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England and Wales High Court (Commercial Court) Decisions
You are here: BAILII >> Databases >> England and Wales High Court (Commercial Court) Decisions >> Lehman Brothers International (Europe) v Exxonmobil Financial Services BV  EWHC 2699 (Comm) (28 October 2016)
Cite as:  EWHC 2699 (Comm)
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QUEEN'S BENCH DIVISION
Fetter Lane, London, EC4A 1NL
B e f o r e :
| LEHMAN BROTHERS INTERNATIONAL (EUROPE)
(an unlimited company incorporated under the law of England and Wales)
|- and -
|EXXONMOBIL FINANCIAL SERVICES BV
Mr DANIEL TOLEDANO Q.C. and Mr CONALL PATTON (instructed by Norton Rose Fulbright LLP) for the Defendant
Hearing dates: 18th – 21st and 28th July 2016
Crown Copyright ©
Mr Justice Blair:
15 September 2008
"Re: Default notice following the occurrence of the Event of Default under the TBMA / ISMA Global Master Repurchase Agreement dated January 9, 2008
With immediate effect, [EMFS] hereby serves [LBIE] a default notice as per the [GMRA].
This default notice follows the occurrence of an Event of Default set out in section 10(a) of the [GMRA]. As a result, the repurchase date for all transactions effected under the [GMRA] becomes immediately due.
Further, given the nature of the Event of Default and in line with the Collateral Management Repo Agreement …, please be advised that EMFS has
(a) as per Section 16(A) of the Agreement, notified the Agent of the occurrence of the Event of Default under the [GMRA]; and
(b) instructed the Agent to immediately withhold (and suspend any movement of) any securities on the Collateral Accounts used for the purposes of the transactions under the [GMRA].
"We refer to the Default Notice we sent you this morning. With this letter we confirm that the Default Notice is given following the appointment of joint administrators in respect of Lehman Brothers International (Europe) which gives rise to an Act of Insolvency under paragraph 2(a)(iii) of the [GMRA] and which is mentioned as an Event of Default under paragraph 10(a)(iii).
16 September 2008
"Basically we've pushed the aggressiveness as far as I think it will be possible to achieve (it's hard to estimate how much the market can stand), and hopefully we've got a relatively realistic representation in this analysis. Basically, by increasing the aggression of the trading it looks like it might be possible to complete in 2 days with I estimate around 95% completion after the first day. In reality, I think one of the names may go over to a third day."
17-18 September 2008
"Unfortunately as I am sure you've heard from the news headlines there is not a lot of interest in buying fixed income, oh sorry financial instruments and we didn't manage to find any completions or any trades on any of the American names so we will have to be going back into the market again today. Hopefully there is a little bit more interest today."
19 September 2008
22 September 2008
"…we were trying to get bids through our own dealing room, through our pension fund group in the US. We were trying to get quotes from RBS and from Barclays, and only after that, it was very clear to us that nobody, in addition to what JPM already mentioned, was interested to pay anything for it at all".
(1) Appendix 1 identified the 163 equities (the "A1 equities") and 6 bonds (the "A1 bonds") that had been sold (together, the "A1 securities"), and valued them at their sale prices. If the DVN was in time, it is common ground that these values cannot be impugned by LBIE.
(2) Appendix 2 identified 7 bonds that had not been sold, but for which JP Morgan had obtained a bid quotation (which it is not in dispute the bank "refreshed" on 22 September 2008) (the "A2 bonds") and valued them at those quoted prices. EMFS accepts that the DVN is not compliant in this respect, because only one bid quotation was stated, whereas paragraph 10(e)(i)(B) of the GMRA required two.
(3) Appendix 3 identified 5 bonds which JP Morgan had been unable to sell or obtain any bids for (the "A3 bonds") and stated EMFS'S opinion of their value, which involved reducing observed screen prices by 40%. This valuation is challenged by LBIE whether or not the DVN was otherwise valid.
(1) Issue 1: whether the communication of 15 September 2008 or 16 September 2008 was a Default Notice.
(2) Issue 2: whether the Default Valuation Notice (DVN) was validly served to the -4034 fax machine.
(3) Issue 3: whether LBIE waived any objection to service of the DVN to the -4034 fax machine.
