254 All England Law Reports [2012] 1 All ER (Comm)

a
Lehman Brothers Commodity
Services Inc v Crédit Agricole
Corporate and Investment Bank
[2011] EWHC 1390 (Comm) b

QUEEN’S BENCH DIVISION, COMMERCIAL COURT

FIELD J
1–3 MARCH, 7 JUNE 2011
c
Contract – Construction – International Swaps and Derivatives Association (ISDA)
Master Agreement – Defendant issuing letter of credit in favour of claimant –
Claimant seeking to draw down on letter of credit – Defendant relying on terms of
ISDA Master Agreement to set off moneys allegedly owed to it by claimant under
master agreement against letter of credit – Whether defendant entitled to set off d
against letter of credit.

In September 2007, the defendant issued a letter of credit in favour of the

claimant. The letter of credit was provided in connection with a derivatives
trading contract contained in an ISDA Master Agreement and schedule thereto,
including a credit support annex (the EDF CSA), entered into between the e
claimant and EDF (the EDF/LBCS Master Agreement). The letter of credit
was governed by English law. As at September 2007, the parties were already in
a wholly separate contractual relationship governed by a distinct ISDA Master
Agreement and schedule (the Calyon Master Agreement). That agreement was
governed by the law of New York. Section 6(f) of the Calyon Master
Agreement provided, inter alia, ‘(i) In addition to any rights of set-off a party f
may have as a matter of law or otherwise, upon the occurrence of an Event of
Default, Credit Event Upon Merger, or an Additional Termination Event and
the designation of an Early Termination Date pursuant to Section 6 of the
Agreement with respect to a party (“X”), the other party (“Y”) will have the
right (but not be obliged) without prior notice to X or any other person to g
set-off or apply any obligation of X owed to Y …’. The Calyon Master
Agreement also contained an entire agreement clause. The claimant’s
obligations under the Calyon Master Agreement were guaranteed by an
associated company, LBHI. LBHI was also the credit support provider under
the Calyon Master Agreement. In September 2008, LBHI filed under
Chapter 11 of the United States Bankruptcy Code; an act that constituted an h
event of default in respect of the claimant under the Calyon Master
Agreement. On 15 and 16 September 2008 the defendant served notices on the
claimant under s 6(a) of the Calyon Master Agreement designating those dates
early termination dates on which all outstanding transactions under the Calyon
Master Agreement would be terminated; the defendant subsequently served a
notice on the claimant stating the sum said to be due under that agreement. j
LBHI’s filing under Chapter 11 also constituted an event of default under the
EDF/LBCS Master Agreement and 16 September 2008 was designated an early
termination date under that contract. The claimant was said to be owed a
significant sum by EDF under that agreement. In November 2008, the claimant
sought to draw down on the letter of credit. The defendant paid some moneys
 QBD Lehman Brothers v Crédit Agricole 255

a to the claimant under the letter of credit, and relying on section 6(f) of the
Calyon Master Agreement sought to set off moneys said to be due under that
agreement. The claimant did not accept that the defendant was entitled to
set-off the sum due from the claimant against the defendant’s obligation under
the letter of credit. The claimant issued proceedings against the defendant,
suing on the letter of credit. The claimant contended, inter alia, that: (i) on its
b true construction section 6(f) did not apply to the defendant’s obligation under
the letter of credit; (ii) there was no legal set-off; and (iii) that any entitlement
to set-off the letter of credit obligation against the debt due from the claimant
was automatically stayed under the provisions of the US Bankruptcy Code. A
number of preliminary issues were ordered to be tried. By the time of the
c hearing, the main issue was whether on the proper construction of (i) the
Calyon Master Agreement and (ii) the letter of credit, section 6(f) of the Calyon
Master Agreement entitled the claimant to set off any early termination
payment calculated by the defendant pursuant to section 6(d) of the Calyon
Master Agreement against the amount payable by the defendant to the
claimant under the letter of credit.
d
Held – In the absence of an express agreement to the contrary, where an
obligee was owed money by A and could look to B in respect of the same debt,
a set-off by B reduced pro tanto the debt owed by A. In the absence of a
contrary provision in the EDF/LBCS Master Agreement the defendant’s set-off
in respect of the sum owed by the claimant reduced the sum owed by the
e defendant to the claimant; and that reduction would feature in the taking of
account between EDF and the claimant that was implied by the law. Further,
there was nothing in the EDF CSA that excluded that outcome. The letter of
credit was not to be construed as being payable without any right of set-off
(see [29], [32], [36], [37], [40], [42], [43], below).
MS Fashions Ltd v Bank of Credit and Commerce International SA (in liq) (No 2)
f [1993] 3 All ER 769 applied.

