Lehman Brothers succeed in argument that continuing Events of Default will be “cured” upon exit from administration

Linklaters acted for the administrators of LBIE against two entities which had relied on the suspensory effect of provisions in the ISDA Master Agreement to avoid paying close out sums of over US$ 60 million. The Court held that, on exit from its administration, various Events of Default in respect of LBIE would no longer be continuing and the amounts owed to LBIE would become due and payable. This case provides welcome clarification of important provisions of the ISDA Master Agreement and will be relevant to other agreements using the same language (including repos, stock loans, debt securities and facility agreements). It is also an example of the importance of interpreting clauses in their contractual context. The full High Court judgment is available here and a more comprehensive summary and commentary, written by Simon Firth, is available here.


Lehman Brothers International (Europe) (“LBIE”) went into administration in September 2008. At the time, it was a counterparty to a large number of derivatives contracts governed by ISDA Master Agreements (the “Master Agreements”) including, relevantly, two swap transactions with FR Acquisitions Corporation (Europe) Ltd and JFB Firth Rixson Inc. (collectively referred to as “Firth Rixson”). The vast majority of counterparties of LBIE closed out their transactions shortly after LBIE’s entry into administration, resulting in payments from the party which was “in the money” at the relevant time. However, a small number of counterparties, including Firth Rixson – likely assuming that LBIE would never be restored to solvency – declined to do so.

Those counterparties instead relied on section 2(a)(iii) of the Master Agreement which provides, in summary, that the payment obligation of a party is suspended (but not extinguished) for as long as an Event of Default in respect of its counterparty has occurred and is continuing (as was confirmed in Lomas v JFB Firth Rixson Inc [2012] 1 CLC 713).

Firth Rixson have, for more than a decade, relied on a number of alleged Events of Default to avoid making any payments to LBIE in respect of the transactions. It was common ground that some of those Events of Default had occurred: LBIE entered administration; it was unable to pay its debts as they fell due (and admitted the same in writing); and it failed to make two payments under the sterling swap (the “Undisputed Events of Default”). In addition, Firth Rixson alleged that LBIE’s scheme of arrangement (the “Scheme”), promulgated in 2018 to resolve issues as to the distribution of the surplus in its estate, the associated Chapter 15 order under the US Bankruptcy Code recognising the Scheme, and French and Spanish exequaturs recognising the administration order, were further continuing Events of Default.

The Directions Application

In the event, the administration of LBIE has been remarkably successful. LBIE has paid (or reserved for) all creditor claims in full, together with statutory interest, and has made significant distributions to its shareholder. LBIE now has a substantial surplus of assets over liabilities in its estate and the administrators are pursuing the statutory objective of rescuing the company as a going concern (as confirmed by the Court in Re Lehman Brothers International (Europe) [2020] Bus LR 1875).

The administrators therefore sought directions from the Court under paragraph 63 of Schedule B1 to the Insolvency Act 1986 as to whether, upon the Company exiting administration in due course, any continuing Events of Default would be “cured”, such that the amounts owed to LBIE by Firth Rixson under the Master Agreements would become due and payable.

Meaning of “continuing

The key question in relation to the Undisputed Events of Default was whether they would be “continuing” once LBIE exited administration. Firth Rixson argued that this meant looking at whether the effects of the Event of Default are still continuing. The Court rejected this argument and agreed with the Administrators that the correct inquiry is whether the event or state of affairs which constitutes the Event of Default is “continuing”. In this case, it was held that exiting the administration and confirming that LBIE was able to pay its debts as they fell due would cure all of the Undisputed Events of Default, such that they would no longer be “continuing”. The Court also held that the French and Spanish exequaturs would no longer be continuing at that stage (if they had ever constituted freestanding Events of Default, in respect of which the Judge expressed some doubt).

Meaning of “arrangement

One of the Events of Default listed in the Master Agreement is where a party “makes a general assignment, arrangement or composition with or for the benefit of its creditors”: Section 5(a)(vii(3). Firth Rixson alleged that the Scheme was an “arrangement” within the meaning of this provision on the basis that it involved a permanent variation of creditors’ rights. However, the Administrators successfully argued that the word must be interpreted in light of its context, namely that the relevant clause deals with events involving financial distress giving rise to a credit risk. The Judge agreed with the Administrators that the word “arrangement” had to be “read-down”, and that (properly construed) it meant an arrangement with a similar premise or trigger to the other events identified in the clause. The Scheme was not entered into in circumstances of financial distress and did not affect or otherwise alter the credit risk of Firth Rixson; rather, the Scheme determined the distribution of surplus assets in the estate. Accordingly, the Court held that it did not constitute an Event of Default. The US Chapter 15 Order, which recognised the Scheme, was also found not to constitute an Event of Default for essentially the same reason.

If you would like to discuss this case further or have any questions, please get in touch with Susan Roscoe or Luke McCabe (advisers to the LBIE administrators), Simon Firth, or our Banking Litigation team.

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