(4) Issue 4: time of effective receipt of the DVN.
(5) Issue 5: whether the DVN was validly served by email.
(6) Issue 6: whether paragraph 14(b) of the GMRA deems the DVN as received at the opening of business on 23 September 2008.
(7) Issue 7: whether it was open to EMFS to determine a single Appropriate Market.
(8) Issue 8: whether the DVN conveyed a determination of a global Appropriate Market.
(9) Issue 9: if the DVN conveyed no determination of Appropriate Market, what are the consequences.
(10) Issue 10: what Appropriate Market should be determined.
(11) Issue 11: when did close of business in the Appropriate Market occur.
(12) Issue 12: was the DVN served before the Default Valuation Time.
(13) Issue 13: if EMFS'S valuation of the A3 bonds in the DVN was invalid, what are the consequences.
(14) Issue 14: was EMFS'S valuation of the A3 bonds in the DVN valid.
(15) Issue 15: if EMFS'S valuation of the A3 bonds was invalid, what valuation should have been given under paragraph 10(e)(i)(C).
(16) Issue 16: what is the correct approach to valuation under paragraph 10(e)(ii).
(17) Issue 17(a): would EMFS validly have relied on the actual sale prices for the A1 equities.
(18) Issue 17(b): if the answer to Issue 17(a) is no, how would EMFS validly have valued the A1 equities.
(19) Issue 18(a): would EMFS validly have relied on the actual sale prices for the A1 bonds.
(20) Issue 18(b): if the answer to Issue 18(a) is no, how would EMFS validly have valued the A1 bonds.
(21) Issue 19(a): would EMFS validly have adopted the bid quotations obtained by JPMS as the value of the A2 bonds.
(22) Issue 19(b): if the answer to Issue 19(a) above is no, how would EMFS validly have valued the A2 bonds.
(23) Issue 20(a): if the DVN was invalid, would EMFS validly have adopted the values for the A3 bonds stated in the DVN.
(24) Issue 20(b): if the answer to Issue 20(a) above is no, how would EMFS validly have valued the A3 bonds.
(25) Issue 21: what net sum is payable and to whom (for consideration post-judgment).
(26) Issue 22: interest on any net sum payable (for consideration post-judgment).
(27) Issue 23: is EMFS entitled to legal expenses and compensation for wasted management time (for consideration post-judgment).
Introduction to the discussion of the issues
Applicable legal principles
"In simple terms, a repo is a transaction in which one party sells an asset (such as fixed-income securities) to another party at one price, and commits to repurchase the asset at a different price in the future. Although a repo is structured legally as a sale and repurchase of the securities, it behaves economically like a secured loan, with the securities acting as collateral (see e.g. DCC Holdings (UK) Ltd v Revenue and Customs Commissioners  1 WLR 44, SC ; In the Matter of Lehman Brothers International (Europe) (in Administration)  EWHC 2914 (Ch) at , Briggs J; and the definition in Directive 2002/47/EC of 6 June 2002 on financial collateral arrangements, Art 2 )."
The Default Notice: Issue 1
"an Act of Insolvency occurs with respect to Seller or Buyer and … the non-Defaulting Party serves a Default Notice on the Defaulting Party;"
"a written notice served by the non-Defaulting Party on the Defaulting Party under paragraph 10 stating that an event shall be treated as an Event of Default for the purposes of this Agreement;"
The parties' contentions
(1) On the true construction of paragraph 2(l) of the GMRA, there must be a written notice which contains an express statement that "an event" shall be treated as an Event of Default. This means that the notice will have to state what that event is.
(2) This requirement reflects the fact that paragraph 10(a) makes the service of a Default Notice a precondition to the occurrence of an Event of Default: the non-Defaulting Party is not obliged to treat an Act of Insolvency (for example) as an Event of Default, but has the option to do so.
(3) This requirement also serves the commercial purpose of enabling the recipient to evaluate whether the event in question is one that potentially qualifies as an Event of Default, and thus to assess whether the purported Default Notice is a valid one (Laminates Acquisition Co v BTR Australia Ltd  1 All ER (Comm) 737 at ).
