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High Court confirms objective standard of reasonableness in the determination of the Close-out Amount


In Lehman Brothers Special Financing Inc. v National Power Corporation and another [2018] EWHC 487 (Comm), the High Court ruled that the requirement to use "commercially reasonable procedures" to produce a "commercially reasonable result" in determining the Close-out Amount under the 2002 ISDA Master Agreement was to be assessed by reference to an "objective" standard of reasonableness. This decision emphasises the need for close scrutiny of the exact contractual wording in question in determining the ambit of any contractual discretion.

The transaction

National Power Corporation (NPC) entered into a US dollar/Philippine peso forward currency swap with Lehman Brothers Special Financing Inc. (LBSF) (the Transaction) as part of a currency hedging strategy in connection with its issuance of certain US$ denominated bonds. A fixed rate premium was payable semiannually by NPC to LBSF. The Transaction also included an option for NPC to extinguish the forward payment obligations arising in 2028 (the Option). The Transaction was made under a standard form 2002 ISDA Master Agreement (2002 ISDA MA).1

LBDF's default

With the collapse of Lehman Brothers in September 2008, LBSF filed for Chapter 11 bankruptcy relief in the United States on 3 October 2008, which constituted various events of default under the Transaction. NPC therefore served notice of early termination of the Transaction on 17 October 2008, designating an “Early Termination Date” of 3 November 2008.

It was common ground that it was then for NPC, as the non-defaulting party, to determine the Close-out Amount payable, and to do so using “commercially reasonable procedures in order to produce a commercially reasonable result”.

NPC's determination of the close-out amount

On the Early Termination Date, NPC sought and obtained three indicative2 quotations for a replacement transaction from global investment banks. On 7 November 2008, NPC sought and obtained firm quotations from the same dealers and, on 14 November 2008, entered into a replacement transaction with the dealer offering the most favourable terms (the Replacement Transaction).

On 26 January 2009, NPC demanded US$3,461,590.93 from LBSF, which was based on the cost of the Replacement Transaction. LBSF contended that commercially reasonable procedures were not used to arrive at this figure and that it was not a commercially reasonable result. Instead, it contended that NPC owed LBSF US$12,826,887.

However, on 27 October 2016, by which time the proceedings in question had already been commenced, NPC served what it termed a "revised calculation statement" on LBSF, demanding from it a higher figure of US$10,778,943.12, based on the three indicative quotations it had received on the Early Termination Date.

NPC argued that its initial determination based on the Replacement Transaction had not accorded with the definition of Close-out Amount, since (among other things) it had failed to account for a portion of the semiannual premium payments that had accrued under the Transaction (the Accrued Amount). This, according to NPC, meant that there had not yet been a valid determination of the Close-out Amount. It therefore fell to NPC, as the non-defaulting party, to make a fresh determination.

As the case raised issues relating to the interpretation of the 2002 ISDA MA, which were of general market importance, the case was listed on the Financial List.

The issues

In the circumstances, the following two main issues of principle fell to be determined by the court.

  1. Is a party entitled remake a determination of the Close-out Amount, in the event that the initial determination is accepted by that party to have been invalid?
  2. How should the court construe the requirement to use “commercially reasonable procedures” to produce a “commercially reasonable result” in determining the Close-out Amount, and what are the consequences of a non-compliant determination?

Issue 1: Re-determination of the close-out amount

It was a somewhat unusual feature of this case that NPC argued that its initial determination of the Close-out Amount made on 26 January 2009 was invalid. NPC argued this in order to rely on its subsequent and more favourable determination made some 8 years after the event.

Knowles J rejected NPC's arguments on this point. On a true interpretation of the 2002 ISDA MA, the early termination of the agreement and the determination of the Close-out Amount were significant contractual events, which affected the relationship between the parties and which were not reversible (save by agreement).

If there had indeed been an error in NPC's determination, then, absent any agreement, it was for the court (rather than the determining party) to declare that and to state what the Close-out Amount would have been on a determination that was without error.3

Issue 2: "Commercially reasonable procedures" and a "commercially reasonable result"


Where the concept of "reasonableness" is deployed in a contract in the context of the exercise of a power or discretion, the authorities4 have considered that two different standards could potentially apply:

  1. "Rationality": under this standard, the only requirement is the absence of arbitrariness, capriciousness, perversity or irrationality on the part of the decision maker. In a sense, this is analogous to Wednesbury unreasonableness, a concept borrowed from public and administrative law. In other words, a decision will fall foul of this standard only if it was a decision which no reasonable decision-maker would have made.
  2. "Objective" reasonableness: this standard is analogous to that applied when a party is subject to a duty to take reasonable care, where the concept of reasonableness is assessed by reference to purely objective criteria. It is a higher standard than mere rationality.

NPC's argument

NPC argued that the references in the definition of Close-out Amount to “commercially reasonable procedures” and a “commercially reasonable result” required only that the determining party use rational procedures in order to produce a rational result. This effectively meant that, unless NPC reached a result that no reasonable non-Defaulting Party could have come to, then the question of which particular outcome was appropriate was a subjective matter for it. In particular, no higher, objective standard of reasonableness, analogous to a duty to take reasonable care, should be applied to its decision making.

