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	England and Wales Court of Appeal (Civil Division) Decisions
You are here: BAILII >> Databases >> England and Wales Court of Appeal (Civil Division) Decisions >> Lehman Brothers International (Europe) v Lehman Brothers Finance SA [2013] EWCA Civ 188 (14 March 2013) URL: http://www.bailii.org/ew/cases/EWCA/Civ/2013/188.html Cite as: [2013] EWCA Civ 188

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IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
(CHANCERY DIVISION) (COMPANIES COURT)
BRIGGS J
[2012] EWHC 1072 (Ch)

		Royal Courts of Justice Strand, London, WC2A 2LL
		14/03/2013

Lady Justice Arden:

INTRODUCTION- THIS APPEAL IN BRIEF

1. Lehman Brothers International (Europe) ("LBIE"), now in administration, laid off risks arising from its derivative trading with clients over a number of years by (a) entering into back-to-back transactions ("Inter-company Transactions") with a fellow Lehman company, Lehman Brothers Finance SA ("LBF"); and (b) signing a side letter ("the Side Letter") dated 24 July 2006 with LBF. The back-to-back transactions were carried out on the terms of an agreement ("the Master Agreement") which followed the form of the 1992 version of the Master Agreement issued by the International Swap Dealers Association ("ISDA") as modified to incorporate certain provisions of the 2002 version of the Master Agreement dealing with the consequences of termination. The Side Letter provided: (1) for automatic termination of a back-to-back Inter-company Transaction if the related transaction (a "Client Transaction") terminated; (2) for LBIE to pay to LBF under any Inter-company Transaction only the amount recovered from the client under the related Client Transaction.
2. In the events which happened, an Event of Default under the Inter-company Transactions occurred in respect of LBF with the result that those transactions automatically terminated by virtue of the terms of the Master Agreement.
3. The consequence of this default was that, under the Master Agreement, there had to be a determination of compensation by "closing out" the Inter-company Transactions in accordance with the Master Agreement. This involves determining gains or losses at the date of the closing out in replacing or providing the economic equivalent of the "material terms" of the Inter-company Transactions and assuming that all conditions precedent as to payment and delivery were fulfilled. Those material terms were referred to in argument on this appeal as the terms of a "replacement contract", and I will also use that expression.
4. The ultimate issue on this appeal, brought by the administrators of LBIE, is: should the provisions of the Side Letter be treated as terms of the replacement contracts contemplated for the purposes of closing out the Inter-company Transactions? On the one hand, LBIE submits that those provisions are "material terms" of the Inter-company Transactions and that they fall to be taken into account by virtue of the definition of Close-out Amount introduced by ISDA in its 2002 form of the Master Agreement. On the other hand, LBF submits that they must be left out of account because the valuation had to be carried out on the assumption that conditions precedent were deemed to have been fulfilled (this assumption is known both as the "value clean" principle and "the continuity assumption").
5. Briggs J, in a masterly judgment, held in essence that the Side Letter was not a material term of the Inter-company Transaction, and that it should be left out of the ascertainment of the economic equivalent of the material terms, alternatively that, if it was a material term, that term had no value.
6. This appeal is of considerable importance to:

i) The creditors of LBIE, since the administrators of LBIE estimate that it may increase the amounts payable to LBIE by some US$1bn.

ii) The derivatives market, which daily conducts very large volumes of transactions on the basis of the 2002 Master Agreement.

OVERALL CONCLUSIONS AND SUMMARY OF REASONS

7. In summary, for the detailed reasons given below, I would hold that this appeal succeeds and that the Side Letter should be taken into account for the purposes of determining the value of replacement transactions under the 2002 Master Agreement closing out provisions. I reach this conclusion by the following steps:

(1) The 2002 Master Agreement should be interpreted (a) according to its own terms and (b) taking into account all the relevant background (paragraphs 51 to 56 below).

(2) The reasons for the changes shown in the 2002 Master Agreement given in the User's Guide to the ISDA 2002 Master Agreement published by ISDA in 2003 ("the User's Guide") suggest that those changes were regarded as more important than the preservation of the "value clean" principle in the form in which it existed in the 1992 Master Agreement (paragraphs 57 to 60 below).

(3) The "value clean" principle appears in the 2002 Master Agreement in a different context from that in which it appeared in the 1992 Master Agreement (paragraphs 61 to 64 below).

(4) Where more than one meaning is possible the court should prefer that which is more consistent with business common sense and the judge's application of the "value clean" principle conflicts with business common sense (paragraphs 65 to 70 below).

(5) Words should generally be given their natural meaning (paragraphs 71 to 76 below).

(6) "Material terms" are those that impact on pricing and (but for the judge's ruling on the "value clean" principle) they would in the present case include the terms of the Side Letter (paragraphs 77 to 84 below).

(7) The judge's restriction on the meaning of "option rights" is not justified by the words used to describe option rights in the definition of Close-out Amount or by the User's Guide (paragraphs 85 to 91 below).

(8) The inclusion in the Close-out Amount of permission to the Determining Party to take account of its own creditworthiness involves a clear departure from the "value clean" principle (paragraphs 92 to 95 below).

(9) The words "assuming satisfaction of the conditions precedent in clause 2(a)(iii)" cannot be taken to deprive the references to "material terms" and "option rights" of the weight that they would otherwise have (paragraphs 96 to 111 below).

8. The starting point is clearly the terms of the ISDA Master Agreements, the relevant case law on them, including the jurisprudence on the "value clean" principle, and then the Side Letter. After describing these, I will then set out briefly the background, summarise the salient parts of the judge's judgment and set out the submissions and my analysis of them. At the end I refer to some subsidiary arguments.
9. We are not asked to decide the issues in this appeal against the context of any particular Inter-company Transaction or on the facts relating to its termination. We are asked to decide these points so that the parties can apply the principle to the numerous Inter-company Transactions that have to be settled.

BACKGROUND: (A) ISDA MASTER AGREEMENTS

10. The first standardised terms of business for use with all types of derivative transactions produced by ISDA were issued in 1992. The terms as to the consequences of early termination were revised in 2002. The reason for this appears to have been that the provisions of the 1992 Master Agreement did not produce a closing out which met regulators' requirements with regard to the capital base of the market participants (see the passage from the User's Guide set out below). For the first time, the calculation of the liabilities due on closing out had to be carried out "in order to produce a commercially reasonable result". The fact that it had to be expressly stated suggests that the drafting had not always met commercial expectations in the past, and that ISDA wanted a new approach to be adopted.
11. ISDA Master Agreements are very detailed. We are concerned only with the provisions dealing with payment and delivery, the occurrence of Early Termination and closing out on Early Termination. In 2002, ISDA merely amended the 1992 Master Agreement. When I refer to the 2002 Master Agreement, I refer to the 1992 Master Agreement as amended by the version issued in 2002, so far as adopted by LBIE and LBF.

Payment and delivery

12. Obligations as to payment and delivery are dealt with in the 1992 Master Agreement, and they are not affected by the 2002 revisions adopted by LBIE and LBF. So far as material, they are as follows:

"2 Obligations

(a) General conditions.

(i) Each party will make each payment or delivery specified in each Confirmation to be made by it, subject to the other provisions of this Agreement.

(ii) Payments under this Agreement will be made on the due date for value on that date in the place of the accounts specified in the relevant Confirmation or otherwise pursuant to this Agreement in freely transferable funds and in the manner customary for payments in the required currency. Where settlement is by delivery (that is, other than by payment), such delivery will be made for receipt on the due date in the manner customary for the relevant obligation unless otherwise specified in the relevant Confirmation or elsewhere in this Agreement.

(iii) Each obligation of each party under Section 2(a)(i) is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing, (2) the condition precedent that no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated and (3) each other applicable condition precedent specified in this Agreement."

Early Termination

13. "Early Termination Date" is defined in sections 14 and 6 of the Master Agreement: in short, the occurrence of an Early Termination Date depends on the happening of an Event of Default or a Termination Event. A Termination Event is defined as "an Illegality, a Tax Event or a Tax Event upon Merger, or if specified to be applicable, a Credit Event upon Merger or an Additional Termination Event". Thus:
    
    (a) Under Section 14 (Definitions), the expression "Early Termination Date" means the date determined in accordance with Section 6 (a) or (b) (iv)".

(b) Section 6(a) provides:

"6. Early Termination

(a) Right to Terminate Following Event of Default. If at any time an Event of Default with respect to a party (the "Defaulting Party") has occurred and is then continuing, the other party (the "Non-defaulting Party") may, by not more than 20 days notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions. If, however, "Automatic Early Termination" is specified in the Schedule as applying to a party, then an Early Termination Date in respect of all outstanding Transactions will occur immediately upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(1), (3), (5), (6) or, to the extent analogous thereto, (8), and as of the time immediately preceding the institution of the relevant proceeding or the presentation of the relevant petition upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(4) or, to the extent analogous thereto, (8).

(c) Section 6(b)(iv) provides:

"(iv) Right to Terminate

If:-

(1) a transfer under Section 6(b)(ii) or an agreement under Section 6(b)(iii), as the case may be, has not been effected with respect to all Affected Transactions within 30 days after an Affected Party gives notice under Section 6(b)(i); or

(2) an Illegality under Section 5(b)(i)(2), a Credit Event Upon Merger or an Additional Termination Event occurs, or a Tax Event Upon Merger occurs and the Burdened Party is not the Affected Party,

either party in the case of an Illegality, the Burdened Party in the case of a Tax Event Upon Merger, any Affected Party in the case of a Tax Event or an Additional Termination Event if there is more than one Affected Party, or the party which is not the Affected Party in the case of a Credit Event Upon Merger or an Additional Termination Event if there is only one Affected Party may, by not more than 20 days notice to the other party and provided that the relevant Termination Event is then continuing, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all Affected Transactions."