(4) It is clear that EMFS's doubts about the validity of the notice were contemporaneous, which is why it prepared and sent the second communication specifying that it was the appointment of joint administrators of LBIE that constituted an Event of Default under the GMRA.
(5) It is irrelevant that a Default Notice may have to be given urgently, because the definition is clear and simple.
(6) EMFS's case is consonant with authority, see the statement at §17.15 of Lewison on The Interpretation of Contracts (6th Ed) that "An option to terminate is construed in the same manner as any other option, and accordingly any condition must be strictly complied with" (see also Mannai Investment Co Ltd v Eagle Star Life Assurance Ltd  AC 749 at 768).
(7) That a repudiatory breach may be accepted without any form of notice tells one nothing about how to construe an express contractual power which depends on the service of written notice. The latter, unlike the former, is governed by the requirement for strict compliance.
(8) There is no relevant distinction between the definition of Default Notice and the requirements for a "Special Default Notice" under paragraph 14(c) of the GMRA.
(9) The recipient (who may wish to challenge the declaration of an Event of Default) is also entitled to know precisely where he stands on receipt of the notice. An informative Default Notice will serve this purpose, while an uninformative one is a recipe for confusion and uncertainty.
(1) It contains no statement identifying any relevant "event" nor any statement that such event is to be "treated" as an Event of Default. It does not, therefore, constitute a Default Notice.
(2) Although the recipient would understand that EMFS intended the letter to be a Default Notice, the label used is not conclusive: what matters is whether, in substance, the document falls within the contractual definition, which it does not.
(3) The words "given the nature of the Event of Default" do not point to the appointment of administrators, and it is not enough to hint at an event. The event must be stated for the definition to be satisfied.
(4) Mannai is consistent with this, because the lease in question did not impose any formal requirements as to what a notice should state. The notice stated the wrong date, and the court was prepared to overlook the error because the notice left the landlord in no reasonable doubt that the right to determine the lease was being exercised.
(5) This and other cases do not in any way detract from the need for strict compliance where the contract does prescribe a formal requirement for a valid notice (Mannai at ), or where the case is one where it is an indispensable condition that the notice should contain specific information (see e.g. Burman v Mount Cook Land  Ch 256).
(6) The GMRA, like the statute in Burman, but unlike the lease in Mannai, requires the Default Notice to "state" certain things, and the letter of 15 September does not.
(1) EMFS seeks to read into the definition of "Default Notice" a requirement to "identify an event", which is not contained in the express words of the clause.
(2) The emphasis of the wording is on the treatment of an event as (i.e. the designation of) an Event of Default, not on the "event" is which is being so treated.
(3) Since the letter conveyed clearly to LBIE what the Event of Default was said to be, EMFS has to contend that the word "stating" does not merely require a certain meaning to be conveyed to the recipient of the notice, but that it requires a certain matter to be specified expressly in the notice itself.
(4) Authorities such as Mannai Investment Co Ltd v Eagle Star Life Assurance Ltd  AC 749 and Rennie v Westbury Homes (Holdings) Ltd  2 P. & C.R. 12 establish that (i) contractual notices must be construed against the relevant factual background, with the focus on the meaning that the notice conveys rather than the matters expressly stated in the notice, and (ii) it is formalism to suggest that a notice which conveys the required meaning is invalid because it does not use a particular verbal formula.
(5) EMFS is obliged to contend that the requirements it is seeking to imply into the definition of "Default Notice" are "indispensable conditions", within the meaning of that phrase in Mannai at p.767.
(6) EMFS accepts that, when it says that the mandatory requirement it contends for is an "indispensable condition", it means a condition of the "blue paper/pink paper" kind referred to in Mannai.
(7) Commercial lawyers are familiar with "indispensable conditions" in the context of notices, but usually in respect of some easily verifiable requirement (as in Lord Hoffmann's blue paper/pink paper example). But an "indispensable condition" that a notice expressly specifies something is rare, because if the notice succeeds in conveying the required meaning, there can be no sensible reason for an additional requirement that a specific (and no other) form of words be used.
