In Lehman Brothers Special Financing Inc v National Power Corporation(1) the High Court considered whether, in the event of the early termination of a transaction under the 2002 International Swaps and Derivatives Association (ISDA) Master Agreement, a party could 'remake' its determination of the close-out amount and the nature of that party's discretion in calculating the close-out amount.


The claimant, Lehman Brothers Special Financing (LBSF), was part of the Lehman Brothers Group. The defendant, National Power Corporation (NPC), was owned and controlled by the Philippine government. On July 18 2007 LBSF and NPC entered into a principal-only US dollar/Philippine peso forward currency swap under a 2002 ISDA Master Agreement (the LSBF transaction). NPC entered into the LBSF transaction in order to hedge some of the currency exposure arising under $300 million in bonds that it had issued, which would mature in 2028.

Under the LBSF transaction:(2)

  • in 2028 LBSF and NPC were to pay each other $100 million and P4.4788 billion (the Philippine peso equivalent of $100 million as at the date of the transaction), respectively; and
  • NPC was to pay LBSF a fixed rate of 2.687% per annum of $100 million in semi-annual coupons between November 15 2007 and May 15 2026.

On October 3 2008 LBSF filed for Chapter 11 bankruptcy relief in the United States, which constituted an event of default under the LBSF transaction. On October 17 2018 NPC served notice of early termination, which designated the contractual early termination date as November 3 2008. Under the 2002 ISDA Master Agreement:

  • NPC, as the non-defaulting party, had the right and obligation to determine the close-out amount;
  • Section 14 defined 'close-out amount' as (in summary) "the amount of the losses or costs [or gains]… in replacing or in providing for [NPC] the economic equivalent of… the material terms of" the terminated transaction;
  • in making its determination, NPC was obliged to "act in good faith and use commercially reasonable procedures in order to produce a commercially reasonably result"; and
  • the close-out amount had to be "determined as of the Early Termination Date or, if that would not be commercially reasonable, as of the date or dates following the Early Termination Date as would be commercially reasonable".

Around that time, NPC was looking to replace the gap in its hedging strategy resulting from the early termination of the LBSF transaction and so, on November 3 2008 (the early termination date), requested indicative quotations from three financial institutions. UBS quoted an annual coupon of 3.68%. On November 7 2008 NPC requested firm quotations and received a cheaper quotation of 2.96% from UBS. NPC traded with UBS on that basis (the UBS transaction).

On January 26 2009 NPC served a demand on LBSF – supported by calculations, which it enclosed – for $3,461,590.93 (payable by LBSF to NPC) and filed a proof of claim in LBSF's bankruptcy proceedings. The close-out amount was calculated based on the price of the UBS transaction.

Nearly six years later, on September 12 2014, NPC withdrew its proof of claim and, on October 27 2016 (after LBSF had commenced proceedings) served a revised calculation statement with primary and alternative determinations of $10,778,943 and $2,140,482, respectively (payable by LBSF to NPC in each case). The primary determination was based on the UBS indicative quotation of 3.68%, received on the early termination date of November 3 2008. The alternative determination was the sum demanded in January 2009, less an amount representing the coupon accrued between the last payment date and the early termination of the LBSF transaction (which –as was common ground between the parties – had been omitted in error from the January 2009 calculation).

LBSF claimed that NPC owed it $12,826,887, based on LBSF's calculations of the mark-to-market value of the LBSF transaction.

Remaking determination of close-out amount

NPC contended that its failure to take into account the accrued semi-annual coupon in its January 2009 calculation was a manifest error, which meant that the determination was invalid and not contractually binding and it was therefore free to make a fresh, valid and binding determination (as it had purported to have done in 2016).

The court rejected this argument, holding that NPC had completed its obligation and right to make a determination in January 2009. If there was an error in the determination (including manifest numerical or mathematical errors), then – in the absence of an agreement between the parties – it was for the court to declare that and to decide what the close-out amount would have been on a determination without error. The alternative – that a non-compliant determination was not a determination at all – left open the possibility of "repeated remittance back to NPC to make a compliant determination", which "cannot be the approach objectively intended under the contract".