14. Under Section 5(a), "Events of Default" are defined in a conventional way to include such matters as a party's failure to pay or deliver in accordance with the Master Agreement.

Closing out

15. Both the 1992 Master Agreement and the 2002 Master Agreement provided for the settlement of liabilities in the event of Early Termination. I refer below to these provisions as "closing out provisions". I need to describe the closing out provisions in the 1992 Master Agreement as well as those in the 2002 Master Agreement as the 1992 Master Agreement forms part of the matrix of fact against which the 2002 Master Agreement is to be interpreted. As we shall see, some language is repeated but there are also some new expressions, such as "the material terms", "the option rights" and "the creditworthiness of the Determining Party".
16. Under the closing out provisions in the 1992 Master Agreement, where there is an Early Termination Date, as opposed to termination through effluxion of time or in some other way, the non-defaulting party has to calculate inter alia the Close-out Amounts in accordance with Section 6(e)(i).
17. Transactions which were still in existence at the Early Termination Date had to be valued. The parties had four options for this. The most commonly used method (and also the default method of valuation) was called the "Second Method and Market Quotation". There was another method called the "Second Method and Loss". Under the definition of "Market Quotation", the Determining Party (the party not in default) had to obtain quotations from market makers for a replacement transaction with the market-maker:

"'Market Quotation' means, with respect to one or more Terminated Transactions and a party making the determination, an amount determined on the basis of quotations from Reference Market-makers. Each quotation will be for an amount, if any, that would be paid to such party (expressed as a negative number) or by such party (expressed as a positive number) in consideration of an agreement between such party (taking into account any existing Credit Support Document with respect to the obligations of such party) and the quoting Reference Market-maker to enter into a transaction (the "Replacement Transaction") that would have the effect of preserving for such party the economic equivalent of any payment or delivery (whether the underlying obligation was absolute or contingent and assuming the satisfaction of each applicable condition precedent) by the parties under Section 2(a)(i) in respect of such Terminated Transaction or group of Terminated Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date. For this purpose, Unpaid Amounts in respect of the Terminated Transaction or group of Terminated Transactions are to be excluded but, without limitation, any payment or delivery that would, but for the relevant Early Termination Date, have been required (assuming satisfaction of each applicable condition precedent) after that Early Termination Date is to be included …" (italics added)

18. Amounts which had fallen due on or before the Early Termination Date but which had not then been paid were called "unpaid amounts":

"'Unpaid Amounts' owing to any party means, with respect to an Early Termination Date, the aggregate of (a) in respect of all Terminated Transactions, the amounts that became payable (or that would have become payable but for Section 2(a)(iii)) to such party under Section 2(a)(i) on or prior to such Early Termination Date and which remain unpaid as at such Early Termination Date and (b) in respect of each Terminated Transaction, for each obligation under Section 2(a)(i) which was (or would have been but for Section 2(a)(iii)) required to be settled by delivery to such party on or prior to such Early Termination Date and which has not been so settled as at such Early Termination Date, an amount equal to the fair market value of that which was (or would have been) required to be delivered as of the originally scheduled date for delivery …"

19. "Loss" for the purpose of valuation was defined as follows:

" 'Loss' means, with respect to this Agreement or one or more Terminated Transactions, as the case may be, and a party, the Termination Currency Equivalent of an amount that party reasonably determines in good faith to be its total losses and costs (or gain, in which case expressed as a negative number) in connection with this Agreement or that Terminated Transaction or group of Terminated Transactions, as the case may be, including any loss of bargain, cost of funding or, at the election of such party but without duplication, loss or cost incurred as a result of its terminating, liquidating, obtaining or re-establishing any hedge or related trading position (or any gain resulting from any of them). Loss includes losses and costs (or gains) in respect of any payment or delivery required to have been made (assuming satisfaction of each applicable condition precedent) on or before the relevant Early Termination Date and not made, except so as to avoid duplication, if Section 6(e)(i)(1) or (3) or 6(e)(ii)(2)(A) applies. Loss does not include a party's legal fees and out-of-pocket expenses referred to under Section 11. A party will determine its Loss as of the relevant Early Termination Date, or, if that is not reasonably practicable, as of the earliest date thereafter as is reasonably practicable. A party may (but need not) determine its Loss by reference to quotations of relevant rates or prices from one or more leading dealers in the relevant markets."

20. The 2002 Master Agreement reduced the options for valuation to one, and made the provisions for valuation more flexible. This is explained in the User's Guide. The stated purpose of the User's Guide was to explain the 2002 Master Agreement and to highlight significant changes from the 1992 Master Agreement.
21. The User's Guide makes it clear that the changes in 2002 were "significant":

"5. Payments on Early Termination The 2002 Agreement has been modified significantly from the 1992 Agreement in terms of calculating payments owed if an Early Termination Date occurs…

The addition of Close-out Amount, and the deletion of Market Quotation and Loss as payment measures, was made in response to member comments that a single measure of damages in the 2002 Agreement was desirable as was the single method of payment. The 1992 Agreement included two payment methods, the First Method and the Second Method. The First Method under the 1992 agreement was sometimes referred to as "limited two-way payments" or a "walk away clause". Under the First Method, if a single net amount ran in favour of the Defaulting Party, it would not receive that amount from then Non-defaulting Party. The First Method has been deleted from the 2002 Agreement leaving the second method as the sole payment method, in response to member comments that the First Method was no longer used, most likely due to rules adopted by bank regulators that conditioned the recognition of netting for capital purposes on use of the Second Method.

a. Close-out Amount. One of the more significant amendments in the 2002 Agreement is the inclusion of a single measure of damages provision, Close-out Amount, as defined in section 14. This Section will: (i) explain the definition of and illustrate differences between this definition, and the 1992 Agreement's definitions of "Market Quotation" and "Loss"; (ii) explain the mechanics and results on the application of Close-out Amount if an Event of Default or a Termination Event occurs…

Close-out Amount is a payment measure developed to offer greater flexibility to the party making the determination of the amount due upon the designation and occurrence of an early termination date and to address some of the potential weaknesses of Market Quotation that became apparent during periods of market stress in the late 1990s. The need for increased flexibility was highlighted during the market crises in 1998 and 1999 when many determining parties encountered difficulty in trying to obtain quotations from Reference Market-makers as required by the definition of Market Quotation in the 1992 agreement. In addition, even in instances where four quotations could be obtained, in an illiquid market those quotations could be widely divergent. Balanced by the interest of increased flexibility was the need to ensure that the new provision incorporated certain objectivity and transparency requirement, that were felt to be lacking, particularly in the definition of Loss in the 1992 Agreement.

The first paragraph of the definition of Close-out Amount provides that the Determining Party will determine the amount of the losses or costs incurred or the gains realised in replacing or providing the economic equivalent of the material terms of the Terminated Transaction …. This calculation includes the payments and deliveries owed under Section 2 (a)(i) in respect of that Terminated Transaction or group of Terminated Transactions that would have, but for the occurrence of the Early Termination Date, been required. The calculation of Close-out Amount also includes option rights in respect of the Terminated Transaction or group of Terminated Transactions that would have existed but for the occurrence of the Early Termination Date. The language related to preserving the economic equivalent of payments and deliveries owed under Section 2(a)(i) is similar to the "Market Quotation" definition in the 1992 Agreement, but the paragraph clarifies that it is the "material terms" of the terminated transaction or terminated transactions that are considered. The addition of the phrase "material terms" was intended to refer to direct payment flows and other items that impact pricing. The reference to option rights is also new in the 2002 Agreement as a matter of clarification.

The second paragraph of the Close-out Amount definition instructs the Determining Party to act in good faith and to use commercially reasonable procedures when determining a Close-out Amount in order to produce a commercially reasonable result. This is an overarching principle that applies to all determining party actions in its determination of a Close-out Amount."

22. Next are the new closing out provisions introduced in the 2002 Master Agreement. These are achieved through a new obligation to make payments on Early Termination in Section 6(e) and a revamped definition of "Close-out Amount" in Section 14. The basic principle in the 2002 Master Agreement is that liabilities payable on closing out are determined by ascertaining the value of a replacement transaction, notionally carried out on the same terms as the "material terms" of the Terminated Transactions, and then "netting the resultant amounts", that is, setting the amounts owed by one party against the amounts owed by the other so that the balance only is payable. The party with the negative balance is said to be "out of the money". The value of this transaction has to be ascertained by a market maker, taking account of the material terms, including options. The replacement transaction need not be one with the market maker.
23. So far as relevant, the new Section 6(e)(i) provides as follows:

"(e) Payments on Early Termination. If an Early Termination Date occurs, the amount, if any, payable in respect of that Early Termination Date (the "Early Termination Amount") will be determined pursuant to this Section 6(e) and will be subject to any Set-off.

(i) Events of Default. If the Early Termination Date results from an Event of Default, the Early Termination Amount will be an amount equal to (1) the sum of (A) the Termination Currency Equivalent of the Close-out Amount or Close-out Amounts (whether positive or negative) determined by the Non-defaulting Party for each Terminated Transaction or group of Terminated Transactions, as the case may be, and (B) the Termination Currency Equivalent of the Unpaid Amounts owing to the Non-defaulting Party less (2) the Termination Currency Equivalent of the Unpaid Amounts owing to the Defaulting Party. If the Early Termination Amount is a positive number, the Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay the absolute value of the Early Termination Amount to the Defaulting Party…."

