ISDA pre-cessation fallback consensus: will this reduce legacy LIBOR risk in the derivatives market?

The International Swaps and Derivatives Association (ISDA) has announced the preliminary results of its re-consultation on the implementation of pre-cessation fallbacks for derivatives referenced to LIBOR (see press release). It follows an earlier consultation on pre-cessation fallbacks last year, which failed to achieve market consensus on whether or not (and if so, how) to include a pre-cessation trigger (see the consultation and the results), causing a delay to the development of a way forward in the critical derivatives market. See our previous blog post on ISDA’s decision to carry out a second consultation.

While these are only preliminary results, ISDA expects to proceed on the basis of the views of the significant majority of respondents who are in favour of including both pre-cessation and permanent cessation fallbacks as standard language in the amended 2006 ISDA Definitions for LIBOR and in a single protocol for including the updated definitions in legacy trades.

It is noteworthy that ISDA has published the fact that consensus has been reached at the earliest opportunity (without the usual practice of including a preliminary report), recognising the significance of the outcome of this consultation for the market.

The outcome is significant because it will allow ISDA to press ahead with finalising the way forward in the critical derivatives market and give impetus to other markets to progress their own solutions.  Moreover, this should avoid different derivative contracts switching away from LIBOR at different times (which would have created mismatches between different parts of a portfolio). However, some market participants will be concerned at the loss of flexibility in how to address LIBOR cessation across their derivative positions, which may have the undesirable effect of putting them off adhering to the protocol at all.

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Commercial Court dismisses challenge to exercise of options in swap confirmations incorporating 2000 ISDA Definitions

The Commercial Court has dismissed a challenge to the exercise of options contained in five extendable interest rate swaps which incorporated the 2000 ISDA Definitions: Alfred Street Properties Ltd v National Asset Management Agency [2020] EWHC 397. The challenge was brought on the basis that notice was either not given by a contractually prescribed method or at all, despite the resultant swap transactions having been performed to term without challenge by either party.

The decision provides some helpful guidance on the approach to contractual interpretation of the ISDA Master Agreement and the 2000 Definitions. The court noted that while a strict approach, favouring clarity, certainty and predictability is required in interpreting the terms of standard market agreements, any questions as to incorporation and variation of such provisions should be interpreted according to the recognised principles of general contractual interpretation as confirmed by the Supreme Court, e.g. in Wood (Respondent) v Capita Insurance Services Limited (Appellant) [2017] UKSC 24 (see our litigation blog post).

Adopting a “unitary” approach, which involves an iterative process by which rival interpretations are checked against the provisions of the contract and the commercial consequences investigated, the court considered (in particular) Article 10 of the 2000 Definitions (which sets out the definitions of “Option Transaction” and “Swaption”). The court held that there is no requirement under Article 10 for parties to use the precise name or label “Option Transaction” or “Swaption” in the confirmation evidencing the swap transaction. It is sufficient for a transaction to be identifiable as such, e.g. by defining or describing either the transaction or its operation, in terms which “make it clear that it falls within the provisions dealing with those transactions”.

The key parts of the decision are considered below.

Background

Alfred Street Properties Limited (“ASPL”) entered into facilities totalling £111.5 million with Anglo Irish Banking Corporation, together with five extendable interest rate swaps to hedge its interest rate exposure under the facilities (the “Swaps”). The National Asset Management Agency (“NAMA”) subsequently acquired the bank’s interests in the loans and the Swaps. For convenience, in this blog post the bank’s rights and obligations under these documents are referred to as belonging to NAMA.

Each of the confirmations relating to the Swaps (each a “Confirmation”) incorporated the 2000 ISDA Definitions and was governed by the 1992 ISDA Master Agreement (Multicurrency-Cross Border) (the “ISDA MA”).

The Confirmations provided, amongst other things, that NAMA had the right, but not the obligation, to extend the Swaps by 11.00am (London time) on 2 April 2012 (the “Options”). In the event that NAMA exercised that right by the specified time and date, the Swaps would be extended on the same terms for a further three years, save that ASPL would pay an increased fixed rate.

NAMA sought to exercise the Options (via its agent) on 2 April 2012 at 9.15am by telephone (the “Notice Call”). Thereafter, ASPL made quarterly payments to NAMA on the assumption that the Swaps had been duly extended, totalling £4,778,289.56 (the “Swap Payments”).

