The High Court has provided important guidance on the application of the standard to which a determining party’s calculation of Loss under the 1992 ISDA Master Agreement will be held in Lehman Brothers Finance AG (in liquidation) v (1) Klaus Tschira Stiftung GmbH & Anor [2019] EWHC 379 (Ch).

Upon an Event of Default under the 1992 ISDA, the standard to which the determining party is held in calculating Loss (if elected) under the 1992 ISDA has previously been confirmed in Fondazione Enasarco v Lehman Brothers Finance SA [2015] EWHC 1307 (read our summary here). The test is one of rationality, rather than objective reasonableness (in contrast to the position under the 2002 version of the ISDA Master Agreement). This gives the determining party greater latitude, with the result that the amounts can be determined quickly and with only limited basis for challenge. In the classical formulation of the test, the defaulting party can challenge the determination if it is irrational, capricious or arbitrary.

The Tschira decision provides additional clarification of the limitations on the determining party’s discretion to determine Loss, illustrating that the width of the discretion does not mean that the determination can only be challenged if it can be shown that “no reasonable Non-defaulting Party acting in good faith could have come to the same result“. In particular:

  1. Whilst an administrative-law style assessment would consider whether the determining party took into account all relevant factors and ignored all irrelevant factors, that does not mean that the determining party has the freedom to determine what the definition of Loss in the 1992 ISDA actually means. In other words, the determining party cannot apply its own interpretation of Loss and the court will scrutinise whether the correct interpretation has been applied.
  2. The definition of Loss in the 1992 ISDA did not provide a de facto indemnity against all losses suffered as a result of the Event of Default. Accordingly, common law principles of remoteness applied and it was necessary for the court therefore to consider whether all of the losses incorporated into the determination were in the reasonable contemplation of the parties.
  3. Whilst the determining party is plainly able to use indicative quotations obtained from market participants for the purpose of its calculation of Loss, care must be taken:
  • Only in limited circumstances will it be appropriate to rely on indicative quotations as at a later date than the Event of Default.
  • Whilst Enasarco established that the replacement trade to which the quotation applies need not be identical to the trade being valued, where the differences would obviously produce a substantially different result there is a real risk that use of such quotations to determine Loss would be deemed irrational.
  • It is clear that the determining party need not in fact enter into the replacement trade in order to be able to use the indicative quotation for the determination of Loss. However, in order for use of an indicative quotation to be rational, it may need to have been possible for the determining party to have been able to enter into it.


The defendants were two German entities established by one of the founders of SAP. Since their principal assets consisted of shares in SAP, they had each entered into a number of single stock derivative transactions with Lehman Brothers Finance AG (the “Bank“), a Swiss entity which was part of the Lehman Brothers group, to hedge against significant falls in the price of SAP shares. The hedging transactions were governed by the 1992 version of the ISDA Master Agreement. Given the poor credit quality of the defendants, the terms of the transactions required the SAP shares they held to be placed as collateral with the UK subsidiary of the Lehman Brothers group (“LBIE“).

The collapse of Lehman Brothers on 15 September 2008 caused an Event of Default on the hedges triggering the need for the defendants to determine the close-out payments (on the basis of Loss, which the parties had elected as the methodology to apply in the 1992 ISDA). Soon after the Event of Default, the defendants sought indicative quotations from Goldman Sachs and Mediobanca, Banca di Credito Finanziario SpA (“Mediobanca“) for replacement hedges on the basis that they would be collateralised in a similar way to the original trades.

However, the defendants later learnt that the SAP shares held by LBIE as collateral would be dealt with as part of its administration, raising the prospect of them being unavailable to the defendants for use in any replacement trade for the foreseeable future. As a result, Mediobanca and Goldman Sachs were asked to provide revised indicative quotations for replacement trades on an uncollateralised basis. Unsurprisingly, these quotations were substantially higher than the earlier quotations which had been obtained on a collateralised basis (reflecting, amongst other things, the significantly greater credit risk to which the counterparty would be exposed).

The defendants ultimately served a determination of Loss based on Mediobanca’s quotation for an uncollateralised replacement trade. Accordingly, the determination of Loss which it sought to recover from the Bank (over €511m) was far higher than it would have been had it been determined on the basis of the earlier quotations which were based on a collateralised replacement trade (which were €28.22m and €17.46m).

The Bank challenged the calculation of Loss.


The court held that the determination of Loss by the defendants was invalid. First, it had not been performed in accordance with the definition of Loss. In any event, it was found to have been irrational.

Application of the rationality standard

It is well established by the authorities (for example, Enasarco) that the relevant standard which applies to the determining party’s calculation of Loss under the 1992 ISDA is one of rationality, reflecting the test of Wednesbury reasonableness of an administrative decision. However, it was noted that this did not resolve all uncertainties as to the standard to which the determining party will be held. In particular, it was unclear whether this test imported into the court’s assessment of all the elements of a review of an administrative decision, including the process by which the determination was reached.