24. Section 6(e)(v) throws light on the meaning and purpose of Section 6(e):

"(v) Pre-Estimate. The parties agree that an amount recoverable under this Section 6 (e) is a reasonable pre-estimate of loss and not a penalty. Such amount is payable for the loss of bargain and the loss of protection against future risks, and, except as otherwise provided in this Agreement, neither party will be entitled to recover any additional damages as a consequence of the termination of this Agreement or any Transaction or for any claim arising out of or in connection with this Agreement or any Termination (This clause is set out as amended from the standard form by Part 5 (e) of the Schedule.)."

25. The new definition of "Close-out Amount" inserted into Section 14 of the 2002 Master Agreement is as follows:

"Close-out Amount' means, with respect to each Terminated Transaction or each group of Terminated Transactions and a Determining Party, the amount of the losses or costs of the Determining Party that are or would be incurred under then prevailing circumstances (expressed as a positive number) or gains of the Determining Party that are or would be realised under then prevailing circumstances (expressed as a negative number) in replacing, or in providing for the Determining Party the economic equivalent of, (a) the material terms of that Terminated Transaction or group of Terminated Transactions, including the payments and deliveries by the parties under section 2(a)(i) in respect of that Terminated Transaction or group of Terminated Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date (assuming satisfaction of the conditions precedent in section 2(a)(iii)) and (b) the option rights of the parties in respect of that Terminated Transaction or group of Terminated Transactions.

Any Close-out Amount will be determined by the Determining Party (or its agent), which will act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result. The Determining Party may determine a Close-out Amount for any group of Terminated Transactions or any individual Terminated Transaction but, in the aggregate, for not less than all Terminated Transactions. Each Close-out Amount will 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.

Unpaid Amounts in respect of a Terminated Transaction or group of Terminated Transactions and legal fees and out-of-pocket expenses referred to in section 11 are to be excluded in all determinations of Close-out Amounts.

In determining a Close-out Amount, the Determining Party may consider any relevant information, including, without limitation, one or more of the following types of information:

i) quotations (either firm or indicative) for replacement transactions supplied by one or more third parties that may take into account the creditworthiness of the Determining Party at the time the quotation is provided and the terms of any relevant documentation, including credit support documentation, between the Determining Party and the third party providing the quotation;

ii) information consisting of relevant market data in the relevant market supplied by one or more third parties including, without limitation, relevant rates, prices, yields, yield curves, volatilities, spreads, correlations or other relevant market data in the relevant market; or

iii) information of the types described in clause (i) or (ii) above from internal sources (including any of the Determining Party's Affiliates) if that information is of the same type used by the Determining Party in the regular course of its business for the valuation of similar transactions.

The Determining Party will consider, taking into account the standards and procedures described in this definition, quotations pursuant to clause (i) above or relevant market data pursuant to clause (ii) above unless the Determining Party reasonably believes in good faith that such quotations or relevant market data are not readily available or would produce a result that would not satisfy those standards. When considering information described in clause (i), (ii) or (iii) above, the Determining Party may include costs of funding, to the extent costs of funding are not and would not be a component of the other information being utilised. Third parties supplying quotations pursuant to clause (i) above or market data pursuant to clause (ii) above may include, without limitation, dealers in the relevant markets, end-users of the relevant product, information vendors, brokers and other sources of market information." (Bold type and italics added)

BACKGROUND: (B) JURISPRUDENCE ON THE "VALUE CLEAN" PRINCIPLE

26. The origin of this jurisprudence is this court's judgment in Australia & New Zealand Banking Group Ltd v Société Générale [2000] CLC 833 ("ANZ"), interpreting the definitions of "Market Quotation" and "Loss" in the 1992 Master Agreement. There this court held, principally as a result of the direction that conditions precedent were to be assumed to be satisfied, that the Terminated Transaction had to be valued disregarding any option or right of substituted, or early, payment that might be exercised prior to termination at term. The decision was one as to the true interpretation of the 1992 Master Agreement.
27. In Lomas v JFB Firth Rixson [2012] EWCA Civ 419, [2012] CLC 713, this court approved a summary of the "value clean" jurisprudence, as formulated by Briggs J in Anthracite Rated Investments v Lehman Brothers Finance [2011] 2 Lloyd's Rep 538. That summary, of which proposition (ii) is particularly relevant, was as follows:

"(i) Loss and Market Quotation are, although different formulae, aimed at achieving broadly the same result, so that outcomes derived from one may be usefully tested by way of cross-check by reference to the other: see per Mance LJ in the Australia case at paras 2, 15 and 22. This derived from a concession in that case, but has subsequently been reaffirmed after adversarial argument in the Peregrine case at para 30, in the Britannia Bulk case at paras 44 to 46 and 51, and in the Pioneer case at paras 98 and 105. It is one of those sensible concessions which has hardened into hornbook law.

(ii) The identification of the non-defaulting party's loss of bargain arising from the termination of the Derivative Transaction requires a "clean" rather than "dirty" market valuation of the lost transaction. This means that the loss of bargain must be valued on an 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: see in the Australia case at paras 5, 22 to 27 and 30-31, the Britannia Bulk case at paras 11 to 14 and 34-35, and in the Pioneer case at paras 112 to 117.

(iii) The termination payment formulae under s 6(e) are not to be equated with, or interpreted rigidly in accordance with, the quantification of damages at common law for breach of contract. They are methods of calculating close-out positions on the termination of a derivative transaction or series of transactions: see the Britannia Bulk case per Flaux J at para 37. This is, in particular, because the Second Method works both ways, and may lead to a close-out payment due to the defaulting party."

28. A major issue on this appeal (considered below) is the extent to which the "value clean" principle, or the continuity assumption as the judge called it, animates the closing out provisions of the 2002 Master Agreement.

BACKGROUND: (C) SIDE LETTER

29. The Side Letter was executed for regulatory purposes. This means, I assume, that the regulators required LBIE to execute it so that its derivatives business was not treated by regulators as impacting on its financial position for the purpose of any capital adequacy requirement applying to it.
30. There is no question of this court being asked to give effect to the terms of the Side Letter since it only applies if the Client Transaction terminated before the related Inter-company Transaction. This was not the sequence of events (as to which see paragraphs 35 to 37 below). The only way in which the Side Letter is said to be relevant is that its terms were part of "the material terms" of the Inter-company Transactions so that they had to be taken into account for the purposes of the Close-out Amount.
31. A risk not covered by the Side Letter was the risk that LBIE would be in default rather than its clients. The parties did not foresee this risk when they executed the Side Letter. That does not mean, however, that it has no weight for valuation purposes.
32. The Side Letter conferred important and valuable rights. By entering into the Inter-company Transactions on the basis of the Side Letter, LBIE protected itself against three types of risk. First, in respect of market risk, i.e. the risk of adverse trading movements, LBIE protected itself by entering into the back-to-back Inter-company Transactions with LBF. Second, the Side Letter addressed valuation risk, namely the risk that, in the event of default, there was a discrepancy between the valuation of the replacement transactions under the Client Transaction and the cost to LBIE of closing-out the related Inter-company Transaction. The Side Letter provided that LBIE would be able to use, for the purposes of a closing out of the Inter-company Transaction, the same valuation as it would for the purpose of valuing the replacement contract under the Client Transaction. Third, as respects credit risk, namely the risk that the client would not be able to pay, the Side Letter provided that the liability of LBIE was limited to that which it received from the client under the related Client Transaction.
33. The Side Letter was written by LBIE to LBF in these terms:

"This letter will confirm the agreement between Lehman Brothers International (Europe) ('LBIE') and Lehman Brothers Finance SA ('LBF') concerning transactions between LBIE and LBF ('Inter-company Transactions') for which LBIE has an offsetting transaction on identical terms with a client (the 'Client Transaction') leaving LBIE with no market position risk. In the event [("a Side Letter Event")] that a Client Transaction should terminate or be closed-out and a settlement amount be calculated in respect of that termination or close-out, LBIE and LBF agree that the related, offsetting Inter-company Transaction will also terminate or be closed-out contemporaneously, and a settlement amount determined as payable by LBIE under the Client Transaction will become payable by LBF to LBIE as a settlement amount under the Inter-company Transaction, and a settlement amount payable to LBIE under the Client Transaction will become payable by LBIE to LBF as a settlement amount under the Inter-company Transaction, but only to the extent LBIE actually receives that settlement amount from its client under the Client Transaction, it being the intent of LBIE and LBF that LBIE should not accept market risk or counterparty credit risk under any Client Transaction and that all risks under Client Transactions should be passed to LBF under the Inter-company Transactions." (definition of Side Letter Event added)

34. If a Side Letter Event occurred, the Inter-company Transactions then outstanding were automatically terminated. A major issue on this appeal (considered below) is whether the Side Letter constituted a "material term" or a "condition precedent" for the purposes of the definition of "Close-out Amount" in the 2002 Master Agreement.

SEQUENCE OF EVENTS

35. LBIE carried on business dealing in over-the-counter ("OTC") equity derivatives with clients until September 2008. As explained, it entered into back-to-back transactions with LBF on the terms of the 1992 Master Agreement. There were no separate, paper confirmations for the Inter-company Transactions. Ordinarily, the specific terms of transactions under ISDA Master Agreements would have been identified in Confirmations so that, in relation to any particular transaction, the totality of its terms is to be ascertained from the combination of the Master Agreement, the Schedule and the relevant Confirmation. However, the judge found that the Inter-company Transactions automatically generated for the purpose of transferring the risks and benefits of LBIE's equity OTC derivatives business to LBF were not recorded in separate confirmations; they were recorded electronically simply in inter-company accounting entries  (judgment, paragraph 7).
36. On 29 August 2008, LBIE and LBF (along with many other financial institutions) entered into an agreement known as the Close-out Amount Multilateral Agreement. This had the effect of amending Sections 6 and 14 of the 1992 Master Agreement between them so that the 2002 version of those Sections applied.
37. In September 2008, the Inter-company Transactions terminated before the Client Transactions as a result of LBF's ultimate parent company ("LBHI") becoming insolvent. LBIE was rendered the non-defaulting party and therefore the Determining Party for the purposes of the definition of Close-out Amount. LBIE's position as the party not in default was short-lived as within a few hours LBIE itself went into default under the Client transactions. Clients holding open Client Transactions then started to exercise their rights of termination because the insolvency of LBHI also constituted an Event of Default under the Client Transactions. However, we have not been concerned with working out the consequences of that chain of events, and express no view on it.