The claim

A year after the term of the Swaps expired, ASPL alleged that NAMA’s exercise of the Options was invalid and sought restitution of the Swap Payments plus interest. Proceedings were commenced in January 2017 in which ASPL claimed that:

  1. NAMA was not entitled under the terms of the Confirmations to notify ASPL of the exercise of the Options by telephone. Whilst, s.12.2 of the 2000 Definitions allowed for notice of the exercise of Options to be provided orally, including by telephone, ASPL argued that the s.12.2 procedure was not engaged because the Confirmations did not expressly identify (using capitalised terms) that the transactions in question were “Option Transactions” or “Swaptions”. Instead, ASPL asserted that NAMA should have given notice in accordance with s.12(a) of the ISDA MA, which did not allow for notice by telephone. Alternatively, ASPL argued that, even if the s.12.2 procedure in the 2000 Definitions was engaged, exercise of the Options by telephone was not permissible as the Confirmations did not include a telephone contact number for ASPL, only a postal address (the “Notice Issue”); and
  2. NAMA’s agent did not actually exercise the Options on the Notice Call but merely indicated NAMA’s intention to exercise the Options (the “Intention Issue”).

Decision

The court dismissed the claim in its entirety.

The Notice Issue

The court noted that while a strict approach, favouring clarity, certainty and predictability is required in interpreting the terms of standard market agreements such as the ISDA MA or 2000 Definitions, any question as to incorporation and variation of such provisions should be interpreted according to the recognised principles of general contractual interpretation. It cited the Supreme Court’s decisions in Rainy Sky SA v Kookmin Bank [2011] 1 UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita. The court emphasised the “unitary” approach to contractual interpretation in Rainy Sky and Arnold, which involves an iterative process by which rival interpretations are checked against the provisions of the contract and the commercial consequences investigated.

Applying this approach, the court rejected ASPL’s arguments, finding that NAMA was entitled to give notice to ASPL by telephone under s.12.2 of the 2000 Definitions. The key reasons given by the court were as follows:

  1. The court held that Article 10 of the 2000 Definitions, which sets out the definitions of “Option Transaction” and “Swaption”, simply requires that a transaction be identifiable as such in the confirmation evidencing the swap transaction (e.g. by defining or describing either the transaction or its operation, in terms which “make it clear that it falls within the provisions dealing with those transactions”). It said there was no requirement to use the precise name or label “Option Transaction” or “Swaption”. The court found that the terms of the Swaps set out in the Confirmations “clearly and obviously” showed the transactions were “Option Transactions” because of how they were described – even though the defined (capitalised) terms were not used. Accordingly, s.12.2 of the 2000 Definitions was the correct procedure for NAMA’s exercise of the Options.
  2. The court considered, obiter, the alternative scenario if its conclusion at point (1) above was wrong, namely whether the s.12.2 procedure could still apply, or whether notice had to be given in accordance with s.12(a) of the ISDA MA which did not allow for notice to be given orally. The court commented that a textual analysis of the Confirmations suggested the s.12.2 procedure could still apply because:
    1. Even if the Options were not identified as “Option Transactions”, the s.12.2 procedure had been incorporated into the Confirmations – in particular because the Options and their terms were structured solely by reference to terms defined in Articles 11 and 12 of the 2000 Definitions.
    2. For the s.12(a) ISDA MA method to apply, the parties would need to have set out contact details in a Schedule to the Confirmations which they had not done. In the absence of contact details, only the s.12.2 procedure was workable.
    3. The broader business context of the Confirmations also supported the conclusion that the parties had chosen to adopt the s.12.2 procedure. The decision to exercise an option by 11am on a particular day, would be highly sensitive to market movements and may be made at the last minute; that meant NAMA’s ability to exercise the Options orally made far more business sense than the alternative which would have required notice by post.
  3. The court also rejected ASPL’s argument that, as the Confirmations only specified a postal address and not a telephone number, notice by post was the only method permitted under the s.12.2 procedure. The parties could use the s.12.2 procedure irrespective of whether telephone contact details had been provided. S.12.2 expressly permitted oral notification, so the inclusion of a postal address did not implicitly exclude the other notice methods to which s.12.2 referred. In any event, the court found that the postal address had been included as an address for the Confirmation to be sent, rather than as an address for notice under s.12.2.

