The High Court’s decision in relation to an ISDA Master Agreement will likely guide interpretation of other English law-governed financing documentation.

Prior to entering into administration, Lehman Brothers International (Europe) (LBIE) entered into sterling and dollar interest rate swap transactions with Firth Rixson entities under ISDA Master Agreements (the Master Agreements). The terms of the swaps required the parties’ net payment obligations to be settled on a quarterly basis, with the final payment date falling in December 2010.

Following its entry into administration in 2008, LBIE failed to make two quarterly payments to Firth Rixson under the sterling swap. However, a subsequent decline in the floating interest rates payable by LBIE under each swap entitled LBIE to receive net payments from Firth Rixson until their maturity. Firth Rixson suspended payments to LBIE, since the ISDA Master Agreement permitted such suspension in respect of a counterparty “if events of default have occurred and are continuing” in respect of that counterparty (emphasis added).

These events of default entitled Firth Rixson to terminate the swaps. However, unlike the vast majority of LBIE’s hedge counterparties, Firth Rixson decided against termination in order to avoid crystallising its payment obligations to LBIE, expecting that LBIE would never be restored to solvency so allowing Firth Rixson to postpone payment indefinitely.

Fast forward 15 years: contrary to expectations, the administrators of LBIE are now working to bring the administration to an end solvently, terminating their appointments, and returning control to LBIE’s directors. The administrators applied for directions to the High Court contending that, if and when their appointments terminated, none of the various events of default would be “continuing” under the Master Agreements and thus the suspensory condition would fall away. Firth Rixson would then become liable to fulfil its payment obligations to LBIE of approximately US$60 million.

Events of Default and the Meaning of “Continuing”

LBIE’s entry into administration, its financial position at the time, and its payment defaults in 2008 each gave rise to events of default under the Master Agreements. In addition, the administration event of default was continuing at the date of the application to the court for directions.

Firth Rixson asserted that other events during LBIE’s administration also resulted in further events of default. These events related to a scheme of arrangement proposed by the administrators on behalf of LBIE to compromise various outstanding legal proceedings, facilitate the distribution of the administration surplus, and assist in concluding the administration, together with a petition for Chapter 15 recognition of that scheme in the United States (together, the Scheme Events).

Master Agreements do not contain any definition of the word “continuing” in the context of events of default. Indeed the LBIE case appears to be the first occasion in which the court has given detailed consideration of the meaning of that term in the context of a Master Agreement, or indeed any other financing contract.

Firth Rixson argued that an event of default should be treated as “continuing” if the effects of the event of default were continuing. It also argued that the administration was akin to a distributing administration involving a permanent alteration of creditors’ rights, and therefore the effects of the administration would not cease merely when the administrators’ appointment ended.

The court rejected this approach, confirming that the test to be adopted was whether the identified event or state of affairs that constituted the event of default was continuing, rather than whether creditors’ rights had been significantly and permanently altered, or continued to be affected. In the case of the administration event of default, the relevant state of affairs would no longer be “continuing” once the administration terminated, and the fact that the administration was more akin to a distributing administration than a non-distributing administration was of no consequence.

The court did not have to decide whether the Scheme Events were “continuing” since it held that the relevant scheme of arrangement (and related recognition proceedings in the United States) did not actually trigger an event of default on account of not being an “arrangement” made by LBIE “with or for the benefit of its creditors”. However, Hildyard J opined that, were he wrong on that point, the Scheme Events would indeed be “continuing” because the state of affairs brought about by the relevant scheme had continued and would be continuing for so long as the scheme had effect, irrespective of whether the administration was continuing or had concluded.

This interpretation would seem commercially fair. The purpose of the Master Agreement’s suspensory condition is to ensure that a non-defaulting party is not obliged to pay a defaulting party when the defaulting party is of dubious solvency and thus may fail to make future payments to the non-defaulting party. After the maturity of the swaps in 2010, LBIE was not required to make any further payments, and so Firth Rixson was no longer facing the sort of counterparty risk that the provision is designed to mitigate.

Leave to Appeal and Wider Application

Firth Rixson has been granted leave to appeal the decision. In the meantime, legal practitioners might choose to provide further colour on the nature of the word “continuing” in legal documents.

Indeed, contrasting the word “continuing” in the context of the Master Agreement with its common usage in the context of loan facility agreements in the leveraged finance market can be instructive. Such facility agreements are, to a greater or lesser extent, based on the Loan Market Association’s standard form of facility agreement which provides drafting flexibility such that “…an Event of Default is ‘continuing’ if it has not been [remedied or waived]/[waived]”.

The loan market has broadly speaking adopted the “remedied or waived” option, which allows debate with the borrower about whether a default has been remedied or is indeed capable of remedy. This drafting would imply that the state of affairs constituting the default needs to be remedied, rather than any consequent effects. This interpretation would be consistent with the Firth Rixson judgment, though how any given default can be remedied is unclear.

Many facility agreements go beyond the Loan Market Association’s drafting option, clarifying that the non-compliance with an obligation on a particular date (e.g., the provision of financial information by a particular deadline) can be expressly remedied by a later compliance with such obligation. This type of language often also provides for the automatic cure of any subsequent events of default that would not have arisen had the original event of default not occurred (such as a representation that was untrue when made as a result of the original event of default). Until the LBIE litigation concludes, seeing borrowers expand this type of language would come as no surprise.