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Lehman case confers clarity on “COB”

Whilst many know of the infamous collapse of Lehman Brothers, not many are aware of how Lehman Brothers helped to clarify important business terms. In a recent dispute between Lehman Brothers (Lehman) and ExxonMobil (Exxon), the High Court was faced with a number of issues, in particular, issues relating to what was meant by ‘close of business’.

The facts

Lehman, Exxon, and JP Morgan entered into a collateral management agreement alongside a Global Master Repurchase Agreement (GMRA) on 09/01/2008 under which Exxon was the purchaser. At 9.22am on 15/09/2008, following the collapse of Lehman, Exxon sent a default notice to Lehman terminating all trades outstanding under the GMRA via fax (number ending -2044). Exxon then tried to send a second fax to the same number on the same day but this was unsuccessful. As a result, Exxon sent the failed fax by email to Lehman on the following day (16/09/2008). In the meantime, JP Morgan and Exxon agreed to liquidate the securities Exxon had purchased under the GMRA. JP Morgan managed to sell most of the equities but struggled to sell any of the bonds due to lack of interest.

Exxon prepared a Default Valuation Notice (DVN) containing 3 appendices. The first appendix listed bonds which had been sold. The second noted the bonds which were unsold but in relation to which bid quotations had been obtained. The third noted the bonds which could not be sold. With respect to the third appendix, Exxon instructed JP Morgan to sell the bonds at a discount of 40% to garner interest. The DVN was then sent to Lehman via fax (number ending -4034), arriving at 6.02pm on 22/09/2008. Exxon also sent a copy of the fax via email which was received at 7.30pm on the same day.

The dispute

In the litigation that followed, the court was asked to opine on three basic issues.

Issue 1: Lehman argued that the default notice sent on the day it collapsed constituted a valid default notice, whilst Exxon were of the opinion that it was the email sent the following day which was valid since only this latter default notice identified the actual ‘default event’. Lehman counterclaimed that the aforementioned email was invalid due to the method of service (via email instead of fax). The timing of the notice was considered significant to both parties as it not only affected the valuation of the securities, but also the deadline to submit the DVN.

Issue 2: Lehman contended that the DVN sent on the 22/09/2008 was received after the close of business hours and was sent to the wrong fax number.

Issue 3: The 40% discount on the unsold bonds was unjustifiable according to Lehman.

The ruling

On the first issue, the court found in Lehman’s favour. It went back to basics by referring to normal contractual principles in order to establish whether the notice was valid. It noted that such notices did not require any particular form; what sufficed was that the right being exercised was clearly conveyed. Identifying the event which constituted the default event was, therefore, not necessary for validity. Moreover, to specify what the event was would elevate a standard default notice into a special default notice. As regard the method of service, the court did not want to rule on this aspect but did say in obiter that email was an appropriate channel of communication. Its use was anticipated by the GMRA itself and Lehman had provided their email address in the annex to the GMRA for this purpose.

With respect to the second issue, the court first addressed the fact that the DVN was sent to the wrong fax machine. The court’s default position was that the notice should have been sent to the correct number (the number set out in the annex to the GMRA: -2044). However, it held that this requirement could be waived where it would not make commercial sense. Although the DVN was faxed to the wrong machine it was sent to a fax machine which was on the same floor as the correct fax machine. Further, a responsible employee did receive the DVN despite it being sent to the wrong fax machine. Thus, the only conclusion that made commercial sense was to find that the fax had been validly served despite the fact it had been sent to the wrong fax machine.

The most interesting part of the judgment related to what was meant by ‘close of business’. The deadline for service of notices under a GMRA is set by reference to ‘close of business’: a day on which commercial banks are open for business. Lehman suggested that ‘close of business’ in this context should be taken to mean at 5pm. They argued this was a time that most high street banks in London closed. Conversely, Exxon believed that 7pm was more appropriate given the nature of an investment bank such as Lehman. The court held that in absence of an express cut-off time, a later time would make more commercial sense in the case at hand. As the GMRA did not state expressly a cut-off time, the court accepted that the DVN was received before the ‘close of business’ on the 22/09/18. This interpretation is in line with similar agreements dealing with derivatives. For example, the ISDA Master Agreement refers to ‘local business day’. Despite the different terminology it has an almost identical meaning as ‘close of business’ under the GMRA. With there being no concrete rule as to what is meant by ‘close of business’, it seems that courts want to provide parties with flexibility in deciding a time for notices to be served.

Finally, the court was in agreement with Lehman that a discount of 40% could not be ‘justified on a rational basis’. Exxon and JP Morgan had not tested the market at discounts approaching 40%. Moreover, it was not unlikely to find buyers at discounts lower than 40%. Therefore, the discount was held to be unreasonable.

Naturally, the court provided a plain reading of what is meant by ‘close of business’. To have set down a specific time would have been unworkable in practice considering the various types and sizes of businesses that exist. The case highlights that the context is determinative of the meaning of ‘close of business’. As this was a commercial case, a later time was considered suitable. The opposite may have been true if the court was dealing with a small, local business. It appears that courts are reluctant to ‘impose a one size fits all approach’. Therefore, if parties don’t want to risk missing a deadline for serving a particular document, the best thing is to expressly agree a time to avoid any nasty surprises if the dispute proceeds to court.

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