JUDGMENT OF BRIGGS J

38. The judge dealt with a number of matters with which this appeal is not concerned. I will refer only to those matters that are relevant for the purposes of this appeal.
39. LBIE submitted to the judge that the terms of the Side Letter were part of the "material terms" of the Inter-company Transaction for the purpose of the definition of Close-out Amount. LBF's principal submission was that the market maker had to achieve a "clean valuation" (that is, a valuation in accordance with the "value clean" principle) at the end of its natural life so that the terms of the Side Letter were of no value.
40. The judge defined materiality in the context of "the material terms" to cover any term which is material to the pricing of a hypothetical replacement transaction (judgment, paragraph 49). That meaning follows the User's Guide and neither party has challenged that meaning on this appeal.
41. The judge's approach was to treat the "value clean" principle as governing the terms of the 2002 Master Agreement (judgment, paragraph 63). The wording in the earlier definitions of "Market Quotation" and "Loss" (to support the principle) had been repeated in the 2002 Master Agreement. (The parties accept on this appeal that the judge was wrong in so far as he suggested that the language was identical). However, in the view of the judge, changes from the 1992 Master Agreement did not cut down "the importance of the continuity assumption, as the bedrock of clean valuation, into a mere shadow of its former self" (judgment, paragraph 66).
42. The judge accepted that the 2002 Master Agreement permitted the Determining Party to take account of its own creditworthiness. However, he considered that, as third parties were previously required only to take into account existing Credit Support Documents with respect to the obligations of the Determining Party, the 2002 Master Agreement merely built out from a "slightly narrower platform" (judgment, paragraph 59).
43. On this basis:

i) The "option rights" had to be treated as excluding early termination rights.

ii) The new reference in the 2002 Master Agreement to the creditworthiness of the Determining Party in the process of valuation was not an indication that the "value clean" principle had been qualified.

iii) The terms of the Side Letter were not "material terms" for the purposes of the definition of "Close-out Amount".

iv) Failure to take account of the Side Letter as a material term would not lead to uncompensated loss since the parties could have made some special provision.

v) The Side Letter had to be excluded from the process of valuation. Alternatively, if included, it had no value.

SUBMISSIONS AND ANALYSIS

This appeal is about the valuation of a replacement contract

44. This appeal is about the use of the Side Letter for valuation purposes, that is, for determining the gains or losses at the date of the closing out in providing the economic equivalent of the material terms of the Inter-company Transactions under Section 14 of the 2002 Master Agreement. The Side Letter Event has not occurred: at the time of the termination of the Terminated Transaction it was simply a contingency. The fact that it has not occurred does not, as LBF seemed at one point to suggest, constitute a short answer to this appeal since the question is whether the possibility that the contingency might occur during the remainder of the life of the Inter-company Transaction being valued should be taken into account for valuation purposes.

Multiple payment date valuation

45. To clear one point out of the way, there is no reason in principle why a market maker cannot value a transaction by reference to both the last date for performance of the payment obligation and any intermediate date on which it may terminate. In finding the present value of the sums to be paid (either way) on termination, the market maker will have to consider what value to place on the possibility that the transaction may end earlier than the date scheduled for performance as well as to the scheduled date. The exercise to be done is similar in principle to the exercise of valuing a redeemable or convertible bond that is redeemable or convertible, at the option of, say, the issuer, on dates prior to the final redemption or conversion date. Moreover, it is the exercise that the 2002 Master Agreement contemplates will be done in relation to option rights if the restriction placed on those rights by the judge does not apply.
46. The point is, however, of significance because the judge may have thought (and, if so, he misunderstood) that the conditions precedent as to payment and delivery could not be assumed to be satisfied unless there was only one event in which the replacement contract could terminate, namely by reaching the scheduled date for settlement. Thus, for example, at paragraph 70 of his judgment, when he states his conclusion, the judge holds that the Side Letter must be left out of account "precisely because the effect of the Side Letter is (where it applies) to bring about an early termination of the Inter-company Transactions, contrary to the continuity assumption underlying the 2002 determination of Close-out Amounts". That is not the effect of the Side Letter in the valuation context: it does not bring about Early Termination, rather its role is as a contingency that must be valued. The assumption about condition precedent is simply that they will be satisfied if the scheduled or any settlement date arrives. The assumption does not make it impossible, as the judge appears to have thought, to treat the Side Letter Event as a further contingency.
47. Mr Railton's submissions indicated that he may have been under the same misunderstanding. He spoke of the terms of the Side Letter "unravelling" the "value clean" principle. In the course of his submissions, he asked:

"… why include the assumption at all if you're also including any other term which might falsify it, and that would be any provision which terminates the agreement, whether automatically or on notice, or any provision that suspends payment, and, as the judge effectively said at paragraph 66 of his judgment, to construe it was including such terms would drive effectively a coach and horses through the continuity assumption…"(transcript of hearing page 141)

48. The point I am making is that to take account of say an option to terminate early does not of itself "unravel" or "falsify" the "value clean" principle. That principle can be applied to each event in which the transaction may terminate.
49. The effective date for the valuation is in my judgment the Early Termination Date: see the words "under the then prevailing circumstances" in the first paragraph of the definition of the "Close-out Amount".

Submissions

50. We have had most helpful submissions from Mr Iain Milligan QC, for LBIE, and Mr David Railton QC, for LBF. I propose to deal with their submissions as I develop my reasons for allowing this appeal.

(1) The 2002 Master Agreement should be interpreted (a) according to its own terms and (b) taking into account all the relevant background

51. The point I principally address here is the test that the judge applied for ascertaining whether the Side Letter could be taken into account in ascertaining the economic equivalent of the material terms of the Terminated Transaction. He held that that possibility would involve a radical departure from the "value clean" principle and that this could only be entertained if the 2002 Agreement "could be construed as having substantially abandoned the continuity principle" or if the Terminated Transaction had some special feature (which was not suggested) (paragraph 61 of his judgment).
52. The 2002 Master Agreement must of course be interpreted in the light of the relevant background. That includes the 1992 Master Agreement, the prior case law on the 1992 Master Agreement (not limited to the jurisprudence on the "value clean" principle) and the User's Guide.
53. In my judgment, the judge's test does not ask the right question. The court should not require substantial grounds to be shown for concluding that the "value clean" principle has a different effect in the 2002 Master Agreement from that which it had in a different context in the 1992 Master Agreement. At the end of the day, the 2002 Master Agreement must be interpreted according to the words it uses. The question is what is the meaning of the 2002 Master Agreement in the light of the relevant background?
54. It is important not to underestimate the scale of the changes between the 1992 Master Agreement and the 2002 Master Agreement. I emboldened three of the relevant changes in the definition of Close-out Amount when I set it out in paragraph 25 above. The User's Guide calls them significant changes. I will call them "the Disclosed Changes". They are as follows:

i) The relevant content of the replacement contract whose economic equivalent is to be ascertained has been expanded from payment obligations to all the "material terms" of the transaction. Payment and delivery obligations have become simply part of the material terms;

ii) Option rights are now included, and the User's Guide states that the reason for that is "clarification"; and

iii) The direction that the quotation for the replacement transaction could have regard to the Determining Party's own creditworthiness is new;

55. An important question is: why were the Disclosed Changes made? For that it is necessary to look closely at the passage from the User's Guide set out in paragraph 21 above. I do this under my next reason.
56. It follows from what I have said under this reason that I do not accept Mr Railton's submission that the effect of Lomas is that it establishes the "value clean" principle for the purposes of the 2002 Master Agreement as well as the 1992 Master Agreement. Lomas is not an authority on the interpretation of the 2002 Agreement. That Agreement must be interpreted in the manner that I have just explained. As Mr Milligan explained, there are no cases which interpret the 2002 Master Agreement other than BNP Paribas v Wockhardt EU Operations (Swiss) AG [2009] EWHC 3116, which is not relevant.

(2) The reasons for the changes shown in the 2002 Master Agreement given in the User's Guide suggest that those changes were regarded as more important than the preservation of the "value clean" principle in the form in which it existed in the 1992 Master Agreement

57. The User's Guide shows that there were at least the following reasons for the changes:

i) Single measure of damages: ISDA members wanted a single measure of damages and a single measure of payment. The change to a single measure of damages was regarded as one of the more significant changes.

ii) The rules of the bank regulators restricted the recognition for capital purposes of provisions as to netting.

iii) The reference to "material terms" was new and it was intended to refer to direct payment flows and to other items that impact pricing.

iv) The reference to "option rights" was added not because it was thought necessary but for clarification.

v) The ways in which the Determining Party could determine the amount due on Early Termination were made flexible, objective and transparent.

vi) An obligation to act in good faith was included.

vii) The principle that the Determining Party should use commercially reasonable procedures when determining a Close-out Amount was to be an "overarching principle".

58. Overall the purpose of the changes on closing out appears to have been to reduce avoidable risks to participants involved in carrying out that operation.
59. Certain matters are conspicuous by their absence from the User's Guide:

Any statement that the "value clean" principle either is, or is not, to be retained or modified.