(8) The GMRA does not say that a Default Notice has to "identify" any particular facts relied on. It requires that a qualifying event shall have occurred and that the non-Defaulting Party shall have served a Default Notice which states that that is the case. There is not a requirement to specify the facts relied upon. On EMFS's case, the definition would have to say:"a written notice ... under paragraph 10 [identifying the facts relied upon as constituting a potential Event of Default and] stating that [such facts] an event shall be treated as an Event of Default for the purposes of this Agreement."
(9) Acceptance of a repudiatory breach of contract need not take any particular form (Chitty on Contracts (32nd ed), [24-13]). Furthermore, a termination can be justified by a good reason even if no reason or a bad reason has been given at the time (Chitty, [24-13]). Those being the common law rules, it cannot be necessary to read such unnecessary complications into the GMRA.
(10) As to commercial purpose, if the alleged Defaulting Party did not believe it had defaulted it would doubtless seek further information immediately.
(11) There is no obvious reason why a Defaulting Party is entitled to precise details of its default; the common law has never felt it appropriate to impose such an entitlement; and the GMRA does not provide for any express contractual machinery by which a Defaulting Party can challenge the designation of an Event of Default.
(12) Support is to be found in paragraph 14(c) of the GMRA which deals with the requirements for a "Special Default Notice" when a counterparty cannot be served by the prescribed methods. A Special Default Notice is defined as one which "specifies the relevant event referred to in paragraph 10(a) which has occurred". EMFS is seeking to read in words which are present in the definition of a Special Default Notice but which are not present in the definition of an ordinary Default Notice.
(13) EMFS's construction creates a trap for those seeking to serve Default Notices, often in circumstances of considerable commercial pressure when a potential default has occurred and it is necessary to take swift action. If it is to be essential to the validity of a valid notice under paragraph 10(a) that it should specify facts, that requirement should be spelled out plainly in the contract so that the users of the GMRA can understand it without the need for specialised legal advice.
(14) EMFS's approach opens up an unnecessary area of complication. If the notice has to specify the facts relied upon as an Event of Default, then there will inevitably be cases where the wrong facts, or slightly wrong facts, are specified. The result will be to create uncertainty.
(15) LBIE relies on Rennie v Westbury Homes (Holdings) Ltd  2 P. & C.R. 12 at , and on appeal at  EWCA Civ 1401 . This is not a case of "indispensable conditions". The definition of a "Default Notice" as one stating that an event shall be treated as an Event of Default simply describes what it is that the notice must convey to the recipient. Here, there can be no doubt that the 15 September 2008 letter conveys to the reader that EMFS wished to treat an event as an Event of Default (e.g. Savings Bank of the Russian Federation v Refco Securities LLC  EWHC 857).
(16) As to whether the letter of 15 September 2008 complied with the definition, if EMFS submits that the notice had to use the exact form of words used by the definition, then there was never a valid Default Notice since neither the 15 September nor the 16 September 2008 letter uses that form of words. If EMFS means that the 15 September letter failed to communicate that EMFS was seeking to declare an Event of Default that is unsustainable, because the content of the letter makes it plain that this was what EMFS was trying to do.
Discussion and conclusion
"Where a contract contains a termination clause no particular formality is necessary (unless the contract so provides) to exercise the right. Any communication which clearly conveys that the right is being exercised will suffice. Nevertheless in interpreting a termination clause the court must still adopt a commercially sensible interpretation. In determining whether a termination clause has been validly exercised, there must be substantive compliance with the contractual provisions, and any notice exercising the right to terminate must be in sufficiently clear terms to communicate to the recipient clearly the decision to exercise the contractual right to terminate. It is, however, a question of interpretation of the contract whether each and every specific requirement is an indispensable condition which renders termination ineffective in the absence of full compliance. But any interpretation needs to be tempered by reference to commercial common sense."
(1) This provides for the giving of a "Special Default Notice" where the non-Defaulting Party has made all practicable efforts to serve a Default Notice by one of the methods specified in the agreement but has been unable to do so.
(2) A Special Default Notice by paragraph 14(c)(aa) is one which "specifies the relevant event referred to in paragraph 10(a) which has occurred" (italics added).
(3) Similarly, paragraph 14(c)(dd) refers to "the event specified in accordance with sub-paragraph (aa) above..." (italics added).