The Intention Issue

The court considered that, to decide whether the Options had actually been exercised on the Notice Call, the test was whether a reasonable person in the position of ASPL’s Head of Finance (ASPL’s representative on the Notice Call), with knowledge of the relevant circumstances, would have understood during the Notice Call, that NAMA was exercising the Options.

As the transcript of the Notice Call showed, NAMA’s agent stated that NAMA would be exercising the Options; identified the Swaps in question (but not discussed the terms relevant to the extension); and stated that he would follow up with a formal confirmation.

The court found that NAMA’s agent’s words were “exactly what would be expected of a party…exercising an option in a trade…”. The context, including the fact that the call took place during the limited window when the Options could be exercised, and the wording of a confirmation email sent by NAMA’s agent to ASPL’s Head of Finance after the Notice Call, also supported the argument that a reasonable person in the position of ASPL’s Head of Finance would have understood that the Options were being exercised.

Conclusion

Accordingly, the court found that the Options had been validly exercised and the Swaps extended. The court further found on an obiter basis that – in the absence of the Options having been validly exercised – NAMA would have had defences of estoppel by convention or by conduct, or change of position, given the parties’ performance of the Swaps to term.

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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.

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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.

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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.

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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.

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Commercial Court finds that ‘negative’ interest is not payable on cash collateral posted in accordance with the standard form ISDA Credit Support Annex

The question of whether ‘negative interest’ will be payable by a transferor of cash collateral in the context of a standard form ISDA 1995 Credit Support Annex (Bilateral Form – Transfer) (“CSA“) has been considered by the Commercial Court in The State of the Netherlands v Deutsche Bank AG [2018] EWHC 1935 (Comm). The court found that there was no obligation on the transferor of cash collateral to account to the transferee for negative interest on that collateral.

Many market participants will already have been aware of the uncertainty surrounding negative interest rates under the CSA given the lack of express terms. It was this uncertainty which led ISDA to publish the ISDA 2014 Collateral Agreement Negative Interest Protocol (the “2014 Protocol“), containing express terms dealing with negative interest rates. As such, the decision is not entirely unexpected, but will provide clarity on this point.

The decision raises an interesting question as to the position in circumstances where the interest rate is not negative for an entire Interest Period (as was the case here). If the interest rate is fluctuating daily between negative and positive amounts in a given Interest Period, should negative interest be taken into consideration in calculating the daily Interest Amount? While the judgment does not cover this fact pattern specifically, it may be thought to be anomalous to take account of negative amounts on a daily basis (netting them off against any positive amounts within the same Interest Period, rather than ascribing a zero value), when the instant judgment confirms that a negative amount at the end of the Interest Period does not need to be accounted for/paid (in the absence of an express obligation).

Central to the court’s decision was its finding that an obligation to pay negative interest would have to be “spelled out“. This was not done in paragraph 5(c)(ii) of the CSA (the obvious place for such an obligation to appear), which only contemplated payment of interest from the transferee of collateral to the transferor.

In reaching its conclusion, the court emphasised the objective nature of the task of construction of the ISDA documentation. It determined that the 2013 Statement of Best Practice for the OTC Derivatives Collateral Process and the 2014 Protocol (which address negative interest), could not be considered part of the context of the agreement between the parties, as they were not available to the parties at the time the relevant agreement was made. In any event, those statements were not offered by ISDA as a view on interpretation (and the 2014 Protocol expressly envisaged amendments which parties could make). By contrast, the ISDA User’s Guide – which was available to the parties at the time of the agreement – could be used as an aid to interpretation. The ISDA User’s Guide reinforced the point that the focus of the agreement was on what the transferee would do in return for holding cash collateral.

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 (Multicurrency – Cross Border), Schedule and CSA (together the “Agreement“). The CSA was amended in 2010 to delete and replace paragraph 11.

Pursuant to the Agreement, the parties entered into a number of derivative transactions. 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 (the “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.

Claim

The State brought a claim against the Bank for negative interest in respect of the Collateral.

