High Court gives important guidance on interpretation of the ISDA Master Agreement

31/10/16

The High Court has given judgment in Lomas v Burlington Loan Management Limited [2016] EWHC 2417 (Ch) (also known as the "Waterfall IIC Application"), the most recent case arising out of the long-running Lehman Brothers administration.

The case decides a number of important issues regarding the interpretation of the ISDA Master Agreement. In particular, Hildyard J considered in detail the ISDA terms governing the payment of interest.

The ISDA Master Agreement provides for payment of interest at a "Default Rate", based on the relevant payee's certification of its own "cost...of funding" the amount due. This raised an important point of principle, namely whether the relevant payee could certify a "cost of funding" that took into account the cost of all types of funding, including the cost of equity funding, or whether it could only certify a cost of borrowing. The Joint Administrators had suggested that up to £5 billion could turn on the correct answer to this question, given the amounts at stake in the Lehman Brothers insolvency.

Following a two week trial, the Court held that the phrase "cost of funding" was limited to a cost of borrowing. Hildyard J accepted that the word "cost " could have a broader meaning "from a commercial perspective". However, he concluded that the definition of "Default Rate" had to be read more narrowly in the context of the ISDA Master Agreement. He therefore held that the relevant payee could only certify their cost of borrowing the relevant amount, under an actual or notional transaction.

The Judge did, however, hold that the relevant payee was entitled to certify its cost of funding based on its own assessment of its cost of borrowing, subject only to the requirements that it do so rationally and in good faith and that the certification not contain a manifest numerical or mathematical error.

The judgment appears here.