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That's not fair (market value)

03 May 2018. Published by Christopher Whitehouse, Senior Associate and Simon Hart, Partner

Court of Appeal rules on application of GMRA close-out provisions in a distressed market.

Icelandic bank LBI ehf (LBI) appealed against the High Court decision in its case against Raiffeisen Bank International AG (RZB) regarding the interpretation of the term "fair market value" in the close-out provisions of a repo agreement. The Court of Appeal rejected LBI's arguments that "fair market value" should preclude the use of prices, quotations and other pricing evidence obtained in a distressed or illiquid market and dismissed the appeal.

Background and first instance decision


LBI (formerly known as Landsbanki Islands hf) went into receivership on 7 October 2008 following the collapse of the Icelandic banking system. At the time LBI had various open positions on repo trades made on the terms of the Global Master Repurchase Agreement 2000 edition (the GMRA) with RZB. A repo agreement is effectively a collateralised loan; it involves a sale of assets alongside an agreement to repurchase those assets at a later time for a predefined price (where the difference between sale and repurchase price represents the interest on the loan). In this case LBI (effectively the borrower) had sold various securities to RZB (effectively the lender). LBI's receivership triggered the close-out provisions in the GMRA (being an "Event of Default").


Under the GMRA close-out provisions the assets held by the non-defaulting party (in this case RZB) are valued and a payment is made by the defaulting party in the amount of the repurchase price minus the value of the assets (assuming the assets to be worth less than the repurchase price). If the non-defaulting party serves a "Default Valuation Notice" within a specified timeframe it may select one of three methods of valuation of the assets it holds as prescribed by the GMRA (and discussed further below). However, if it fails to serve such a notice in time (which was the position in this case) the basis of valuation is the non-defaulting party's evaluation of the "Net Value" of "Equivalent Securities" at the "Default Valuation Time".


"Net Value" is defined in the GMRA as follows:


"Net Value" means […] the amount which, in the reasonable opinion of the non-Defaulting Party, represents [the securities'] fair market value, having regard to such pricing sources and methods […] as the non-Defaulting Party considers appropriate […]" (emphasis added)


Disagreeing with RZB's assessment of "Net Value", LBI brought proceedings against RZB in the High Court. It was common ground between the parties that RZB had not valued the repo securities correctly and therefore the judge had to consider what value RZB would have arrived at had the exercise been carried out correctly. Implicit in this assessment was what the term "fair market value" meant within the definition of Net Value.  


LBI submitted "fair market value" meant the market value of the relevant asset in conditions where there was "a willing buyer, willing seller, knowledge of the asset in question and a lack of compulsion". Practically, this would mean that during periods where the relevant market was distressed or illiquid (as was the case at the time of RZB's valuation) it would not be permissible to rely on actual market prices. LBI argued that instead the valuation should be based on what the assets would be worth in 'normal' market conditions.  The High Court disagreed with LBI's submissions and held that evidence gleaned from the actual market conditions at the relevant time, notwithstanding market distress, could form the basis of the valuation.


The appeal


LBI submissions


LBI submitted that the High Court had decided the "fair market value" issue incorrectly. LBI's primary argument was based on the contractual construction of the GMRA. LBI referred to the three bases for valuation permitted in the event a "Default Valuation Notice" had been served within the specified timeframe, which were as follows:

  • the actual sale prices of the relevant securities (option 1)
  • the mean average of commercially reasonable quotations obtained from market makers  for the securities (option 2)
  • the "fair market value" method described above (option 3)
Of the options above, option 3 could only be used in the event that options 1 and 2 were not possible.  LBI submitted that this strongly suggested that the determination of "fair market value" required a valuation which was separate from and not reflective of current market distress as it would be absurd for a non-defaulting party having formed the view that the market quotations it had obtained in an illiquid market were commercially unreasonable under option 2 to then use the same information to determine "fair market value" under option 3.