Notes
For the construction of express contractual terms, see 9(1) Halsbury’s Laws
(4th edn reissue) paras 772–777.
g Cases referred to in judgment
Bank of Credit and Commerce International SA (in liq) v Ali [2001] UKHL 8, [2001]
1 All ER 961, [2002] 1 AC 251, [2001] 2 WLR 735.
Bond and Mortgage Guarantee Co, Re (1935) 196 NE 313, NY Ct of Apps.
Cargill International SA v Bangladesh Sugar and Food Industries Corp [1998]
h 2 All ER 406, [1998] 1 WLR 461, CA.
Edelson (N) Sons Corp v National Union Fire Ins Co (1994) US Dist LEXIS 7463,
SDNY DC.
Lipper Holdings LLC v Trident Holdings LLC (2003) 766 NYS 2d 561, NY Sup Ct.
Lomas v JFB Firth Rixson Inc [2010] EWHC 3372 (Ch), [2011] 2 BCLC 120.
MS Fashions Ltd v Bank of Credit and Commerce International SA (in liq) (No 2)
j [1993] 3 All ER 769, [1993] Ch 425, [1993] 3 WLR 220, CA.
Scandinavian Trading Tanker Co AB v Flota Petrolera Ecuatoriana, The Scaptrade
[1983] 1 All ER 301, [1983] QB 529, [1983] 2 WLR 248, CA; affd [1983]
2 All ER 763, [1983] 2 AC 694, [1983] 3 WLR 203, HL.
Shearson Lehman Bros Holdings Inc v Schmertzler (1986) 500 NYS 2d 512,
NY Sup Ct.
256 All England Law Reports [2012] 1 All ER (Comm)

Simas v Merrill Corp (2004) US Dist LEXIS 1415, SDNY DC. a

Wallace v 600 Partners Co (1995) 658 NE 2d 715, NY Ct of Apps.
Wood v Lucy (1917) 118 NE 215, NY Ct of Apps.

Preliminary issues
In a claim on a letter of credit brought by Lehman Brothers Commodity
b
Service Inc (LBCS) against Credit Agricole Corporate and Investment Bank
(formerly Calyon) Burton J ordered the trial of the preliminary issues set out
at [11] below. The facts are set out in the judgment.

Alain Choo-Choy QC (instructed by Weil Gotshal & Manges LLP) for LBCS.
Robin Dicker QC and Jeremy Goldring (instructed by Clifford Chance LLP) for c
Calyon.
Judgment was reserved.

7 June 2011. The following judgment was delivered.

d
FIELD J.

INTRODUCTION
[1] This is a trial of a number of preliminary issues ordered to be
determined by Burton J.
[2] The issues arise out of proceedings in which the claimant, Lehman e
Brothers Commodity Services Inc, (LBCS) sues on a letter of credit issued by
the defendant (Calyon) in favour of LBCS. The letter of credit was provided in
connection with a derivatives trading contract contained in an ISDA
[International Swap Dealers Association] master agreement and the schedule
thereto, including a credit support annex (the EDF/LBCS Master Agreement).
The contract was made on 23 May 2006; the parties were LBCS and EDF f
Trading Ltd (EDF).
[3] The letter of credit was issued on 25 September 2007 and when drawn
upon on 21 November 2008 was in the sum of €50m. It is governed by English
law. As at 25 September 2007, LBCS and Calyon were already in a wholly
separate contractual relationship governed by a distinct ISDA Master g
Agreement and schedule dated 2 October 2006 (the Calyon Master
Agreement). This agreement is governed by the law of New York.
[4] Section 6(f) of the the Calyon Master Agreement1 provided (in relevant
part):
‘(i) In addition to any rights of set-off a party may have as a matter of
law or otherwise, upon the occurrence of an Event of Default, Credit h
Event Upon Merger, or an Additional Termination Event and the
designation of an Early Termination Date pursuant to s 6 of
the Agreement with respect to a party (“X’), the other party (“Y”) will have
the right (but not be obliged) without prior notice to X or any other person
to set-off or apply any obligation of X owed to Y (whether or not matured j
or contingent and whether or not arising under this Agreement, and
regardless of the currency, place of payment or booking office of the
obligation) against any obligation of Y owed to X (whether or not matured

1 Inserted by part 5(c) of the schedule.

 QBD Lehman Brothers v Crédit Agricole (Field J) 257

a or contingent and whether or not arising under this Agreement, and

regardless of the currency, place of payment or booking office of the
obligation …
(iii) If the amount of an obligation is unascertained, Y may in good faith
estimate that amount and set-off in respect of the estimate, subject to the
relevant party accounting to the other when the amount of the obligation
b is ascertained.
(iv) Nothing herein shall be effective to create a charge or other security
interest. This provision shall be without prejudice and in addition to any
right of set-off, combination of accounts, lien or other right to which any
party is at any time otherwise entitled (whether by operation of law,
c contract or otherwise).’
[5] Section 9(a) and (b) of the Calyon Master Agreement read:
‘(a) Entire Agreement. This Agreement constitutes the entire agreement
and understanding of the parties with respect to its subject matter and
supersedes all oral communication and prior writings with respect thereto.
d (b) Amendments. No amendment, modification or waiver in respect of
this Agreement will be effective unless in writing (including a writing
evidenced by a facsimile transmission) and executed by each of the parties
or confirmed by an exchange of telexes or electronic messages on an
electronic messaging system.’
e [6] Both the Calyon Master Agreement and the EDF/LBCS Master
Agreement provided in section 6(e) for the calculation of payments due on
early termination, depending on whether the early termination date results
from an event of default or a termination event and on the chosen method of
calculation. The chosen method of calculation under each agreement was loss
and second method. Under this method of calculation, if there is an early
f termination date and the non-defaulting party is ‘out of the money’, he can
end up paying the defaulting party.
[7] LBCS’ obligations under the Calyon Master Agreement are guaranteed
by Lehman Brothers Holdings Inc (LBHI) pursuant to a guarantee dated
12 October 2006. LBHI was also the credit support provider under the Calyon
Master Agreement. On 15 September 2008, LBHI filed under Chapter 11 of the
g US Bankruptcy Code (the Code), an act that constituted an event of default in
respect of LBCS under the Calyon Master Agreement. On 15 and 16 September
2008, Calyon served notices on LBCS under section 6(a) of the Calyon Master
Agreement designating those dates early termination dates on which all
outstanding transactions under the Calyon Master Agreement would be
h terminated; and on 30 December 2008, Calyon served a notice on LBCS stating
that the sum due under the Calyon Master Agreement was $US15,030,239.
[8] LBHI’s filing under Chapter 11 also constituted an event of default under
the Calyon Master Agreement and 16 September 2008 was designated an early
termination date under this contract. The sum due and owing to LBCS by EDF
is said to be €125,538,461.
j [9] On 21 November 2008, LBCS sought to draw down on the letter of
credit. On 28 November 2008, Calyon paid LBCS €38,377,190·69 and, relying
on section 6(f), set off the sum of €11,622,809·31 against the $US15,030,239
due under the Calyon Master Agreement.
[10] LBCS does not accept that Calyon were entitled to set off the sum due
from LBCS against Calyon’s obligation under the letter of credit. In its reply it
258 All England Law Reports [2012] 1 All ER (Comm)