The Default Valuation Notice issues: Issues 2 to 6
(1) The faxed DVN went to a different fax machine
(1) Paragraph 14(b)(iii) provides that a faxed notice is effective "when the transmission is received by a responsible employee of the recipient in legible form". It follows, EMFS submits, that, in the case of a fax, actual receipt is the touchstone for effective service.
(2) The point of the provision in paragraph 14(a)(iii) that a notice "shall be sent" to the recipient using the details contained in Annex 1 of the GMRA is that using the Annex 1 contact details was the most likely means of ensuring that a notice would actually be received by LBIE: Yates Building Co v RJ Pulleyn & Sons  1 EGLR 157 at 158. It makes no commercial sense to construe paragraph 14(a)(iii) as meaning that, where different contact details are used and actual receipt is achieved, the notice should be ignored.
(2) When the fax was received by a responsible employee of LBIE
(1) It was only on the next day that the fax reached a responsible employee of LBIE in accordance with 14(b)(iii); or
(2) The fax was received after close of business in London, so that, under the proviso to 14(b), it is to be treated as having been received the next day.
"Subject to sub-paragraph (c) below, any such notice or other communication shall be effective –
(iii) if sent by facsimile transmission, at the time when the transmission is received by a responsible employee of the recipient in legible form (it being agreed that the burden of proving receipt will be on the sender and will not be met by a transmission report generated by the sender's facsimile machine); ..."
(3) Whether the notice was received after close of business
"any notice or communication which is received, or delivery of which is attempted, after close of business on the date of receipt or attempted delivery or on a day which is not a day on which commercial banks are open for business in the place where that notice or other communication is to be given shall be treated as given at the opening of business on the next following day which is such a day."
Determination of the "Appropriate Market": Issues 7-12
The parties' cases and their consequences
"The procedure for the calculation of the close-out amount has been amended in the 2011 Version, amongst other things, to provide more flexibility to the non-defaulting party as to the default valuation time. The non-defaulting party calculates the close-out amount by reference to an actual sale or purchase price or, if the non-defaulting party chooses, the market value of the securities, in either case at any time "on or about the Early Termination Date" (as opposed to the requirement under the 2000 Version that this be during the five dealing days following the occurrence of the Event of Default)."
This however was not the subject of comment by the parties, and no more need be said.
The contractual provisions
"If between the occurrence of the relevant Event of Default and the Default Valuation Time the non-Defaulting Party gives to the Defaulting Party a written notice (a "Default Valuation Notice") which – …".
The requirements as in (A), (B), and (C) are then set out as summarised above. (No issue arises as to the form of the DVN.)
"the "Default Valuation Time" means, in relation to an Event of Default, the close of business in the Appropriate Market on the fifth dealing day after the day on which the Event of Default occurs ...".
"the "Appropriate Market" means, in relation to Securities of any description, the market which is the most appropriate market for Securities of that description, as determined by the non-Defaulting Party".
Whether it was open to EMFS to determine a single Appropriate Market: Issue 7
The expert evidence as to "global market" and the parties' cases in this respect
Discussion of and conclusion on the "global market" issue
"… quotations in respect of Securities of the relevant description from two or more market makers or regular dealers in the Appropriate Market in a commercially reasonable size (as determined by the non-Defaulting Party) …" (emphasis added)
Did the DVN convey a determination of a global Appropriate Market? Issue 8
(1) Although the DVN did not expressly state an Appropriate Market, it falls to be construed against the backdrop of paragraph 10 of the GMRA, which contemplated that the non-Defaulting Party would determine one.
(2) In Appendix I of the DVN, the penultimate column (headed "country"), which lists the location of the head office of the issuers of the securities, spans the globe, from Australia, to Japan, Europe and the USA. The reader would have been struck by the range and diversity of countries with which the securities in the portfolio were connected.
(3) The A1 equities were traded or capable of being traded both OTC and on a wide variety of different primary and secondary exchanges worldwide, while bonds can generally be traded anywhere in the world (subject to country-specific restrictions).
(4) Accordingly, if a single Appropriate Market were to be determined for the equity portfolio and the bond portfolio respectively, the natural determination would have been a global market for each; and the terms of the DVN did not suggest that EMFS had made a different determination.
