High Court Rules that ISDA Bankruptcy-Related Events of Default Can Be Cured in Lehman Case

In Grant & Ors v FR Acquisitions Corporation (Europe) Ltd & Anor (Re Lehman Brothers International (Europe)) [2022] EWHC 2532 (Ch), the English High Court ruled on an application for directions (the “Application”) made by the administrators (the “Administrators”) of Lehman Brothers International (Europe) (LBIE) relating to the construction and effect of certain bankruptcy-related events of default (“Events of Default”) specified under the ISDA Master Agreements (as defined below), specifically:

• Whether certain bankruptcy-related Events of Default specified under Section 5(a)(vii)[1] can be cured, so that they are no longer “continuing” for the purposes of Section 2(a)(iii), and that a party relying on such a provision to suspend its obligation to perform can no longer do so; and
• Whether certain events in connection with the administration can be construed as constituting Events of Default and, if so, whether they are “continuing” for the purposes of Section 2(a)(iii).

The Court ruled on the side of the Administrators, holding that (i) the relevant bankruptcy-related Events of Default could be cured, and therefore the non-defaulting counterparty could no longer rely on Section 2(a)(iii) to suspend performance of its obligations, and (ii) certain other administration-related events did not constitute Events of Default within the meaning of the relevant provisions under Section 5(a)(vii) of the ISDA Master Agreement, as the non-defaulting counterparty sought to contend, and therefore the follow-on question of whether the events were “continuing” for the purposes of Section 2(a)(iii) was irrelevant.

Background

FR Acquisitions Corporation (Europe) Ltd (FRAC) and JFB Firth Rixson Inc. (collectively with FRAC, “Firth Rixson”) were parties to a Sterling interest rate swap (the “Sterling Swap”) and a USD interest rate swap (the “USD Swap” and, together with the Sterling Swap, the “Swaps”) with LBIE, respectively. The parties entered into the Swaps on 13 November 2007, with a scheduled maturity in December 2010. The Sterling Swap incorporated the terms of a 1992 ISDA Master Agreement and the USD Swap, a 2002 ISDA Master Agreement (and, for the purposes of this client alert, the 2002 ISDA Master Agreement and the 1992 ISDA Master Agreement, collectively, are the “ISDA Master Agreements”). For the purposes of the Application, there was no material distinction between the 1992 and the 2002 ISDA Master Agreements in respect of the relevant provisions. LBIE went into administration on 15 September 2008, and from that date onwards Firth Rixson relied on Section 2(a)(iii) of the ISDA Master Agreements such that it made no further scheduled payments under the Swaps to LBIE, even though the movement in interest rates meant that a net amount would otherwise have been payable by Firth Rixson to LBIE under the Sterling Swap. Automatic Early Termination was not specified to be applicable for either of the Swaps. At the time of the Application, substantial surplus assets remained in the LBIE insolvency estate, and the Administrators were working to bring the administration to an end by terminating their appointments as Administrators and returning LBIE to the control of its directors.

Analysis

It was not in dispute that the following bankruptcy-related Events of Default had occurred:

1. LBIE entered into administration, constituting an Event of Default under Sections 5(a)(vii)(4) and 5(a)(vii)(6);
2. LBIE failed to make two quarterly payments due under the Sterling Swap in September and December 2008 after it went into administration, constituting an Event of Default under Section 5(a)(i) (note that LBIE never failed to make any payments in respect of the USD Swap); and
3. LBIE admitted in writing its inability to pay debts as they fell due, constituting an Event of Default under Section 5(a)(vii)(2).

The Application was not the first time the Administrators have been involved in litigation with Firth Rixson regarding the suspension of its payment obligations under the Swaps – the parties have previously litigated on this issue and in 2012 the Court of Appeal held that Firth Rixson was entitled to rely on Section 2(a)(iii) to suspend its payment obligations until the Events of Default were no longer “continuing” or, in other words, until all Events of Default were “cured”[2]. The key to this Application, therefore, was for the Court to determine whether all Events of Default had indeed been “cured”. As the ISDA Master Agreements did not prescribe the circumstances in which an Event of Default would be considered as “continuing”, the Court had to consider each event in the context of the status of the administration proceedings. In particular, the Court held that whether a bankruptcy-related Event of Default under Section 5(a)(vii) would be considered as “continuing” was a matter of factual events or a state of affairs, and did not require assessment of its effects on the non-defaulting party. On that basis:

1. With regard to the Events of Default under Sections 5(a)(vii)(4) and (6) relating to LBIE entering into administration – once the Administrators’ appointment terminated pursuant to the Insolvency Act 1986, the Events of Default would no longer be continuing;
2. With regard to the non-payment Event of Default under Section 5(a)(i) – this was held to be no longer continuing in light of the operation of the insolvency set-off provisions pursuant to the Insolvency (England and Wales) Rules 2016, as by December 2009 there had already been three payment dates on which FRAC was required to make a net payment under the Sterling Swap; and
3. With regard to the Event of Default under Section 5(a)(vii)(2) for LBIE’s admission in writing of its inability to pay any debts as they fell due – the Court held that the Administrators’ reports and surrounding publicity have “almost certainly been sufficient to ensure that no creditor would any longer have regard to the original notice”, but nevertheless the Court would direct the Administrator to publish a notice to the effect that the LBIE estate had surplus assets and was now able to settle the debts as they fell due. By publishing such a notice, any doubt about the ability of LBIE to pay its debts as they fell due would be extinguished and, therefore, such Event of Default would no longer be “continuing”.