pleads that: (i) on its true construction section 6(f) did not apply to Calyon’s a
obligation under the letter of credit; (ii) there was no legal set off; and (iii) any
entitlement to set off the letter of credit obligation against the debt due from
LBCS was automatically stayed pursuant to the provisions of s 362(a) of Title
11 of the Code.
THE PRELIMINARY ISSUES b
[11] The preliminary issues ordered to be tried are:
1. Is the question of whether the defendant was entitled to set off,
against its obligation under the letter of credit, the amount of the early
termination payment to be determined solely in accordance with English
law or are the laws of New York (including in particular the bankruptcy c
law applicable in New York) relevant to the determination of that
question?
2. Is the English court required or entitled to recognise or take account of
the provisions of bankruptcy law applicable in New York in these
proceedings or do the Cross-Border Insolvency Regulations 2006,
SI 2006/1030, and/or English public policy preclude it from doing so on d
the facts of this case?
3. On the proper construction of (i) the Calyon Master Agreement dated
2 October 2006 and (ii) the letter of credit between the claimant and
defendant, does section 6(f) of the Calyon Master Agreement entitle the
claimant to set off any early termination payment calculated by the
defendant pursuant to section 6(d) of the Calyon Master Agreement e
against the amount payable by the defendant to the claimant under the
letter of credit?
4. If on the proper construction of the relevant agreements the claimant
is entitled to rely on contractual set off pursuant to section 6(f) of the
Calyon Master Agreement, does the code (insofar as applicable) preclude
the defendant from relying on that provision in any way? f
5. Under the laws of the State of New York (insofar as relevant), did any
amount properly calculated under section 6(d) of the Calyon Master
Agreement cease to be payable to the defendant following the claimant’s
Chapter 11 filing on 3 October 2008 as a result of the stay imposed by
s 362(a) of the Code? g
6. As a matter of English law, is the effect of s 362(a) of the Code (insofar
as relevant) such as to prevent the defendant from satisfying the
requirements under English law for set off under the statutes of set off and
CPR 16.6 with regard to the set off at law of any early termination
payment calculated by the defendant under section 6(d) of the Calyon
Master Agreement against the amount payable by the defendant to the h
claimant under the letter of credit?
7. As a matter of English law and having regard to the proper
construction of the letter of credit, even apart from s 362(a) of the Code, is
the defence of legal set off available in respect of a claim for payment
under the letter of credit?
8. Was the early termination payment calculated in accordance with j
section 6(d) of the Calyon Master Agreement?
THE EXPERT WITNESSES
[12] The court has been assisted by three distinguished expert witnesses who
were called to give their opinions on questions of New York law and the code.
 QBD Lehman Brothers v Crédit Agricole (Field J) 259

