Fondazione Enasarco, the Italian pension fund for sales representatives, has won a $61.5m (€55.3m) payout from Lehman Brothers SA (LB) for payments due to it following the terminaton of a put option when LB went bust in 2008.

The case, heard in the English High Court, concerned a structured investment arranged by LB that provided Enasarco with exposure to hedge funds within its investment portfolio, now worth €6.9bn.

The deal was structured through two special purpose vehicles (SPVs): Anthracite Rated Investments (Cayman) (ARIC) and Anthracite Balanced Company (Balco).

Enasarco’s €780m hedge fund investment was protected by a put option purchased by ARIC from Lehman Brothers Finance (LBF), a company incorporated in Switzerland.

The put option was written in London under the 1992 ISDA Master Agreement (‘master agreement’), a standard template for over-the-counter derivative transactions published by the International Swaps and Derivatives Association (ISDA).

The agreement was ended automatically on 15 September 2008 when LB first filed for formal insolvency protection.

Enasarco, under pressure from the Italian government and media, eventually found a replacement for the put option, which it purchased itself on 6 May 2009.

The master agreement sets out that, when a transaction terminates early, the non-defaulting party must calculate the termination amounts to be paid.

When they sign the deal, parties choose one of several possible methods of calculation provided for in the master agreement.

In their agreement, LBF and ARIC selected the ‘loss’ method of calculation, which allows the non-defaulting party to calculate the termination payment by reference to its loss of bargain – i.e. the cost of replacing the terminated transaction.

The master agreement provides that the non-defaulting party must calculate its loss “reasonably” and “in good faith” and that the calculation should be as of the early termination date, or as soon as reasonably practicable thereafter.

ARIC calculated its loss to be approximately $61m, based on the price Enasarco had paid for the replacement put option.

LBF disagreed with this calculation, contending instead that, had the calculation been performed correctly, it would have resulted in a payment of approximately $42m from ARIC to LBF.

However, the judge found that ARIC’s loss had been calculated reasonably and as soon as practicable following the early termination date.

He also made the following comments of particular interest to the wider market:

  • Where an SPV is party to a derivative that is terminated under a master agreement as part of a structured product, its loss can be calculated by reference to the cost of a replacement transaction entered into by the investor. In addition, the terms of the replacement transaction do not necessarily have to be identical to those of the original.
  • A calculation of loss made “as of” a date several months after the early termination date may still be “as soon as reasonably practicable” as stipulated by the master agreement. 

In this case, although LBF contended that ARIC (or Enasarco) could have obtained a quotation for a replacement transaction earlier than Enasarco actually did, the judge was satisfied that the turmoil in the markets after LB’s bankruptcy, and the difficulties with the transaction structure, meant that no such quotation could have been obtained before at least the end of October 2008, and probably later.

Furthermore, had it been possible to obtain a quotation earlier in 2009 than 6 May, it would have made no difference to the price or the resulting loss calculation.

  • Enasarco’s determination of the amount of loss was not “irrational”.

The judge said the requirement for the non-defaulting party’s loss to be calculated “reasonably” does not mean that it has to arrive at the most reasonable result, only that it must not arrive at a figure that no reasonable party in the same circumstances could come to.

The ruling has important implications for the wider derivatives market, according to Simon Fawell, partner at Sidley Austin, the lawyers who represented Enasarco.

Fawell said: “The ruling is an important one for non-defaulting parties under the 1992 ISDA Master Agreement, as it clarifies how the English court will interpret the calculation of loss following early termination.

“In particular, the finding on what is a reasonable determination of loss makes it much harder for those determinations to be challenged.”

And he said the judge’s finding that ARIC was entitled to calculate its loss on the basis of a quotation obtained by Enasarco was a practical one for structured transactions.

“The judge made clear it was unrealistic to expect Enasarco to leave it to an SPV to obtain a quotation for a replacement transaction and calculate the loss,” he said.

“Enasarco was the party with an economic interest, and ARIC, as an SPV, had neither the staff nor the resources to undertake those tasks. Had the judge found differently, it would have made the use of SPVs in this type of structure much less attractive to investors.”

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