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Bailing out Lehman Brothers?

Bailing out Lehman Brothers? – Lehman Brothers International (Europe) (In Administration) v Exotix Partners LLP and escaping subjective mistakes through contractual construction

Lehman Brothers International (Europe) (In Administration) v Exotix Partners LLP [2019] EWHC 2380 (Ch) is another reminder of the flexibility of contractual construction as an alternative to rectification for subjective mistakes.

The basic facts of the case are that Lehman was holding 22,955 Peruvian Government global depository notes (GDNs), a form of exotic securities which are derivates from governmental bonds issued by an intermediary (in this case Citibank). Lehman regarded these GDNs as ‘scraps’ worth approximately $7,500, seemingly on the tacit assumption that the nominal value of the underlying governmental bonds on which they were based was 1 Peruvian Sol (S/). In fact, the nominal value was S/1000, resulting in the GDNs being 1000 times more valuable than was realised. In order to unload these ‘scraps’, Lehman Bros bundled them together with some Venezuelan securities which Exotix wished to purchase and contracted with Exotix, by means of a recorded telephone call, for the sale of GDNs. Exotix also believed that it was purchasing ‘scraps’ and that the GDNs had little value. Subsequently, Lehman Bros transferred 22,955 GDNs to Exotix for a total consideration of $7,707.93 – 1/1000th of their true value. Exotix did not initially notice the mistake, but when they discovered it, resolved not to inform Lehman and sold on the GDNs leading to a windfall of approximately $8.5m, which Lehman sought to recover.

The principal dispute between the parties was one of contractual construction, namely a dispute as to whether the subject-matter of the contract was 22,955 GDNs or whether it was GDNs with a nominal value of S/22,955 (and therefore 22.955 GDNs). This construction dispute had the complication that neither party had given any thought to this distinction, since their mistaken assumption entailed that the two were identical. Ultimately, Hildyard J preferred Lehman’s interpretation that the contract was for GDNs with a nominal value of S/22,955, and therefore that it had over-delivered on the contract effectively one thousand-fold. This interpretation gave rise to the further problem that GDNs are only tradable in integer values, not fractions. Hildyard J resolved this problem through the implication of an implied term that a contract to deliver 22.955 GDNs entailed an obligation to deliver 22 GDNs and then the cash value of the remaining fraction. Hildyard J held that such an implied term could not be derived from established trade custom, as Lehman primarily advanced, but could be implied in order to give coherence to the contract pursuant to The Moorcock or ‘business efficacy’ test.

Alternatively, Hildyard J held, obiter, that if such a term could not be implied, then the contract should be void by reason of a mistake which rendered the contract impossible to perform according to its terms, since it was impossible to transfer 22.955 GDNs. Since Hildyard J regarded the case as one of impossibility (and since Lehman had not advanced a positive case on mistake), he held that the criteria surrounding ‘state of affairs’ mistakes expounded in The Great Peace did not apply to the present contract. In other words, mistakes leading to impossibility of performance were a separate category of mistake capable of avoiding an executory contract and which led to a failure of consideration and restitution in the event of a contract which had been (imperfectly) performed.

This case is an interesting complement to the much-discussed Court of Appeal decision in FSHC Group Holdings Ltd v GLAS Trust Corporation Ltd [2019] EWCA Civ 1361, which clarified that the test for rectification is subjective (at least up to Court of Appeal level). Rectification was not pleaded in Lehman Bros, and the fact that Lehman was able to succeed without such a plea is a useful reminder that a client’s best first port of call having entered into a transaction under a misapprehension may often be a flexible (and sometimes even creative) construction argument. Such an approach enables a judge to take into account a myriad of considerations – including, importantly, good commercial sense – in order to reach the desired result. This can offer a very powerful route of recourse, especially if such an argument can be bolstered by an implied term, as occurred in this case. Moreover, this argument can have the benefit of circumventing some of the express restrictions and the limitations which the courts have placed upon the doctrines of rectification and mistake, which, given their specific purpose of dealing with subjective errors, might initially be thought to be more apposite.

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