The Judge's decision

In assessing NPC's argument, Knowles J's starting point was the exact wording used in the 2002 ISDA MA. He pointed out that many of the prior authorities which had imposed a (lower) standard of rationality on a decision maker were cases where restrictions on that decision maker's exercise of a discretion had been implied as a matter of necessity, because the contract did not impose any express restrictions upon them. The present case could be distinguished because it was instead concerned with the construction of express terms circumscribing NPC's discretion to determine the Close-out Amount5 .

When construing those express terms, Knowles J placed significant weight on the change in wording as between the definition of "Loss" in the 1992 ISDA Master Agreement (1992 ISDA MA) ("an amount that a party reasonably determines in good faith to be its total losses and costs"), which had previously been assessed only against a rationality standard6, and the definition of "Close-out Amount" in the 2002 ISDA MA (which requires the non-defaulting party to use "commercially reasonable procedures" to reach a "commercially reasonable result"). He also considered the 2002 User’s Guide supporting the 2002 ISDA MA.

Taken together, these factors suggested that the purpose of the change was to promote (greater) objectivity and transparency. In particular, Knowles J noted that under the 2002 Agreement ISDA MA, there was now a requirement for the determining party to reach a reasonable outcome, and not just to use a reasonable process.

Knowles J, therefore, concluded that the 2002 ISDA MA requires the determining party to use procedures that are, objectively, commercially reasonable in order to produce, objectively, a commercially reasonable result. Furthermore, if the determining party does not do this, then the court or tribunal will instead.7

Applying these principles, Knowles J held that NPC's original determination, which was based on a the Replacement Transaction, did in fact comply with the requirements under the definition of Close-out Amount, save in respect of the Accrued Amount (which was common ground) and the fact that the Replacement Transaction contained an option, whereas the Option under the Transaction had already expired by the time of LBSF's default.

In the circumstances, the contractually compliant Close-out Amount was/would have been NPC's original determination, which was based on the cost of the Replacement Transaction, with the appropriate corrections in respect of the two points above.


This judgment is the most detailed examination to date of the close-out provisions of the 2002 ISDA MA by an English court. It has put beyond any doubt that an objective standard of reasonableness, rather than one of rationality, applies to the procedures to be used in determining the Close-out Amount, as well as the resulting determination itself. In reaching this conclusion, Knowles J put great emphasis on construing the exact express wording of the definition of Close-out Amount and, in particular, the change from the definition of "Loss" under the 1992 ISDA MA and the apparent rationale for the change.

The judgment does, however, leave in place the previous authorities on the interpretation of "Loss" under the 1992 ISDA MA, which established that only a rationality standard applied in respect of that agreement. As a result, a determining party will likely be put under greater scrutiny where the transaction being closed out is under the 2002 ISDA MA, rather than under the 1992 ISDA MA.

The judgment may also have implications for a wider range of contracts that confer a decision-making power or discretion on one of the parties. The weight of authorities to date in cases of this type, even where the contract contained express terms governing the manner of the exercise of a power or discretion, appeared to have favoured the lower standard of rationality over objective reasonableness.8 It now appears that very careful scrutiny of the precise contractual wording is required in order to determine the correct standard to be applied to the exercise of such powers or discretion.

In this regard, the following concluding remark from Knowles J is illuminating:

"The recognition of rationality as a basic standard is an important and welcome development of the common law, but looking across the (now many) authorities I am left wondering whether the courts have at times - deflected perhaps by the fact that the role of decision-maker has been given to a party to the contract - rested too readily with rationality, at times confining their interpretation unduly to this now familiar minimum standard whilst the contract wording used by the parties might have a higher claim to a conclusion that a higher standard was intended."

The full text of the judgment is available at: 


NPC subsequently transferred its rights and obligations under the Transaction to Power Sector Assets and Liabilities Management Corp (PSALM). LBSF accepted that PSALM was the correct party to the proceedings. References to "NPC" in this article refer to NPC, PSALM or both.

Clearly stated to be "in preparation for the actual bidding".

3 However, Knowles J noted that a revised determination may still serve as evidence to inform the question of whether there was an error and the question of what the Close-out Amount would have been on a determination that was without error.

4 See, for example, Rix LJ in Socimer International Bank Ltd v Standard Bank London Ltd (No 2) [2008] EWCA Civ 116.

In particular, Knowles J drew a distinction between the contractual term in the seminal case in this area, Socimer, which simply stated that "the value of the [assets] in question … shall be determined on the date of termination by [Standard Bank]", and which was found to be subject to an implied restriction to the effect Standard Bank must exercise its discretion rationally, and the contractual term in this case, which expressly required NPC to use "commercially reasonable procedures" to produce a "commercially reasonable result".

6 See, for example, Fondazione Enasarco v Lehman Brothers Finance SA [2015] EWHC 1307 (Ch).

7 This is the conclusion Knowles J understood Briggs J (as he then was) to have reached when he said in Lehman Brothers International (Europe) (In Administration) v Lehman Brothers Finance SA [2012] EWHC 1072 (Ch) that the definition of the Close-out Amount under 2002 ISDA MA "imposed…objective standards".

8 See, for example: Fondazione Enasarco v Lehman Brothers Finance SA in relation to "Loss" under the 1992 ISDA MA; and Lehman Brothers International (Europe) (in administration) v ExxonMobil Financial Services B.V. [2016] EWHC 2699 (Comm) in relation to "Net Value" under the 2000 GMRA.


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