Any suggestion that terms which met the test of materiality in the User's Guide were to be excluded in order to preserve the rigour of the "value clean" principle.

Any restriction on the option rights that could be taken into account.

60. The conclusion that I draw from the explanation in the User's Guide is that the retention of the "value clean" principle was not regarded as important as making the Disclosed Changes. I deduce from that that the dominating feature is to be the Disclosed Changes, not the "value clean" principle as it had previously existed in the 1992 Master Agreement.

(3) The "value clean" principle appears in the 2002 Master Agreement in a different context from that in which it appeared in the 1992 Master Agreement

61. In ANZ this court held in summary that the "value clean" principle applied to the 1992 Agreement because of the words in the 1992 Master Agreement italicised below in the definition of "Market Quotation":

"…the economic equivalent of any payment or delivery (whether the underlying obligation was absolute or contingent and assuming the satisfaction of each applicable condition precedent) by the parties under Section 2(a)(i) in respect of such Terminated Transaction or group of Terminated Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date."

62. It follows from reason (1) above that the task of the court is to decide what the words "assuming the satisfaction of the conditions precedent in section 2(a)(iii)" mean in the context of the 2002 Master Agreement.
63. Wording similar, though not identical, to the words "assuming the satisfaction of each applicable condition precedent" is used in the 2002 Master Agreement but the context is very different:

"…the economic equivalent of, (a) the material terms of that Terminated Transaction or group of Terminated Transactions, including the payments and deliveries by the parties under section 2(a)(i) in respect of that Terminated Transaction or group of Terminated Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date (assuming satisfaction of the conditions precedent in section 2(a)(iii)) and (b) the option rights of the parties in respect of that Terminated Transaction or group of Terminated Transactions."

64. To assess the impact of the change of context in relation to the assumption about conditions precedent it is necessary to analyse the meaning to be given to a number of expressions used in the definition of Close-out Amount: "the material terms", "including", "condition precedent", "that would, but for the occurrence of the Early Termination Date, have been required after that date" and "the option rights". I will take each expression in turn after making two general points about ordinary meanings and the interpretation of commercial contracts.

(4) Where more than one meaning is possible the court should prefer that which is more consistent with business common sense and the judge's application of the "value clean" principle resulted in the 2002 Master Agreement conflicts with business common sense

65. The 2002 Master Agreement is a commercial agreement: accordingly, if there is any doubt as to which of two or more possible meanings is correct, the meaning which is more consonant with business common sense should be preferred: see per Lord Clarke in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900:

"[21] The language used by the parties will often have more than one potential meaning. I would accept the submission made on behalf of the Appellants that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other."

66. This point arises because the judge accepted in the abstract "the persuasive commercial force" of the argument that contracts that provide for automatic early termination such as the Side Letter should be taken into account as a material term. He noted that Mr Milligan submitted to him as follows:

"He provided me with two colourful examples of early termination provisions which no valuer in the real commercial world could possibly ignore. The first was a ten year interest rate swap with early termination if rates exceeded a stated cap or fell below a stated floor. The second was an oil-based derivative with provision for termination if war broke out between the USA and Iran. To ignore such provisions would make a travesty of the notion that the purpose of the provisions for Close-out Amount determination was to leave the parties no better and no worse off than if the early termination of the transaction had not occurred."

67. The result of Mr Milligan's "colourful examples" is in contrast to section 6(b)(iv) of the 2002 Master Agreement which provides that that the amount recoverable was a reasonable pre-estimate of loss and not a penalty (see above, paragraph 24) and the overarching principle set out in the User's Guide (see above, paragraph 21).
68. The effect of the judge's decision is that a party may be overcompensated on the ascertainment of the Close-out Amount because the possibility of automatic termination has been left out of account. The fact that this produces a wholly uncommercial result is a factor that militates against it being the right interpretation.
69. Furthermore, if, contrary to another conclusion of the judge, the 2002 Master Agreement now permits option rights generally to be taken into account, the conclusion of the judge is even more anomalous because it would mean that rights of early termination were to be taken into account but not early termination that was to occur automatically. There is no logic in this distinction.
70. It is clear that the "value clean" principle in the 1992 Master Agreement can produce unreasonable results: see the second proposition from the judge's decision in Anthracite, which was approved by this court in Lomas. A good example of that would be ANZ where this court held (obiter) that the option rights of one of the parties had to be ignored in order to give effect to the "value clean" principle. It would self-evidently be consistent with the reasons for the changes in the closing out provisions in the 2002 Master Agreement to seek to minimise results that were contrary to business common sense.

(5) Words should generally be given their natural meaning

71. In my judgment, it is well established that, until the contrary is shown, the court should proceed on the basis that ordinary English words are used in their ordinary meaning. I will call this the "ordinary meaning" principle. If the term is a technical one, then this precept does not of course apply.
72. This point applies, for example, to the term "condition precedent." The usual meaning of this term is a contractual stipulation that requires to be satisfied before the obligation of the other party, for example to make a payment or delivery, can arise (as to conditions precedent, see generally Halsbury's Laws of England, volume 22, paragraph 531). The usual meaning should be adopted, interpreting the Master Agreement unless it is clear that this is not intended. If that is so, then of course that extended meaning should be adopted.
73. This point is significant because in ANZ this court there gave "condition precedent" an extended meaning. In that case there were rights of early termination, including rights to terminate on the happening of a Trade Event or Event of Change. In order to find a meaning for the reference in clause 2(a)(iii) to "each other applicable condition precedent specified in this Agreement", the court held that the absence of the exercise of a right of early termination had to be assumed:

"27. It is true that the contract does not expressly make the absence of a determination of a Trade Event at the settlement date a condition precedent to payment as agreed in clauses 5 and 6 of the confirmations. But it is also true that it is difficult to tie the reference in ISDA s.2(a)(iii) to "each other applicable condition precedent specified in this Agreement" into other particular terms. One place where additional conditions precedent may be found is among the specially agreed provisions of the confirmations. The concepts of Trade Event, Cost Event, Russian Market Event, Event of Change and Occurrence of an Event of Change are none of them ISDA concepts, they are tailor-made for these transactions and it is accordingly understandable if their language does not in all respects echo or tie exactly into that of the standard ISDA terms. The effect of occurrence of an Event of Change is, in specified circumstances, to transmute SG's primary obligation under clauses 5 and 6 to make payment on the settlement date in dollars in London into an obligation to make payment by one of the four specified methods. It is not difficult, therefore, to treat the non-occurrence of an Event of Change as a condition precedent to SG's obligation to make any payment on settlement under s.2(a)(i). On that basis the language of the Market Quotation clause is precisely satisfied."

74. The absence of the exercise of a right of early termination is not, however, a condition precedent in the usual sense because there is no contractual stipulation to this effect. If, in the present case, the court is satisfied that there is a conflicting message, namely an express indication that the possibility of the exercise of that right was to be taken into account, then the conventional meaning of "condition precedent" could not be treated as extended by implication. I return to this point when I discuss the meaning of "material terms".
75. Likewise, it follows from the ordinary meaning principle that restrictions should not be read into terms that are expressed in an unqualified way unless it is clear that they have to be read in that restricted way. This too is relevant to the meaning of "material terms" and also to "option rights" as the judge held that they had to be given restricted meanings: in each case he held that they would exclude Early Termination rights.
76. Accordingly I next turn to the meaning of "material terms" in the definition of Close-out Amount in the 2002 Master Agreement.

(6) "Material terms" are those that impact on pricing and (but for the judge's ruling on the "value clean" principle) they would in the present case include the terms of the Side Letter

77. There is no issue about the meaning of materiality in this context. As I have explained (paragraph 40 above), the judge's ruling on the meaning of materiality in the context of terms was that "material terms" are those which affect direct payment flows or impact on pricing. This ruling, which is admirably sensible, is not challenged. The User's Guide supports it and accordingly I would adopt the same meaning.
78. There is, however, a dispute about whether the terms of the Side Letter meet this definition in the context of the definition of the Close-out Amount.
79. Mr Milligan submits that the replacement transaction must include terms of the original Inter-company Transaction as to payment on termination. In the present case, it is common ground that those terms included the Side Letter.
80. Mr Milligan submits that the true interpretation of the definition of Close-out Amount is that terms as to duration are material terms in the sense that they have an impact on pricing for the following reasons. Material terms are clearly not limited to those about payments and deliveries: loss of the bargain means loss of all the material terms, not just terms requiring payment or delivery. Loss of protection against future rate risks will critically depend on duration. Loss of rights with respect to the Side Letter are part of what is lost. So the Side Letter is one of the material terms which defines the duration of the Inter-company Transaction that is to be replaced.
81. Mr Railton did not really dispute these points. His case was that a term could not be a "material term" if it caused the "value clean" principle to be "unravelled".
82. I too, therefore, would accept that the terms of the Side Letter would, but for the judge's ruling on the effect of the "value clean" principle, constitute "material terms" for the purpose of the definition of Close-out Amount. The use of the words "including the payments and deliveries by the parties" makes it clear that the category of "material terms" was meant to be larger than the category of "payments and deliveries".
83. Mr Railton submits that the silence of the User's Guide on the application of the "value clean" principle is a point in support of his case. He submits that it would be "quite extraordinary if there had been an intention to make what would effectively be a seismic shift as regards the value clean principle, someone on the various committees hadn't spotted it and no one had thought it right [to flag it up] in the guide" (transcript of the hearing, pages 118-9). The difficulty with this submission is that there is no evidence that members would have thought it a seismic shift, given the changes to the 1992 Master Agreement that were being made.
84. Before I deal with the effect of the assumption in relation to conditions precedent, I turn to deal with two of the other changes.