(5) This conclusion also serves to promote the prospect of the DVN being valid, by enabling it to be served up to close of business anywhere in the world; and a saving construction of an instrument is generally to be preferred (Lewison §7.16).
(1) The DVN makes no reference to any determination of the Appropriate Markets (or to the concept of the "Appropriate Market" at all), or to the "Global Market". Indeed, EMFS does not appear to contend positively that it did, merely pleading that the DVN did not suggest a determination other than the "Global Market".
(2) A reader of the DVN would therefore conclude that no determination of the Appropriate Markets had been made. Alternatively, if that is wrong, he would conclude that the "Country" column was intended to set out the Appropriate Market (a conclusion which LBIE contends for on its alternative case, but which EMFS does not accept).
(3) The "Global Market" does not exist in a relevant sense. Therefore, a reasonable reader would not have deduced from the DVN that EMFS had selected it. Further, the reasonable reader is to be taken to have known that certain of the Outstanding Securities were prohibited from sale in the United States in their primary market period.
Consequences of no determination of Appropriate Market: Issue 9
What appropriate markets would EMFS have determined? Issue 10
When did close of business in the Appropriate Markets occur? Issue 11
(1) The GMRA refers to close of business "in the Appropriate Market", which is naturally a reference to the time regarded as close of business in that market, not a general concept of "close of business for financial institutions generally".
(2) The day on which "close of business" will occur is described by the GMRA as the "fifth dealing day", implying that the close of business is the close of business for dealing.
(3) LBIE's case makes commercial sense, because the Default Valuation Time is the time at which, under paragraph 10(e)(ii), the securities fall to be valued. According to Mr Ruiz, the concepts of "close of business" and "close of business prices" are well established in the financial markets. If close of business means "close of business for dealing" in the Appropriate Market, the non-Defaulting Party can, rapidly and simply take the relevant close price of each security at that time; for example, for equity securities, the close price is published and available upon close of dealing, and it is this close price which is used across the financial world in respect of financial indices, margin calculations, derivatives, etc.
(4) By contrast, on EMFS's case, a non-Defaulting Party is obliged to value the securities at "the close of business for financial institutions generally". However, neither prices nor liquidity are easily available at that time. Indeed, it is at least uncertain as to when the "close of business for financial institutions generally" occurs, whereas LBIE has been able to specify the closing time for all of the relevant equity markets.
(1) LBIE's case is not as simple as it claims. Mr Ruiz has proven unable to find a closing time for markets specified as "US OTC" and his approach departs in certain other respects from LBIE's pleaded case.
(2) The ordinary and natural meaning of the words refers to close of all forms of business. True it is that the DVT occurs on the "fifth dealing day" but this merely indicates that non-dealing days, such as weekends, are left out of account and does not require an artificially narrow meaning to be given to the expression "close of business".
(3) The difference this makes is that financial institutions close for business rather later than the end of trading: As explained above, this does not happen in London until about 7pm. Thus, even on LBIE's case as to Appropriate Market, the DVN would have been valid, not only for the North American securities, but also for the 4 equities and 1 bond for which the UK or Ireland is said by LBIE to have been the Appropriate Market. (In financial terms, EMFS says that this would move the net balance US$970,000 in EMFS' favour.)
Was the DVN served in time? Issue 12
The approach to valuation: Issue 16
For the purposes of paragraph 10(e)(ii) of the GMRA:
(a) Should the Securities be ascribed a fair market value in accordance with the opinion which EMFS (acting rationally) would have formed and/or would have been entitled to form, had EMFS conducted the valuation exercise required by paragraph 10(e)(ii) of the GMRA (as contended by EMFS)?
(b) Should the Securities be ascribed their objectively reasonable fair market value (as contended by LBIE on its primary case)?
(1) EMFS says that the securities should be ascribed a fair market value in accordance with the opinion which EMFS (acting rationally) would have formed had it conducted the valuation exercise required by paragraph 10(e)(ii) of the GMRA.
(2) LBIE's primary case is that the securities should be ascribed their objectively reasonable fair market value.