Rationality versus reasonableness

As noted above, it was common ground between the parties that the accrued coupon should have been taken into account in the calculation. Therefore, putting that to one side, the issue was whether the requirement for "commercially reasonable procedures in order to produce a commercially reasonable result" was complied with (good faith was not at issue).

NPC contended that, in circumstances where the contract reserved the decision making to one party, the wording imposed an obligation to determine the close-out amount only rationally, as per the implied limitation on the decision-maker's discretion imposed in Socimer International Bank Ltd v Standard Bank London Ltd (No 2).(3) Accordingly, NPC argued, its determination was not to be assessed by an objective standard of reasonableness.

The court rejected this argument, noting that its task was to construe the express terms of the contract, rather than to decide what term to imply in circumstances where the express terms did no more than give one party a bare discretion. The court held that the contract did require reasonableness in the sense of assessment by reference to an objective standard, and that this applied both to process adopted and to the outcome. The court stressed that objective reasonableness nevertheless allowed for a range of outcomes, although that did not mean that the determining party could simply take the result that suited it best at one end of the range.

The court noted that this meant that the limitation in the 2002 ISDA differed materially from that in the 1992 ISDA, in which the relevant calculation was to be of an amount that the relevant party "reasonably determines in good faith to be its total losses and costs", which a series of authorities had held to be essentially a test of rationality. The court noted that this tightening was consistent with the commentary in the user guide for the 2002 ISDA.

Was January 2009 determination commercially reasonable?

As noted above, the close-out amount must be:

"determined as of the Early Termination Date or, if that would not be commercially reasonable, as of the date or dates following the Early Termination Date as would be commercially reasonable."

On the early termination date of November 3 2008, indicative quotations (including that from UBS, which NPC used as the basis for its primary determination in 2016) were available. However, in circumstances where NPC proposed to enter into a replacement transaction and for that purpose would and did seek firm quotations a few days later, the court was not persuaded that it was commercially reasonable for NPC to determine the close-out amount as of November 3 2008 using an indicative quotation. The court considered it commercially reasonable for NPC to make its determination as it had in 2009 (subject to the error in relation to the accrued coupon), by using UBS's firm quotation from November 7 2008 which was the basis for the replacement UBS transaction.

As noted above, LBSF sought to rely on its own mark-to-market valuations which showed that the LBSF transaction had a significant value in its favour when terminated. However, the court did not consider that, in this case, these were the same as the price at which a replacement transaction could be achieved, and at which the definition of the close-out amount was expressly directed.

Accordingly, NPC's 2009 determination based on the UBS transaction stood (subject to the correction in respect of the accrued coupon). If there had been no determination in 2009, the court would have made the determination for the parties on the same basis.


The court itself suggested by way of conclusion that this case demonstrates the wisdom of the change that ISDA made between the 1992 and 2002 Master Agreements, in that it may prevent a party, like NPC, that has actually replaced the terminated transaction pressing for a close-out amount calculated on a different basis – which would result in an immediate windfall.

As noted above, the court stressed that the requirement for objective reasonableness did not mean that there was a single right answer. Accordingly, it is hoped that this decision's confirmation that the 2002 ISDA wording is tighter than its predecessor does not offer too much encouragement to recipients of close-out valuations which they do not like, but which they concede may be just about reasonable, to ask the court to recalculate.

More generally, the circumstances in which close-out determinations (under the ISDA Master Agreement and, subject to terms to the contrary, other master agreements and analogous contractual arrangements) will be deemed so flawed as to have no legal effect now appear to be very limited. As such, parties must either get it right the first time or be prepared for the court to step in and do it for them.

For further information on this topic please contact Simon Hart or Daniel Hemming at RPC by telephone (+44 20 3060 6000) or email ( or The RPC website can be accessed at


(1) [2018] EWHC 487 (Comm).

(2) The LBSF transaction also incorporated a pre-payment option whereby NPC could pre-pay in 2008 in 2028 obligation. This received some consideration in the judgment but has been omitted for the purpose of this summary.

(3) [2008] EWCA Civ 116.

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