The State acknowledged that paragraph 5(c)(ii) of the CSA only required the transferee (defined in the Agreement as the State) to pay interest to the transferor (defined in the Agreement as the Bank); there was no reciprocal obligation. Accordingly, rather than rely on CSA paragraph 5(c)(ii), the State argued that the Bank was obliged to ‘account’ for negative interest in calculating the Credit Support Balance (broadly speaking, the aggregate of the Collateral received by the State, i.e. the valuation of the Collateral). The State relied on the final line of the definition of Credit Support Balance which states that Interest Amounts “not transferred pursuant to Paragraph 5(c)(i) or (ii) will form part of the Credit Support Balance“. The State contended that unpaid interest should increase – or in the case of negative interest, decrease – the value of the Credit Support Balance.

Decision

The court held that the State’s claim for negative interest failed. In reaching its decision, it set out in brief the basic requirements for interpreting an ISDA standard form agreement (commenting that there was no sound reason for any different approach in the case of a CSA that takes an ISDA standard form). This included:

The court considered the specific terms of the Agreement (and in particular the CSA) and found that the State failed to show that the Agreement included an obligation for the Bank to pay negative interest.

In coming to this conclusion, the court considered the following factors in particular:

  1. The court agreed with the Bank that if there was an obligation to pay negative interest “it would be spelled out“. The terms of paragraph 5(c)(ii) of the CSA contemplated payment of interest from the State to the Bank only. Had the parties wished to, they could have included an obligation on the Bank to pay negative interest. Illustrating the point that there was nothing to suggest the parties had intended negative interest to be payable, the court noted that (under paragraph 11 of the CSA), the parties had provided for a zero interest rate, rather than the payment of negative interest, if the Bank transferred the Collateral to the wrong account.
  2. The final sentence of the definition of Credit Support Balance was explained by providing for amounts of interest the State was obliged to pay under paragraph 5(c)(ii) but had not yet transferred, without requiring an obligation in respect of negative interest where none was “spelled out“.
  3. Paragraph 5(c)(ii) of the CSA was the obvious place for any obligation to pay negative interest to appear. There was no credible commercial rationale for the parties having chosen different mechanisms to deal with positive and negative interest.
  4. The court also considered potential reasons why commercial parties may have been concerned only with positive and not negative interest, including that payment of interest on the Collateral by the State was “a price for having use of the [Collateral]“. It said this reflected the fact that the Collateral, being in cash, could be expected to make money solely by being held (by the State). Conversely, if cash Collateral was held in a negative interest rate scenario, it did not follow that the State could be expected to lose money and so that burden should be shouldered by the Bank. In this context, the court noted that the parties had agreed that the State could freely use the Collateral to generate a return elsewhere, such that the State would not necessarily incur loss by holding cash where interest rates were negative.
  5. The court did not accept that the exercise of interpretation was assisted by either ISDA’s 2013 Statement of Best Practice for the OTC Derivatives Collateral Process, or ISDA’s 2014 Protocol, given that these post-dated the agreement. In any event, they did not assist the State since the protocol envisaged parties making amendments in order to bring about the payment of negative interest. This was contrasted with ISDA’s User Guide, which was available as an aid to interpretation.

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Court of Appeal finds ISDA jurisdiction clause trumps ‘theoretically competing’ clause in separate agreement governing wider relationship

Consistent with recent authority, the Court of Appeal has given primacy to an English jurisdiction clause in an ISDA Master Agreement (overturning the first instance decision that had declined to do so), in circumstances where there was a “theoretically competing” jurisdiction clause in a separate agreement governing the wider relationship: Deutsche Bank AG v Comune di Savona[2018] EWCA Civ 1740.

The appellate decision contributes to market certainty in respect of contracting parties’ choice of jurisdiction and therefore represents good news for derivative market participants. The Court of Appeal commented that it would have been “startling” if the bank’s claims for declaratory relief falling squarely under the relevant swap contracts could not be brought in the forum selected by the parties in the ISDA Master Agreement.

The approach taken by the Court of Appeal focused on determining the “particular legal relationship” to which the dispute related for the purpose of Article 25 of the Recast Brussels Regulation, which deals with jurisdiction agreements. In circumstances where there were two contracts (with theoretically competing jurisdiction clauses), it held that there was a distinction to be drawn between a generic wider relationship on the one hand, and a specific interest rate swap relationship governed by the ISDA Master Agreement on the other. It concluded in general terms that disputes relating to the swap transactions were therefore governed by the jurisdiction clause in the ISDA Master Agreement.

