The recent Court of Appeal decision in LBI EHF v Raiffeisen Bank International AG  EWCA Civ 719 affirms the wide discretion of the non-Defaulting Party to determine “fair market value” in accordance with the close-out mechanism under paragraph 10(e)(ii) of the standard Global Master Repurchase Agreement (2000 version) (“GMRA“). Agreeing with the first instance judgment, the Court of Appeal reiterated that (in the absence of some express or implied limitation in the contract), the only constraint to be implied on the non-Defaulting Party’s discretion to determine “fair market value” was that of rationality; the decision-maker must have “acted rationally and not arbitrarily or perversely“: Socimer International Bank Ltd v Standard Bank London Ltd  EWCA Civ 116 as applied to the GMRA in Lehman Brothers International (Europe) v Exxonmobil Financial Services BV  EWHC 2699 (Comm).
Interestingly, the Court of Appeal confirmed that there is no basis to imply that the determination of “fair market value” under the GMRA must be by reference to a price agreed between a willing buyer and willing seller in a market which is not suffering from illiquidity or distress. In accordance with the wording of the GMRA, the Court of Appeal found that in determining “fair market value” the non-Defaulting Party may have reference to “such pricing sources and methods” as it considers appropriate, as long as it acts rationally. It should be noted that the width of the discretion afforded to the non-Defaulting Party arises from the specific wording of the GMRA; the Court of Appeal did not, and did not seek to, provide any more general interpretation of “fair market value“.
The court thereby rejected the attempt to import into the contractual framework other uses of fair market value which would incorporate the willing buyer and seller language in accounting terms – so the non-Defaulting Party is entitled to have regard to its commercial interests in establishing Net Value. This is particularly important in circumstances where the close-out takes place in a distressed market – the non-Defaulting Party is therefore able to take into account prices which reflect the distressed conditions prevalent at the time.
The appellant, the bank formerly known as Landsbanki Islands hf. (“LBI“), entered into 11 ‘repo’ trades with Raiffeisen Bank International AG (“RBI“) on the terms of the 2000 version of the GMRA (capitalised terms not otherwise defined in this e-bulletin are to the GMRA defined terms). On 7 October 2008, LBI went into receivership. This was an Event of Default under the GMRA and RBI served Default Notices on LBI. Under the GMRA, LBI was required to pay RBI (as the non-Defaulting Party) the agreed Repurchase Price for the securities minus the Default Market Value of Equivalent Securities.
Sub-paragraph 10(e) of the GMRA sets out the methods by which the non-Defaulting Party can ascertain the Default Market Value. The framework mechanism in the 2000 version of the GMRA allows for two scenarios: (a) where a Default Valuation Notice has been served by the Default Valuation Time (defined as the close of business on the fifth dealing day after the day on which the Event of Default occurred); and (b) where a Default Valuation Notice has not been served on time.
Where a Default Valuation Notice has been served on time, sub-paragraph 10(e)(i) provides for three methods of valuation:
- The bonds may be sold (or bought, as the case may be) in good faith and the sale price used to determine the Default Market Value;
- The Default Market Value may be determined from the mean average of commercially reasonable quotations obtained from market makers for the bonds; and
- Where the non-Defaulting Party has endeavoured but been unable to sell the bonds or obtain commercially reasonable quotations, or determined that it would be commercially reasonable not to seek such quotations the non-Defaulting Party can determine the Net Value of Equivalent Securities and elect to treat that Net Value as the Default Market Value.
Where a Default Valuation Notice has not been served on time, sub-paragraph 10(e)(ii) provides that the non-Defaulting Party should determine the Net Value as at the Default Valuation Time. It is of note that the 2011 version of GMRA has since disposed of the 5-day window in which to serve the Default Valuation Notice; providing instead that the determination of Default Market Value (using broadly similar methodology as described above) “on or about the Early Termination Date”.
RBI had not served the Default Valuation Notice by the Default Valuation Time and therefore Default Market Value fell to be assessed under GMRA sub-paragraph 10(e)(ii). In order to provide context for the decision, the relevant paragraphs of the GMRA are set out in full, below:
“10(e)(ii)…If by the Default Valuation Time the non-Defaulting Party has not given a Default Valuation Notice, the Default Market Value of the relevant Equivalent Securities or Equivalent Margin Securities shall be an amount equal to their Net Value at the Default Valuation Time; provided that, if at the Default Valuation time the non- Defaulting Party reasonably determines that, owing to circumstances affecting the market in the Equivalent Securities or Equivalent Margin Securities in question, it is not possible for the non-Defaulting Party to determine a Net Value of such Equivalent Securities or Equivalent Margin Securities which is commercially reasonable the Default Market Value of such Equivalent Securities or Equivalent Margin Securities shall be an amount equal to their Net Value as determined by the non-Defaulting Party as soon as reasonably practicable after the Default Valuation Time.” (Emphasis added)
Net Value is defined in sub-paragraph 10(d)(iv) by reference to “fair market value“:
“10(d)(iv)…”Net Value” means at any time, in relation to any Deliverable Securities or Receivable Securities, the amount which, in the reasonable opinion of the non-Defaulting Party, represents their fair market value, having regard to such pricing sources and methods (which may include, without limitation, available prices for Securities with similar maturities, terms and credit characteristics as the relevant Equivalent Securities or Equivalent Margin Securities) as the non-Defaulting Party considers appropriate, less, in the case of Receivable Securities, or plus, in the case of Deliverable Securities, all Transaction Costs which would be incurred in connection with the purchase or sale of such Securities;”
The principal issue for the court to decide was the meaning of “fair market value” in this context.