a Professor Jeffrey Bruce Golden gave evidence on behalf of Calyon. He is

admitted to practice in the states of New York and New Jersey and before the
US Supreme Court. He was in practice for over 30 years in New York and
London and is now visiting professor in the law department at the London
School of Economics. He participated in the preparation of ISDA’s standard
master agreement forms and other documentation for global derivatives and
b has written extensively on the law of derivatives.
[13] Calyon also called Professor Jay Westbrook who is licensed to practise in
the state of Texas and before the US Supreme Court. Professor Westbrook
practised in Washington DC for a number of years before becoming a member
of the University of Texas law faculty. He has written extensively on insolvency
c and bankruptcy subjects.
[14] The expert called by LCBS was Professor Edward R Morrison, Harvey J
Miller Professor of Law and Economics at Columbia Law School. Professor
Morrison has published broadly on topics related to bankruptcy law and
currently serves as a member of the Bankruptcy Rules Advisory Committee,
which advises the US Supreme Court on rules of procedure in bankruptcy
d courts.
[15] By the time of the hearing, issues (2), (4), (5), (6) and (7) had fallen away,
since Professors Westbrook and Morrison were agreed that: (1) if Calyon had a
right of set off, this right would not be stayed under s 362(a) of the Code;
(2) debts arising between the parties under the Calyon Master Agreement and
the letter of credit were mutual, as that term is used under the applicable law
e of New York and the Code; (3) s 362(a) of the Code does not render the
amount properly calculated under section 6(d) of the Calyon Master
Agreement non-payable in the sense of ‘incapable of being paid’; and (4) such
an amount may be ‘payable immediately’ to the extent that ‘safe habour’ rules
contained in s 362(b)(17) and s 560 of the code permit Calyon to satisfy its
claims by means of a contractual right of set off.
f [16] It was also agreed (and so ordered by Burton J) that the determination
of issue (8) should be deferred pending resolution of the question whether
Calyon was entitled to the set off it alleges was available to it under section 6(f).
In the result, the argument at trial centred on issue (3).
[17] On the question whether an obligation owed as issuer of a letter of
g credit was covered by the words ‘any obligation’ in section 6(f),
Professor Golden testified that the courts of New York adopt a ‘formalistic,
textualist approach’ when construing contracts. Entire agreement clauses such
as that in section 9(a) of the Calyon Master Agreement are given virtually
conclusive effect and the parol evidence rule is strictly applied. The aim of
section 6(f) was ‘to mitigate the risk, following termination of the ISDA Master
h Agreement, of a non-defaulting party making a payment to a defaulting party
while, at the same time, that non-defaulting party may not have had any
realistic expectation of receiving payments owed to it by the defaulting party
(and its affiliates) under the ISDA Master Agreement or under other
agreements or instruments’2. The words ‘any obligation’ were unlikely to be
held to be ambiguous. Letters of credit are a familiar form of credit support in
j the global derivatives market. If an obligation owed by one party to the other
under a letter of credit was to be excluded from the reach of section 6(f) it
would have been easy so to have provided.

2 Paragraph 76.
260 All England Law Reports [2012] 1 All ER (Comm)

[18] This approach is essentially the same as that adopted by Briggs J in a

Lomas v JFB Firth Rixson Inc [2010] EWHC 3372 (Ch), [2011] 2 BCLC 120 when
construing the ISDA Master Agreement:
‘It is necessary to begin with some preliminary observations about the
correct approach to construction. The ISDA master agreement is one of
the most widely used forms of agreement in the world. It is probably the b
most important standard market agreement used in the financial world.
English law is one of the two systems of law most commonly chosen for
the interpretation of the master agreement, the other being New York law.
It is axiomatic that it should, as far as possible, be interpreted in a way that
serves the objectives of clarity, certainty and predictability, so that the very
large number of parties using it should know where they stand: see c
Scandinavian Trading Tanker Co AB v Flota Petrolera Ecuatoriana,
The Scaptrade [1983] 1 All ER 301 at 308–309, [1983] QB 529 at 540 per
Robert Goff LJ.’
[19] In his first report, Professor Morrison says that a New York court would
likely observe that the language of section 6(f) is broad, particularly because d
the term ‘obligation’ is not defined in the Calyon Master Agreement. Viewed in
isolation, the term would appear to encompass any payment due from the
claimant to the defendant, regardless of whether the payment arises from an
agreement between the parties or from an undertaking by one party for the
benefit of the other. However, the question arises whether the letter of credit,
coming after the Calyon Master Agreement, expressly or impliedly, curtails the e
right of set off conferred by section 6(f). In Professor Morrison’s view, a
New York court would likely conclude that this was the case if the letter of
credit were explicit that the defendant’s obligations under it are not subject to
set off or if the parties’ intent—as construed by English law—showed that they
expected the defendant’s duties under the letter of credit to be independent of
any rights of set off. f
[20] In a joint memorandum signed on 4 February 2011, Professors
Morrison and Golden agreed that: (1) A New York court, reading section 6(f) in
isolation would (in Professor Golden’s view) or would likely (in Professor
Morrison’s view) permit set off of obligations arising from the Calyon Master
Agreement against obligations arising either from separate agreements
g
between the parties or from separate undertakings by one party for the benefit
of another; (2) a New York court would enforce a purported amendment of
the Calyon Master Agreement only if the amendment modifies or conflicts
with the Calyon Master Agreement and satisfies the procedural rules
established by section 9(b) of the Calyon Master Agreement;
Professor Morrison believed that a New York court would interpret these h
procedural rules in light of New York’s General Obligations law and related
case law; and (3) a New York court would apply New York law to determine: (i)
the scope of the set off rights created by section 6(f); (ii) the formalities
required by section 9(b) with respect to amendments, modifications, or waivers
of the Calyon Master Agreement and whether the letter of credit satisfies these
requirements; and (iii) whether the terms of the letter of credit conflict with, j
and therefore modify, the rights created by section 6(f).
[21] A few days before the hearing LBCS raised a new point. It was alleged
that there was a market practice which rendered the word ‘obligation’ in
section 6(f) ambiguous with the result that the word would be narrowly
construed so as to exclude obligations arising under the letter of credit and
 QBD Lehman Brothers v Crédit Agricole (Field J) 261

