A recent decision discusses the termination provisions in the Global Master Repurchase Agreement (GMRA) and Global Master Securities Lending Agreement (GMSLA), whether fax is an appropriate method of serving default notices and how the securities should be valued.
LBI EHF (in winding up) v Raiffeisen Zentralbank Österreich AG and Raiffeisen Bank International AG  EWHC 522 (Comm)
The claimant, LBI EHF, contended that the default notice had not been served effectively and that the securities had not been valued correctly. The Commercial Court held that serving the notices by fax was effective as that was allowed under the GMRA and GMSLA and the securities had been valued correctly.
What are the practical implications of this case?
The case highlights the importance of following default provisions to ensure that notices are effective and also that non-defaulting parties are entitled to behave rationally and in good faith when determining valuations for securities.
What was this case about?
The claimant (LBI) entered into a number of trades with the defendants (RZB). In 2008, LBI failed. At this time there were eleven open positions between LBI and RZB relating to repo transactions and three open positions relating to securities lending transactions. These trades were on the terms of two master agreements—the repos were under the terms of the GMRA 2000 edition and the securities lending transactions were under the terms of the GMSLA 2000 edition. The dispute between the parties was in relation to valuation and whether default notices were effectively served by RZB.
What were the arguments arising in relation to the effective service of default notices?
RZB contended that it had sent default notices by fax. LBI said that it could not trace receipt of any default notices and so challenged this contention.
Under both the GMRA and GMSLA, service by fax is permissible—this is pursuant to paragraph 14(a)(ii) and (b)(iii) under the GMRA and paragraph 21.1 under the GMSLA. LBI criticised the choice of fax but the parties had provided a fax number under the agreements and so the choice could not be disputed.
RZB had transmission receipts marked “OK”. The receipt containing the number for LBI commenced “0207” rather than “0044207” but the judge thought that the difference in number related to the answerback of the machine reached, and did not mean that the fax number had been dialled incorrectly.
The faxes had to be received by a ‘responsible employee’ of LBI and LBI challenged that they had been. LBI thought that a ‘responsible employee’ should be someone who would recognise a default notice for what it was. The judge however thought that read too much into the phrase and that it would allow too much uncertainty into the system. LBI relied on a paragraph in Henderson on Derivatives which discussed the 1992 ISDA Master Agreement, in which Mr Henderson commented that a responsible official was ‘presumably not the employee in the fax room’. However, the judge in this case thought that an employee in the fax room had been given responsibility by his employer to be the first point of receipt and too much uncertainty would arise if that employee had to have sufficient appreciation of what the notice was and what it signified.
The judge commented that although LBI had looked for the notices and had been unable to find them, this did not mean that they had not been appropriately delivered. The judge thought that LBI did not have a reliable enough system of recording or storing faxes and so, on the information available, accepted that RZB had sent the default notices effectively.
What were the arguments arising in relation to the valuation?
LBI contended that the way the securities were ascribed their valuation was incorrect because of the meaning that should be given to the words ‘fair market value’.
RZB failed to send a default valuation notice by the default valuation time and so the GMRA prescribed in paragraph 10(e)(ii) that the default market value of equivalent securities should be an amount equal to the net value as determined by RZB as soon as reasonably practicable after the default valuation time. Net value is defined under paragraph 10(d)(iv) of the GMRA as representing the fair market value of the securities in the reasonable opinion of RZB (the non-defaulting party).
The parties had not agreed a ‘generally recognised source’ of prices for securities as the definition of ‘market value’ in the GMRA had contemplated.
LBI contended that the fair market value should have been informed by definitions found in certain valuation standards. Mr Justice Knowles did not think that such definitions could not be limited on this basis unless such sources had been listed in the GMRA.
LBI accepted that the court had to put itself in the shoes of the decision maker (here, RZB) and ask what decision RZB would have reached, acting rationally and not arbitrarily or perversely. The judge considered what Blair J had said in his judgment of Lehman Brothers International (Europe) v Exxonmobil Financial Services BV and concluded that the court should examine carefully what RZB contends it would have taken as a ‘fair market value’ and why.
As soon as RZB had dispatched the Default Notice to LBI, RZB asked for bids from ten institutional counterparties. RZB used algorithm-based pricing based on a Bloomberg screen. However, RZB did not consider these prices to be commercially realisable in light of its experiences with Lehmans defaulting in the previous month. Even LBI’s expert agreed that pricing at the Bloomberg prices in the current market conditions was challenging and that applying a haircut to the securities was rational.
The judge thought that RZB’s calculations were therefore rational and made in good faith.
The judge concluded by stating that ‘any assessment of fair market value would be imperfect but the non-defaulting party was nonetheless entitled to make one’.
To what extent is the judgment helpful?
The judgment is helpful in clarifying again the importance of following default provisions to the letter. In this case, RZB had followed the provisions of the GMRA and GMSLA in sending the default notices and while LBI contended that fax was not the most sensible method, it was a method that could be used pursuant to the agreements in place between the parties.
The case highlights the problems inherent in sending notices by fax. LBI contended that they had not received the fax but it seemed that the systems they had in place were not sufficient to monitor what faxes had been received nor indeed properly store faxes that they had received. Practitioners should ensure that they have appropriate systems in place to receive and store faxes, especially where important notices may be going to back office departments who might not understand the importance of such notices.
The judgment also clarifies the fact that where market conditions are challenging, non-defaulting parties must just act in good faith and rationally to determine valuations. Any agreement should contain sufficient details over how to ascribe valuations to securities to avoid arguments as to whether the valuations are fair and in line with market expectations.
- Court: High Court of Justice, Queen’s Bench Division, Commercial Court
- Judge: Mr Justice Knowles CBE
- Date of judgment: 20 March 2017