Constructing the default valuation procedures found in the GMRA (LBI EHF v Raiffeisen Bank International AG)

Constructing the default valuation procedures found in the GMRA (LBI EHF v Raiffeisen Bank International AG)

This case concerned the interpretation of ‘fair market value’ as it appears in the Global Master Repurchase Agreement (GMRA).

LBI EHF v Raiffeisen Bank International AG [2018] EWCA Civ 719

What are the practical implications of this case?

This case confirms that non-Defaulting Parties are given a wide amount of discretion to provide valuations, especially in distressed situations. The only limitation on the non-Defaulting Party is that it should always act rationally and not arbitrarily or perversely. This should be of comfort to parties who are trying to value securities in a market that is illiquid or distressed, since they maintain a wide contractual discretion.

What was the background?

The appeal is in relation to a decision made in March 2017 by Robin Knowles J, whereby the meaning of ‘fair market value’ in the context of a GMRA was discussed. For more information on that first instance decision, see news analysis: Effective service of default notices under a GMRA and GMSLA (LBI EHF (in winding up) v Raiffeisen Zentralbank Österreich AG and Raiffeisen Bank International AG).

The claimant (LBI) entered into a number of trades with the defendants (RZB). In 2008, LBI went into receivership. At this time there were eleven open positions between LBI and RZB relating to repo transactions and three open positions relating to securities lending transactions. These trades were on the terms of two master agreements—the repos were under the terms of the GMRA 2000 edition and the securities lending transactions were under the terms of the Global Markets Securities Lending Agreement (GMSLA) 2000 edition. The dispute between the parties was in relation to valuation and whether default notices were effectively served by RZB. This appeal only relates to the repo transactions.

The failure and insolvency of LBI constituted an Event of Default under paragraph 10 of the GMRA and Default Notices were served by the respondent. What should happen next is that the Defaulting Party (eg LBI) would pay the non-Defaulting Party the agreed Repurchase Price for the securities minus the Default Market Value of Equivalent Securities. Paragraph 10(e) of the GMRA provides for how to ascertain the Default Market Value. This depends on the Default Notice being served by the Default Valuation Time, which is defined as the close of business on the fifth dealing day after the day on which the Event of Default occurred. In this case this was 15 October 2008. The GMRA sets out three methods of valuation if the Default Valuation Notice had been served by the Default Valuation Time and an alternative method if the Default Valuation Notice is not served on time. The Default Valuation Notice was not served in time so the alternative method was the only method available to the respondent. This relied on the Equivalent Securities being an amount equal to the Net Value at the Default Valuation Time and Net Value is defined in paragraph 10(d)(iv) of the GMRA. It was agreed during the original trial that the respondent had not carried out the correct valuation process, and so the judge had to consider what the Default Market Value would have been if the respondent had acted in accordance with the GMRA and accordingly the judge had to decide what the meaning of ‘fair market value’ was as that phrase was used in the GMRA.

The decision of Knowles J was appealed on the basis that the judge:

  • failed to give sufficient weight to the contractual context in which the words ‘fair market value’ appear
  • failed to take sufficient account of the Guidance Note that accompanies the GMRA (the Guidance), and
  • reached a commercially unsound decision contrary to the guidance promulgated by the publishers of the GMRA

What were the main arguments set forward by LBI?

The main submission put forward by the appellant was that the words ‘fair market value’ within the definition of ‘Net Value’ requires that the non-Defaulting Party should make an assessment of the price from the perspective of a willing buyer and seller which does not reflect the situation found in a distressed or illiquid market. It was argued that the word ‘fair’ must add something to ‘market value’ and in this context it should take account of any illiquidity and distress in the market and that this approach was supported in the Guidance and within the frequently asked questions on repo published by ICMA.

What did the court decide?

The court dismissed the appeal. Lord Justice Flaux set out his reasoning for doing so and Lord Justices Henderson and Longmore agreed.

Flaux LJ agreed that the starting point had to be the definition of ‘Net Value’ in which the phrase ‘fair market value’ appears. He agreed that the definition confers significant discretion in the non-Defaulting Party and that this discretion is only limited by the non-Defaulting Party acting rationally and not arbitrarily or perversely. However, Flaux LJ did not agree that the assessment of ‘fair market value’ must be set by reference to a price agreed by a willing buyer and seller since this is not set out in the GMRA and is generally contrary to the wide discretion conferred on the non-Defaulting Party. The decision of Blair J in Lehman Brothers International (Europe) v Exxonmobil Financial Services BV [2016] EWHC 2699 (Comm) was considered because that is the only other case considering this provision in the GMRA—however, the Commonwealth cases to which the appellant referred were dismissed as being largely unhelpful since they involved different factual contexts. In Exxonmobil, although Blair J did not consider the precise definition of ‘fair market value’, the exercise of assessment was considered and the exercise was seen as being broad, subject only to the non-Defaulting Party acting rationally. For more information on the decision in Exxonmobil, see news analysis: Effective termination of a repo (Lehman Brothers International (Europe) v Exxonmobil Financial Services).

Flaux LJ points out that it would be inappropriate to provide a precise interpretation or definition of ‘fair market value’ since the GMRA is used for a wide variety of financial instruments, not just bonds and that the wide wording afforded to the non-Defaulting Party is so that its discretion is not limited.

Case details

Court: Court of Appeal, Civil Division

Judges: Longmore, Henderson and Flaux LJJ

Date of judgment: 11 April 2018

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About the author:

Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.

Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.