a thereby avoid an unreasonable and/or absurd result. The alleged market

practice was the inclusion in credit support annexes, where a letter of credit is
‘Eligible Credit Support’ under an ISDA Master Agreement, of provisions
allowing the counter-party beneficiary to draw on the letter of credit after an
event of default and apply the ‘proceeds’ (in the sense of a cash receipt) from
such drawing against amounts payable to the counterparty-beneficiary under
b the master agreement.
[22] In support of this new point, LBCS relied on a second supplemental
report by Professor Morrison dated 21 February 2011. In this report, Professor
Morrison assumed that the effect of allowing a set off under section 6(f) would
lead to an ‘absurd’ situation in which EDF would be liable to indemnify Calyon
c for the whole value of the letter of credit (€50,000,000) and yet remain liable to
LBCS for the difference between €125,538,461 and €38,377,190·69—
€87,161,270·40—and at the same time LBCS would have the benefit of a
windfall of €11,622,809·31, by reason of being discharged of its indebtedness to
Calyon.
[23] At the hearing, Mr Choo-Choy QC for LBCS accepted that Calyon had
d been given insufficient notice of the alleged market practice for that part of the
new case to be proceeded with. What he sought leave to do was to be allowed
to run a construction argument under New York law that was founded on the
assumed unreasonable/absurd outcome in this particular transaction without
placing any reliance on a market practice. And this is what he was permitted to
do, with the grudging acceptance of Mr Dicker QC for Calyon.
e [24] Mr Choo-Choy’s submission that a right to set off Calyon’s obligations
under the letter of credit against debts due under the Calyon Master
Agreement would give rise to absurd/unreasonable results depends on the
meaning and effect of the terms of the EDF/LBCS Master Agreement,
including in particular the credit support annex (the EDF CSA).
[25] The basic scheme of the EDF CSA is to ensure that any exposure that
f the parties have in relation to their transactions is credit supported by a transfer
of title in cash or certificated securities by delivery in the manner specified. If
there is a default, the value of cash and/or securities is set off against the
exposure. In respect of eligible credit support comprised of a letter of credit,
however, the value thereof is excluded from the calculation of the value of the
g credit support balance for the purposes of fixing payments on early
termination under cl 6(e) (see para 6, default, set out at [26], below), but if
there is an event of default or termination event with respect to a transferor of
a letter of credit, or an early termination date is designated or deemed to occur
with respect to a transferor of a letter of credit, then—
‘[T]he Transferee may draw on the entire or part of the undrawn portion
h of any outstanding letter of credit upon submission to the issuer thereof of
one or more documents specifying the amounts due and payable to the
Transferee in accordance with the specific requirements of the Letter of
Credit. The Transferor shall remain liable for any amount due and payable
to the Transferee and remaining unpaid after the application of the
amounts so drawn by the Transferee’. (See para 11(h)(iv)(v)(3) set out
j at [26], below.)
[26] The particular relevant provisions of the EDF CSA are:
‘[The opening paragraph]
This annex supplements, forms part of, and is subject to the ISDA Master
Agreement referred to above and is part of its Schedule. For the purposes
262 All England Law Reports [2012] 1 All ER (Comm)

of this Agreement, including, without limitations, ss 1(c), 2(a), 5 and 6, the a

credit support arrangements set out in this Annex constitute a Transaction
(for which this Annex constitutes the Confirmation) …
Paragraph 6. Default
If an Early Termination Date is designated or deemed to occur as a result
of an Event of Default in relation to a party, an amount equal to the Value b
of the Credit Support Balance, determined as though the Early
Termination Date were a Valuation Date, will be deemed to be an Unpaid
Amount due to the Transferor (which may or may not be the Defaulting
Party) for purposes of s 6 (e). For the avoidance of doubt if Market
Quotation is the applicable payment measure for purposes of s 6 (e), then
the Market Quotation determined under s 6 (e) in relation to the c
Transaction constituted by this Annex will be deemed to be zero, and, if
Loss is the applicable payment measure for purpose of s 6 (e), then the
Loss determined under s 6 (e) in relation to the Transaction will be limited
to the Unpaid Amount representing the Value of the Credit Support
Balance …
d
Paragraph 10. Definitions
“Credit Support Balance” means, with respect to a Transferor on a
Valuation Date, the aggregate of all Eligible Credit Support that has been
transferred to or received by the Transferor under this Annex, together
with any Distributions and all proceeds of any such Eligible Credit Support
or Distribution, as reduced pursuant to Paragraph 2 (b), 3 (c)(ii) or 6; Any e
Equivalent Distributions or Interest Amount (or portion of either) not
transferred pursuant to Paragraph 5(c)(i) or (ii) will form part of the Credit
Support Balance.
Paragraph 11. Elections and variables …
(b) Credit Support Obligations …
(ii) Eligible Credit Support. The following items will qualify as “Eligible f
Credit Support” for the party specified …
(2) Letter of Credit (as defined in Paragraph 11(h)(iv)(i) but only to the
extent that the undrawn portion of the Value of the Letters of Credit
comprised in a party’s Credit Support Balance does not (or would not if as
of the Valuation Date one or more Letters of Credit were comprised in g
Eligible Credit Support Transferred pursuant to Paragraph (2) (a), 3(c) or
4 (a) exceed $100,000,000 (USD one hundred million) or its equivalent in
Euros.
[The party specified is B (ie EDF) and the Valuation Percentage is: “100%
of the Value of the undrawn portion of any Letter of Credit unless a
Letter of Credit Default shall occur and be continuing with respect to such h
Letter of Credit, in which case the Valuation Percentage shall be zero”.
Party A is LBCS.] …
(h) Other Provisions …
(iv) Letters of Credit – Definitions
(i) Letter of Credit means an irrevocable, transferable standby letter of
credit denominated in the Base Currency or an Eligible Currency issued by j
a financial institution acceptable to the other Party with a Credit Rating at
the time of issue of at least A by S&P or A2 by Moody’s, in a form
acceptable to the Transferee.
(v) Letters of Credit - Other Provisions
(1) Default. For the purposes of Paragraph 6:
 QBD Lehman Brothers v Crédit Agricole (Field J) 263

