The ISDA Master Agreement and Implied Terms: Text Over Context in the English Court of Appeal

Should a commercial contract be interpreted literally, or should a court adopt a non-literal interpretation if necessary to achieve a result that makes commercial sense given the context (the factual matrix) of the agreement? This issue is an enduring one in contractual interpretation, and was recently put to the test in Lomas & Ors v. JFB Firth Rixson Inc. & Ors, a decision of the English Court of Appeal arising from the failure of Lehman Brothers. At issue was whether to imply terms into the Master Agreement of the International Swaps and Derivatives Association Inc. (the “ISDA Master Agreement”), which governs most derivatives transactions in the world. The Court of Appeal chose not to do so. On the facts the decision was not surprising, but it was nonetheless a choice of literalism over a proposed contextualist interpretation.

The case may well head to the Supreme Court of the United Kingdom, so the battle between text and context may not yet be over. Even if the case is not appealed further, any appellate case interpreting the ISDA Master Agreement is a noteworthy one.



Lomas comprised four separate appeals, but only the first appeal, which addressed the implied term issue, will be considered here.

Prior to its insolvency in 2008, Lehman Brothers was a party to numerous interest rate swap transactions governed by the ISDA Master Agreement. Conceptually, an interest rate swap is simple (although in practice swap transactions can be exceedingly complex). One party agrees to pay a floating rate of interest on a notional loan over a notional term (both are notional because there is no actual loan and no actual term). The counterparty agrees to pay a fixed rate of interest on the same notional loan over the same notional term. At the end of the notional term, the party whose total notional interest payment is higher is “out of the money” and pays the difference to the party who is “in the money”. A swap can be used either to hedge interest rate risk, or as pure speculation.

Upon the insolvency of Lehman Brothers, it was in the money on a number of swap transactions. The administrators of Lehman Brothers wanted to collect, but on the literal language of the ISDA Master Agreement they had a problem. The agreement includes a condition precedent: a payment obligation is subject to “the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing”. Insolvency is an Event of Default. A non-defaulting party has the right to designate an Early Termination Date, which would trigger a payment obligation notwithstanding the condition precedent, but for the swaps in question the non-defaulting parties (who were out of the money) understandably did not exercise that right.


To avoid the problem created by the literal language, the administrators proposed four possible implied terms. They suggested that the condition precedent suspending the obligation to pay would end: (i) upon the expiry of such time as required to allow the non-defaulting party to elect an Early Termination Date; or (ii) upon the expiry of a reasonable time; or (iii) upon the expiry or maturity of all relevant transactions; or (iv) upon the expiry or maturity of all transactions between the parties governed by the ISDA Master Agreement.

Multiple “in the alternative” arguments rarely make for good advocacy (they give off too much of an air of desperation), and the Court of Appeal was unimpressed with the plethora of choices on offer. It rejected all four proposed implied terms. The Court found them to be contrary to the express language of the ISDA Master Agreement, specifically the words “and is continuing” in the condition precedent and the provision allowing the non-defaulting party to designate an Early Termination Date (why should the right to designate an Early Termination Date be transformed into an obligation to do so?). The Court found that the ISDA Master Agreement worked “perfectly well” without the proposed implied terms. To imply a term “would be to re-write the contract for the parties which it is no business of the court to do. The court will only imply terms if it is necessary to do so or if it would be obvious to any disinterested third party that the contract must have the meaning which the implied terms would give it.”

Thus the Court of Appeal concluded that the condition precedent continues in force until the Event of Default is cured or an Early Termination Date is designated. If the cure never comes and no Early Termination Date is ever designated, the payment obligation of the out-of-the-money non-defaulting party remains suspended forever.

Potential Significance

On the facts the decision is not particularly surprising. The Court of Appeal expressed some very cogent reasons for rejecting the proposed implied terms. Moreover, implying terms into the ISDA Master Agreement would raise the spectre of commercial uncertainty in a document used globally for transactions worth billions of dollars, a prospect no court would welcome. Yet at the same time, there is some merit to the argument that the outcome does not make commercial sense given the factual matrix. Why should a party that is out of the money escape its payment obligation forever? And why should the creditors of Lehman Brothers be deprived of the benefit of Lehman being in the money? Thus the choice of text over context, while unsurprising in this case, was nonetheless a choice. Contractual interpretation questions tend to be quite intractable, and where text and context conflict it is particularly difficult to tell which will prevail. A clear choice of text over context is noteworthy.

Also noteworthy is any appellate interpretation of the ISDA Master Agreement, and regardless of one’s views of whether the case was correctly decided anyone involved in the derivatives market should take note of the Court of Appeal’s approach to the agreement.

Case information

Lomas & Ors v. JFB Firth Rixson Inc. & Ors, [2012] EWCA Civ. 419

Case No.: A2/2011/0070, A2/2011/0070(A), A3/2011/1107, A3/2011/2106, A2/2011/1059

Date of Decision: April 3, 2012

commercial contract English Court of Appeal factual matrix implied terms insolvency interest rate swap transactions International Swaps and Derivatives Association Lehman Brothers master agreement



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