While it may be expected that disputes relating to a specific transaction should be governed by the contract for that transaction, the position had been undermined by the High Court decision in the instant case (which considered a number of points of Italian law and the effect of the declarations sought by the bank on any potential claims in Italy). The Court of Appeal noted that while each case should be considered on its own terms, it agreed in principle with the approach in the recent case of BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2018] EWHC 1670 (Comm): which focused on the question of whether the English Court had jurisdiction under the relevant agreements, rather than to trying to predict whether the declarations sought, if made, would act as defences in another jurisdiction (read our banking litigation e-bulletin). Given that there had been conflicting first instance decisions on this issue, it is helpful to have this clarification from the Court of Appeal.

Background

In this case, the court considered “two theoretically competing jurisdiction clauses“. The clauses, in favour of the Italian and English courts respectively, were included in: (i) a written agreement dated 22 March 2007 between Deutsche Bank AG (the “Bank“) and Comune di Savona (“Savona“) (referred to as the “Convention“); and (ii) a 1992 multicurrency ISDA Master Agreement dated 6 June 2007 agreed between the same parties. In June 2007 the Bank and Savona executed swap confirmations, subject to the terms of the Master Agreement, by which the Bank and Savona entered into two interest rate swap transactions.

Years after the conclusion of the swaps, the validity of the transactions came under some scrutiny in Italy. In June 2016 this prompted the Bank to apply to the English Commercial Court seeking twelve declarations (in most cases) carefully tracking the wording of the Master Agreement. Savona challenged the jurisdiction of the English court in relation to five of the declarations sought, arguing that they fell to be determined in the Court of Milan and under Italian law, in accordance with the Convention.

High Court Decision

At first instance, the High Court allowed Savona’s challenge to the jurisdiction of the English court in respect of the five declarations and dismissed the Bank’s claims.

The High Court referred to Article 25 of the Recast Brussels Regulation, which provides that parties may agree to refer disputes in connection with a “particular legal relationship” to the court of a Member State. The High Court proceeded to consider the proper interpretation of the jurisdiction clauses, distinguishing the Bank’s role as an adviser under the Convention, from the Bank’s position “simply as a counterparty” under the swaps. The High Court concluded that the dispute was essentially concerned with the Bank’s role as an adviser, and more naturally fell within the Italian jurisdiction clause than the English jurisdiction clause.

Court of Appeal Decision

The Court of Appeal overturned this decision, finding that all twelve declarations sought fell within the English jurisdiction clause in the ISDA Master Agreement.

In reaching its conclusion, the Court of Appeal drew a distinction between the generic relationship between the Bank and Savona, which was governed by the Convention, and the specific derivative transactions entered into between the Bank and Savona, which were governed by the ISDA Master Agreement. It commented that this was a more natural and reasonable demarcation than the High Court’s distinction between “advice” on the one hand and being a “counterparty” on the other.

The Court of Appeal noted that:

  • While the Convention required the Bank to provide Savona with its expertise as to how to manage its debt, any transaction or agreement proposed by the Bank for this purpose and accepted by Savona would be the subject matter of a separate contract.
  • If a separate contract was proposed and approved, the relationship agreed in that contract would be the “particular legal relationship” envisaged by Article 25. Any proceedings “relating” to that contract would then be a dispute in connection with the particular relationship for the purposes of Article 25.
  • Consistent with this, the interest rate swap relationship was set out in the swap contracts incorporating the ISDA Master Agreement.
  • The existence of the entire agreement clause in the ISDA Master Agreement was a strong confirmation that the swap contracts were indeed separate contracts and any dispute relating to them was to come within the jurisdiction clause of those contracts.

In the Court of Appeal’s view, it would have been “startling” if the Bank’s claims falling squarely under the swap contracts could not be brought in the forum selected by the parties through the jurisdiction clause under those agreements, namely that contained in the ISDA Master Agreement. It said that a conclusion to that effect would have been highly damaging to market certainty.

Having found that disputes relating to the swaps were therefore to be determined by the English courts, the only question for the Court of Appeal was whether the particular declarations sought arose from disputes relating to the swaps. The Court of Appeal found, on reviewing the text of the declarations sought, that they did.

