The High Court has summarily determined that a bank’s default notice of an event of default to an energy company, for failure to pay monies due under a foreign exchange (FX) swap, was valid under the terms of the 2002 ISDA Master Agreement governing the transaction: Macquarie Bank Limited v Phelan Energy Group Limited  EWHC 2616 (Comm).
The decision will be of interest to financial institutions trading in derivatives based on standard form ISDA documentation. It provides guidance on what constitutes a valid notice of an event of default by a non-defaulting party under section 5(a)(i) of the 2002 ISDA Master Agreement. The decision is also a reassuring one for financial institutions as it highlights that where there is a dispute over the terms of a transaction, such as the amount or currency of a swap, this does not necessarily mean that the default notice is automatically invalid, as long as it complies with the contractual provision in the transaction documentation requiring the notice.
In the present case, the court was satisfied that it was not necessary for the amount stated in the bank’s default notice to be correct for it to be valid. The court emphasised that it was clear that the default notice served by the bank met the requirements of section 5(a)(i) of the 2002 Master Agreement. It would have been immediately and unambiguously clear to the company that: (i) the bank was complaining of a failure to make the payment due to it under the FX swap; (ii) the company had made no payment under the FX swap; and (iii) on the face of the documents, it was obliged to pay a certain sum to cure the default to remedy that failure.
We consider the decision in more detail below.
On 14 May 2021, a bank (Bank) and an energy company (Company), entered into a USD / ZAR FX swap with payment being due by the Company on 28 May 2021 (the FX Swap). The FX Swap was governed by an ISDA 2002 Master Agreement agreed between the Bank and Company in 2019 (the Master Agreement). On 28 May 2021, the Bank emailed the Company stating that it had not yet received the amount due. The Bank used the strike price of ZAR 22.16 to estimate the amount due in its email. The Company disputed that the amount included in the Bank’s email was due or was correct. On 31 May 2021, the Bank served a default notice on the Company requiring it to make a payment of the amount it had estimated (the Default Notice). The Default Notice stated that a failure to make the payment in the time period set out would amount to an event of default under section 5(a)(i) of the Master Agreement. The Company again disputed that the amount was due or correct.
On 3 June 2021, the Bank sent a letter designating 4 June 2021 as the early termination date pursuant to section 6(a) of the Master Agreement (the Early Termination Date Notice). The Company contended that it was not open to the Bank to designate an early termination date as the Company had disputed the Default Notice. Subsequently, on 9 June 2021, the Bank sent the Company a notice of the early termination amount (again determined based on the strike price of ZAR 22.16) (the Early Termination Amount Notice).
The Bank brought a debt claim against the Company. The Bank’s case was that the Company was required under the FX Swap to make certain payments on the settlement dates prescribed in the FX Swap. The Company’s failure to make the payment due in May 2021 constituted an event of default under the Master Agreement. This was a continuing event of default which triggered the early termination provisions under the Master Agreement. The Bank had followed the applicable provisions for early termination, pursuant to which the Company became liable to pay the early termination amount due. The Company denied the claim. The Company contended that it was not liable to pay the sums due given that it disputed the terms of the FX Swap, in particular the strike price for the trade.
The Bank subsequently brought an application for summary judgment on the termination issue, pending the resolution of the issue as to what was the correct strike-out price.
The High Court found in favour of the Bank on the termination issue.
The court held that it was clear that the Default Notice served by the Bank met the requirements of section 5(a)(i) of the Master Agreement. It would have been immediately and unambiguously clear to the Company that: (i) the Bank was complaining of a failure to make the payment due to it under the FX Swap; (ii) the Company had made no payment under the FX Swap; and (iii) on the face of the documents, it was obliged to pay a certain sum to cure the default to remedy that failure.
The key issues which may be of broader interest to financial institutions are examined below.
1. Was there an Event of Default within section 5(a)(i) of the Master Agreement?
Key terms of the Master Agreement
The court noted that for an event of default to occur under section 5(a)(i) of the Master Agreement, there must be a failure by a party to make payment, which has not been remedied in the grace period after notice of the failure has been given.
Construction of the Master Agreement
The court highlighted that it had regard to the following legal principles when interpreting the Master Agreement:
- the Master Agreement 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 (as per Lomas v JFB Firth Rixson Inc  EWHC 3372).
- the focus is ultimately on the words used, which should be taken to have been selected after considerable thought and with the benefit of the input and continuing review of users of the standard forms and of the knowledge of the market (as per Lehman Brothers International (Europe)  EWHC 2417 (Ch)).
Requirements for a valid notice under sections 5(a)(i) and 5(a)(ii) of the Master Agreement
The court emphasised that the issue of whether the notice under section 5(a)(i) needed to specify the outstanding amount of payment at all, and what the consequence of including an incorrect figure would be, was ultimately a matter of construction of two documents:
- the contractual provision providing for the notice to be served, in order to identify what was described in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd  UKHL 19 as “the specification in the clause”.
- of the notice, to ascertain whether, properly construed in context, it met the requirements of that specification.
The court also noted that the grace period which service of a valid notice triggers is a relevant consideration when determining what is necessary for a notice to be effective. As per Deutsche Bank AG v Sebastian Holdings Inc  EWHC 3463 (Comm) and Greenclose Ltd v National Westminster Bank plc  EWHC 1156 (Ch), the whole point of section 5 (a)(ii) and section 2(a)(iii) is to provide an opportunity to remedy the failure which gave rise to the event of default or potential event of default.
The court then underlined that a valid notice under section 5(a)(i) must be such as to:
- communicate clearly, readily, and unambiguously to the reasonable recipient in the context in which it is received the failure to pay or deliver in question, such that the recipient will clearly understand the trade under which the obligation to pay or deliver has arisen and the particular obligation which it is said has not been performed; and
- thereby enable the recipient to identify what the relevant trade requires it to do in order to cure the alleged failure within the applicable grace period.
The court rejected the Company’s contention that a valid notice required the notice to set out: (i) identification of the confirmation for the relevant transaction, (ii) a precise and accurate statement of the amount due, and (iii) the currency of the payment. In the court’s opinion, this would result in a number of improbable consequences such as very minor mistakes (e.g., in relation to the reference number of the relevant trade or other typing errors) invalidating the notice. The court did not agree that the language or nature of the Master Agreement required such an interpretation.
The court also highlighted that, as per Mannai, the issue of whether the required information had been communicated unambiguously does not solely rely on the language used, and that there can be an unambiguous communication of information even if the communication involves a mistake. This is because the context in which the notice is received will also be relevant to what information the notice communicates to the recipient.
Did the disputed Default Notice meet the requirements of section 5(a)(i)?
The court considered the context in which a reasonable person would have received and read the Default Notice. In the circumstances of the present case, the court highlighted, amongst others, the following factors:
- the Default Notice referred to the Company’s failure to make a payment on 28 May 2021 in respect of the FX Swap.
- the 28 May 2021 settlement date and the Master Agreement were expressly referred to in the Default Notice.
- the transaction reference included in the Default Notice was the same as that included on the confirmation sent by the Bank regarding a trade done on 14 May 2021 for settlement on 28 May 2021.
The court concluded that the Default Notice was valid because it would have been immediately and unambiguously clear to the Company on reading the Default Notice that: (i) the Bank was complaining that the Company had failed to make payment due by the 28 May 2021 settlement date under the FX Swap; (ii) the Company had indeed made no payment under the FX Swap; and (iii) on the face of the documents, it was obliged to pay a certain sum to cure the default to remedy that failure.
2. Was the Early Termination Date Notice valid?
The court said that given it had concluded that the Default Notice was valid (and consequently that there was an event of default as the failure to pay was not remedied in the grace period after the Default Notice was served), the Company’s argument that the Early Termination Date Notice was invalid because there was no event of default failed.
The court then confirmed that the FX Swap had been terminated and that the termination date was 4 June 2021.
Accordingly, the court found in favour of the Bank on the termination issue.