a (aa) the Value of Eligible Credit Support comprised of a Letter of Credit

shall be excluded from the calculation of the Value of the Credit Support
Balance; and
(bb) in respect of any Letter of Credit, to the extent that the Transferee draws
under such Letter of Credit, the Transferee may apply any proceeds of such
drawing against any amount payable to it as a result of a Termination Event, an
b Event of Default or an Early Termination Date and exercise any other applicable
rights it may have in respect of such proceeds. [My emphasis.] …
(3) Drawing. If:
(aa) an Event of Default or Termination Event has occurred and is
continuing with respect to a Transferor of an outstanding Letter of Credit;
c or
(bb) an Early Determination Date is designated or deemed to occur as a
result of an Event of Default or Termination Event with respect to a
Transferor of an outstanding Letter of Credit; or
(cc) The Transferor of an outstanding Letter of Credit shall fail to pay or
deliver, when due, any amount payable by it under the Agreement and
d such failure is continuing ; or
(dd) a Letter of Credit Default has occurred and is continuing with
respect to a Letter of Credit comprised in a party’s Credit Support Balance,
then the Transferee may draw on the entire or part of the undrawn portion of any
outstanding Letter of Credit upon submission to the issuer thereof of one or more
documents specifying the amounts due and payable to the Transferee in accordance
e with the specific requirements of the Letter of Credit. The Transferor shall remain
liable for any amounts due and payable to the Transferee and remaining unpaid
after the application of the amounts so drawn by the Transferee. [My emphasis.]
(4) Other …
(c) For the avoidance of doubt and notwithstanding that the Value of
Eligible Credit Support comprised of a Letter of Credit shall be excluded
f from the calculation of the Value of the Credit Support Balance for the
purpose of Paragraph 6, the amount of any drawing of a Letter of Credit
shall constitute Eligible Credit Support and shall be comprised in the
Credit Support Balance of the Letter of Credit’s Transferor.’
[27] Mr Choo-Choy submitted that the net effect of above provisions,
g particularly the italicised paragraphs (paras 11 (h)(iv)(v)(1)(bb) and 11
(h)(iv)(v)(1)(3)), is that: (1) the amount payable by the transferor to the
transferee of a letter of credit which has been provided as eligible credit
support is only reduced ‘to the extent that the Transferee draws under such
Letter of Credit3 [and] appl[ies] any proceeds of such drawing against any
amount payable to it as a result of … an Event of Default or an Early
h Termination Date’; and (2) the Transferor remains liable to the Transferee for
the amount which remains unpaid after the application of the proceeds of the
drawing by the Transferee.’
[28] Mr Choo-Choy emphasised that under these provisions the application
of the proceeds of any drawing is expressed to be by the transferee (ie the
j beneficiary of the letter of credit) and the transferor continues to be liable for
what remains unpaid after the transferee has applied the proceeds of the
drawing to the transferee’s debt. This is inconsistent, he submitted, with
the issuer of the letter of credit having a right to determine how to apply the
3 In other words, the transferee of a letter of credit (here, LBCS) is entitled, but not obliged, to draw
on a letter of credit which has been procured by the transferor (here, EDF) in the transferee’s favour.
264 All England Law Reports [2012] 1 All ER (Comm)

