The 25-page 12th March Knowles J judgment in Lehman Brothers Special Financing Inc v National Power Corporation, an example of the English courts continuing to excel globally in financial markets disputes (as well as providing a heading that could be the title of an undiscovered Jane Austen novel) ends with a warning:
“The present case may also show the value of contracting parties being clear about what they expect when they make one contracting party the decision maker in certain events, and of thinking about the consequences… if contracting parties want objective criteria of reasonableness to apply, they may need to do more than just use the word ‘reasonable’.”
Under the 1992 ISDA Master, a party calculating its “Loss” must act reasonably, but as David Richards J put it in Enasarco, “that party is not required to comply with some objective standard of care as in a claim for negligence, but, expressing it negatively, must not arrive at a determination which no reasonable non-defaulting party could come to. It is essentially a test of rationality, of the type developed in the quite different context of public law duties in Associated Provincial Picture Houses Ltd v Wednesbury Corporation “. So long as it considers the matter properly, the court will not intervene. The focus is on the process, not the result. The standard has found its way into a number of commercial contexts recently: e.g. (Lord Neuberger’s HK judgment in Akai Holdings) the standard for banks where there is inadequate corporate benefit.
The 2002 Master gave more flexibility about determining the “Close-out Amount”, but to balance this it included (as the 2002 User’s Guide says) “objectivity and transparency requirements that were felt to be lacking, particularly in the definition of Loss in the 1992 Agreement”, by requiring the party to “act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result”. Knowles J confirms this is more than just Wednesbury. Not only must the procedure used be reasonable, so must the outcome. In this case, NPC got a firm quote for replacing its hedge with Lehmans, which showed it was in the money, but the quote was not quite on the right basis, because it assumed NPC had an option which had already expired. Lehmans argued that it was in the money, based on its mark to market valuation (which however ignored NPC’s fairly weak credit). Knowles J held that NPC had, on the facts, met the standard.