High Court decision
The court at first instance held that the fair market value determined by RBI for each security was a “rational and honest determination of fair market value” as at the Default Valuation Time. These figures were a statement of RBI’s position derived from the sources available to it as at the Default Valuation Time, rather than a product of evidence from an expert or witness of fact. The sources used by RBI to determine Net Value included:
- Bids from 10 institutional counterparties which the respondent had requested (for some securities there were no indicative bids; for other securities there were indicative bids from multiple institutions);
- Algorithm-based prices shown on Bloomberg which RBI used for internal purposes, and which it did not consider to represent a practical and commercial realisable value; and
- The only activity experienced by the RBI on 15 October 2008 (the Default Valuation Time) itself, namely a bid shown by Citi at 45 for ICICI (USD) bonds and a request by Citi that RBI place an order with it at 80 for RAK Bank bonds.
The figures RBI put forward did not apply prices from days other than 15 October but they did include adjustments from price information available on other days.
The sources available at that time were – in the words of the High Court – “imperfect” and included Bloomberg prices (which RBI did not consider to represent a practical and commercial realisable value). However, the court held that: “…the circumstances at that time were imperfect. Any assessment of fair market value would have been imperfect but the non-Defaulting [P]arty was nonetheless entitled to make one.”
Grounds of appeal / response
LBI appealed on the basis that the judge at first instance erred in holding that, on the true construction of the GMRA, the non-Defaulting Party’s assessment of “fair market value” of securities could be based on actual prices achieved, indicative quotes or screen prices obtained in the distressed or illiquid market prevalent at the time. RFI argued that the discretion afforded by the GMRA is wide and LBI’s approach involved a significant restriction as a matter of law on this apparently wide discretion, in particular the non-Defaulting Party’s ability to have reference to “such pricing sources and methods as it considers appropriate“. RFI argued that the restriction sought by LBI was fundamentally inconsistent with the language of the GMRA.
Court of Appeal decision
The Court of Appeal dismissed the appeal, affirming RFI’s wide interpretation of the GMRA.
The Court of Appeal found (in line with Socimer and Exxonmobil), that in the absence of some express or implied limitation in the GMRA on the exercise of the non-Defaulting Party’s discretion in determining “fair market value“, the only limitation is that the decision-maker must have “acted rationally and not arbitrarily or perversely“. Repeating the general principle set out in Barclays Bank plc v Unicredit Bank AG EWCA Civ 302, the Court of Appeal noted that what was meant by “fair market value” under the GMRA must be “determined as a matter of construction of this particular contract in its particular context“. Accordingly, the Court of Appeal resisted providing any fixed definition of “fair market value“.
Key to this decision is the specific wording of the GMRA. In particular, the entitlement of the non-Defaulting Party, as per the definition of Net Value in the GMRA, to have regard to whatever “pricing sources and methods” and to “available prices for Securities” as it considers appropriate, with no limitation as to the factual circumstances in which it may do so. The Court of Appeal therefore rejected LBI’s argument that the determination by a non-Defaulting Party of “fair market value” in the context of the GMRA should be interpreted (consistently with its use in other contexts) by reference to a price agreed between a willing buyer and a willing seller, neither being under any particular compulsion to trade, such that illiquidity or distress in the market at a particular time would not be taken into account. It held that such an implied limitation would be contrary to the express language of the GMRA.
Similarly, any argument that a non-Defaulting Party could not use evidence or information as to actual market value, albeit in an illiquid or distressed market, in determining “fair market value” was rejected. The Court of Appeal held that the non-Defaulting Party was not required to determine Net Value in distressed market conditions by reference to some notional or theoretical value of securities. Arguments that the non-Defaulting Party was obliged in these circumstances to mark-to-model (made by reference, inter alia, to the Frequently Answered Questions (FAQs) on Repo published by ICMA), were also rejected.
This decision is important in reiterating and reinforcing the width of the discretion of the non-Defaulting Party to determine “fair market value” under the GMRA and will therefore provide useful comfort to non-Defaulting Parties (and their legal teams) who are faced with the need to determine close-out amounts under the GMRA following their counterparty’s Event of Default. In particular, the only implied limitation on the non-Defaulting Party in formulating its “reasonable opinion” using the “pricing sources and methods” it considers appropriate, is that the decision-maker must act “rationally and not arbitrarily or perversely“. It is obviously important to appreciate that the width of this discretion arises from the specific wording of the GMRA and the framework for determining the close-out amount which that sets out.