification on the approach a non-defaulting party should take when it is determining the compensation that it is owed. 


On 16 May 2007, the parties entered into variable forward sales and purchases transactions which were undertaken pursuant to 1992 ISDA Master Agreements. The terms of these transactions required the defendants' principal asset - a large volume of shares in SAP (a charitable organisation) – to be placed as collateral with Lehman.

On Monday, 15 September 2008, the bankruptcy of the Lehman group gave rise to an Automatic Early Termination of the Master Agreements under section 6(a).  As a consequence, an Early Termination Date occurred on 15 September 2008.

The payment measure that the parties elected to use in such circumstances was "Loss" (as opposed to "Market Quotation").  In this context, the 1992 ISDA Master Agreement states that "a party may determine its Loss by reference to quotations of relevant rates or prices from one or more leading dealers in the relevant markets".  Accordingly, the defendants sought indicative quotations from Mediobanca and were advised that if the replacement transactions were priced as at the close of XETRA (a trading venue operated by the Frankfurt Stock Exchange) on 12 September 2008, they would have to pay Mediobanca a combined total of €7.45 million, whereas if they were priced as at the opening of XETRA on 15 September 2008, they would have had to pay Mediobanca a combined total of €28.22 million. 

In addition to this, the defendants sought indicative quotations from Goldman Sachs.  On the basis of Goldman Sachs' valuation of the cost of replacements for the transactions as at the opening of business on 15 September 2008, the defendants would have had to make a net payment to Goldman Sachs of €17.46 million. 

On 25 September 2008, the defendants collated the information they had received from Mediobanca and Goldman Sachs. This resulted in an aggregate net payment of about €22.84 million by the defendants to a counterparty, i.e. a close-out payment of this amount was required from Lehman to the defendants.

However, in the knowledge that the SAP shares fell to be dealt with by the Joint Administrator in the course of the administration (and, therefore, were essentially inaccessible), and in the light of the volatility of the SAP share price, the defendants also sought to calculate their Loss on an uncollateralised basis.  Mediobanca provided a quotation on this basis, as at the close of XETRA on 16 October 2008, which resulted in net amounts payable to it of €511.13 million (the increased amount reflecting the fact that Mediobanca would have increased exposure in the absence of any collateral).   

The defendants proceeded with this more attractive figure, and set out their formal calculation of Loss in a letter to Lehman which was sent on 16 December 2008 (the "Loss Calculation").


Lehman challenged the defendants' Loss Calculation.  Lehman contended that:

  • the defendants did not determine their Loss reasonably or in good faith in accordance with the requirements of the ISDA Master Agreements;
  • the Loss Calculation was based on a valuation of materially different (i.e. non-collateralised) transactions which the defendants could never have entered into; and
  • the defendants' valuation should have been obtained by reference to the Early Termination Date itself, and ought to have been for collateralised replacement transactions.

In response, the defendants contended that:

  • the ISDA Master Agreements did not prescribe the method that they had to use to determine Loss, and did not require them to base their determination on live market quotations;
  • the ISDA Master Agreements simply required them to determine an amount that would be required to put themselves into the position that they would have been in if the transactions had not terminated; and
  • their approach was reasonable and honest unless Lehman could demonstrate that no Non-Defaulting Party acting reasonably and in good faith could have acted in the same way.

Snowden J's decision

The Court was therefore tasked with determining whether the defendants' Loss Calculation was made in accordance with the ISDA Master Agreements and hence was contractually valid and binding on Lehman.

The defendants placed considerable reliance upon what they contended was the deliberately non-exhaustive definition in the ISDA Master Agreement when it came to prescribing a specific methodology for determining Loss.  The defendants contended that a determination of Loss is what the non-defaulting party "reasonably determines in good faith to be its total losses and costs … in connection with the termination transactions".

The Judge accepted that the text of the 1992 ISDA Master Agreement was designed to give the non-defaulting party discretion and flexibility in selecting the method for calculating its Loss, subject to such methodology being reasonable and in good faith (in accordance with the established common law principles relating to contractual damages and remoteness). It was also accepted that a non-defaulting party has a degree of latitude as to when it is obliged to obtain quotations in order to reflect the problems that might arise in practice.  However, the Judge did not agree that the non-defaulting party has similar freedom to decide what matters can be included within the meaning of Loss. 

The Judge therefore rejected the argument that (i) it was up to the defendants to decide for themselves what "Loss" meant in the Master Agreement and (ii) Lehman should be deemed to have agreed to be bound by the defendants' own interpretation of "Loss".  The Judge explained that it would not have been within the reasonable contemplation of the parties that the SAP shares would be inaccessible in the event of a default by Lehman.  It was also not rational for the Loss Calculation to be determined on an uncollateralised basis.  As such, it was not contractually valid or binding on Lehman as the terminated transactions should have been valued on the basis of collateralised replacement transactions.

Having determined that the defendants' Loss Calculation was not in accordance with the Master Agreements and not binding on Lehman, the Judge turned to the question of what would have happened if a reasonable person in the position of the defendants had correctly performed their task of determining Loss under the Master Agreements.  He considered that such determination should have been based upon quotations or valuations for collateralised replacement transactions as of a date as soon as reasonably practicable after the Early Termination Date, and that the valuations from Mediobanca and Goldman Sachs both fulfilled those requirements.


The Court's approach was that it should not readily become involved in a detailed assessment of whether the determining party took into account all relevant factors when determining its loss as this would encourage challenges to be made to the calculation by the non-defaulting party, which would cut across the desire for speed and commercial certainty of determination.  It follows that a non-determining party must be given latitude and flexibility in choosing the method by which they should determine 'Loss', as long as the requirements of rationality and good faith are satisfied.  This freedom also extends in certain (limited) circumstances to the determination using valuations prepared by reference to a date which is some time after the Early Termination Date.

However, the case makes clear that there are limits on what the non‑defaulting party can do when calculating Loss, and that it does not have a complete freedom to decide what matters can be included within the meaning of Loss.