(7) The judge's restriction on the meaning of "option rights" is not justified by the words used to describe option rights in the definition of Close-out Amount or by the User's Guide

85. Mr Milligan submits that option rights are specifically included to clarify all the material terms (see the User's Guide). In any event, it is commercially absurd to ignore the right of early termination. Mr Milligan submits that options are very common in derivative transactions, save in "plain vanilla" transactions (ie transactions without any special features). Valuation may be difficult but banks usually have software to achieve it. Simply because valuation is difficult, the court should not be deflected from including options. The judge's restriction of option rights to options which did not amount to a right of early termination, such as an option to take physical delivery rather than cash, effectively deprived the reference to option rights of any relevant meaning. Physical delivery makes no difference to valuation. The further example given by Mr Railton of an option right within the judge's meaning was said to be the failure to provide collateral. However, the failure to provide collateral would be a failure to comply with the Master Agreement and a failure to deliver within Section 5(a) (see paragraph 15 above), and so within the "value clean" principle anyway without any special reference to option rights since performance of any obligation as to collateral would have to be assumed.
86. Mr Railton does not accept that this particular example is wrong as he submits that there are others, such as an option to exercise voting rights in the case of an equity derivative, or rights to nominate a particular calculation agent.
87. On the meaning of "option rights", I prefer Mr Milligan's submission. The words "option rights" are not qualified in any way either in the User's Guide or the definition of Close-out Amount and therefore any qualification on them would have to be clearly stated. No doubt, given the high status of ISDA Master Agreements in the financial world, these words were drafted after considerable thought and with the benefit of knowledge of the market.
88. Furthermore, the restriction on the meaning of "option rights" seems to me to run counter to the explanation given in the User's Guide. This states quite clearly that it was intended to make significant changes to the 1992 Master Agreement. The closing out provisions had attracted the interest of regulators and it seems to me a reasonable inference that to meet capital adequacy requirements the process of closing out had to work in a reasonable way (thus, for example, avoiding the walk away clauses referred to in the User's Guide). It was also intended to provide much more flexibility as to how the valuation was carried out. It seems to me a reasonable inference that in those circumstances there would be a desire to remove artificiality in the process. That would be a reason for making the object of valuation one that was near to the Terminated Transaction. That would explain the introduction of option rights. Mr Railton produced some examples of rights that might be within the judge's limited meaning of "option rights" but they were very minor ones. If Mr Railton is right, the change in the 2002 Master Agreement with respect to option rights was more like rearranging the deckchairs on the Titanic than a structural change to the closing out procedure which would meet the member comments described in the User's Guide and the intention to make significant changes.
89. I do not consider that, as Mr Railton submits, there was any lack of clarity about the explanation for introducing an express reference to option rights. The judge made the same point. I disagree. The User's Guide states that the reference to option rights was "for clarification". The reference was only needed to clarify the position because they would have been material terms in any event. In other words, the express inclusion of option rights in the light of this explanation is a pointer towards a wider meaning of "material terms" than simply conditions precedent as to payment and delivery.
90. The meaning that the judge gave to "option rights" did not in fact, contrary to statement in the User's Guide, clarify it since it left a major limitation unsaid.
91. The fact that a specific reference to option rights was included in the definition of Close-out Amount is an indication that the expression was intended to have some real content and meaning.

(8) The inclusion in the Close-out Amount of permission to the Determining Party to take account of its own creditworthiness involves a clear departure from the "value clean" principle

92. Mr Milligan submits that the definition of Close-out Amount now specifically enables account to be taken of the credit risk of the Determining Party so that, when the market maker is looking at what he may expect to receive, the price which he quotes will be affected by his perception of the credit risk and that assumption is inconsistent with any assumption that the transaction will be performed. If that assumption were to be made, the value of the credit risk would always be nil.
93. Mr Milligan submits that this reverses the decision of Moore-Bick J (as he then was) in Peregrine Fixed Income Ltd v Robinson Department Store Public Co Ltd [2000] CLC 1328. Moore-Bick J held that it was a commercially unreasonable result for the quotation produced by the market maker to take into account the lack of creditworthiness of the Determining Party because the nominal amount of the payment obligations was reduced to take account of its lack of creditworthiness. Mr Milligan submits that the change was made in the 2002 Master Agreement to authorise the Determining Party to obtain a quotation that takes account of its own lack of creditworthiness so that the parties can no longer say that to do so is an unreasonable commercial result.
94. Mr Railton's response was that there had been a similar but more limited permission in the 1992 Master Agreement to take account of credit support documents. He relies on the judge's reasoning. Moreover, Mr Railton relies on the further holding of Moore-Bick J in paragraph 21 that the "value clean" principle assumed the satisfaction of conditions precedent but not the ability to perform when the time comes. For my own part I have difficulty in accepting this point, especially in the light of the extended meaning given to condition precedent in ANZ.
95. In any event, however, the point made by Mr Railton, and with respect the same point made by the judge does not address the point that certainly under the 2002 Master Agreement the "value clean" principle is infringed by the permission to take account of the creditworthiness of the Determining Party. That conclusion supports the argument that "material terms" and "option rights" should not be interpreted as the judge interpreted them, on the basis that it is necessary to maintain the integrity of the "value clean" principle.

(9) The words "assuming satisfaction of the conditions precedent in Section 2(a)(iii) cannot be taken to deprive the reference to "material terms" and "option rights" of the full weight that they would otherwise have

96. Section 2(a)(iii) sets out three categories of conditions precedent: see paragraph 12 above. These are very important. If Section 2(a)(iii) does not apply in the context of the Side Letter, the "value clean" principle does not apply to exclude the market maker from taking account of the Side Letter.
97. The first category requires that there shall have been no Event of Default or Potential Event of Default. Mr Milligan submits that the Side Letter Event was not an Event of Default as defined in Section 5. I agree with that point. In particular, as there was no Event of Default, the provision for automatic termination in Section 6(a) does not apply.
98. The second category is "the condition precedent that no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated". This category did not apply as the required notice was not given.
99. The third category is "each other applicable condition precedent specified in this Agreement". Mr Milligan submits that that the Side Letter did not create a condition precedent, but a term as to duration. He submits that the judge confused duration and termination. The difficulty here is that, as I have explained in paragraphs 72 and 73 above, while the expression "condition precedent" would normally connote a contractual stipulation that requires to be satisfied before the obligation of the other party, for example to make a payment or delivery, can arise, this expression was interpreted well beyond its normal meaning in ANZ.
100. Mr Railton's basic approach is that the status quo has not been changed. He rejects the argument that the judge wrongly confused duration and termination. He submits that to say a term goes to duration is another way of saying that it goes to termination. On Mr Railton's submission, the purpose of the definition of termination provisions in the definition of Close-out Amount is to assess the loss or gain as to the Terminated Transaction. That object is achieved through market quotation or otherwise, applying the assumptions. If the "value clean" principle applies, the result of the Side Letter can be analysed, as the judge analysed it, as non-material or it can be said that it is displaced by the "value clean" principle.
101. However, to accept Mr Railton's submissions, would, as I see it, largely deprive the expressions "material terms" and "option rights" of any meaning. I do not consider that it is a sufficient answer to Mr Milligan's submissions, as the judge did in paragraph 70 of his judgment, to say that the Side Letter functionally produces the same result as Early Termination as defined in the 2002 Master Agreement.
102. There is no doubt that there has to be some qualification to the wide wording of Section 2(a)(iii) to take account of the fact that creditworthiness of the Determining Party can be taken into account in producing the quotation of the value of the replacement transaction. That illustrates that the assumption the market maker has to make as to the satisfaction of conditions precedent is subject to contrary indication in the Master Agreement.
103. While it is true that the User's Guide does not explain that any change was being made to the "value clean" principle, it does quite clearly explain that material terms and option rights, in each case without any stated restriction, are being brought into the definition of Close-out Amount. In so doing it is to my mind clear that the 2002 Master Agreement reversed the conclusion in ANZ that option rights without restriction were excluded from the valuation process. These were important changes. They have to be accommodated in the interpretation of the new definition of Close-out Amount. In order to give effect to the desired changes, it is to my mind the "value clean" principle, not the language of option rights and material terms, that must give way.
104. It is thus no answer to say that the language of Section 2(a)(iii) has not changed. It is the language of Section 14 that has significantly changed and that change affects the way that Section 2(a)(iii) can operate in the context of Section 14. The language of Section 2(a)(iii) admits the possibility that not all conditions precedent apply. It is only those which are "applicable" which are within Section 2(a)(iii). This is a further indication that, in the event of any conflict between Section 2(a)(iii) and Section 14, it is the provisions of Section 14 that prevail.
105. My approach is supported by the fact that the contrary result is uncommercial and fails to reflect the parties' agreement to the terms of the Terminated Transaction. These include the terms of the Side Letter.
106. My conclusion also receives a measure of support from a further amendment made to the 2002 Master Agreement which the parties did not adopt, namely the substitution for Section 2(a)(iii) of the words "each other condition specified in this Agreement to be a condition precedent for the purposes of this Section 2(a)(iii)." On the face of it, this is a point against Mr Milligan's case. If this change of wording had been adopted, it would have been clear that LBF would have to point to some statement in the 2002 Master Agreement that one of the conditions to be treated as a condition precedent for the purposes of Section 2(a)(iii) was the non-occurrence of the Side Letter Event.
107. However, the availability of the new Section 2(a)(iii) and the explanatory text in the User's Guide form part of the matrix of fact against which the 2002 Master Agreement is to be construed. The explanation for the new Section 2(a)(iii) is on page 6 of the User's Guide. It states:

"Section 2(a)(iii) of the 2002 Agreement has been modified from the 1992 Agreement to provide that if the parties wish additional conditions to serve as conditions precedent for the purposes of Section 2(a)(iii), they must clearly specify them as such in the 2002 Agreement." (Italics added)

108. Mr Railton submits that under the new Section 2(a)(iii) a "condition precedent" would extend to any matter which is designed to suspend the whole of the obligation until the condition is satisfied and any matter which effectively prevents the obligations from continuing. That seems to me to deprive the words "specified in this Agreement to be a condition precedent for the purposes of Section 2(a)(iii)" of their ordinary meaning and therefore I reject that submission.
109. The fact that the parties could have avoided the problem on this appeal by adopting that wording does not mean that they did not do so by the wording that they actually used. The question remains: what is the true construction of the 2002 Master Agreement in the form adopted by the parties in this case?
110. In my judgment, the new Section 2(a)(iii) serves this purpose: it reinforces the conclusion that the court would be wrong to infer from the factual matrix that the wording of the standard form 2002 Master Agreement was intended to preserve the "value clean" principle in the form that it stood under the 1992 Master Agreement. If that is so, there is little reason to hold that the parties' 2002 Master Agreement had that effect.
111. Furthermore, the task of valuation of the replacement contract on the basis that the Side Letter is taken into account is well capable of being undertaken. Events that have not occurred by the Early Termination Date are then future events. These events include the scheduled payment and delivery dates. There is no reason why, when an assumption is made that conditions precedent will be satisfied, it cannot be an assumption about the scheduled date for payment and delivery if and when that occurs.
112. I accept that there may be uncertainties and difficulties in the carrying out of the task of valuation on this basis. However, I would not assume that such an event is incapable of valuation: I would expect it to be heavily discounted to reflect the uncertainty. Moreover, under the definition of Close-out Amount in the 2002 Master Agreement account has to be taken of the Determining Party's creditworthiness, which may in any event require account to be taken of a number of uncertainties.

SUBSIDIARY ARGUMENTS

113. There are a number of subsidiary arguments with which I can deal shortly. LBIE submits that, if funding costs and hedging costs may be included under the final paragraph of the definition of Close-out Amount, the value of the Side Letter should not be excluded. LBF submits that the contrary is the case. I do not consider that this point adds to, or detracts from, the submissions that I have accepted.
114. Section 14 limits the payments and deliveries to be included in the material terms to those "under Section 2(a)(i) in respect of the Terminated Transaction or group of Terminated Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date (assuming satisfaction of the conditions precedent in section 2(a)(iii))". Those words of qualification are clearly required because otherwise there would be no obligation to make payments and deliveries. Nothing turns on this qualification. It is, however, of some note (1) that the assumption is put into parenthesis, consistently with a subordinate status, and (2) that the assumption does not say that it is to be assumed that the transaction will in fact run to term.
115. The parties referred the court to Firth on Derivatives Law and Practice. The solicitor to LBIE is the author of this work. I have no reason to doubt that it is a work of scholarship but in all the circumstances I do not propose to place weight on it as I have been able to reach my conclusion without it.
116. Mr Railton raised the further spectre of complexity arising out of the fact that some Client Transactions may have terminated after LBIE was itself in default. If there are such complexities, they do not affect the question of construction. The cataclysmic concatenation of events that occurred in this case could hardly have been foreseen when the 2002 Master Agreement was drafted.

CONCLUSION

117. For the reasons given above I would allow this appeal.

Lord Justice Aikens:

118. I have reached the same conclusion as Arden LJ. However, as we are disagreeing with the judge's careful judgment and as this decision is financially very important to the parties and their creditors, I am going to express my own reasons. Arden LJ has summarised the facts, set out the essential contractual terms, referred to the relevant parts of Briggs J's judgment and has summarised the parties' arguments before us. I will only refer to them as needed so as to follow my reasons.
119. The issue between LBIE's administrators and LBF is how to calculate what sum is due as between LBIE and LBF as a result of the early determination of many intercompany transactions between them, all of which were back to back with LBIE-client transactions. The intercompany transactions were terminated earlier than their term as a result of the collapse of the Lehman Group on 15 September 2008. The first company in the group to fold was LBHI, when Chapter 11 proceedings were started in New York in respect of that company at 06.45 hours BST on 15 September. Then, at 07.56 hours BST an administration order was made in respect of LBIE. Lastly, insolvency proceedings were instituted in respect of LBF in Switzerland on 29 October 2008. It is common ground that the effect of the instigation of Chapter 11 proceedings in respect of LBHI constituted an "Event of Default" by LBF within meaning of the contractual terms governing the intercompany transactions between LBIE and LBF.
120. There are two key contractual documents. First, the Amendment Agreement of 27 November 2007 between LBIE and LBF and, secondly, the CMA of 29 August 2008, which bound many Lehman entities and other, unconnected, banking entities worldwide. The effect of the Amendment Agreement was, broadly, that if there was an "Event of Default" with respect to LBF (but not with respect to LBIE), then there would be Automatic Early Determination of all outstanding intercompany transactions between LBF and LBIE immediately upon the occurrence of that "Event of Default".
121. The CMA of 29 August 2008 concerned the intercompany transactions between LBIE and LBF. Its effect was, for present purposes, to replace certain terms of the 1992 ISDA Master Agreements with those of the 2002 edition of the ISDA Master Agreement. Both the old and the new terms concern the calculation of the close-out and settlement amounts that would be due between the companies in the case of an early determination of any of these intercompany transactions. The key provisions of the amended (ie 2002) ISDA Master Agreement terms are clauses 6(e) and the definition of "Close-Out Amount" in clause 14. In very broad terms (and when these replacement ISDA Master Agreement terms are read in conjunction with the Amendment Agreement) the amended clauses provide that where there has been an Event of Default in respect of LBF, then there will be an Automatic Early Determination of all intercompany transactions between LBF and LBIE, which transactions thereby became "Terminated Transactions". This early determination then triggers the calculation and payment of an "Early Determination Amount" as between the two parties, pursuant to clause 6(e)(i) of the Amended ISDA Master Agreement.
122. Under clause 6(e)(i) the calculation of this Early Determination Amount has to be determined by the Non-Defaulting Party. By the same clause, to produce the figure for the Early Determination Amount, the Non-Defaulting party has to make a calculation of a total sum which has three different components. The resulting total figure might be either positive or negative and so could lead to either a payment to the Non-Defaulting Party, if the figure is positive, or a payment by it to the Defaulting Party if the figure is negative. The present dispute concerns the first of these three components for the calculation of the total sum payable between the parties. That element is referred to in clause 6(e)(i) as "…the Termination Currency Equivalent of the Close-out Amount or Close-out amounts (whether positive or negative)…for each Terminated Transaction or Terminated transactions…".
123. The central issue between the parties is focused on the proper construction of the definition of the phrase "the Close-out Amount". This definition is contained in clause 14 of the ISDA Master Agreement (as amended) between LBIE and LBF. The definition goes on for two pages. The critical element of the definition for our purposes is in the first paragraph, which itself consists of a single sentence running over 11 lines and containing 158 words. In the very broadest terms, this paragraph provides that the "Close-out Amount" will be either (1) the loss or cost to the Determining (ie. Non-Defaulting) Party or (2) the gains to the Determining Party in replacing or providing for the Determining Party two elements. First, "the economic equivalent of" what are called "the material terms" of the Terminated Transactions; and, secondly, "the economic equivalent" of "the option rights of the parties" in respect of those Terminated Transactions.
124. The scope of the principal dispute over the construction of the definition of "Close-out Amount" can be narrowed down even further. It concerns the first of these two elements of "economic equivalent" that has to be determined to arrive at the "Close-out Amount". To understand the point more easily I will set out again the critical phrase, emphasising the particular words which have given rise to the arguments before Briggs J and on appeal. They are:

"…the economic equivalent of (a) the material terms of that…group of Terminated Transactions, including the payments or deliveries by the parties under Section 2(a)(i) in respect of that ….group of Terminated Transactions that would, but for the occurrence of the relevant Early Determination Date, have been required after that date (assuming satisfaction of the conditions precedent in Section 2(a)(iii)…".