The court held that the 1992 ISDA did not import a requirement that the court undertake a detailed assessment of whether the determining party took into account all relevant factors and ignored irrelevant factors. To allow such an expanded basis for challenge would undermine the desire for speed and commercial certainty which is clearly one of the driving principles of the Loss definition. However, the determining party does not have free rein to determine for itself not only the method it will adopt to determine Loss, but also the actual meaning of Loss. Accordingly, the Bank was not limited only to being able to challenge the determination of Loss on the basis that the method chosen was irrational (or in bad faith), for which the defendants had a large measure of latitude. It could also challenge the determination on the basis that the defendants had interpreted the definition of Loss incorrectly.

Remoteness test in the meaning of Loss

The court held that the correct meaning of Loss incorporated usual common law principles applicable to the assessment of contractual damages, including remoteness. The key question, therefore, was whether all of the Loss claimed was of a type that was in the reasonable contemplation of the parties. Applying this test, the court found that it was not within the reasonable contemplation of the parties that the defendants would be able to recover the additional financial consequences of having to enter into an uncollateralised replacement trade as a result of being unable to retrieve the collateral from LBIE.

The court noted that this conclusion was consistent with the ‘value clean’ principle, pursuant to which the loss of bargain within the Loss calculation must be valued on the assumption that “but for termination, the transaction would have proceeded to a conclusion, and that all conditions to its full performance by both sides would have been satisfied, however improbable that assumption may be in the real world“. Applying the ‘value clean’ principle in this case, the provision of the collateral by the defendants was a condition precedent for the trades. Accordingly, the assumption should be made for the replacement trades that this condition would be satisfied, notwithstanding that this was not possible in the real world. This meant that any quotations for replacement transactions should have been on a collateralised basis.

Appropriate date for determining Loss

The court also considered a criticism made that the quotations used for the defendants’ determination should have been ‘as of’ the Early Termination Date. The Bank argued that, whilst the Loss definition permitted (for practical reasons) some flexibility in the use of a firm quotation obtained after the Early Termination Date, it did not allow an indicative quotation to be used other than as of the Early Termination Date. The rationale for this was that it should always be possible to obtain an indicative quotation as at the earlier date (on a retrospective basis).

The court did not agree with such a restrictive interpretation of Loss, which would have the effect of requiring, rather than permitting, the Non-defaulting Party to use firm quotations rather than any other method in circumstances where, for whatever reason, it was unable to obtain quotations at the time of the Early Termination Date (for instance where it did not learn of the Event of Default until a later point in time or where there was no available market as at the Early Termination Date). However, it noted that this flexibility would only apply in those sorts of limited circumstances.


The court also found that it was, in any event, irrational for the defendants to use the uncollateralised replacement transactions as a basis for the calculation of Loss.

First, whilst the existence of some differences between the terms of the trade and the terms of the replacement trade may not invalidate the determination of Loss (as illustrated in the Enasarco case), there were limits to that latitude. In this case, seeking quotations for replacement trades on an uncollateralised basis would obviously, and did, produce a substantial difference when compared to seeking quotations on a collateralised basis. This meant that they were not a reliable guide as to the value of what had been lost, and to use this as a basis for the calculation of Loss was irrational.

Second, the method of using quotations or valuations of the cost of a replacement trade to measure loss depends on the replacement being one that the party could enter into in an available market (albeit that they need not actually enter into the replacement trade). Having made a finding of fact that the defendants, given their poor credit risk, could not have entered into a replacement hedge on an uncollateralised basis, it was irrational to use a quotation for such a transaction as a method of determining its Loss.

The court’s calculation of Loss

Having found that the determination was invalid, the task for the court was to determine what Loss determination would have been arrived at by the defendants acting reasonably and in good faith. It therefore substituted the defendants’ invalid determination with its own calculation, using the initial quotations which had in fact been obtained by the defendants (on a collateralised basis). Whilst there were criticisms made of aspects of those quotations by the Bank’s expert, these were characterised by the court as differences of methodology, rather than fundamental errors that would lead to a substantially different price.

The court’s approach emphasised the potential importance of all contemporaneous quotations received by the Non-defaulting Party. Whilst it is clear from previous case law (see our e-bulletin on National Power) that the determining party gets only one bite at the cherry, the steps taken to obtain other quotations at or around the time of the Event of Default are likely to provide important evidence for the court to use in its own calculation of Loss.

It is noteworthy, also, that in this aspect of the judgment the court left open the question of whether the determining party could validly favour its own interests in the selection of which quotation to use in its determination, or whether choosing the one which was most favourable would necessarily be irrational. The court adopted the pragmatic approach of averaging the two quotations which the defendants received on the basis that the defendants had, as a matter of fact, used that average when providing a ‘without prejudice’ informal calculation of Loss in the initial days after the Event of Default. However, in doing so, it has left the question to be determined in future litigation.

Harry Edwards
Harry Edwards
+44 20 7466 2221
Amel Fenghour
Amel Fenghour
+44 20 7466 2389
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948