proceeds of a demand for payment under the letter of credit (such as by set off a
against a separate debt owed or alleged to be owed by the transferee to the
issuing bank). It followed that, since the proceeds of LBCS’s drawing under the
letter of credit amounted to €38,377,190·69 only, the debt owed by EDF to
LBCS as a result of the relevant event of default (ie the Lehman bankruptcy)
and consequent early termination date was only reduced by that amount,
leaving EDF liable to LBCS for €125,538,461, less €38,377,190·69 b
ie €87,161,270·40. And if, by reason of its purported set off, Calyon were
entitled to claim credit for the full letter of credit amount of €50,000,000 as
against EDF, the absurd result would be a windfall of €11,622,809·31 for LBCS
with EDF being liable for that amount twice over.
[29] I do not accept these submissions. In the absence of an express c
agreement to the contrary, where an obligee is owed money by A and can look
to B in respect of the same debt, a set off by B reduces pro tanto the debt owed
by A; see MS Fashions Ltd v Bank of Credit and Commerce International SA (in liq)
(No 2) [1993] 3 All ER 769, [1993] Ch 425. It follows that, in the absence of a
contrary provision in the EDF/ISDA Master Agreement, Calyon’s set off in
respect of the sum owed by LBCS reduced the sum owed to LBCS by EDF; and d
this reduction would feature in the taking of the account between EDF and
LBCS that is implied by the law, see Cargill International SA v Bangladesh Sugar
and Food Industries Corp [1998] 2 All ER 406, [1998] 1 WLR 461. Furthermore,
there is nothing in the EDF CSA, including the above italicised provisions, that
excludes this outcome. Instead, the words, ‘the Transferor shall remain liable
for any amount due and payable to the Transferee and remaining unpaid after e
the application of the amounts so drawn by the Transferee’ mean that if there
is anything that is still due after the full value of the letter of credit has been
received, EDF has to pay the balance in any event. The words do not
contemplate that merely because the issuer of the letter of credit pays and the
transferee receives value under the letter of credit partly by way of set off, that
receipt of value is something of which the transferor cannot take the benefit. f
[30] EDF has not been made a party to the proceedings and the agreement
governing Calyon’s right to be reimbursed or indemnified in respect of the
letter of credit has not been disclosed on grounds of French banking secrecy.
However, approaching the matter in terms of general principle, I am of the
opinion that, LBCS having had the full value of the letter of credit, EDF would g
be obliged to reimburse or indemnify Calyon in respect of that full value.
[31] Professors Golden and Morrison are agreed that in New York
proceedings the meaning and effect of the EDF/LBCS Master Agreement
would be determined by English law. It follows that LBCS’s ‘absurdity’
argument would be bound to fail at the first hurdle in a New York court, for on
its true construction the EDF CSA does not have the ‘absurd’ or ‘unreasonable’ h
consequences on which the argument is premised.
[32] But even if the EDF CSA does give rise to the consequences contended
for by LBCS, I am not persuaded that a New York court would read down what
would otherwise be the plain meaning of section 6(f) so as to hold that ‘any
obligation’ did not include obligations arising under the letter of credit.
[33] Whilst recognising that there are no cases directly on point, Professor j
Morrison expressed the view that a New York court could construe Section 6(f)
so as to avoid the ‘unreasonable’ result of EDF being liable both to indemnify
Calyon for the full value of the letter of credit and to pay LBCS the difference
between €125,538,461 and €38,377,190·69—€87,161,270·40, whilst LBCS would
have the windfall of being released from its debt due to Calyon.
 QBD Lehman Brothers v Crédit Agricole (Field J) 265

a Professor Morrison instanced cases4 where a New York court had adopted a
particular construction of a contract so as to avoid an unreasonable result as
between the parties to the contract. He agreed that in these cases the approach
of the court was to construe the intention of both parties and if on the basis of
matters known to both a particular construction would produce an absurd
result, it could be concluded that the parties were unlikely to have intended
b that result. He also referred to Re Bond and Mortgage Guarantee Co (1935) 196 NE
313 where an insured was held to be free to terminate the appointment of an
insurance company under a contract of mortgage insurance to collect the
interest and principal due from a mortgagor in circumstances where,
subsequent to the execution of the contract, the mortgagor was made
c independent of both the mortgagee and the insurer by a change in the law and
the insurer was in the hands of a rehabilitator having become insolvent. In the
opinion of the Court of Appeals of New York, the basis on which the policy
had been entered having been removed and the value of the guarantee
impaired, the question was what would a reasonable and fair-minded business
man in the place of the insurer be entitled to expect. To which the answer was
d that the insured should be entitled to end the contract upon giving a release to
the insurer.
[34] Professor Morrison said that at first he had thought that this case was a
frustration case but his researches revealed that it had only been cited as an
interpretation case and not a frustration case by the courts of New York.
Nonetheless, he accepted that ‘arguably it does seem to fall into a frustration
e kind of paradigm’.
[35] Professor Golden was firmly of the view that a New York court would
not read down section 6(f) in light of the absurdity alleged by LBCS.
Section 6(f) conferred a most important right of set off and its language was
plain and unambiguous. The set off right is particularly important given that
under the second method of calculation of sums due on early termination the
f non-defaulting party may have to pay a defaulting party which has become
insolvent. Certainty in commercial transactions such as the ISDA Master
Agreement was of the greatest importance. A New York court would not
undermine the clear right of set off conferred by section 6(f) where the alleged
absurdity arises from a subsequent contract to which Calyon is not a party and
g which contained a peculiarly English CSA which involved risks in that it treated
a letter of credit as eligible credit support. These risks arose because English
CSAs (like the EDF CSA) rely on a transfer of title theory and might for that
reason be characterised by US courts as creating a security interest and then be
struck down for failure to comply with the formalities necessary to perfect that
interest.
h [36] I found Professor Golden’s evidence to be persuasive. In my judgment,
a New York court would not read down section 6(f) to avoid the postulated
absurdity because: (i) Calyon entered into the Calyon Master Agreement and
issued the letter of credit unaware of the EDF/LBCS Master Agreement;
(ii) the right of set off conferred by section 6(f) is an important right and
Calyon were entitled to assume that section 6(f) meant what it said; (iii) the
j absurdity cases cited by Professor Morrison did not involve third party

