The English High Court has recently interpreted the term
"default rate" under the ISDA Master Agreement in one of
a series of cases concerning the administration of Lehman Brothers
International (Europe). We consider the outcome of this case and
its likely impact.
The case arose in the context of a substantial surplus in Lehman
Brothers International (Europe)
("LBIE") administration after
paying for the provable debts owed by LBIE.
Although the process of paying the principal of LBIE's
proved debts completed in 2014, creditors have still not received
any interest in respect of those debts. Many of LBIE's
creditors have claims under ISDA Master Agreements and this case
concerned the scope of their entitlements to default interest under
Meaning of default rate
The ISDA Master Agreement provides that where there is default
on a payment, the party to whom the payment is due,
or relevant payee, is entitled to interest at the
default rate. The default rate, in simple terms, is the cost of
funding plus 1% per annum.
Cost of funding
The Court had to interpret what is meant by "cost of
funding". It held that a party's cost of funding means its
cost of borrowing the relevant amount whether that cost is actual
or hypothetical. The party's "cost of funding" cannot
be calculated by reference to costs associated with any other type
of funding, such as the cost of raising equity finance etc.
Original counterparty's cost of funding
The Court further held that when calculating the cost of
borrowing, it is the cost of the payer's original counterparty
under the contract that must be used as a reference. So even if the
original counterparty sold the interest in the amount payable to a
third party, that third party must calculate the cost of funding
based on the original counterparty's costs and not its own
The outcome of this case will have a significant impact on
the amount of the surplus the administrators will be required to
distribute in respect of statutory interest. Given that the
majority of claims admitted against LBIE arise under an ISDA Master
Agreement, and that these claims represent approximately £4
billion, this decision will be closely analysed by those with an
admitted claim in LBIE's administration.
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