HomeP.R.I.M.E. Finance Case Summary: Lehman Bros Intl. (Europe) v. AG Fin. Prods., Inc., 2018

P.R.I.M.E. Finance Case Summary: Lehman Bros Intl. (Europe) v. AG Fin. Prods., Inc., 2018

By Rachel Finn

On July 2, 2018, ruling on a motion for summary judgment, Justice Marcy Friedman of the New York State Supreme Court analyzed in detail the Loss provision of the ISDA Master Agreement. Lehman Bros Intl. (Europe) v. AG Fin. Prods., Inc., 2018 N.Y. Misc. LEXIS 2974, 2018 NY Slip Op 51100(U).

Justice Friedman held that although non-defaulting parties have discretion in calculating termination payments, industry standards are part of a reasonableness determination, and can be factored into an analysis of whether a termination payment was calculated in a commercially reasonable manner. In so ruling, Justice Friedman denied in part Assured's motion for summary judgment and found that a genuine issue of fact existed as to whether Assured calculated its termination payment in a commercially reasonable manner. As one basis for her holding, Justice Friedman relied upon an expert report of P.R.I.M.E. Finance Expert Leslie Rahl. Analysis from P.R.I.M.E. Finance Chairman Jeffrey Golden and a deposition from P.R.I.M.E. Finance Expert Peter Niculescu also influenced the Court’s decisions.

Background. Lehman Brothers (LBIE) and AG Financial Products (Assured) entered into 28 credit default swap (CDS) transactions between 2005 and 2008, each one governed by (1) a standard form 1992 ISDA Master Agreement, (2) a Schedule, and (3) an individual negotiated Confirmation. Under their Schedule, parties elected to use “Market Quotation and the Second Method” to calculate termination payment. The ISDA Master Agreement authorized Assured to use an alternative Loss method to calculate termination payment in the event that a Market quotation “cannot be determined or would not (in the reasonable belief of the party making the determination) produce a commercially reasonable result.”

On September 15, 2008, LBIE entered into bankruptcy. On July 23, 2009, Assured notified LBIE of event of default, and hired a third party, Henderson Global Investors Ltd., to design and execute an auction of the transactions to satisfy the Market Quotation process. Although 11 potential bidders were contacted, none ultimately submitted bids. Assured then applied an alternative Loss method, choosing to use loss of bargain. It calculated the present value of the fixed premium payments LBIE have had to make during the duration of the transactions, and deducted the amounts Assured expected to pay LBIE, yielding a net termination payment of $24,799,972.85.

LBIE filed an action on November 28, 2011 alleging breach of implied covenant of good faith and fair dealing for a segment of the CDS transactions, and breach of implied covenant of good faith and fair dealing and breach of contract for a second segment of the transactions. Assured’s motion to dismiss the first claim was granted at a hearing in 2013.[1] On the remaining two causes of action, Assured moved for summary judgment on both.

Analysis: Loss Methodology and Calculation

After quickly granting summary judgment for Assured on the breach of implied covenant, on the grounds that LBIE failed to support its contention that Assured undertook the Market Quotation process in bad faith, the Court turned to the crux of its analysis: assessing whether Assured had breached the ISDA Master Agreement by "improperly calculate[ing] Loss without reference to any market information and in a manner that was commercially unreasonable." (Compl.¶ 46). Both Assured and LBIE relied on the plain language of the contract (ISDA Master Agreement Loss provision Section 14). LBIE argued that Assured’s method was not reasonable because it was (1) contrary to market practice and (2) violated the “cross-check principle.”

Industry Practice. In reaching its decision, the Court first found that industry practice can be utilized in determining the meaning of a specialized contract.[2] The Court referenced P.R.I.M.E. Finance Chairman Jeffrey Golden’s analysis[3] that industry practice is particularly appropriate in the case of an ISDA Master Agreement, given the potential for judicial construction of the Agreement to affect non-parties and millions of transactions around the globe.

The Court reasoned that nothing in the text of the provision mandated a particular calculation method, and the Loss provision “could not be clearer” in stating that a party “need not” calculate Loss using market quotations of rate or prices. Drawing on the ISDA Brief of Amicus Curiae in the 2015 Intel case,[4] the Court noted that the ISDA Master Agreement must be read “in light of its purpose, which is to promote legal certainty and predictability or market stability when applied to termination of a diverse array of derivative transactions in global markets.” Thus, the final sentence of the Loss provision demonstrates that there may be situations in which calculation of Loss using market prices may not be possible or would be unreasonable.

The Non-Defaulting Party’s discretion to calculate Loss without reference to market prices does not, however, mean that the Non-Defaulting Party’s decision to do so can never be unreasonable or undertaken in bad faith. Four expert reports, including one from Leslie Rahl,[5] indicate that calculating Loss using market prices to approximate the cost of a replacement transaction is standard industry practice. Thus, as applied here, “Evidence of departure by Assured from standard industry practice is a factor, among others, to be considered in assessing its reasonableness and good faith in calculating Loss.”

Cross Check Principle. Market Quotation and Loss methods of the ISDA Master Agreement are largely aimed at finding the same result, so the outcome derived by one may be “usefully tested by way of cross-check by reference to the other.” This cross-check principle shows that the Loss (however calculated) should generally be within the range of what the market would pay for a replacement transaction. Failure of a Market Quotation auction does not necessarily mean the price of a replacement transaction is impossible to estimate. In this instance, LBIE received “indicative price quotes” from other entities for the Transactions, that deviate “substantially” from Loss calculated by Assured. Such a discrepancy thus also supported the finding that triable issues of fact exist as to whether the cross-check principle is capable of application, and if so, whether Assured’s calculation of Loss satisfies the test imposed by that principle.

Additional Factors. The Court rejected Assured’s contention that its Loss methodology was reasonable as a matter of law, because triable questions of fact were found for three additional reasons: (1) The parties’ experts dispute whether loss projections made for other business purposes constitute a reasonable basis for the measurement of Loss within the meaning of the ISDA Master Agreement;[6] (2) There is persuasive authority from Anthracite[7] and Intel[8] that ISDA Master Agreement’s formulae for calculating termination payments “are not to be equated with, or interpreted rigidly in accordance with, the quantification of damages at common law for breach of contract:” and (3) The context of the financial crisis, in which the termination of the Transactions took place, also raised a genuine question of fact as to the reasonableness and good faith of Assured’s calculation of its Loss.

The full decision is found here.


[3] See Jeffrey Golden, Interpreting ISDA Terms: When Market Practice Is Relevant, As Of When Is It Relevant?, 9 Capital Mkts. L.H. 299, 302-305 (2014). [Windels Aff. Exh. 40]. https://doi.org/10.1093/cmlj/kmu022

[5] Expert Report of Leslie Rahl, [Windels Aff., Exh. 1].

[6] See id. at ¶ ¶ 112-115, See generally Niculescu Rebuttal Report, ¶ 200 [a]-[g] & Exh. 33.