In a claim brought by LBI EHF (formerly Landsbanki Islands hf) (“LBI“) relating to repurchase (or “repo”) transactions against Raiffeisen Zentral Bank Österreich AG (now Raiffeisen Bank International AG) (“RZB“), the Court of Appeal has ruled on the meaning of the words “fair market value” in the default valuation provisions in the Global Master Repurchase Agreement 2000 edition (the “GMRA“).

Following on from the recent decision in Lehman Brothers International (Europe) v Exxonmobil Financial Services BV[1](which also involved the 2000 edition of the GMRA), the Court of Appeal has avoided limiting the wide discretion given to the non-Defaulting Party when determining “fair market value” under the GMRA, particularly in distressed markets.

Background

In October 2008, at the time of LBI’s collapse, there were 11 open positions between it and RZB relating to repo trades which were on the terms of the GMRA.

The failure and insolvency of LBI constituted an Event of Default under paragraph 10 of the GMRA.  In short, the terms of the GMRA required LBI (as the Defaulting Party) to pay RZB (as the non-Defaulting Party) the agreed Repurchase Price for the securities minus the Default Market Value of Equivalent Securities.  The methods of valuation provided for under the GMRA depended upon whether the non-Defaulting Party had served a Default Valuation Notice by the Default Valuation Time.

In this case, RZB had not served a Default Valuation Notice by the Default Valuation Time.  In this circumstance, the GMRA required RZB to determine the “fair market value” of the relevant Equivalent Securities.  Paragraph 10(e)(ii) of the GMRA provided:

“…the Default Market Value of the relevant Equivalent Securities…shall be an amount equal to their Net Value at the Default Valuation Time; provided that, if at the Default Valuation Time the non-Defaulting Party reasonably determines that, owing to circumstances affecting the market in the Equivalent Securities…in question, it is not possible for the non-Defaulting Party to determine a Net Value of such Equivalent Securities…which is commercially reasonable, the Default Market Value of such Equivalent Securities…shall be an amount equal to their Net Value as determined by the non-Defaulting Party as soon as reasonably practical after the Default Valuation Time“.

“Net Value” was defined in paragraph 10(d)(vi) of the GMRA as meaning “…the amount which, in the reasonable opinion of the non-Defaulting Party, represents their fair market value, having regard to such pricing sources and methods…as the non-Defaulting Party considers appropriate…“.

Crucial to this definition of “Net Value” was what factors the non-Defaulting Party may take into consideration when determining the “fair market value” of the Equivalent Securities.  The Default Valuation Time for the securities in question in this case was 15 October 2008, the height of the financial crisis and a time of extreme distress in the markets.  The question of whether or not the distress in the markets could be taken into consideration, therefore, was of critical importance.

The decision at first instance

It was common ground, by the end of the trial, that RZB had not carried out the correct valuation process. This meant the court had to consider a counter-factual question as to what Default Market Value RZB would have arrived at if it had acted in accordance with the GMRA.  As such, the primary issue that the court had to consider was the meaning of “fair market value” in the GMRA.

It was argued by LBI that the words “fair market value” should carry the meaning attributed to them in a variety of other legal and financial contexts, both domestically and internationally.  LBI argued that these other definitions showed that there was a consistently recognised concept associated with “fair market value” involving a willing buyer, a willing seller, knowledge of the asset in question and a lack of compulsion.  The “lack of compulsion” element was central to LBI’s argument.  This, it submitted, excluded prices achieved in a distressed market.  However, the court found this argument “difficult to reconcile with the fact that under paragraph 10(e)(i) of GMRA the non-Defaulting Party may actually sell the securities, in what may be a distressed market, and determine the Default Market Value on the basis of the prices obtained, provided always that it acts in good faith“.

On the basis of the judgment in Socimer Bank Ltd v Standard Bank Ltd[2], LBI accepted that the task for the court was to put itself in the shoes of the decision maker and ask what decision it would have reached, acting rationally and not arbitrarily or perversely.

In Exxonmobil, it was held that the securities should be ascribed a fair market value in accordance with the opinion which the non-Defaulting Party (acting rationally) would have formed if it had conducted the valuation exercise required by paragraph 10(e)(ii).  This was largely a question of fact.

At the point of the written closing submissions, RZB provided what it thought was the “fair market value” for each of the bonds as at 15 October 2008, and the information that it had used to arrive at that value.  The court acknowledged that the information available in this case was “imperfect”, but “the circumstances at that time were imperfect“, and “[a]ny assessment of fair market value would have been imperfect but the non-Defaulting Party was nonetheless entitled to make one“.  Accordingly, at first instance, it was accepted that the figures provided by RZB met the requirement “for a rational, honest determination of fair market value as at 15 October 2008“.

The appeal

The appeal concerned whether, on the true construction of the GMRA, the non-Defaulting Party’s assessment of “fair market value” of securities could be based on prices achieved or quotations obtained in a distressed or illiquid market.

LBI submitted that the words “fair market value” in the definition of “Net Value” required the non-Defaulting Party to assess the price from the perspective of a willing buyer and a willing seller, neither being under any particular compulsion to trade.  Such an assessment should not therefore reflect liquidity issues or distress that happen to feature in a particular market at a particular time.

LBI submitted that this would be consistent with the meaning attributed to “fair market value” (albeit in different contexts) in authorities from Australia and Canada. However, the Court of Appeal concluded that these cases were of no real assistance as they involved different factual contexts; the meaning of “fair market value” in the present case had to be “determined as a matter of construction of this particular contract in its particular context“[3].  Accordingly, the correct starting point when determining the meaning of “fair market value” was to consider the definition of “Net Value”.

Instead, it was held that the meaning ascribed to the words “fair market value” by LBI was not one which was to be found in the express terms of the GMRA.  Furthermore, there was no basis for it to be implied, because it was”contrary to the express language of the GMRA and, in particular, the wide discretion conferred on the non-Defaulting Party“.

LBI’s appeal was dismissed and the Court of Appeal concluded that the wording of the GMRA “entitled the non-Defaulting Party to have regard to any evidence and information as to the particular market at the particular time” (as held by Knowles J).  Similarly, there was “no warrant for limiting the width of the discretion provided by the contract wording by requiring the non-Defaulting Party to disregard the evidence of the market merely because it was illiquid or distressed at the particular time“.

Implications

The English courts have resisted setting out an interpretation or definition of “fair market value”. The risk of doing so would be to restrict what, under the GMRA, is a wide discretion given to the non-Defaulting Party to assess the “fair market value” of the Equivalent Securities by reference to “such pricing sources and methods…as the non-Defaulting Party considers appropriate“.  Furthermore, a tailor-made definition of “fair market value” to fit the facts of this case would have been inappropriate, because the GMRA was used in respect of a wide variety of financial instruments.

This case confirms that a non-Defaulting Party is given a wide discretion in reaching a determination on “fair market value”, particularly in distressed situations.  In the absence of an express or implied term in the GMRA on the exercise of discretion, as a matter of principle, the only limitation when determining “fair market value” will be the one recognised in Socimer, that the decision-maker “must have acted rationally and not arbitrarily or perversely“.

Parties who are trying to value securities in a distressed or illiquid market should derive some comfort from this judgment.  However, what the meaning of “fair market value” is will be determined as a matter of construction of the particular contract in its particular context.

Abdulali Jiwaji is a Partner at Signature Litigation.

Harry Denlegh-Maxwell is an Associate at Signature Litigation.

Johnny Shearman is Professional Support Lawyer at Signature Litigation.

[1] [2016] EWHC 2699 (Comm)

[2] [2008] EWCA Civ 116

[3]Per Longmore LJ in Barclays Bank plc v Unicredit Bank AG [2014] EWCA Civ 302; [2014] 2 Lloyd’s Rep 59