"...at any time, in relation to any Deliverable Securities or Receivable Securities, the amount which, in the reasonable opinion of the non-Defaulting Party, represents their fair market value, having regard to such pricing sources and methods (which may include, without limitation, available prices for Securities with similar maturities, terms and credit characteristics as the relevant Equivalent Securities or Equivalent Margin Securities) as the non-Defaulting Party considers appropriate, less, in the case of Receivable Securities, or plus, in the case of Deliverable Securities, all Transaction Costs which would be incurred in connection with the purchase or sale of such Securities"
"When a contract allocates only to one party a power to make decisions under the contract which may have an effect on both parties, at least two questions arise. One is, what if any are the limitations on the decision-maker's freedom of decision? The other is, what is to happen if the contractual power was not in fact exercised at the time when the relevant party was obliged to make a decision?"
"… a decision-maker's discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The concern is that the discretion should not be abused."
"… the relevant authorities now quite clearly establish that in considering whether the non-defaulting party has "reasonably determined" its Loss, that party is not required to comply with some objective standard of care as in a claim for negligence, but, expressing it negatively, must not arrive at a determination which no reasonable non-defaulting party could come to. It is essentially a test of rationality, of the type developed in the quite different context of public law duties in Associated Provincial Picture Houses Ltd v Wednesbury Corporation  1 KB 223: see Australian & New Zealand Banking Group Ltd v Societe Generale  1 All ER (Comm) 682, Peregrine Fixed Income Ltd v Robinson Department Store Public Co Ltd  CLC 1328."
"Rationality is not the same as reasonableness. Reasonableness is an external, objective standard applied to the outcome of a person's thoughts or intentions. The question is whether a notional hypothetically reasonable person in his position would have engaged in the relevant conduct for the purpose of preventing or detecting crime. A test of rationality, by comparison, applies a minimum objective standard to the relevant person's mental processes. It imports a requirement of good faith, a requirement that there should be some logical connection between the evidence and the ostensible reasons for the decision, and (which will usually amount to the same thing) an absence of arbitrariness, of capriciousness or of reasoning so outrageous in its defiance of logic as to be perverse."
"… in the present case the decision maker is not the court, with or without expert or other evidence to assist it: the decision maker, with an absolute discretion, is Nomura (whether Nomura International or Nomura Bank). In circumstances where it ought to have, but has not conducted a valid valuation exercise, the question, as the judge rightly put to himself, is how would Nomura have decided the matter, on or at least as at 30 September 2008, had it made a valid determination, honestly and rationally: Socimer at -."
(1) LBIE's case is that EMFS would have valued the equities in accordance with LBIE's expert valuation evidence because it says that accords both with the contractual requirements and with the advice which EMFS would have received from JP Morgan had it asked.
(2) EMFS's case is that the value which (acting rationally) it would have ascribed to the securities had it conducted a paragraph 10(e)(ii) valuation in September 2008 is in accordance with its actual valuation, alternatively, with the lowest permissible figure as ascertained by reference to its expert valuation evidence.
The Appendix I Equities
Is EMFS entitled to say that it would validly have adopted under paragraph 10(e)(ii) the prices at which the Appendix I Equities had been sold? Issue 17(a)
If EMFS is unable to rely upon the sold prices, should the closing prices at the Default Valuation Time be adjusted (i) by a market impact adjustment of 58 bps as Mr Ruiz says and LBIE contends or (ii) by an adjustment according to Dr Ellis's Method 2 as EMFS contends? Issue 17(b)
The parties' methodologies
The parties' contentions
The Appendix 3 Bonds
On the true construction of paragraph 10(e)(i)(C) of the GMRA, in order to be valid and effective, did a non-Defaulting Party's determination of Net Value have merely to be a determination which was not arbitrary, capricious or irrational (as contended by EMFS), or did it in addition have to be an objectively reasonable determination (as contended by LBIE on its primary case)? Issue 13(a)
Was EMFS'S determination of the Net Value of the A3 bonds in the DVN valid? Issue 14
(1) EMFS did not test the market at discounts even approaching the 40% level, and therefore cannot support that level of discount by reference to JP Morgan's failure to sell or receive bids for the bonds during the short period in which it tried to do so.
(2) EMFS itself recognised that a 40% discount was "definitely not reasonable", and the 40% discount should be compared with Mr Sanders's calculation of a median discount on the A2 bonds of 15%.