Donny Surtani
Donny Surtani
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Ceri Morgan
Ceri Morgan
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Emma Deas
Emma Deas
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High Court holds ISDA jurisdiction clause trumps competing jurisdiction clause in separate but related agreement

The decision of the High Court in BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2018] EWHC 1670 (Comm) confirms that an express agreement to the jurisdiction of the English court within standard form ISDA documentation will not easily be displaced or restricted. The court found that the jurisdiction clause in a 1992 ISDA Master Agreement was effective over a ‘competing’ jurisdiction clause in a separate but related agreement between the same parties. This was despite a provision in the Schedule to the Master Agreement that in the event of conflict, the related agreement would prevail.

The decision is likely to be of interest to financial institutions trading in derivatives based on ISDA documentation, and of particular interest to those involved in cross-border funding transactions which require the implementation of associated hedging through separate but related agreements. Significantly, the court found no conflict between ‘competing’ jurisdiction clauses in an ISDA Master Agreement and a separate financing agreement. The court noted that in complex financial transactions it was possible for the same parties to have multiple relationships, each governed by a separate agreement, and there was no inconsistency in each agreement having a different jurisdiction provision.

The court gave two further points of guidance in response to arguments raised by the bank’s counterparty relating to the background context within which to interpret the jurisdiction clause:

  1. In considering the declarations sought in these English proceedings, the court did not engage with the question of whether those declarations may act as defences to a claim in another jurisdiction (preferring the approach taken in Dexia Crediop SPA v Provincia di Brescia [2016] EWHC 3261 (Comm), over that in the more recent case of Deutsche Bank AG v Comune di Savona [2017] EWHC 1013 (Comm)).
  2. More generally, the court suggested that the use of ISDA standard documentation was evidence of the parties’ intention to limit the use of the specific factual background to their transaction in interpreting the agreement between them. It emphasised that the purpose of using such standard documentation is to achieve greater consistency and certainty in the parties’ dealings with each other. This reflects the approach of the court more generally in limiting the extraneous factors which will be considered where standard documentation, including ISDA documentation, is used by sophisticated commercial parties.

Background

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

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

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

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 challenged the jurisdiction of the English High Court.

Decision

The court considered TRM’s arguments that the Bank should not be permitted to pursue the English proceedings because: (1) there was no serious issue to be tried; and (2) the English court had no jurisdiction.

(1) Serious issue to be tried

TRM argued that there was no relevant dispute regarding the Master Agreement (containing the English jurisdiction clause) and the swap transaction. However, the court held that while there was no argument as to the validity of the swap transaction or Master Agreement, there was a dispute as to the Bank’s rights under them, and therefore a serious issue to be tried.

(2) Jurisdiction

The court started its analysis by reference to Article 25(1) of the Recast Brussels Regulation, which provides that parties may agree to refer disputes to the court of a Member State. The court went on to consider the ‘competing’ jurisdiction clauses in the Finance Agreement and Master Agreement. The court said that this was a question of construction or interpretation, and that its approach should be broad and purposive (Sebastian Holdings Inc v Deutsche Bank AG [2010] EWCA Civ 998).

It was held that the Bank had much the better of the argument that the dispute fell within the English jurisdiction clause of the Master Agreement. The following points made by the court in reaching its conclusion are likely to be of wider interest and application:

  • The two jurisdiction clauses could “readily bear” the interpretation that one was concerned with the Master Agreement and the other was concerned with the Financing Agreement. That fitted well in the context of the parties’ dealings and recognised that the parties had more than one relationship.
  • Similarly, the wide contractual language of the jurisdiction clauses in the two agreements did not prevent “an interpretation that allows those contracts to fit together“.
  • The provision in the Schedule to the Master Agreement providing that the Financing Agreement would prevail in cases of conflict was not engaged, simply because there was no conflict.
  • Addressing TRM’s argument that the interpretation of the jurisdiction clauses should have taken into account the specific factual context:

Comment

This decision is in line with recent judgments in relation to jurisdiction clauses in associated agreements and reinforces the view that non-identical clauses can co-exist in related agreements. The decision is also another example of judicial recognition of the need for certainty and consistency associated with the use and interpretation of the ISDA standard documentation.

Harry Edwards
Harry Edwards
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Donny Surtani
Donny Surtani
Partner
+44 20 7466 2216
 
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
 
Emma Deas
Emma Deas
Senior Associate
+44 20 7466 2613