The High Court has for the first time considered the close-out provisions under the 2002 ISDA Master Agreement.


This case involved a forward currency swap between Lehman Brothers Special Financing Inc. (LBSF) and National Power Corporation (NPC).

The parties entered into a 2002 ISDA Master Agreement (2002 Agreement) with an accompanying Schedule. Under the swap, LBSF agreed to pay US$100 million to NPC in 2028, and NPC agreed to pay LBSF the US$ equivalent of Philippine pisos 4.4788 billion in 2028 (4.4788 billion pisos being the equivalent of US$100 million when the transaction was entered into). Semi-annual coupons were payable at a fixed rate by NPC to LBSF.

In September 2008, Lehman Brothers collapsed and LBSF filed for bankruptcy relief in the United States under Chapter 11. These events constituted events of default under the swap and it was terminated early in accordance with its terms. The designated contractual “Early Termination Date” was 3 November 2008. Pursuant to the 2002 Agreement, NPC had to determine the close-out amount using “commercially reasonable procedures” and act with a view to reaching a “commercially reasonable result”. Hence, on the Early Termination Date, it obtained three indicative quotations from UBS, Deutsche Bank and Goldman Sachs. On 7 November 2008, it obtained firm quotations from each of the dealers and entered into a replacement transaction with UBS on 14 November 2008.

In January 2009, NPC served a calculation notice on LBSF demanding payment of around US$3.5 million, based on the cost of the transaction actually entered into with UBS. LBSF challenged this calculation, contending that NPC had neither used “commercially reasonable procedures” nor had reached a “commercially reasonable result” as required by the Agreement. LSBF then issued proceedings against NPC claiming an amount of around US$13 million. In 2016, NPC attempted to withdraw its 2009 calculation statement and to serve a revised statement based on the UBS indicative quotation, claiming that it was owed approximately US$11 million.

The High Court considered several issues in its judgment:

  • most notably, whether NPC had followed “commercially reasonable procedures” in order to achieve a “commercially reasonable result” when assessing its losses
  • the standard of reasonableness applicable
  • the question of whether it was possible to validly submit a revised notice.


Robin Knowles J confirmed that under the 1992 ISDA Master Agreement (1992 Agreement), a determining party must act “reasonably” and “in good faith” whilst making an assessment of its “Loss”. In contrast, under the 2002 Agreement, it must “act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result”. Whilst they appear to be similar, these are two separate and distinct tests. The Judge held that the former was analogous to Wednesbury unreasonableness i.e. the determining party must act rationally such that its decision can only be attacked if it was one that no reasonable determining party could reach. In this context, any challenge to such a decision must demonstrate that the decision maker acted irrationally, and the test involves asking whether the decision-maker had temporarily “taken leave of his senses”. It also includes an analysis of the process undertaken to reach the decision. As is well known, this is a high threshold to meet for any challenger. Hence, the 1992 Agreement makes things less onerous for the determining party when calculating its “Loss”.

Under the 2002 Agreement, the introduction of the phases “commercially reasonable procedures” and “commercially reasonable result” results in a very different test. The Judge held that the 2002 Agreement requires a determining party to act by objective standards with reference to what a reasonable person would have done in the same circumstances. Quoting Briggs J (as he then was) in Lehman Brothers International (Europe) (In Administration), the Judge agreed that the 2002 agreement imposes “objective standards. The first is that the procedures used should be commercially reasonable and the second is that the result produced should also be commercially reasonable”. Though there is some flexibility in the range of procedures it can adopt, it also makes the determining party’s task more onerous as it is required to strive towards an objective ‘target’. For these reasons, NPC’s argument that the 1992 standard should apply was rejected by the Judge.

The Judge pointed to the terms of the 2002 Agreement, which provide that in ” determining a Close-Out Amount, the Determining party may consider…quotations (either firm or indicative) for replacement transactions supplied by one or more third parties”. The Early Termination Date was 3 November 2008. The Judge did not believe that it was unreasonable for NPC to determine the close-out amount based on the information which became available a little later in November 2008 i.e. the firm quotes and the cost of the replacement transaction. The 2002 Agreement required a determining party to make its calculation “as of the Early Termination Date” or if that was not reasonable, as soon as possible thereafter. Knowles J stated that he had “heard no evidence that persuaded [him] that it was other than commercially reasonable to make the determination, as NPC did, as of the dates of the firm quotation from UBS”. He added that “where a firm quotation existed from UBS it was appropriate to regard that as having superseded the indicative quotation from UBS”.

Once a reasonable determination had been made by NPC, it was unable to withdraw its calculation statement and replace it with another. Were it allowed to do so, this would in effect allow NPC to replace a reasonable determination with an unreasonable determination. Knowles J agreed with LBSF who argued that to allow a notice to be replaced eight years later and in the midst of litigation could not have been the intention of the ISDA Master Agreement. He went on to quote the authoritative Derivatives Law and Practice by Firth stating that once “a determination has been validly made of the… Close-out Amount, it will be final and binding on both parties. The determining party cannot subsequently change its mind”. He added that where an error had been made, it was for the court or tribunal chosen by the parties to declare that a mistake has been made. The court/tribunal would then decide what the close-out amount would have been on an objective basis.

Robin Knowles J affirmed that the ISDA Master Agreement is “one of the most widely used forms of agreement in the world. It is probably the most important standard market agreement used in the financial world”. To this end, this judgment is a welcome clarification on the close-out provisions under the 2002 Agreement and practically demonstrates how they differ from those of the 1992 Agreement.

For the market, it is important to note the more demanding standard of objective reasonableness that applies under the 2002 Agreement. Parties should be mindful of this when deciding to choose between the 1992 Agreement and the 2002 Agreement. The determining party must also note that it only has one chance to get it right: it will not get a second opportunity to submit a calculation notice.

Lehman Brothers Special Financing Inc v National Power Corporation and Power Sector Assets & Liabilities Corp [2018] EWHC 487 (Comm)