LBI also referred to various cases from the Australian and Canadian courts where the interpretation of the wording "fair market value" had been considered in various (non-GMRA) contractual contexts. In one such case, MMAL Rentals Pty Limited v Bruning [2004] NSWCA 451, the Court of Appeal of New South Wales stated:


"fair" has, in my opinion, work to do. In a contractual context, this additional word suggests that the valuation should proceed on the assumption, […] that there is no impediment to the process of bargaining […]


LBI also referred to passages in the guidance notes to the GMRA (GMRA Guidance) and an International Capital Market Association document dealing with frequently asked questions on repos (the ICMA FAQs), which it claimed supported its interpretation.


RZB submissions


RZB submitted that the definition of "Net Value" – specifically the ability to use pricing sources and methods that the non-defaulting party reasonably considers appropriate - gave a very wide discretion to the non-defaulting party. The only constraint on this discretion was the requirement to act rationally and not arbitrarily or perversely.


RZB submitted that, in contrast to LBI's position, as a matter of contractual construction the GMRA supported its interpretation of "fair market value". RZB referred to the wording of a specific mechanism that permitted a non-defaulting party who had not submitted a "Default Valuation Notice" within the specified timeframe to defer calculating the "Net Value" of the relevant assets in circumstances where it "reasonably determines that, owing to circumstances affecting the market […], it is not possible to determine a Net Value […] which is commercially reasonable". If "fair market value" within the definition of "Net Value" already had the constraint argued by LBI then the wording of this deferral mechanism would not make sense.


RZB also referred to the case of Lehman Brothers International (Europe) v Exxonmobil Financial Services BV [2016] EWHC 2699 (Comm), another GMRA case, which had proceeded on the basis that the non-defaulting party was entitled to determine "fair market value" by reference to the actual market conditions at the time, notwithstanding the fact the market was distressed following the collapse of Lehman Brothers.


RZB also argued that under LBI's interpretation, a non-defaulting party would find itself in a situation where having attempted unsuccessfully to transact in a market or obtain commercially reasonable quotations due to the prevailing market conditions, it would be required to attribute a theoretical value to the assets it was selling, ignoring whatever information it had gleaned as to their actual market value. RZB argued that such an outcome would be absurd.


RZB also dismissed LBI's references to the GMRA Guidance and ICMA FAQs; it submitted that the former merely restated the wording of the GMRA and the latter was not admissible as an aid to construction and was in any event irrelevant. Finally RZB dismissed the foreign jurisdiction cases cited by LBI on the basis that "fair market value" appeared in different contractual contexts in those cases.


Court of Appeal decision


The Court of Appeal agreed with RZB's submissions, dismissing LBI's appeal.


Its starting point was the principle (accepted by both parties) that in the absence of some express or implied limitation in the contract on the exercise of the discretion, the only limitation will be the requirement to act rationally and not arbitrarily or perversely (i.e. the test in Socimer Bank Ltd v Standard Bank Ltd [2008] EWCA Civ 116). Considering the wording of the GMRA, the court was unable to find any basis to support the limitation LBI sought to imply.


The court did not accept LBI's contractual construction argument, holding that it was fallacious to assume that because it was not possible to obtain a commercially reasonable offer or bid quotation for an asset that should preclude the use of any evidence or information that was available as to its actual market value and instead value the asset on a theoretical basis. In contrast, the court agreed with RZB's contractual construction argument that the deferral mechanism wording in the GMRA was not consistent with LBI's interpretation of "fair market value" which would render it otiose.


Overall, looking at the GMRA as a whole, the "fair" part of "fair market value" simply referred to the rationality requirement.


The court was not persuaded by the Australian and Canadian cases cited by LBI, agreeing with RZB that their factual contexts were different. Similarly the court agreed with RZB that the GMRA Guidance and ICMA FAQs referred to by LBI were of little assistance.




The Court of Appeal decision is a useful reminder of the analysis the courts will carry out when assessing the scope of a contractual discretion and it is useful to have greater clarity on the workings of the mechanisms of popular framework agreements such as the GMRA. That said, on the facts, the appeal brought by LBI was quite ambitious and the court's decision unsurprising.


The clarity this brings to the manner in which "fair market value" is to be determined is welcome, as is the Court's endorsement of the view that this provision is largely unfettered other than by Socimer style considerations.  


LBI ehf v Raiffeisen Bank International AG [2018] EWCA Civ 719 can be found here: