Leaving LIBOR – the ISDA Protocol and Supplement

With LIBOR due to disappear by end-2021, work has been underway to facilitate the transition from LIBOR and other IBORs to alternative risk free rates (RFRs). The derivatives market has been at the forefront of the transition and is some distance further ahead than other financial markets. In particular, ISDA has recently published the 2020 IBOR Fallbacks Protocol and IBOR Fallbacks Supplement, which introduce hardwired fallbacks from IBORs to relevant RFRs for new products and legacy products.

Publication of these documents is a key milestone in the transition journey from IBORs to RFRs, and amounts to the starting gun being fired on what is expected to be a mass market wide repapering and amendment exercise as the market says goodbye to the old world of IBORs and welcomes the new world of RFRs. We expect clients will wish to enter into the IBOR Fallbacks Protocol to amend existing transactions, and to include the IBOR Fallbacks Supplement in new trades. In agreeing to do so, hardwired fallbacks from LIBOR to RFRs will be included in the transactions, which will clearly have a significant impact on those transactions and beyond. Clients are therefore well advised to give careful thought to the issues raised by these documents.

Our briefing (which can be found here) provides a detailed analysis of the two publications, including the issues they raise and how adherence to these documents will affect clients’ existing and future transactions.

Nick May
Nick May
Partner
+44 20 7466 2617
Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Clive Cunningham
Clive Cunningham
Partner
+44 20 7466 2278
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Commercial Court grants declaratory relief to bank relating to its rights under the 1992 ISDA Master Agreement

The Commercial Court has granted declaratory relief concerning a bank’s rights under an interest rate hedging arrangement governed by the 1992 ISDA Master Agreement: BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2020] EWHC 2436 (Comm).

This is the substantive English trial judgment in the long-running (and cross-jurisdictional) dispute between BNP Paribas S.A. (the Bank) and the Italian public-private partnership, Trattamento Rifiuti Metropolitani S.p.A. (TRM). The dispute relates to a 2008 loan provided by a syndicate of banks (led by the claimant Bank) to TRM, and the associated hedging arrangements, which TRM says the Bank negligently advised it to enter into.

The decision will be welcomed by market participants for providing an abundance of detailed and helpful commentary on key provisions of the ISDA Master Agreement, and more broadly by financial institutions for its analysis of non-reliance clauses, together with guidance for parties seeking declaratory relief. The key takeaways are as follows:

1. Non-reliance clauses in a financial services context

One of the declarations considered by the court tracked the Non-Reliance provisions at Part 5(d)(i) of the Schedule to the ISDA Master Agreement, and asked for a declaration that TRM had “made its own independent decision” to enter into the hedging transaction and was not relying on communications from the Bank as investment advice or as a recommendation to enter into the hedging transaction. A further declaration sought provided that these provisions gave rise to a contractual estoppel, so that TRM was estopped by the ISDA Master Agreement from contending, for example, that it had relied on any representations given by the Bank as investment advice or a recommendation to enter into the hedging transaction.

The court swiftly agreed to grant the declarations tracking the parts of the Schedule, but the question of contractual estoppel gave rise to more detailed analysis. Following Springwell Navigation Corpn v JP Morgan Chase Bank [2010] EWCA Civ 1221, the court confirmed that there is no distinction between: (a) warranties and undertakings (each of which TRM accepted could give rise to an estoppel); and (b) an acknowledgement or a representation (each of which TRM argued could not). The court referred to Leggatt LJ’s commentary suggesting otherwise in First Tower Trustees and another v CDS (Superstores International) Ltd [2018] EWCA Civ 1396, noting that this was obiter. The court also noted that the factual situation in First Tower was very different (since the case concerned the effect of an exclusion clause in a commercial lease and its effect vis à vis pre-contractual enquiries which misrepresented the position as regards asbestos on site). The court specifically noted that Leggatt LJ was not purporting to consider the effect of representations typically made in a financial services context.

The court also rejected TRM’s argument that the Non-Reliance provisions sought to exclude liability for misrepresentation under the Misrepresentation Act 1967, and so were subject to the requirement of reasonableness under section 11(5) of the Unfair Contract Terms Act 1977 (UCTA). This can be contrasted again with the decision in First Tower (which, interestingly, was not cited in the judgment on this point), as considered in our blog post: Court of Appeal finds non-reliance clause sought to exclude liability for misrepresentation and was therefore subject to UCTA reasonableness test.

Although the court considered these arguments in the context of the 1992 ISDA Master Agreement, its findings would also be relevant for a bank relying on the non-reliance language in the 2002 ISDA Master Agreement.

2. Entire Agreement clause in the ISDA Master Agreement

The court rejected TRM’s argument that the standard ISDA entire agreement clause was not effective and that TRM was able to rely on separately negotiated terms of the Financing Agreement as prevailing over the ISDA terms. The court said that the meaning of the entire agreement clause in the ISDA Master Agreement is “clear and unambiguous” on its face, and that TRM’s approach would sit uneasily with, while the Bank’s argument was harmonious with, the dicta in the authorities as to the importance of certainty and clarity in interpreting the ISDA Master Agreement (see for example Lomas v Firth Rixson [2010] EWHC 3372).

3. Guidance for applications for negative declaratory relief

The court provided helpful guidance on the correct approach to applications for negative declaratory relief, which are common in these types of cross-border disputes. As set out in more detail below, the court found that the Bank in this case met the threshold requirements for such relief. In particular, the court noted that in such applications, the touchstone will be whether there is any utility in the claimant obtaining the negative declarations sought. It also noted a number of specific limitations on the grant of declaratory relief, including that the court should not entertain purely hypothetical questions and there must be a real and present dispute between the parties as to the existence or extent of a legal right between them (which need not fall within the jurisdiction of the English court).

A more detailed analysis of these issues and further questions of more general application for financial services institutions, is set out below.

Background

In 2008, a syndicate of banks led by the claimant Bank, entered into a loan agreement (the Financing Agreement) with TRM, an Italian public-private partnership, to fund the building of an energy plant. The Financing Agreement was governed by Italian law and contained a jurisdiction clause in favour of the Italian court.

The Financing Agreement included an obligation for TRM to enter into an interest rate swap with the Bank to hedge the interest rate risks associated with the loan. In 2010, pursuant to that obligation, the parties executed a swap pursuant to a 1992 ISDA Master Agreement (the ISDA Master Agreement). The ISDA Master Agreement contained an exclusive jurisdiction clause in favour of the English court.

In correspondence in July 2016, TRM alleged that the Bank negligently advised TRM to enter into the hedging transactions, which (among other things) TRM said were mismatched with its real hedging requirements, generated a significant negative cash flow, and had a negative mark-to-market value.

In September 2016, the Bank issued proceedings in the English Commercial Court against TRM seeking declarations of non-liability in relation to the hedging transaction, in most cases tracking the wording of the ISDA Master Agreement. In April 2017, TRM sued the Bank before the Italian court and then issued an application in the Commercial Court to challenge its jurisdiction.

Jurisdictional challenge

The Commercial Court found that the proceedings for declaratory relief brought before the English court were governed by the jurisdiction clause in the ISDA Master Agreement, finding that this clause was not displaced or restricted by the apparently competing Italian jurisdiction clause in the Financing Agreement (see the first instance decision). This was despite a provision in the Schedule to the Master Agreement that, in the case of conflict between the terms of the ISDA Master Agreement and those of the Financing Agreement, the latter should “prevail as appropriate”. See our blog post for more detail: High Court holds ISDA jurisdiction clause trumps competing jurisdiction clause in separate but related agreement.

The Court of Appeal agreed (see the Court of Appeal decision), finding that there was no conflict between the jurisdiction clauses, which were found to govern different legal relationships and were therefore complementary, rather than conflicting (such that the conflicts provision was not in fact engaged). The Court of Appeal emphasised that factual overlap between potential claims under the ISDA Master Agreement and the related Financing Agreement did not alter the legal reality that claims under the two agreements related to separate legal relationships. See our blog post for more detail: Court of Appeal finds ISDA jurisdiction clause trumps competing clause in related contract.

Decision

The Bank succeeded on the majority of its claim for declaratory relief, with the court (Mrs Justice Cockerill DBE) granting a significant number of the declarations sought. This blog post provides a summary of the court’s analysis below, focusing on the key points for financial institutions seeking negative declaratory relief and the points of interest in relation to the ISDA Master Agreement.

Preliminary issue: correct approach to applications for negative declaratory relief

Before turning to the substantive issues in dispute, the court considered a preliminary point on the correct approach to applications for negative declaratory relief.

The court noted that its power to grant such relief lay in section 19 of the Senior Courts Act 1981, which appears to be unfettered, but said that the grant of a declaration remains a discretionary remedy (see Zamir & Woolf, The Declaratory Judgment, Fourth Edition at 4-01). While the court acknowledged the authorities indicating that a court should be cautious when asked to grant negative declaratory relief, it was not persuaded by TRM that there should be a reluctance in cases involving foreign proceedings. The court confirmed the following general principles to be applied when considering negative declarations:

  1. The touchstone is whether there is any utility in the claimant obtaining the negative declarations sought.
  2. Negative declarations should be scrutinised by the court and rejected where they would serve no useful purpose.
  3. The prime purpose is to do justice in the particular case, which includes justice to both the claimant and defendant.
  4. The court must consider whether the grant of declaratory relief is the most effective way of resolving the issues raised and consider the alternatives (as per Rolls Royce v Unite the Union [2010] 1 WLR 318).
  5. Limitations on the court include: (i) it should not entertain purely hypothetical questions (see Regina (Al Rawi) v Sec State Foreign & Commonwealth Affairs [2008] QB 289); (ii) there must be a real and present dispute between the parties as to the existence or extent of a legal right between them (see Rolls Royce); and (iii) if the issue in dispute is not based on concrete facts the issue can still be treated as hypothetical. This can be characterised as “the missing element which makes a case hypothetical”.
  6. Factors such as absence of positive evidence of utility and absence of concrete facts to ground the declarations may not be determinative. However, where there is such a lack (in whole or in part) the court should be particularly alert to the dangers of producing something which is not useful and may create confusion.

The court confirmed that it would apply these general principles when considering each of the declarations sought.

Application of general principles for negative declaratory relief

TRM made the overarching submission that the general principles applicable to negative declaratory relief (as outlined above), precluded such relief from being granted in this case. The court found that the application met the threshold requirements for declaratory relief, considering the following two key principles, in particular:

No hypothetical questions / real and present dispute between the parties

TRM argued that the “dispute” on which the Bank relied to bring the claim for negative declarations did not arise in the English court, pointing out that no claims had been brought or intimated by TRM in this jurisdiction, and that the Bank was not able to identify what claims TRM might bring before the English court. Accordingly, it said the “dispute” was purely hypothetical.

The court was not persuaded that it would be appropriate to shut the Bank out from the possibility of declarations based on this ground. In particular, it noted the Bank’s intention to use the declarations sought by way of defence to the Italian claim. Although TRM had brought no claim under the ISDA Master Agreement in the Italian proceedings, the court considered that there was plainly scope for overlap. Moreover, the Bank had specifically pleaded the contractual rights under the ISDA Master Agreement as defences to the Italian claim.

In the court’s view, this was a case that was comfortably on the right side of the hypothetical/actual divide, noting as follows:

“The bottom line is that regardless of where the parts of the debate take place, there is a dispute between the parties as to whether the picture as to TRM’s rights is one which is framed within the [ISDA Master Agreement], or whether, despite the existence of the [ISDA Master Agreement], those rights are different. That is a dispute as to the existence of the rights which the Bank asserts, which is an actual existing dispute. That dispute is not divorced from the facts or based on hypothetical facts. It is plainly not one which has ceased to be of practical significance.”

Utility in obtaining the declarations sought

The court found that at least some of the declarations met the utility threshold requirement. In particular, the court noted that a judgment in England as to the meaning and legal effect as a matter of English law of specific clauses within the ISDA Master Agreement would be enforceable against TRM in Italy under the Brussels Regulation. Given that the ISDA Master Agreement was governed by English law, to the extent the Italian court had to grapple with what the agreement meant, the English court was best placed to decide and the Italian court was likely to be assisted by that determination.

Contractual construction of the ISDA entire agreement clause

Before considering the individual negative declarations sought by the Bank, the court ruled on a question of contractual interpretation of the standard entire agreement clause found in the ISDA Master Agreement.

TRM argued that the Entire Agreement clause was not effective and that it was able to rely on separately negotiated terms of the Financing Agreement prevailing over ISDA Master Agreement (relying on the comments of Lord Millett in The Starsin [2004] 1 AC 715).

The court rejected TRM’s approach, making the following observations, in particular:

  • On its face, the meaning of the ISDA entire agreement clause is “clear and unambiguous”. This was reflected by the decision in Deutsche Bank v Commune di Savona [2018] EWCA Civ 1740 (see our blog post), which said that the ISDA Master Agreement is a “self-contained” agreement, exclusive of prior dealings.
  • The court was not persuaded that TRM’s approach successfully undermined this simple reading of the clause, in particular because it did not identify the specific provisions in the ISDA Master Agreement which were allegedly offensive and which provisions of the Financing Agreement overrode them.
  • While TRM was a party to both the ISDA Master Agreement and to the Financing Agreement, the Bank was a party to the latter as Mandated Lead Arranger (and other roles), not in its capacity as the “Hedging Bank” (even though the Bank was separately defined in the Financing Agreement as fulfilling this role). The court said it would be something of an oddity if the terms of a separate agreement in which the Bank participated with a different hat on, could impact the ISDA Master Agreement.
  • The hedging transaction was entered into “in connection with” the Financing Agreement, highlighting the fact that there were two distinct, albeit connected, agreements.
  • TRM’s approach would sit uneasily with, while the Bank’s argument was harmonious with, the dicta in various authorities as to the importance of certainty and clarity in interpreting the ISDA Master Agreement (most famously in Lomas v Firth Rixson).

Analysis of the individual negative declarations sought

The court then turned to consider the individual negative declarations, granting the majority of them, particularly where those declarations simply tracked the wording of the ISDA Master Agreement, Schedule or Confirmation.

Of the declarations considered by the court, there is one category which has particular significance for financial services contracts. This is the court’s analysis of the effect of the ISDA versions of “no representation” clauses and “non-reliance on representation” clauses, and the application of contractual estoppel to those clauses.

No representation / non-reliance on representation / contractual estoppel

The Bank sought a number of declarations which simply tracked the ISDA documentation:

  • That TRM had “made its own independent decision” to enter into the hedging transaction and was not relying on communications from the Bank as investment advice or as a recommendation to enter into the hedging transaction (the Non-Reliance provisions at Part 5(d)(i) of the Schedule).
  • That TRM was capable of evaluating and understanding the terms, risks etc. of the hedging transaction (Evaluations and Understanding at Part 5(d)(ii) of the Schedule).
  • That TRM was acting as principal and not as agent or in any other capacity, fiduciary or otherwise (Acting as Principal at Part 5(d)(iv) of the Schedule).
  • That TRM had specific competence and expertise to enter into the hedging transaction and in connection with financial instruments (Competence and Expertise at Part 5(e)(i) of the Schedule).
  • That TRM entered into the hedging transaction for hedging purposes and not for speculative purposes (Hedging Purposes at Part 5(e)(ii) of the Schedule).
  • That TRM had full capacity to undertake the obligations under the hedging transaction, the execution of which fell within its institutional functions (Capacity at Part 5(e)(iii) of the Schedule).

In addition, the Bank sought a further declaration that these clauses gave rise to a contractual estoppel, which prevented TRM from contending, for example, that it had relied on any representations given by the Bank as investment advice or a recommendation to enter into the hedging transaction).

The Bank argued that applying accepted principles of contractual interpretation, it was clear that TRM agreed that the Bank did not make any actionable representations to TRM, and that TRM did not rely on any representations in connection with the hedging transaction.

The court swiftly agreed to grant the declarations tracking the parts of the Schedule listed above, but the question of contractual estoppel gave rise to more detailed analysis.

Existence of a contractual estoppel

The court noted that Springwell broadly supported the finding of contractual estoppels arising from such clauses, citing the following comments from Aikens LJ in that case:

“…there is no legal principle that states that parties cannot agree to assume that a certain state of affairs is the case at the time the contract is concluded or has been so in the past, even if that is not the case, so that the contract is made upon the basis that the present or past facts are as stated and agreed by the parties.”

TRM argued that there was a distinction between warranties and undertakings on the one hand (which it accepted could give rise to a contractual estoppel), and an acknowledgement or a representation on the other. In relation to the latter, it said that there was no “agreement”, and therefore an acknowledgement/representation could not create a contractual estoppel. TRM pointed to the judgment of Leggatt LJ in First Tower, in which he questioned whether a clause which simply said that a party “acknowledges” that it has not entered into the contract in reliance on any representation could give rise to a contractual estoppel.

However, the court noted that Springwell itself disagreed with this proposition, with the Court of Appeal finding in that case that Springwell was bound contractually to its statement, or acknowledgement, that no representation or warranty had been made by Chase Manhattan. The court emphasised that Leggatt LJ’s commentary in First Tower was obiter, and did not think he was intending to overrule or qualify Springwell. The court noted that the factual situation in First Tower was very different (since the case concerned the effect of an exclusion clause in a commercial lease and its effect vis à vis pre-contractual enquiries which misrepresented the position as regards asbestos on site). Leggatt LJ was not purporting to consider the effect of representations typically made in a financial services context.

The court also considered obiter comments in Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103 (Comm), a case concerning the ISDA Master agreement, which TRM suggested drew a distinction generally between warranties and mere representations. Again the court was not persuaded that this authority took matters any further forward, as it was bound by Springwell.

Even if not bound by Springwell, the court considered that the question was whether it could “objectively conclude that by the relevant contractual materials the parties did intend to agree” to the contractual estoppel. It said the question was not dependent on the precise wording (representation vs warranty), but was a question of substance (per Hamblen J in Cassa Di Risparmio Della Repubblica Di San Marino Spa v Barclays Bank Ltd [2011] EWHC 484 (Comm)). This would require the court to discern the intention of the parties, taking into consideration the relevant factual background, including the nature and status of the ISDA Master Agreement. On that basis, even if it had not been bound by Springwell, the court said it would have reached the same conclusion, namely that a contractual estoppel existed.

Effect of the Misrepresentation Act 1967

The court also considered TRM’s argument that the Non-Reliance provisions sought to exclude liability for misrepresentation under the Misrepresentation Act 1967, and so were subject to the requirement of reasonableness under section 11(5) of the Unfair Contract Terms Act 1977 (UCTA).

The court was “entirely unpersuaded” of the merits of this argument. In particular, the court specifically endorsed the decision in Barclays Bank plc v Svizera Holdings BV [2014] EWHC 1020 (Comm), which held that a clause in a mandate letter gave rise to a contractual estoppel against reliance on alleged representations. In that case, the court referred to the consistent judicial recognition of the effectiveness of such clauses giving rise to a contractual estoppel, and said the suggestion that the clause should be struck down as unreasonable under UCTA was “hopeless”. In the present case, the court commented that this conclusion might very well apply here.

The court was critical of TRM’s approach to the argument on the Misrepresentation Act, in particular because it had failed to put its argument formally in issue in the proceedings, cautioning as follows:

“It cannot be acceptable for a party to (as TRM did here) stay absolutely quiet on the subject until the door of the court, and then play their joker in the form of the [Misrepresentation Act], asserting that the burden of proving reasonableness has not been discharged by its opponent.”

The court was also critical of the fact that TRM failed to identify clearly which clauses were said to be exclusion clauses, and the absence of any factual evidence to suggest that the provision should be struck down as unreasonable.

In fact, the court pointed to a number of factors suggesting that the clause was in any event reasonable, including that: this was not a case of a consumer transaction or where there was an inequality of bargaining power; the terms were contained within an ISDA Master Agreement which contains effectively market standard terms; and the bespoke Schedule was agreed between two commercial parties.

The court was therefore prepared to grant the declarations sought relating to representations and contractual estoppel.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Court of Appeal upholds High Court decision to grant summary judgment in FX de-pegging case

The Court of Appeal has upheld the High Court’s decision to grant summary judgment in favour of a bank defending a claim brought by a foreign exchange (FX) broker seeking to recover losses incurred on FX spot transactions during the 2015 “Swiss Flash Crash”: CFH Clearing Ltd v MLI [2020] EWCA Civ 1064.

In doing so, the Court of Appeal has confirmed that the bank’s terms and conditions of business (TOB) did not import into the FX transactions a contractual obligation to comply with “market practice”, so as to require the bank to re-price the transactions, or otherwise cancel them.

This decision will be of broader interest to financial institutions in that it provides reassurance that English courts are prepared to determine decisively, at the summary judgment stage, that the express terms of market standard master agreements will be enforceable and will not readily incorporate vague concepts of market practices into such contracts. This will be the case even if the claimant can point to its loss arising from unusual or important market events – a sophisticated claimant investor will be held to the consequences of an agreement in which they have failed to provide for market disruption.

Background

This case concerned FX transactions which the claimant broker entered into with the defendant bank on 15 January 2015, in which the claimant bought Swiss francs and sold euros, and were documented by a 2002 ISDA Master Agreement (the ISDA Agreement) together with an electronic confirmation. The FX transactions took place on the same day (and shortly before) the Swiss National Bank ‘de-pegged’ the Swiss franc from the euro, by removing the currency floor with respect to the value of the Swiss franc against the euro. This led to severe fluctuations in the foreign exchange market in those currencies. The extreme rates triggered automatic liquidation of certain client positions of the claimant at prices below the official low set by the e-trading platform for Swiss franc interbank trades, known as the Electronic Broking Service (EBS). Later that day, other banks amended the pricing of trades which they had executed with the claimant to prices at or above the official EBS low. The bank agreed to improve the pricing of its trades, but to a level below the EBS low.

The claimant’s case was that since the FX transactions were entered into at a time of severe market disruption, the bank was obliged to make a retrospective adjustment to the price of those transactions (e.g. to adjust the price to a rate to the EBS low, in accordance with alleged market practice), or to cancel them, in accordance with its express or implied contractual obligations and/or pursuant to a duty of care in tort.

The bank applied for strike out and/or summary judgment.

High Court decision

The High Court granted summary judgment in respect of all claims, holding there was no real prospect of the claim succeeding and that there was no other compelling reason for the claim to proceed to a trial. 

The High Court’s reasoning is summarised in our previous blog post here.

The claimant appealed.

Court of Appeal decision

The claimant contended that the effect of the bank’s TOB imported into the FX transactions a contractual obligation to comply with “market practice”, so as to require the bank to re-price the transactions at the EBS low, or otherwise cancel them. This was on the basis that the bank’s TOB provided that:

“All transactions are subject to all applicable laws, rules, regulations howsoever applying and, where relevant, the market practice of any exchange, market, trading venue and/or any clearing house and including the FSA Rules (together the “applicable rules”). In the event of any conflict between these Terms and any applicable rules, the applicable rules shall prevail…”

The Court of Appeal dismissed the appeal, finding that there was no arguable basis for holding that such an agreement had been made by the parties. The words “subject to” did not incorporate “market practice” into the contract; rather it meant that neither party was required to act contrary to such market practice (in which case it would be relieved of its contractual obligations).

The starting point for the contractual analysis was that the parties had agreed that their FX transactions would be governed by a standard ISDA Master Agreement, had negotiated the specific terms of the Schedule and had incorporated the 1998 FX Definitions, which would have permitted them to provide for market disruption. The transactions were therefore governed by a detailed contract which on industry standard terms reflected market practice and was tailored by the parties for their specific business relationship. The Court of Appeal also referred to the well-known observation of Briggs J in Lomas & Ors v JFB Firth Rixson Inc & Ors [2010] EWHC 3372 that the ISDA Master Agreement is probably the most important standard market agreement used in the financial world and that it was obvious that it should be interpreted in a manner that met the objectives of clarity, certainty, and predictability, so that the very large number of parties using it should know where they stand. The suggestion that the parties had agreed to incorporate “market practice” generally, even though not reflected in the ISDA Agreement and, indeed, overriding its provisions, therefore must be treated with considerable caution.

In the Court of Appeal’s view, it was also difficult to see how a “market practice” overriding the ISDA Agreement’s standard terms could be derived from the International Code of Conduct and Practice for the Financial Markets (the Code). Indeed, the Code itself recognised that Master Agreements should be entered into to reflect market practices and to provide for exceptional circumstances. The claimant in its arguments had focused on only one provision of the Code whilst ignoring the more fundamental recognition in the Code that legal certainty, including as to market practices and exceptional circumstances, should be ensured by adopting a Master Agreement.

Furthermore, the Court of Appeal considered that the alleged “market practice” was far too vague and uncertain to be incorporated as a contract term. It was not clear precisely what obligation was said to have arisen with regard to re-pricing (there being no reference in the Code to the “authenticated market price” or the “official low”), and when a party must re-price and when it must cancel. In the Court of Appeal’s opinion, the inclusion of those two very different routes would give rise, at best, to an unenforceable agreement to agree. The fact that the other liquidity providers “readily” complied with the alleged practice was deemed by the Court of Appeal to be rationalisation after the event, in circumstances where the terms of the relevant contracts with those counterparties were unknown to the court.

Finally, the Court of Appeal also firmly rejected the suggestion that the unusual and important nature of the market events was itself a compelling reason that the matter should be allowed to proceed to trial. The Court of Appeal remarked that there was no reason why the claimant should not be held to its bargain on the basis that it: (a) was a sophisticated commercial party who had entered into automatic transactions at the next available price without specifying a limit; and (b) had negotiated and agreed with the bank the ISDA Agreement, an agreement in which it could have but did not provide for market disruption.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529

Commercial Court grants summary judgment in favour of defendant bank in FX de-pegging case

The Commercial Court has granted summary judgment in favour of a bank defending a claim brought by a foreign exchange (“FX“) broker seeking to recover losses it suffered when the Swiss franc was de-pegged from the euro in 2015: CFH Clearing Limited v MLI [2019] EWHC 963 (Comm).

The decision represents a robust approach by the court in response to an attempt to shift losses caused by market forces to the defendant bank, through a suite of alleged express/implied contractual obligations and tortious duties. It is an example of how the court will be prepared – in appropriate cases – to summarily determine claims, without the need for a full trial and all the time and costs involved. As such, the decision should be welcomed by financial institutions.

In the present case, the broker argued that since its FX transactions with the bank were entered into at a time of severe market disruption, the bank was obliged to make a retrospective adjustment to the price of those transactions (which the broker said were automatically liquidated at a price below the official low), or to cancel them. In particular, the broker relied upon: (i) an alleged express/implied contractual obligation to follow market practice; (ii) the alleged incorporation of a contractual term based on the bank’s own best execution policy; and (iii) an alleged tortious duty to take reasonable care to ensure that transactions were priced correctly and, in circumstances where orders were wrongly priced due to market turbulence, to retrospectively re-price them.

The Commercial Court rejected all of the alleged contractual/tortious duties and granted summary judgment in favour of the defendant bank. In doing so, it emphasised the significance of the ISDA Master Agreement governing the specific FX transactions, which it said prevailed over the bank’s standard terms and conditions (rejecting the broker’s submission that the standard terms should be regarded as having primacy). The court held that the ISDA Master Agreement did not incorporate any express provisions relating to market practice/disruption, and pointed against the incorporation of an implied term to that effect and the alleged tortious duty.

Background

This case concerned FX transactions which the claimant broker entered into with the defendant bank on 15 January 2015, in which the claimant bought Swiss francs and sold euros, and were documented by an ISDA Master Agreement together with an electronic confirmation. The FX transactions took place on the same day (and shortly before) the Swiss National Bank ‘depegged’ the Swiss franc from the euro, by removing the currency floor with respect to the value of the Swiss franc against the euro. This led to severe fluctuations in the foreign exchange market. The extreme rates triggered automatic liquidation of certain client positions of the claimant at prices below the official low set by the e-trading platform for Swiss franc interbank trades, known as the Electronic Broking Service (“EBS“). Later that day, other banks amended the pricing of trades which they had executed with the claimant to prices at or above the official EBS low. The bank agreed to improve the pricing of its trades, but to a level below the EBS low.

The claimant’s case was that since the FX transactions were entered into at a time of severe market disruption, the bank was obliged to make a retrospective adjustment to the price of those transactions (e.g. to adjust the price to a rate to the EBS low, in accordance with alleged market practice), or to cancel them, in accordance with its express or implied contractual obligations and/or pursuant to a duty of care in tort.

The bank applied for strike out and/or summary judgment.

Decision

The court granted summary judgment in respect of all claims, holding there was no real prospect of the claim succeeding/no other compelling reason for a trial. The key issues which are likely to be of broader interest to financial institutions are summarised below.

1. Express term as to market practice

To establish an express term as to market practice, the claimant relied on clause 7 of the bank’s terms and conditions, as follows:

All transactions are subject to all applicable laws, rules, regulations howsoever applying and, where relevant, the market practice of any exchange, market, trading venue and/or any clearing house and including the FSA Rules (together, the “applicable rules”). In the event of any conflict between these Terms and applicable rules, the applicable rules shall prevail subject that nothing in this preceding clause shall affect our rights under clause 15.” (Emphasis added)

The claimant alleged that the effect of the words “subject to” was to incorporate all applicable laws rules and regulations (and market practice) into the contract. It said that this imposed a number of obligations on the bank. In particular, in the case of extreme events where deals took place outside of the market range (i.e. those shown on the EBS platform), to immediately adjust the deal within the EBS range or to cancel it. The claimant alleged that the bank was in breach of clause 7 because it did not act in accordance with good market practice, by failing to rebook the relevant trades within the EBS range at the time or cancel the trades.

Applying established principles of contractual interpretation, the court held that the objective meaning of the language of clause 7, was that market practice was not imported into the contract as an express term of the contract giving rise to contractual obligations. Rather, clause 7 was intended to relieve a party of contractual obligations that would otherwise place it in breach of its contract, where it was unable to perform its obligations by reason of relevant market practice.

One of the key factors influencing the court’s decision was that the standard terms stated they were subject to any specific transaction documentation, which the court held clearly included the ISDA Master Agreement governing the FX transactions. The court held that the ISDA Master Agreement prevailed over the standard terms (rejecting the claimant’s submission that the standard terms should be regarded as having primacy), and added that the ISDA Master Agreement was the appropriate place for the parties to have specified express provisions dealing with market disruption, and they had not done so in this case.

In the court’s view, this was not a case where there were reasonable grounds for believing that a fuller investigation into the facts would add to or alter the evidence on the issue of the express term. Accordingly, the court was prepared to “grasp the nettle” and decide the point finally on the application.

2. Implied term as to market practice

In the alternative, the claimant asserted that it was an implied term of the contracts relevant to the FX transactions that the parties would act in accordance with market practice.

Applying the test for implied terms in Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72, the court held that there was no real prospect of the claimant establishing the implied term as alleged. In particular, the court noted that in circumstances where the parties had entered into an ISDA Master Agreement, which contained extensive and comprehensive provisions used widely in the market, it could not be said that a general implied term for the incorporation of relevant market practice was either necessary for business efficacy or so obvious that it went without saying.

3. Contractual term based on the bank’s best execution policy

The claimant also alleged that the bank’s best execution policy was incorporated into the standard terms and conditions. It relied again upon clause 7, which stated (in addition to the part of the clause quoted above in relation to an alleged implied term as to market practice):

“Your orders will be executed in accordance with our order execution policy (as amended from time to time), a summary of which will, where applicable, be provided to you separately…”

The court held that the fact that the bank was obliged to follow the best execution policy did not mean that it was incorporated as a contractual term. In particular, the court highlighted that the best execution policy derived from the regulatory rules and emphasised that it was clear from the authorities that obligations on banks to comply with the Conduct of Business rules did not confer direct rights on their clients except and to the extent that the statute expressly provided. Further, given that only a summary of the best execution policy was provided to the claimant, this supported the bank’s submission that the best execution policy was not intended by the language of clause 7 to be incorporated into the standard terms and conditions as a contractual term. In the court’s view, even if the best execution policy was incorporated as a contractual term, there was no real prospect that it would extend to a requirement to retrospectively adjust the pricing of the trades, or to cancel them, where the price of the trades was affected by market turbulence.

4. Duty of care in relation to execution and settlement of orders

The claimant alleged that the bank assumed a duty to take reasonable care to ensure that transactions were priced correctly and, in circumstances where orders were wrongly priced due to market turbulence, to retrospectively re-price them.

The court found that there was no real prospect of the claimant establishing such a duty of care in the circumstances, given that both parties were professionals dealing at arm’s length. The court relied in particular on the terms of the ISDA Master Agreement and the standard terms and conditions, which expressly provided that the bank was not acting as a fiduciary. In the court’s view, the duty alleged had not been breached in any event.

Accordingly, the court granted the bank’s application for summary judgment, holding that there was no real prospect of the claim succeeding and no other compelling reason to allow the claim to proceed.

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Commercial Court gives guidance on definition of ‘consumer’ under Recast Brussels Regulation in cryptocurrency futures trading case

An individual investor, with substantial means and more knowledge and experience than the average person, may still be considered a ‘consumer’ for the purposes of Article 17 of Regulation (EU) No 1215/2012 on jurisdiction and enforcement of judgments in civil and commercial matters (“Recast Brussels Regulation“), even when contracting to trade a specialised product such as cryptocurrency futures.

The recent Commercial Court decision in Ramona Ang v Reliantco Investments Limited [2019] EWHC 879 (Comm) has confirmed the purposive test to be applied when considering whether an individual investor is a consumer under the Recast Brussels Regulation. While this decision arguably gives a generous interpretation as to who is a consumer under Article 17, it does provide some helpful clarification for financial institutions contracting with retail clients. In particular:

  1. The court held that the key question when assessing if an individual investor is a consumer is the purpose for which the investment was entered into. Specifically, whether the individual entered into the contract for a purpose which can be regarded as being outside his or her trade or profession. While the circumstances of the individual and the nature of the investment activity (including the use of intermediaries/advisers) will be considered, the court emphasised that these factors will not be determinative of the issue.
  2. This decision is a good example of how each case will be fact-specific and will turn on whether the individual is considered to be contracting for a non-business purpose. In this instance, the court held that despite the specialised nature of the products themselves, a wealthy individual committing substantial capital to speculative transactions in the hope of making investment gains was a consumer for the purposes of Article 17 of the Recast Brussels Regulation. It disagreed with the suggestion from other EU Member State courts that such activity must necessarily be a business activity, i.e. cannot ever be a consumer activity.
  3. In cases where a person does meet the ‘consumer’ test, if they have nonetheless given the other party the impression that they are contracting for business purposes, they will not be able to rely upon Article 17. (However, that was not the case here).
  4. This case is a reminder that if an individual investor meets the criteria under Article 17 of the Recast Brussels Regulation and brings a claim in the courts of their choice as a consumer under Article 18, this may trump an exclusive jurisdiction clause under Article 25 (unless certain exceptions apply, such as agreeing the exclusive jurisdiction clause after the dispute has arisen).

It is worth noting that the Court of Justice of the European Union (“CJEU“) has recently published an Advocate General (“AG“) opinion in a similar case, concerning a preliminary ruling on whether a natural person who engages in trade on the currency exchange market is to be regarded as a consumer within the meaning of Article 17: Jana Petruchová v FIBO Group Holdings Limited Case C 208/18. The AG opinion is largely consistent with the decision of the High Court in this case, save that it goes further by stating that no account should be taken of the circumstances of the individual and the nature/pattern of their investment (whereas in the instant case, the High Court said such factors would be considered, but would not be determinative – see the first point above).

Background

The claimant (an individual of substantial means) invested in Bitcoin futures, on a leveraged basis, through an online trading platform (UFX), owned by the defendant. The claimant had no education or training in cryptocurrency investment or trading and was not employed at the time, but she played a part in looking after the family’s wealth and assisting her husband, a computer scientist with cybersecurity and blockchain expertise, who has identified himself publicly as being “Satoshi Nakamoto”, the online pseudonym associated with the investor of Bitcoin.

During the account opening process on the UFX platform, the claimant provided certain information about herself, including that she was self-employed, familiar with investment products including currencies and was a frequent trader (75+ trades). She was provided with and accepted the defendant’s terms and conditions.

The defendant terminated the claimant’s UFX account, the claimant alleged that the defendant did so wrongfully and brought a claim in the English High Court for compensation for the loss of her open Bitcoin positions. In response, the defendant challenged the jurisdiction of the English High Court, by reference to an exclusive jurisdiction clause in favour of the courts of Cyprus in the terms and conditions (and relying upon Article 25 of the Recast Brussels Regulation).

Decision

The claimant argued that the exclusive jurisdiction clause in the defendant’s terms and conditions was ineffective, either because she was a consumer within Section 4 of the Recast Brussels Regulation or because the clause was not incorporated into her UFX customer agreement in such a way to satisfy the requirements of Article 25 of the Recast Brussels Regulation.

The High Court held that the claimant was a consumer within Article 17 of the Recast Brussels Regulation, on the basis that she was contracting with the defendant for a purpose outside her trade or profession. As a result, she was permitted under Article 18 of the same regulation to continue her claim in the High Court and the defendant’s challenge to the jurisdiction was dismissed. The court’s decision in relation to Article 17 is discussed further below.

Test to be applied to an individual under Article 17 of the Recast Brussels Regulation

Article 17 of the Recast Brussels Regulation applies to contracts “concluded by a person, the consumer, for a purpose which can be regarded as being outside his trade or profession“. The court noted that the concept of ‘consumer’ had been considered a number of times by the ECJ/CJEU and had an autonomous meaning under EU law, which was independent of national law.

The defendant contended that the ECJ/CJEU had ‘glossed’ the definition of consumer, relying in particular upon the ECJ’s statement in Benincasa [1997] ETMR 447 that “only contracts concluded for the purpose of satisfying an individual’s own needs in terms of private consumption” were protected by the consumer rule under Article 17. The High Court rejected this contention, however, following the approach taken by Longmore J in Standard Bank London Ltd v Apostolakis [2002] CLC 933 and holding that this reference to “private consumption” was not a new or different test to the one under the Recast Brussels Regulation. The court reaffirmed that there were “end user” and “private individual” elements inherent in the notion of a consumer, but that an individual acting for gain could nonetheless meet the test.

In doing so, the court made the following key observations:

  • The court confirmed that the issue as to whether an individual investor is a consumer will be fact-specific in any given case. It emphasised that the question of purpose is the question to be asked, and must be considered upon all of the evidence available to the court and not to any one part of that evidence in isolation.
  • It agreed with the decision in AMT Futures Limited v Marzillier [2015] 2 WLR 187that any assessment of whether an individual investor is a consumer is “likely to be heavily dependent on the circumstances of each individual and the nature and pattern of investment“. However, it emphasised that these factors cannot determine the issue, as to do so would be to effectively replace the non-business purpose test set by the Recast Brussels Regulation.
  • It disagreed with the conclusion reached by the Greek courts in both Standard Bank of London v Apostolakis [2003] I L Pr 29 and R Ghandour v Arab Bank (Switzerland) [2008] I L Pr 35 that “the purchase of moveable property for the purpose of resale for profit and its subsequent actual resale…” was intrinsically commercial, so that engaging in such trading was necessarily a business activity and not a consumer activity.

Application of the test

Applying the purposive test as set out in the Recast Brussels Regulation, the court’s view was that the claimant had contracted with the defendant for a non-business purpose. It is worth noting that the court reached this conclusion despite finding that the claimant had over-stated the extent of her prior trading experience. Given that such over-statement did not go as far as creating the impression that the claimant was opening an account for a business purpose, it did not affect the court’s overall conclusion.

Donny Surtani
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Ceri Morgan
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Phoebe Jervis
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Court of Appeal finds ISDA jurisdiction clause trumps competing clause in related contract

The Court of Appeal’s judgment in BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA provides further assurance that jurisdiction clauses within standard form ISDA documentation will not readily be displaced by contrary jurisdiction clauses in related contracts. The Court of Appeal gave effect to an English jurisdiction clause in an ISDA Master Agreement over an apparently competing Italian jurisdiction clause in a related financing agreement, despite a provision in the Schedule to the ISDA Master Agreement stating that, in the event of conflict, the financing agreement would prevail. The first instance decision of the Commercial Court was upheld (see our banking litigation e-bulletin).

Key to the Court of Appeal’s decision was its conclusion that there was no conflict between the jurisdiction clauses, which were found to govern different legal relationships and were therefore complementary, rather than conflicting. The Court emphasised that factual overlap, between potential claims under the ISDA Master Agreement and a related financing agreement, did not alter the legal reality that claims under the two agreements related to separate legal relationships.

The Court of Appeal’s decision is not unexpected, as it is in line with the recent Court of Appeal decision in Deutsche Bank AG v Comune Di Savona [2018] EWCA Civ 1740 (see our banking litigation e-bulletin) – which expressly approved the first instance decision in the present case. However, it will be welcomed as further evidence of the English court’s emphasis on construing commercial contracts, and in particular standard form ISDA documentation, in order to achieve market certainty and predictability.

Following the recent publication of French and Irish ISDA Master Agreements in light of Brexit, the court’s emphasis on predictability may serve as a timely reminder of the advantages of selecting English jurisdiction for ISDA Master Agreements.

Background

In 2008, a syndicate of banks led by the claimant, BNP Paribas S.A. (the “Bank“), entered into a loan agreement (the “Financing Agreement“) with the defendant, Trattamento Rifiuti Metropolitani S.p.A (“TRM“), an Italian public-private partnership, to fund the building of an energy plant. The Financing Agreement included an obligation for TRM to enter into an interest rate swap with the Bank to hedge the interest rate risks associated with the loan (the “Hedging Requirement“).

In 2010, pursuant to the obligation in the Financing Agreement, the parties executed a 1992 form ISDA Master Agreement (the “ISDA Agreement“) and an interest rate swap.

The Financing Agreement included an exclusive jurisdiction clause in favour of the Italian court. The ISDA Agreement contained an exclusive jurisdiction clause in favour of the English court. A clause in the Schedule to the ISDA Agreement stated that, in case of conflict between the terms of the ISDA Agreement and those of the Financing Agreement, the latter should “prevail as appropriate” (the “Conflicts Clause“).

In 2016, the Bank issued proceedings in the English Commercial Court against TRM seeking declarations of non-liability “in connection with a financial transaction pursuant to which [TRM] entered into interest rate hedging arrangements with the [Bank]“. In 2017, TRM sued the Bank before the Italian court and then issued an application in the Commercial Court to challenge its jurisdiction.

Commercial Court decision

The Commercial Court dismissed TRM’s application challenging jurisdiction. Applying Article 25(1) of the Recast Brussels Regulation, under which parties may agree to refer disputes to the court of a Member State, the Commercial Court found that the Bank had much the better of the argument that the dispute fell within the English jurisdiction clause of the ISDA Agreement. Of particular relevance are the Commercial Court’s findings that:

  1. There was no conflict between the two jurisdiction clauses. They could readily bear the interpretation that one concerned disputes relating to the Financing Agreement and the other concerned disputes relating to the ISDA Agreement. As there was no conflict, the Conflicts Clause in the Financing Agreement was not engaged.
  2. The parties’ decision to use ISDA documents was a “powerful point of context” which signalled that the parties wanted to achieve “consistency and certainty” in the interpretation of the contract. The use of ISDA documentation by commercial parties shows that they are “even less likely to intend that provisions in that documentation may have one meaning in one context and another meaning in another context“.

Grounds of appeal

The claimant appealed on the following principal grounds:

  1. The judge was wrong to conclude that there was no conflict between the jurisdiction clauses in the Financing Agreement and the ISDA Agreement. The Conflicts Clause therefore should have been engaged.
  2. In any event, the dispute arose in connection with the parties’ legal relationship set out in the Financing Agreement.

Court of Appeal decision

The Court of Appeal dismissed the appeal on all grounds. The key aspects of the judgment which are likely to be of broader interest (particularly in relation to whether apparently competing jurisdiction clauses are, in fact, in conflict with one another) are considered further below.

Guidance on competing jurisdiction clauses

The Court of Appeal set out useful guidance on how to interpret apparently competing jurisdiction clauses in related contracts:

  1. The starting point is that a jurisdiction clause in one contract was probably not intended to capture disputes more naturally seen as arising under a related contract. There is therefore a presumption that each clause deals exclusively with its own subject matter and that they do not overlap, provided the language and surrounding circumstances allow. The most obvious subject matter of a generally worded jurisdiction clause will be the legal relationship created by the contract.
  2. It is unlikely that sensible business people would intend that similar claims should be subject to inconsistent jurisdiction clauses. However, if the language or surrounding circumstances make clear that a dispute falls within both clauses, the presumption that the clauses deal with separate legal relationships can be displaced.
  3. A broad, purposive and commercially minded approach to construction should be taken which interprets jurisdiction clauses in the context of the overall scheme of the agreements.

Do the jurisdiction clauses conflict?

Applying this approach to the present case, the Court of Appeal held that the natural interpretation of the two jurisdiction clauses was that the clause in the Financing Agreement governed claims relating to the background lending relationship set out in that agreement, and the clause in the ISDA Agreement governed claims relating to the specific interest rate swap relationship set out in that agreement. The Court of Appeal noted that this conclusion was strongly supported by the decision in Savona.

TRM sought to distinguish Savona on a number of bases, including by relying on the Conflicts Clause. With respect to the Conflicts Clause, the Court of Appeal held that the two juridisction clauses governed different legal relationships and were therefore complementary, rather than conflicting. Accordingly, the first instance judge was correct to find that the Conflicts Clause was not engaged.

Overlapping legal relationships

TRM also sought to distinguish Savona on the basis that the inclusion of the Hedging Requirement in the Financing Agreement meant that there was overlap between the legal relationships under the Financing Agreement and ISDA Agreement. It claimed that, as a result, the dispute fell within the legal relationship under the Financing Agreement. However, the Court of Appeal firmly rejected this argument:

  • The Court of Appeal distinguished between factual and legal overlap. TRM alleged that there was overlap between the two agreements, as certain claims regarding the sale of the swap could be brought under both the Financing Agreement (for breach of the Hedging Requirement) and the ISDA Agreement. However, the Court of Appeal held that factual overlap between potential claims under the Financing Agreement and the ISDA Agreement did not alter the legal reality that claims under the two agreements related to separate legal relationships.
  • TRM’s approach would lead to fragmentation of jurisdiction, whereby different terms within the ISDA Agreement would be subject to different jurisdiction clauses in separate contracts. The Court of Appeal considered this to be undesirable and that it was generally unlikely to be the intention of sensible commercial parties.

Declarations sought

Having rejected TRM’s attempts to distinguish Savona, the Court of Appeal proceeded to consider the specific declarations of non-liability sought by the Bank. Subject to the amendment of one of the declarations, the Court found that all of the declarations sought fell within the jurisdiction clause of the ISDA Agreement.

Harry Edwards
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Court of Appeal confirms ISDA 1995 Credit Support Annex does not provide for payment of ‘negative’ interest

The Court of Appeal has upheld the High Court’s decision that ‘negative interest’ is not payable by a Transferor of cash collateral under the standard form ISDA 1995 Credit Support Annex (“CSA“): The State of the Netherlands v Deutsche Bank AG [2019] EWCA Civ 771.

The Court of Appeal’s confirmation of this point is useful, because the lack of any express terms in the CSA in relation to the payment of negative interest had given rise to significant uncertainty (leading to publication of the ISDA 2014 Collateral Agreement Negative Interest Protocol). However, while the Court of Appeal reached the same result as the High Court, it commented that the High Court had adopted “too simplistic an approach” (see our banking litigation e-bulletin on the High Court’s decision).

The Court of Appeal gave three key reasons for its judgment. Firstly, the Court of Appeal agreed with the central reason given by the High Court, which was in summary: that paragraph 5(c)(ii) of the CSA covered positive (but not negative) interest; that this paragraph was the most obvious place to find a reference to negative interest if it had been intended; and the fact that negative interest was actually excluded from paragraph 5(c)(ii) was a powerful indicator that it was not contemplated as payable.

Secondly, both the High Court and Court of Appeal relied on the User’s Guide to the ISDA Credit Support Documents under English Law (published in 1999) as an aid to interpretation. However, the Court of Appeal also relied on other “background materials“, including a Best Practice statement issued just after the CSA was amended in 2010, which said in express terms that interest rates under the CSA should be floored at zero and not drop into a negative figure. The Court of Appeal noted that it would not normally be possible to look at post-contractual documentation as being indicative of factual matrix, but said this was significant as it showed ISDA’s thinking around the time of the CSA.

Finally, as a general and overarching reason, the Court of Appeal could see nothing in the CSA read as a whole that gave the impression that negative interest was contemplated or intended. It suggested this may be a situation of the kind envisaged in Arnold v Britton & Ors [2015] UKSC 36 (see our litigation blog post) where an event subsequently occurs which was plainly not intended or contemplated by the parties – or in this case the market – judging from the language of their contract. Excluding negative interest was not unfair, as was argued, it was just a function of what was actually agreed and not agreed.

The Court of Appeal therefore concluded that the CSA did not provide for the payment of negative, as opposed to positive interest, and dismissed the appeal.

Background

In March 2001 the State of the Netherlands (the “State“) and Deutsche Bank (the “Bank“) entered into an agreement comprising the 1992 ISDA Master Agreement, Schedule and CSA. The CSA was amended in 2010 to delete and replace paragraph 11.

The parties subsequently entered into a number of derivative transactions pursuant to these contractual arrangements. Under these transactions, where the State had a net credit exposure to the Bank: (i) the Bank was required to provide credit support to the State by way of cash collateral; and (ii) the State was required to pay the Bank interest on the collateral.

The State did, in fact, have a net credit exposure to the Bank and the Bank accordingly posted collateral. However, from June 2014, the interest rate applicable to the State’s obligation to pay interest on the collateral was less than zero. The State brought a claim against the Bank for negative interest in respect of the collateral.

High Court Decision

The High Court held that the State’s claim for negative interest failed. For a detailed explanation of the High Court’s decision, please see our banking litigation e-bulletin.

The main reason for the High Court’s decision was that paragraph 5(c)(ii) of the CSA only required the Transferee (the State) to pay interest to the Transferor (the Bank); there was no express reciprocal obligation for negative interest to be paid by the Bank to the State, in that paragraph or elsewhere in the CSA. The High Court agreed with the Bank that if there was an obligation to pay negative interest “it would be spelled out“. In the High Court’s view, had the parties wished to, they could have included an obligation on the Bank to pay negative interest, and paragraph 5(c)(ii) was the obvious place for such an obligation to appear.

Grounds of appeal

The State appealed. It contended that while paragraph 5(c)(ii) of the CSA provided only for the transfer of positive interest from the State to the Bank, other provisions of the CSA required that negative interest was accounted for. In essence, the State submitted that the defined term “Interest Amount” could include negative interest, and the definition of “Credit Support Balance” required that that negative interest should “form part of” that Credit Support Balance.

Court of Appeal decision

The Court of Appeal dismissed the appeal, holding that on its true interpretation the CSA could not be taken as providing for the payment of negative (as opposed to positive) interest. However, the reasoning of the Court of Appeal differed quite significantly to the High Court, which it felt had adopted “too simplistic an approach“.

Considering the authorities on contractual interpretation relied on by the parties, the Court of Appeal first addressed Re Lehman Brothers (No 8) [2016] EWHC 2417 (Ch), which stated in an ISDA context that the focus should be 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 knowledge of the market”. It commented that while this was undoubtedly right to say, it did not take the matter much further in the instant case. Rather, in the Court of Appeal’s view, Wood v Capita Insurance Services Limited [2017] 2 WLR 1095 was more instructive (see our banking litigation e-bulletin). That case emphasised the need to consider the contract as a whole, consider rival meanings in the context of what is more consistent with business common sense, and consider the quality of the drafting when striking a balance between the language of the clause and its commercial implications.

With those points on the authorities in mind, the Court of Appeal gave three key reasons for its judgment, which are summarised below.

1. User’s Guide and background materials

In the Court of Appeal’s view, the User’s Guide to the ISDA Credit Support Documents under English Law (published in 1999) and background materials did not show that ISDA thought that negative interest was intended to be payable. The Court of Appeal said it was significant that the User’s Guide made no reference to negative interest being provided for. It is worth noting here that the User’s Guide was accepted before the High Court as being admissible factual matrix in relation to the interpretation of the CSA, having been published both before the original CSA was entered into in 2001 and amended in 2010.

Interestingly, the other “background materials” referred to by the Court of Appeal, and treated as influential in its thinking, actually post-dated the amendment of the CSA in 2010. The Court of Appeal noted that it would not normally be possible to look at post-contractual documentation as being indicative of factual matrix. However, a Best Practice statement issued just after the CSA was amended in 2010 expressly stated: “[a]t no point should the interest accrual (rate minus spread) drop into a negative figure. If this occurs the rate should be floored at zero”. The Court of Appeal said this was significant as it showed ISDA’s thinking around the time of the CSA (and even though it was not placed before the trial judge, it had been publicly available since 2010). The Court of Appeal accepted that while these (and later) documents were not conclusive, they could not be ignored.

2. Asymmetries created by the State’s interpretation

The Court of Appeal agreed with the Bank that there were a number of asymmetries created by the State’s interpretation of the CSA. The most significant of these was that paragraph 5(c)(ii) covered positive, but not negative, interest. The Court of Appeal agreed with the High Court that this paragraph was certainly the most obvious place to find a reference to negative interest if it were intended. It said the fact that negative interest was actually excluded from paragraph 5(c)(ii) was a powerful indicator that it was not contemplated as payable.

3. Negative interest not contemplated by the parties

As a general and overarching reason, the Court of Appeal could see nothing in the CSA read as a whole that gave the impression that negative interest was contemplated or intended. It suggested this may be a situation of the kind envisaged in Arnold v Britton where an event subsequently occurs which was plainly not intended or contemplated by the parties – or in this case the market – judging from the language of their contract. The result (that negative interest was not payable) was not unfair to the State and was simply a function of what had been agreed and not agreed.

The Court of Appeal accepted that the commercial background could be argued both ways. Having undertaken the process of iterative checking and re-checking of the competing interpretations against each part of the CSA, it concluded that the CSA did not provide for the payment of negative, as opposed to positive interest, and dismissed the appeal.

Harry Edwards
Harry Edwards
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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Court of Appeal emphasises the need to plead conspiracy claims in full

In a recent decision arising out of long-running litigation relating to alleged mis-selling of interest rate hedging products (“IRHPs“), the Court of Appeal has upheld the High Court’s refusal to allow the claimants to pursue claims in unlawful means conspiracy: Elite Property Holdings Ltd & Anor v Barclays Bank plc [2019] EWCA Civ 204. We considered the High Court decision in an earlier banking litigation e-bulletin.

While this decision did not involve new law, it serves as a reminder of the difficulties of bringing a claim based on conspiracy and, in particular, that it is not sufficient simply to plead a claim and hope something turns up in disclosure. The claimant must be able to plead full particulars of all elements of the claim at the outset. Further, as the case makes clear, release clauses in settlements may be construed widely and it is important to be clear as to precisely what claims (if any) are intended to survive the settlement. Both elements of the decision are likely to be welcomed by financial institutions.

The effect of the present judgment is finally to dispose of these proceedings (subject to any attempted appeal to the Supreme Court). The majority of the claimants’ claims relating to the sale of their IRHPs were previously struck out by the High Court (see our e-bulletin), in relation to which the Court of Appeal refused permission to appeal last year (see our e-bulletin). In its strike out judgment, the High Court had ordered the claimants to particularise properly their claims for conspiracy, giving the claim a potential lifeline, but the Court of Appeal has now refused permission to amend to include such claims, bringing this long-running dispute to an end.

Background

The detailed background is set out in our earlier e-bulletin, but in summary, following earlier decisions to strike-out parts of their claim, the claimants sought permission to amend their claim to add claims relating to unlawful interference and conspiracy with a predominant intention to injure, and conspiracy to use unlawful means. In particular, they sought to allege that the defendant bank (the “Bank“) combined with BDO to enable the Bank to foreclose the claimants’ loan facility (in connection with which the IRHPs were entered into) in breach of an undertaking given by the Bank.

The application to amend was dismissed by the High Court, whose judgment also dealt with other issues. The appeal in this case was concerned with the High Court’s decision to refuse permission to amend in relation to the claim for conspiracy to use unlawful means.

Decision

The Court of Appeal upheld the High Court’s decision. It agreed that, for the amendments to be allowed, the claimants needed to show that they had a real as opposed to fanciful prospect of success which was more than merely arguable and carried some degree of conviction: ED&F Man Liquid Products Ltd v Patel [2003] EWCA Civ 472.

The 2014 Release

The Bank argued it had made a redress offer concerned with the sale of the IRHPs (excluding consequential loss) which the claimants had accepted on 29 November 2014 (the “2014 Release“) and which settled any claims, including tortious claims for unlawful means conspiracy.

The claimants sought to argue that the 2014 Release did not, on its proper construction, include claims in unlawful means conspiracy. However, the Court of Appeal considered that, based on the drafting of the relevant agreement, the definition of “Claims” in the 2014 Release was extremely wide and was sufficient to include all claims of unlawful means conspiracy. As a result, it dismissed the appeal because the only claim in the amended pleading which was now pursued could have no real prospect of success.

Elements of unlawful means conspiracy

Although the appeal had been disposed of based on the 2014 Release, the Court of Appeal went on to consider the appeal against the High Court’s decision to refuse permission to amend on the grounds that the essential elements of the tort of conspiracy had not been pleaded.

The Court of Appeal confirmed the basic elements of the tort of conspiracy summarised by Morgan J in Digicel (St Lucia) Ltd v Cable & Wireless plc [2010] EWHC 774 (Ch):

“The necessary ingredients of the conspiracy alleged are: (1) there must be a combination; (2) the combination must be to use unlawful means; (3) there must be an intention to injure a claimant by the use of those unlawful means; and (4) the use of the unlawful means must cause a claimant to suffer loss or damage as a result.”

The claimants accepted that they needed to show that BDO and the Bank had combined to do something unlawful, and that they had simply pleaded an inference that there must have been a combination, rather than setting out a detailed pleading. However, the claimants submitted that pending disclosure it was not possible for them to plead more and that it was legitimate for an inference to be drawn.

The Court of Appeal held that this was not sufficient; it was necessary for each element of the conspiracy to be properly pleaded in full. Therefore the proposed amendments were defective and permission should be refused.

John Corrie
John Corrie
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

Commercial Court rejects EURIBOR implied representations

The Commercial Court has dismissed claims that a bank made implied representations as to EURIBOR rate-setting in the context of selling an interest rate swap: Marme Inversiones 2007 SL v NatWest Markets plc & Ors [2019] EWHC 366 (Comm).

This is the second civil court trial judgment considering IBOR manipulation, the first being Property Alliance Group Ltd v Royal Bank of Scotland [2018] 1 WLR 3529 in which the claim relating to LIBOR manipulation was also dismissed (see our banking litigation e-bulletin). Together, these decisions are a reminder of the difficulties of proving allegations that IBOR-setting banks made implied representations when selling IBOR-linked products. The combined effect of these judgments suggests:

  • The requirement to identify specific conduct which led to the implied representation being made is important (and should not be underestimated). In the context of these transactions, a bank simply entering into an IBOR-linked swap is unlikely to justify the implication of any representation wider than the limited representation formulated by the Court of Appeal in PAG (see below).
  • Implied representations must be certain and obvious: if there is “elasticity of possible meaning“, this will indicate the absence of an implication.
  • The broader and more complex the alleged representations, the more active and specific the conduct must be to give rise to the implication.
  • Proving reliance on any representations which are implied will be fact-specific and onerous.
  • Falsity must be specifically proven: it is not sufficient to draw inferences on the basis of conduct relating to other benchmarks (such as an IBOR in a different currency) or indeed findings of the regulator.

In PAG, the Court of Appeal held that the bank made the narrow implied representation (at the time of entering into the swaps) that it was not itself seeking to manipulate GBP LIBOR and did not intend to do so in the future (however the claimants could not prove that the representation was false). In this case, the court’s view was that a similar narrow representation in relation to EURIBOR could theoretically have been implied, but this implied representation was not alleged, and was not shown to be false in any event.

Background

The proceedings arose out of interest rate swaps set by reference to EURIBOR, entered into between Marme Inversiones 2007 SL (“Marme“) and the defendant banks (the “Banks“). The Banks sought various declarations that they had lawfully terminated the swaps and that Marme owed them €710 million plus interest.

Marme sought rescission of the swaps ab initio and/or damages of up to €996 million on the basis that one of the Banks (RBS plc, “RBS“) negligently/fraudulently made representations regarding the integrity of the process of setting EURIBOR (on its own account and as agent for the other Banks) and that Marme relied upon those representations when entering into the swaps. Marme did not contend that the representations were made expressly, but that they should be implied from the circumstances and RBS’s conduct.

Decisions

The court found in favour of the Banks. It granted the declarations sought and held that the alleged representations did not fall to be implied.

The court distilled the following principles from existing authorities considering implied representations:

  1. It is possible for a representation to be made expressly or impliedly through words or conduct. For a representation to be implied, silence or mere assumption is not usually enough as there is no general duty of disclosure. It is necessary to view the words or conduct objectively to determine whether an implied representation has been made. The natural assumptions of the reasonable representee will be helpful in assessing whether an implied representation has been made through the conduct of the representor.
  2. Whether or not a representation is implied is ultimately a question of fact to be determined in the circumstances of the particular case: see also Deutsche Bank AG v Unitech Global Ltd [2013] EWCA Civ 1372.
  3. More may be required, in terms of words or conduct, to prove an implied representation which is wide in meaning or complex.
  4. It is less likely that a representation that is vague, uncertain or ambiguous would be objectively understood to have been made from words or conduct.

With these principles in mind, the court considered the representations alleged in the instant proceedings, identifying a number of (legal and factual) difficulties with the case alleged by Marme. The key points which are likely to be of broader interest are summarised below.

  • Marme alleged that in the light of PAG, at least some of the alleged representations in this case should be treated as having been “plainly” made by RBS. The court found that in truth PAG provided no support at all for Marme’s case. In PAG, the claimants similarly sought rescission of swap agreements and/or damages on the basis of (among other things) alleged implied fraudulent representations. The Court of Appeal in PAG found that the representations as pleaded could not be implied, but decided that a different implied representation would be justified:

In the present case there were lengthy discussions between PAG and RBS before the swaps were concluded as set out by the judge in the earlier part of her judgment. … RBS was undoubtedly proposing the swap transactions with their reference to LIBOR as transactions which PAG could and should consider as fulfilment of the obligations contained in the loan contracts. In these circumstances we are satisfied that RBS did make some representations to the effect that RBS itself was not manipulating and did not intend to manipulate LIBOR. Such a comparatively elementary representation would probably be inferred from a mere proposal of the swap transaction but we need not go as far as that on the facts of this case in the light of the lengthy previous discussions.

  • Marme submitted that, in the same way as PAG, the representations in this case should be inferred from a mere proposal of the swaps. However, the court observed that the representations in this case were not the same as the (narrow) implied representations reformulated by the Court of Appeal in PAG.
  • The court held that the implied representations were not supported by any other authority, in particular Deutsche Bank v Unitech offered no support. The court emphasised that although the Court of Appeal in Deutsche Bank v Unitech granted permission to amend to include pleas of implied representations about LIBOR, it would be wrong to regard what was decided as having too great a significance (given the appeal related to an interlocutory application to amend statements of claim and merely found that the points advanced were arguable).
  • Importantly, the court was concerned that if Marme’s case on implication was to succeed, it would inevitably involve a ‘watering down’ of the requirement that specific conduct be identified from which any alleged representation is said to arise. It said Marme could identify no conduct other than RBS entering into (and allegedly proposing) the swaps to justify the implication of any representation wider than the limited representation formulated by the Court of Appeal PAG. In the court’s view, this was an “intractable difficulty” for Marme.
  • The court also considered the decision in Geest v Fyffes [1991] 1 All ER (Comm) 672. The court in that case had set out a “helpful test” for evaluating the representor’s conduct in cases of implied representations, which is: to consider whether a reasonable representee would naturally assume that the true state of facts did not exist and that, if it did, he would necessarily have been informed of it. The Court of Appeal in PAG agreed this test was helpful, but it warned that this should not water down the requirement that there must be clear words or clear conduct of the representor from which the relevant representation can be implied. Here, the court said that invocation of the “helpful test” in Geest was not enough by itself – Marme could not merely rely on an internal assumption on its part that RBS failed to correct.
  • The court was concerned about the distinct lack of certainty (and associated lack of obviousness) as to what was entailed in the alleged representations. It said there was the same “elasticity of possible meaning” which had operated against the implication in Raiffeisen Zentralbank Osterreich AG v RBS [2010] EWHC 1392 (Comm).
  • The court accepted that passive conduct may sometimes be sufficient for the implication of a representation. However, it said the broader and more complex the alleged representations, the more active and specific the conduct must be to give rise to the implication.
  • In the court’s view, RBS’s conduct in going along with the swaps was sufficient for the implication of a much narrower representation: namely that RBS was not itself manipulating, and did not intend to manipulate or attempt to manipulate, EURIBOR. However, that implied representation was not put forward by Marme in the action. The court said that this was probably because Marme recognised that it would be “in no position to establish falsity“.

The court therefore rejected the implication of the representations alleged by Marme, the action failed and the court held that the banks were entitled to the declaratory relief sought. In case it was wrong in these conclusions, the court went on to consider questions of falsity and reliance, but this was on an obiter basis given its primary conclusions.

Donny Surtani
Donny Surtani
Partner
+44 20 7466 2216
John Corrie
John Corrie
Partner
+44 20 7466 2763
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

Important High Court guidance on the limits of determining party’s discretion when calculating Loss under the 1992 ISDA Master Agreement

The High Court has provided important guidance on the application of the standard to which a determining party’s calculation of Loss under the 1992 ISDA Master Agreement will be held in Lehman Brothers Finance AG (in liquidation) v (1) Klaus Tschira Stiftung GmbH & Anor [2019] EWHC 379 (Ch).

Upon an Event of Default under the 1992 ISDA, the standard to which the determining party is held in calculating Loss (if elected) under the 1992 ISDA has previously been confirmed in Fondazione Enasarco v Lehman Brothers Finance SA [2015] EWHC 1307 (read our summary here). The test is one of rationality, rather than objective reasonableness (in contrast to the position under the 2002 version of the ISDA Master Agreement). This gives the determining party greater latitude, with the result that the amounts can be determined quickly and with only limited basis for challenge. In the classical formulation of the test, the defaulting party can challenge the determination if it is irrational, capricious or arbitrary.

The Tschira decision provides additional clarification of the limitations on the determining party’s discretion to determine Loss, illustrating that the width of the discretion does not mean that the determination can only be challenged if it can be shown that “no reasonable Non-defaulting Party acting in good faith could have come to the same result“. In particular:

  1. Whilst an administrative-law style assessment would consider whether the determining party took into account all relevant factors and ignored all irrelevant factors, that does not mean that the determining party has the freedom to determine what the definition of Loss in the 1992 ISDA actually means. In other words, the determining party cannot apply its own interpretation of Loss and the court will scrutinise whether the correct interpretation has been applied.
  2. The definition of Loss in the 1992 ISDA did not provide a de facto indemnity against all losses suffered as a result of the Event of Default. Accordingly, common law principles of remoteness applied and it was necessary for the court therefore to consider whether all of the losses incorporated into the determination were in the reasonable contemplation of the parties.
  3. Whilst the determining party is plainly able to use indicative quotations obtained from market participants for the purpose of its calculation of Loss, care must be taken:
  • Only in limited circumstances will it be appropriate to rely on indicative quotations as at a later date than the Event of Default.
  • Whilst Enasarco established that the replacement trade to which the quotation applies need not be identical to the trade being valued, where the differences would obviously produce a substantially different result there is a real risk that use of such quotations to determine Loss would be deemed irrational.
  • It is clear that the determining party need not in fact enter into the replacement trade in order to be able to use the indicative quotation for the determination of Loss. However, in order for use of an indicative quotation to be rational, it may need to have been possible for the determining party to have been able to enter into it.

Background

The defendants were two German entities established by one of the founders of SAP. Since their principal assets consisted of shares in SAP, they had each entered into a number of single stock derivative transactions with Lehman Brothers Finance AG (the “Bank“), a Swiss entity which was part of the Lehman Brothers group, to hedge against significant falls in the price of SAP shares. The hedging transactions were governed by the 1992 version of the ISDA Master Agreement. Given the poor credit quality of the defendants, the terms of the transactions required the SAP shares they held to be placed as collateral with the UK subsidiary of the Lehman Brothers group (“LBIE“).

The collapse of Lehman Brothers on 15 September 2008 caused an Event of Default on the hedges triggering the need for the defendants to determine the close-out payments (on the basis of Loss, which the parties had elected as the methodology to apply in the 1992 ISDA). Soon after the Event of Default, the defendants sought indicative quotations from Goldman Sachs and Mediobanca, Banca di Credito Finanziario SpA (“Mediobanca“) for replacement hedges on the basis that they would be collateralised in a similar way to the original trades.

However, the defendants later learnt that the SAP shares held by LBIE as collateral would be dealt with as part of its administration, raising the prospect of them being unavailable to the defendants for use in any replacement trade for the foreseeable future. As a result, Mediobanca and Goldman Sachs were asked to provide revised indicative quotations for replacement trades on an uncollateralised basis. Unsurprisingly, these quotations were substantially higher than the earlier quotations which had been obtained on a collateralised basis (reflecting, amongst other things, the significantly greater credit risk to which the counterparty would be exposed).

The defendants ultimately served a determination of Loss based on Mediobanca’s quotation for an uncollateralised replacement trade. Accordingly, the determination of Loss which it sought to recover from the Bank (over €511m) was far higher than it would have been had it been determined on the basis of the earlier quotations which were based on a collateralised replacement trade (which were €28.22m and €17.46m).

The Bank challenged the calculation of Loss.

Decision

The court held that the determination of Loss by the defendants was invalid. First, it had not been performed in accordance with the definition of Loss. In any event, it was found to have been irrational.

Application of the rationality standard

It is well established by the authorities (for example, Enasarco) that the relevant standard which applies to the determining party’s calculation of Loss under the 1992 ISDA is one of rationality, reflecting the test of Wednesbury reasonableness of an administrative decision. However, it was noted that this did not resolve all uncertainties as to the standard to which the determining party will be held. In particular, it was unclear whether this test imported into the court’s assessment of all the elements of a review of an administrative decision, including the process by which the determination was reached.

The court held that the 1992 ISDA did not import a requirement that the court undertake a detailed assessment of whether the determining party took into account all relevant factors and ignored irrelevant factors. To allow such an expanded basis for challenge would undermine the desire for speed and commercial certainty which is clearly one of the driving principles of the Loss definition. However, the determining party does not have free rein to determine for itself not only the method it will adopt to determine Loss, but also the actual meaning of Loss. Accordingly, the Bank was not limited only to being able to challenge the determination of Loss on the basis that the method chosen was irrational (or in bad faith), for which the defendants had a large measure of latitude. It could also challenge the determination on the basis that the defendants had interpreted the definition of Loss incorrectly.

Remoteness test in the meaning of Loss

The court held that the correct meaning of Loss incorporated usual common law principles applicable to the assessment of contractual damages, including remoteness. The key question, therefore, was whether all of the Loss claimed was of a type that was in the reasonable contemplation of the parties. Applying this test, the court found that it was not within the reasonable contemplation of the parties that the defendants would be able to recover the additional financial consequences of having to enter into an uncollateralised replacement trade as a result of being unable to retrieve the collateral from LBIE.

The court noted that this conclusion was consistent with the ‘value clean’ principle, pursuant to which the loss of bargain within the Loss calculation must be valued on the assumption that “but for termination, the transaction would have proceeded to a conclusion, and that all conditions to its full performance by both sides would have been satisfied, however improbable that assumption may be in the real world“. Applying the ‘value clean’ principle in this case, the provision of the collateral by the defendants was a condition precedent for the trades. Accordingly, the assumption should be made for the replacement trades that this condition would be satisfied, notwithstanding that this was not possible in the real world. This meant that any quotations for replacement transactions should have been on a collateralised basis.

Appropriate date for determining Loss

The court also considered a criticism made that the quotations used for the defendants’ determination should have been ‘as of’ the Early Termination Date. The Bank argued that, whilst the Loss definition permitted (for practical reasons) some flexibility in the use of a firm quotation obtained after the Early Termination Date, it did not allow an indicative quotation to be used other than as of the Early Termination Date. The rationale for this was that it should always be possible to obtain an indicative quotation as at the earlier date (on a retrospective basis).

The court did not agree with such a restrictive interpretation of Loss, which would have the effect of requiring, rather than permitting, the Non-defaulting Party to use firm quotations rather than any other method in circumstances where, for whatever reason, it was unable to obtain quotations at the time of the Early Termination Date (for instance where it did not learn of the Event of Default until a later point in time or where there was no available market as at the Early Termination Date). However, it noted that this flexibility would only apply in those sorts of limited circumstances.

Rationality

The court also found that it was, in any event, irrational for the defendants to use the uncollateralised replacement transactions as a basis for the calculation of Loss.

First, whilst the existence of some differences between the terms of the trade and the terms of the replacement trade may not invalidate the determination of Loss (as illustrated in the Enasarco case), there were limits to that latitude. In this case, seeking quotations for replacement trades on an uncollateralised basis would obviously, and did, produce a substantial difference when compared to seeking quotations on a collateralised basis. This meant that they were not a reliable guide as to the value of what had been lost, and to use this as a basis for the calculation of Loss was irrational.

Second, the method of using quotations or valuations of the cost of a replacement trade to measure loss depends on the replacement being one that the party could enter into in an available market (albeit that they need not actually enter into the replacement trade). Having made a finding of fact that the defendants, given their poor credit risk, could not have entered into a replacement hedge on an uncollateralised basis, it was irrational to use a quotation for such a transaction as a method of determining its Loss.

The court’s calculation of Loss

Having found that the determination was invalid, the task for the court was to determine what Loss determination would have been arrived at by the defendants acting reasonably and in good faith. It therefore substituted the defendants’ invalid determination with its own calculation, using the initial quotations which had in fact been obtained by the defendants (on a collateralised basis). Whilst there were criticisms made of aspects of those quotations by the Bank’s expert, these were characterised by the court as differences of methodology, rather than fundamental errors that would lead to a substantially different price.

The court’s approach emphasised the potential importance of all contemporaneous quotations received by the Non-defaulting Party. Whilst it is clear from previous case law (see our e-bulletin on National Power) that the determining party gets only one bite at the cherry, the steps taken to obtain other quotations at or around the time of the Event of Default are likely to provide important evidence for the court to use in its own calculation of Loss.

It is noteworthy, also, that in this aspect of the judgment the court left open the question of whether the determining party could validly favour its own interests in the selection of which quotation to use in its determination, or whether choosing the one which was most favourable would necessarily be irrational. The court adopted the pragmatic approach of averaging the two quotations which the defendants received on the basis that the defendants had, as a matter of fact, used that average when providing a ‘without prejudice’ informal calculation of Loss in the initial days after the Event of Default. However, in doing so, it has left the question to be determined in future litigation.

Harry Edwards
Harry Edwards
Partner
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Amel Fenghour
Amel Fenghour
Associate
+44 20 7466 2389
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948