In addition to the three Events of Default, which both Firth Rixson and LBIE agree had occurred, there were three other events which Firth Rixson contended constituted separate Events of Default:

1. A scheme of arrangement proposed by the Administrators and sanctioned by the Court on 18 June 2018 (the “Scheme”), the purpose of which was to facilitate the distribution of surplus assets from the LBIE estate and compromise to bring an end to litigation. Firth Rixson argued that the Scheme constituted an Event of Default under Section 5(a)(vii)(3), being an “…arrangement…with or for the benefit of its creditors”. The Court held that the Scheme did not constitute an arrangement for the purposes of Section 5(a)(vii)(3), which should be read as “descriptive of processes entered into by a debtor in circumstances of financial distress, or which involve a fundamental change in the status of the relevant entity (such as by dissolution or winding-up), such as materially to affect the counterparty’s credit risk”[3]. The Scheme did not meet these criteria. Interestingly, Mr Justice Hildyard noted that if (contrary to his view) the Scheme were an Event of Default, it would not be cured once all steps are taken to give it effect, as the “arrangement” would continue to subsist even when all steps necessary to accomplish it have been taken”[4].
2. The Chapter 15 order (including a permanent injunction) made pursuant to the U.S. Bankruptcy Code, which recognised and enforced the Scheme in the USA (the “Chapter 15 Order”) – Firth Rixson contended that the making of the Chapter 15 Order triggered Events of Default under Sections 5(a)(vii)(4) and 5(a)(vii)(8) (referencing analogous events including in other jurisdictions). The Court held that, similar to Section 5(a)(vii)(3), Section 5(a)(vii)(4) should be read to operate in the context of companies in financial distress, and because the Scheme was properly classified as a solvent scheme, it followed that the related Chapter 15 Order (being a recognition proceeding in respect of the Scheme) would not constitute a separate Event of Default.
3. The recognition of the English administration order pursuant to an “exequatur” order in France and Spain in October 2008 and June 2009 respectively (the “Spanish and French Exequaturs”) – Firth Rixson again contended these orders triggered an Event of Default under any of Sections 5(a)(vii)(4), (6), and (8), and which were “continuing” for as long as the orders giving effect to the Spanish and French Exequaturs remained in force. The Court found that any issue with regard to the Spanish and French Exequaturs would ultimately be academic – once the administration ceases and the appointment of the Administrators comes to an end, the Spanish and French Exequaturs must also cease to have any effect. The orders were therefore not additional Events of Default and, in any case, would not be continuing once the appointments of the Administrators have ceased.

Conclusion

This is believed to be the first case in any jurisdiction that has considered the meaning of “continuing” in the context of Section 2(a)(iii) of the ISDA Master Agreement, and it provides important guidance for market participants who wish to rely on this section to suspend performance of their own obligations in bankruptcy situations. This, and perhaps other cases arising from the Lehman Brothers administration, must be viewed as almost special cases, given the rather unusual circumstance that the LBIE insolvency estate has ended up with such a large surplus towards the end of its long administration. This elucidates the risk that a party relying on Section 2(a)(iii) of the ISDA Master Agreement to suspend performance of its obligations may ultimately have to perform such obligations, even if it is many years from when performance was first due. 

It is also important to remember, as the Court has reiterated throughout its judgment, that the purpose of Section 2(a)(iii) is to “protect the Non-defaulting Party from the additional credit risk involved in performing its own obligations whilst the defaulting counterparty remains unable to meet its own”[5]. Firth Rixson is a net debtor to LBIE, and none of the Events of Default that it sought to rely on in the Application has a substantive adverse effect on Firth Rixson with regard to its rights under the Swaps, and their credit risk as against LBIE was not increased or affected by any of them. The Court held that the result of the contextual interpretation of whether each of those events constitutes an Event of Default was in line with this overall purpose of the relevant provisions. As a result, Firth Rixson has a contractual obligation to pay LBIE the sums owing under the Swaps.   

[1] All references to sections in this client alert are to sections in the ISDA Master Agreements (or the relevant ISDA Master Agreement, as applicable).

[2] Lomas v JFB Firth Rixson Inc [2012] 1 CLC 713.

[3] Mr Justice Hildyard at paragraph 143(2).

[4] Mr Justice Hildyard at paragraph 149.

[5] Mr Justice Hildyard at paragraph 64, citing Lomas v JFB Firth Rixson Inc [2012] 1 CLC 713 at paragraph 92.