125. The dispute concerns the application of the emphasised words in the definition of "Close-out Amount" in the light of the fact that LBIE and LBF had also agreed the terms of the Side Letter of 24 July 2006, which Arden LJ has set out at [33] above. The Side Letter's terms are clear and not in dispute. Their effect was correctly summarised by the judge at [9]-[12] of his judgment, which I need not repeat. The vital point to note is that the Side Letter stipulates that when a LBIE-client transaction is terminated or closed out for whatever reason, then the related, offsetting intercompany transaction is to be terminated or closed out at the same time. As everyone agrees, the Side Letter did not apply directly in the event of a determination of the Intercompany transactions before the determination of the LBIE/client transactions.
126. The question in this case is whether the terms of the Side Letter have to be taken into account indirectly when there is an early determination of the intercompany transactions before any early determination of the LBIE/client transactions. The argument between the parties is, effectively, whether, in making the calculation to arrive at "the economic equivalent" of "the material terms" of the intercompany Terminated Transactions for the purpose of calculating the Close-out Amount due as between LBIE and LBF upon the Early Determination of the intercompany transactions, the Determining Party (in this case LBIE as the Non-Defaulting Party) has to take account of or give value to the parties' rights under the Side Letter.
127. The judge held that the Determining Party should not do so, because of the effect of the wording in brackets set out at [125] above, ie the words "….assuming satisfaction of the conditions precedent in Section 2(a)(iii) and (b). Briggs J said, in summary, that several decisions concerning very similar wording in the ISDA 1992 Master Agreement terms, culminating in the decision in this court of Lomas & Ors v JFB Firth Rixson [2012] EWCA Civ 419, have held that the words in brackets mean that when you are calculating the "economic equivalent" of the Terminated Transaction, you have to assume that, but for the termination, the Terminated Transaction would have proceeded to a conclusion and that all conditions precedent to its full performance by both sides would have been satisfied, however improbable that presumption might be in the real world: see [41(ii)] of the judgment. This assumption has been called the "value clean" assumption or the "continuity assumption" in the cases. It was common ground before the judge that there are no relevant cases on the present wording of the 2002 terms. But Briggs J held that, applying that assumption to the wording of the definition of "Close-out Amount", then, as a matter of construction of clause 14 of the ISDA Master Agreement terms, you must leave out of account the economic effect of the terms of the Side Letter when calculating "the economic equivalent" of the Terminated Transactions, ie. the intercompany transactions, for the purposes of arriving at the figure for the "Close-out Amount".
128. The judge said that there were two reasons for this conclusion. First, because the Side Letter provides that intercompany transactions will automatically be determined early in the event that there has been a default by a client under the LBIE-client transactions and so an early determination of the LBIE-client transactions. Thus the Side Letter is dealing with circumstances in which the intercompany transactions will neither proceed to their term nor on the assumption that all conditions precedent have been fulfilled. Therefore, to take account of the economic equivalent of the terms of the Side Letter would be contrary to the "value clean" or "continuity" assumption in respect of both component (a) and (b) of the "Close-out Amount" as defined in clause 14. Secondly, even if the terms of the Side Letter are to be regarded as "material terms" for the purposes of the definition of "Close-out Amount", the terms are to be given no value. Mr Milligan QC for the appellants, LBIE, submits that both parts of this analysis are wrong.
129. I have found that the easiest way to understand how the two rival constructions work is through one of the examples that Mr Milligan used in the course of argument. I said at the time that this was the very helpful equivalent of using "large coloured bricks" to illustrate the problem. Imagine an interest rate swap transaction with a duration of, say 10 years between the two parties and where one party commits an event of default by the default which results in the swap transaction determining early, say with 5 years left to run. There is a provision in the agreement that in the event of an early termination caused by an event of default, the non-defaulting party will be entitled to recover a certain amount from the defaulting party, (which we can call a "Close-out amount"), which is equal to the cost to the non-defaulting party of replacing the remaining 5 years of the swap. If it is a simple "vanilla" swap, the non-defaulting party just finds out from a market maker the cost of obtaining a similar swap for 5 years. It may be positive or negative. But, next, Mr Milligan asked us to imagine that the 10 year swap with a remaining period of 5 years also had a provision in it that if the floating rate reaches 3% then the swap will automatically terminate. Mr Milligan submitted that, in calculating the "economic value" of the cost of replacing the swap that had terminated early because of an event of default, the economic effect of the term that the swap might end if the floating rate reached 3% would have to be assessed and taken into account in determining what is the "Close-out amount" that is either due to the non-defaulting party or is due to it. In that sense, the provision of the swap that it would determine early if floating rates reached 3% would be a part of the "material terms".
130. In effect, Mr Railton QC, for LBF, argued that it could not be a "material term" if the transaction in the example also had a term in its definition of the "Close-out amount" which stated that there must be an assumption of satisfaction of the conditions precedent set out in the transaction terms. He said that was the consequence of the decisions on the meaning and effect of the "continuity assumption". So, he argued, effect must be given to the wording in brackets in the first paragraph of the definition of the Close-out Amount in the 2002 ISDA Master Agreement terms.
131. The Side Letter is a part of the terms of the Terminated Transactions between LBIE and LBF, as the judge concluded at [48]. On the face of things, those terms must be a part of the "material terms" of the Terminated Transactions between LBIE and LBF for the purposes of the definition of "Close-out Amount" in clause 14 of the amended ISDA Master Agreement terms. That was the conclusion of the judge at [49] of his judgment where he said that "…a term of the Terminated Transaction is material if its inclusion in the replacement transaction (or the economic equivalent of its value) would be relevant to the pricing of that hypothetical transaction". There is no cross-appeal on that conclusion. Therefore, on the face of it, the Side Letter terms must be taken into account in determining the "economic equivalent" to determine the "Close-out amount".
132. Briggs J accepted the "persuasive commercial force' of this construction: see [61] of his judgment. But he held that to give effect to the early termination regime in the Side Letter, would involve a "radical departure" from the "value clean" principle or the "continuity assumption" principle as established in the cases and this could not be justified: see [61]–[70] of his judgment.
133. The fallacy in that reasoning, in my respectful view, is that it attempts to apply decisions on the effect of the wording of the 1992 ISDA Master Agreement terms to those of the 2002 ISDA Master Agreement definition of "Close-out Account" where the wording is not the same. As I have said, all the decisions deal with the 1992 ISDA Master Agreement terms. There are no relevant decisions on the 2002 wording. Admittedly, Peregrine Fixed Income Ltd (in liquidation) v Robinson Department Store plc [2000] CLC 1328 concerned whether the adoption of the 1992 terms "Market Quotations" basis for payments where there had been early determination of the transaction produced a commercially reasonable result. Moore-Bick J held that it did not because the quotation produced by the market maker took account of the creditworthiness of the Determining Party, which was not then specifically provided for. But the effect of this case has now been reversed by the change in the 2002 definition of "Close-out Amount" which permits the Determining Party to take account of its own creditworthiness. So this case can have no relevance to the 2002 wording.
134. In the present case Briggs J emphasised (at [63]) that the "assumption" found in the 1992 Market Quotation terms, ie. the words "assuming satisfaction of the conditions precedent in Section 2(a)(iii)…", had been exactly reproduced in the wording of the definition of Close-out amount in clause 14 of the 2002 terms. Briggs J held that this meant that the "value clean" principle or the "continuity assumption" had been transferred "in full force" to the more modern formula. However, as can be seen clearly from a comparison of the relevant parts of the Market Quotation provisions in the 1992 terms and the definition of "Close-out Amount" in the 2002 wordings which Arden LJ has set out at [62] and [63] above, the "assumption" made in parentheses appears in a different context in the definition in the revised wording. In my view, the effect of the 2002 wording is not the same as that of the earlier wording.
135. The Market Quotation wording (set out at [17] above) defines what the "Replacement Transaction" will embrace. It is such as to preserve for the parties "the economic equivalent of any payment or delivery… (…assuming the satisfaction of each applicable condition precedent) by the parties under Section 2(a)(i) in respect of such Terminated Transaction …that would, but for the occurrence of the relevant Early Termination Date, have been required after that date". In short, the value to be calculated is to assume that the Terminated Transaction had gone to term with all conditions precedent fulfilled.
136. The differences between the Market Quotation wording and that in the first paragraph of the definition of "Close-out Amount" are manifest. First, the Market Quotation wording does not refer at all to the "the economic equivalent of (a) the material terms" of the Terminated Transaction. Effect has to be given to those words in the 2002 terms. The Side Letter is a part of those terms. The Side Letter sets out one factor which may affect the duration of the intercompany transactions; the determination of the LBIE-client for whatever reason which would trigger the early determination of the related intercompany transactions. As everyone accepts, this factor concerning duration of the intercompany transaction will have a big impact on the economic value to be attributed to the intercompany "Terminated Transaction".
137. Secondly, the Market Quotation wording simply defines the basis on which to calculate the "economic equivalent" of the "Replacement Transaction". The wording stipulates that it must be assumed that payment or delivery will be at full term with all conditions precedent fulfilled. But in the 2002 wording, the phrase "the payments and deliveries by the parties under Section 2(a)(i)" and so forth is a part of phrase "(a)" starting with the "material terms". In short, it seems to me that the 'economic equivalent" has to take account of two aspects. First, the aspect of the "material terms" in general (which terms must include the Side Letter) and, secondly, "the payments and deliveries" etc aspect. In valuing the latter aspect, it has to be assumed that the payments and deliveries would be such as would have been required at the end of the Terminated Transaction, that there would have been no Early Termination Date and that, at the time the required payments and deliveries had to be made, there would have been satisfaction of the conditions precedent set out in Section 2(a)(iii). Deciding what is the "economic equivalent" of those two aspects taken together may be difficult, but that is what market-makers are there for.
138. This conclusion is, I think, supported by reference to "the option rights of the parties" in the revised wording of the 2002 ISDA Master Agreement. There is no reference to "option rights" in the Market Quotations provisions of the 1992 terms. The 2002 terms require that, in calculating the Close-out Amount, the Determining party has to take account of the economic equivalent of "the option rights of the parties in respect of the [Terminated Transaction(s)]". That phrase is general. In my view, as a matter of construction of this paragraph of clause 14, it cannot be subject in any way to the "continuity assumption", because option rights are dealt with in a self-contained phrase beginning with "(b)". If those option rights were subject to the "continuity assumption" it could cut them down very considerably. But that is, clearly, not the intent of the draftsman. If the "option rights" are not subject to the "continuity assumption" that, at the least, shows that the draftsman and so the parties contemplated that the calculation of the Close-out Amount has to take full account of the "economic equivalent" of all option rights, which must, I think, include option rights for early termination. If so, then I think it gives support to a construction of "(a)" to the effect that the parties intended that the "continuity assumption" should only qualify that part of (a) which deals with "payments and deliveries by the parties under Section 2(a)(i)" but not the whole of "(a)".
139. For these reasons, which I believe reflect the principal reasons given by Arden LJ, I would allow this appeal.

Sir James Munby, PFD:

140. I agree with both judgments and although we are differing from the judge do not think there is anything I can usefully add.