4 Wood v Lucy (1917) 118 NE 215; Shearson Lehman Bros Holdings Inc v Schmertzler (1986) 500 NYS 2d
512; Wallace v 600 Partners Co (1995) 658 NE 2d 715; Lipper Holdings LLC v Trident Holdings LLC (2003)
766 NYS 2d 561; Simas v Merrill Corp (2004) US Dist LEXIS 1415; N Edelson Sons Corp v National Union
Fire Ins Co (1994) US Dist LEXIS 7463.
266 All England Law Reports [2012] 1 All ER (Comm)

absurdity but were concerned with consequences for the parties to the contract a
under consideration and, save for Re Bond and Mortgage Guarantee Co, were cases
where the intention of the parties was being construed by reference to the
wording they used and the surrounding circumstances known to each when
they entered into the contract; (iv) Re Bond and Mortgage Guarantee Co is in the
nature of a frustration case and in any event is one which is readily
distinguishable on the facts; and (v) such ‘absurdity’ as results from the EDF b
CSA if section 6(f) applies to the letter of credit should be borne by EDF and
LBCS rather than being finessed by a reading down of section 6(f).
[37] Mr Choo-Choy further submitted that under English law, Calyon’s
agreement to issue the letter of credit amounted to an implied exclusion of
whatever rights of set off Calyon might otherwise have had. I am not sure if it c
was Mr Choo-Choy’s intention to separate out a prior agreement to open the
letter of credit from the letter of credit itself. I suspect that it was not. If it was,
I think that such an approach is impermissible on the facts before the court.
Rather, what has to be considered is the scope of Calyon’s rights and
obligations as the issuing bank by reference to the letter of credit’s terms
construed against the admissible background ie ‘all the relevant facts d
surrounding the transaction so far as known to the parties’ per Lord Bingham in
Bank of Credit and Commerce International SA (in liq) v Ali [2001] UKHL 8 at [8],
[2001] 1 All ER 961 at [8], [2002] 1 AC 251 (my emphasis).
[38] It is important to note at the outset that the letter of credit contains no
express provision excluding any right of set off. It is expressed to be available
for payment at sight on presentation of a written statement signed by an e
authorized representative of LBCS certifying that EDF has not performed in
accordance with the terms of an agreement between LBCS and EDF and the
amount being drawn. It also provides:
‘WE (CALYON) HEREBY IRREVOCABLY UNDERTAKE TO COVER
YOU (IE LBCS) AS PER YOUR INSTRUCTIONS WITH VALUE TWO f
BANK WORKING DAYS.
THIS IRREVOCABLE STAND-BY LETTER OF CREDIT IS SUBJECT
TO THE UNIFORM CUSTOMS AND PRACTICE FOR
DOCUMENTARY CREDITS (2007 REVISION), ICC PUBLICATION 600
AND, TO THE EXTENT INCONSISTENT THEREWITH, SHALL BE
GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH g
ENGLISH LAW.’
[39] Mr Choo-Choy argued that LBCS’s instruction to Calyon in its letter of
12 November 2008 ‘to transfer the amount of EUR 50,000,000 without
deduction’ prohibited Calyon from making the set off they purported to make
by reason of the words, ‘We hereby irrevocably undertake to cover you h
(ie LBCS) as per your instructions’ in the letter of credit.
[40] I decline to accept this submission. In my opinion, the words ‘[w]e
hereby irrevocably undertake to cover you (ie LBCS) as per your instructions
…’ have nothing to do with set off but are intended to cover situations such as
where drawings are multiple or partial or where particular bank accounts are
identified to which payment is to be made. They do not mean that Calyon was j
agreeing to give up a pre-existing right of set off depending on the wording of
LBCS’s subsequent instructions.
[41] Further and in the alternative, Mr Choo-Choy argued that it was clear
from the context that it must have been intended by Calyon and LBCS that the
letter of credit was to be paid without deduction. In support of this
 QBD Lehman Brothers v Crédit Agricole (Field J) 267

a submission, he relied on the provisions in the EDF CSA set out above and on
the proposition that the letter of credit arrangement agreed by LBCS and EDF
was a form of eligible credit support which was not at risk of the exercise of
set off by EDF itself, a state of affairs that was inconsistent with LBCS
becoming subject to a set off by Calyon under the letter of credit.
[42] The short answer to this submission is that Calyon was not a party to
b the EDF/LBCS Master Agreement and was unaware of the EDF CSA when it
entered into the Calyon Master Agreement and when it issued the letter of
credit. It follows that the EDF/LBCS Master Agreement cannot of itself affect
Calyon’s pre-existing rights of set off and nor can the EDF CSA be part of the
factual matrix against which the letter of credit stands to be construed.
c Moreover, for the reasons I have already given, properly construed, the
EDF/LBCS Master Agreement does not produce the absurdity postulated by
Mr Choo-Choy.
[43] I accordingly have no hesitation in concluding that the letter of credit is
not to be construed as being payable without any right of set off.
[44] In the face of this conclusion it is plain that a New York court would not
d hold that the letter of credit modifies, waives or conflicts with the rights
conferred on Calyon by section 6(f). A New York court would therefore not go
on to consider whether the letter of credit complies with section 9(b) of the
Calyon Master Agreement or whether the letter of credit is an enforceable
amendment of section 6(f) under the New York General Obligations law.
Instead, a New York court would hold that Calyon has the right under
e section 6(f) to set off LBCS’s debt to it of $US15,030,239 against its obligation
to LBCS under the letter of credit to pay €50,000,000.
[45] In the light of the foregoing conclusion, it is unnecessary to consider
whether Calyon had a right of legal set off under the general law and I decline
to do so.
[46] Given the conclusions expressed above and the agreement reached by
f the experts on various of the Issues, I think it is only necessary and appropriate
to answer the questions posed in Issues 3, 4 and 5, which I answer as follows:
Issue 3: Yes. Issue 4: No. Issue 5: No.
Order accordingly.
g Aaron Turpin Barrister.