Interpreting the ISDA Master Agreement following Lomas v JFB Firth Rixson

The decision of Briggs J in Lomas v JFB Firth Rixson [2010] EWHC 3372 (Ch) gives rise to a number of important considerations for market participants in relation to the interpretation and construction of Section 2(a)(iii) of the ISDA Master Agreement. It also addresses whether this provision offends the anti-deprivation principle or could be classified as a penalty. This note summarises the key areas for consideration by market participants.

Briggs J, whilst recognising the arguments of Flaux J in Marine Trade SA v Pioneer Freight Futures Co Ltd BVI [2010] 1 Lloyd’s Rep 631, took the view that Section 2(a)(iii) is suspensory in nature. This conclusion is in line with ISDA’s submissions and general market opinion. Nevertheless, Briggs J stated that he only reached this conclusion on a “fairly narrow balance”.  

Briggs J decided that reading in an implied term that the suspension could only last for a “reasonable period” would be “contrary to the express terms of the Master Agreement”. Briggs J also rejected the argument of ISDA’s counsel that any payments suspended pursuant to Section 2(a)(iii) could be suspended indefinitely, so they would become due and payable if the relevant Event of Default were to be remedied, even if the remedy occurred after the termination date of the transaction. He rejected this argument primarily on the basis that it was “wholly inconsistent with any reasonable understanding of the Master Agreement that payment obligations arising under a Transaction could give rise to indefinite contingent liabilities”. He therefore decided that the obligations were extinguished on the termination date of the transaction, provided the condition precedent had still not been satisfied by such date. Briggs J also noted that the Survival of Obligations provision included in Section 9(c) of the ISDA Master Agreement did not include payments suspended under Section 2(a)(iii).

Flaux J in Marine Trade held that a Non-defaulting Party may, having taken advantage of Section 2(a)(iii) and suspended its payments, still enforce the Defaulting Party’s obligations in full.  In Lomas v JFB Firth Rixson all of the respondents agreed that the correct interpretation of this provision should instead be that the payments should be treated on a net basis, and that the Non-defaulting Party could not enforce the Defaulting Party’s payment obligation without having its own reverse payment obligation taken into account.  As Briggs J was not required to decide this point, Flaux J’s conclusion in Marine Trade has not been contradicted and, in fact, Briggs J suggests in his judgement that he might have found Flaux J’s judgement difficult to regard as inapplicable in this case.

It is not permissible by contract to remove assets from the pool of assets available to general unsecured creditors on insolvency. In this case Briggs J concluded that the assets which the joint administrators of LBIE argued the creditors had been deprived of were, in fact, “flawed” due to the existence of the condition precedent in Section 2(a)(iii). Briggs J did, however, draw a distinction between a transaction such as an interest rate swap (the transactions in issue were all interest rate swaps) which is an “ongoing contract” and other contracts where one party’s obligations have already been performed (such as options) where the courts may be less inclined to consider such assets as “flawed”.

Briggs J concluded that Section 2(a)(iii) could not give rise to a penalty as the “triggering event is not a breach of contract”.

We expect that at least some of these points will be addressed by the Court of Appeal and potentially the Supreme Court in the near future. In addition, it is worth noting that ISDA has established a working committee to examine the wording of Section 2(a)(iii) in order to address the concerns of market participants raised in cases such as Marine Trade and Lomas v JFB Firth Rixson. Any clarity which can be provided on the issues raised in these cases as a result of ISDA’s initiative is to be applauded.