(3) The 40% discount was arrived at without taking into account the intrinsic characteristics of the bonds, although EMFS recognised in the context of its own internal valuation that these characteristics were a relevant consideration.
(4) Dr Ellis's "cross check" shows that EMFS's value for the Converium bond falls below his range with his value for the Lockheed Martin bond barely above it. When Dr Ellis's calculation is adjusted by removing the intra-day adjustment (but retaining his 40% discount), both these bonds as valued by EMFS are below his range.
(5) The presentation for EMFS's Credit Committee on 26 September 2008 calculated the "Current Market Value" of the A3 bonds by applying only a 20% discount to their screen price.
(6) Ms Nguyen's evidence was that she has never encountered a discount of this level being applied to bonds of the quality of these bonds.
(7) Testing the arguments by reference to the individual bonds, applying a 40% discount to a Statoil or Converium bond cannot be a rational approach.
(8) The "Bonds Schedule" that was put to Dr Ellis demonstrates that EMFS's prices for the A3 bonds were outliers by comparison to independent pricing references.
(1) JP Morgan had been unable to find a buyer for the A3 bonds. It had also been unable to elicit any firm bids for them.
(2) The lack of bids strongly indicated that the A3 bonds were particularly illiquid or distressed.
(3) JP Morgan had said that discounts against screen prices could be as high as 40%. The bank also said that it was "very difficult to establish a price", given that no-one could be persuaded to make a bid.
(4) On 22 September 2008, JP Morgan said it was "impossible for us to say" whether the prices were 0 or 100, and that EMFS'S task was unenviable.
(5) EMFS did know that, where JP Morgan had sold securities, it had done so for less than the pre-trade estimate. Moreover, the quotations obtained for the A2 bonds had been much lower than screen prices, with a mean average discount of 19.57% (14% excluding the distressed MBIA bond) and a median discount of 15%. Given that the A3 bonds were more illiquid than the A2 bonds and generally had lower credit ratings, a higher discount was plainly justified.
(6) Even bonds issued by apparently creditworthy issuers like Statoil had not been traded since July 2007. In a market with high expectations of future volatility, and when EMFS was not required to assume any risk of an adverse movement in prices, a discount of 40% was an entirely reasonable one for these illiquid bonds.
(7) It is immaterial that EMFS had not wanted to sell the bonds at a 40% discount, since its concern was to recover the US$250m from the collateral, which a sale at a 40% discount would prevent (on what LBIE accepted to be the reasonable assumption at the time that any shortfall might not be recoverable from the LBIE estate).
(8) By holding the bonds in the hope of the market recovering in the future, EMFS would be assuming risk, with a consequent change in the "time horizon".
(9) It is immaterial that EMFS had not tested the market at a 40% discount. Not only is this not how bond trading works, but EMFS had no obligation to test the market at any particular discount: the definition of Net Value permitted EMFS to take into account such pricing sources and methods as it thought appropriate.
If EMFS'S determination of the Net Value of the A3 bonds in the DVN was invalid, should they now be valued under paragraph 10(e)(ii) (as contended by LBIE) or under paragraph 10(e)(i)(C) (as contended by EMFS)? Issue: 13(b)/15
If the DVN was not valid and effective in respect of some or all of the A3 bonds, is EMFS entitled to say that it would validly have adopted under paragraph 10(e)(ii) of the GMRA the prices set out in Appendix 3 to the DVN, ie a discount of 40% to screen prices? Issue 20(a)
Issue 20(b): Assuming that EMFS is not entitled to say that it would validly have adopted the prices set out in Appendix 3 to the DVN, then should the valuation approach adopted be the discounted cash flow model of Dr Ellis or the observable price based model of Ms Nguyen?
The Appendix 2 Bonds
Issue 19(a): Is EMFS entitled to say that it would validly have adopted under paragraph 10(e)(ii) of the GMRA the prices at which a bid was received for the Appendix 2 bonds?
The Appendix I Bonds
Issue 18(a): Is EMFS entitled to say that it would validly have adopted under paragraph 10(e)(ii) the prices at which the Appendix 1 bonds had been sold?