Long-form Confirmations and Close-out Amounts: A Key Court Case Assists in Interpreting the ISDA
Ashurst LLP recently reported on an interesting court case heard in the Singapore International Commercial Court (SICC) between Macquarie Bank Ltd (Macquarie) and Graceland Industry Pte Limited (Graceland). The case centered on including Additional Termination Events in a long-form confirmation and how a close-out was done, and a Close-out Amount calculated under the ISDA.
The facts of the case were as follows:
The parties entered into a fertiliser derivatives transaction.
The parties also negotiated the terms of a urea swap and drafted a long-form confirmation (LFC), in which there was an Additional Termination Event (ATE) included, stating that if the parties did not sign an ISDA within 30 days of the trade being done, Macquarie would be entitled to terminate the swap according to the terms of the contract.
Graceland instructed Macquarie to do the swap, but the trade was only completed several days later, when Macquarie then informed Graceland that they would send the LFC for signature.
A further communication was sent to Graceland in which Macquarie asked if Graceland wished to change the index to calculate the settlement price of the swap (which Graceland did change), and a new amended LFC was duly sent.
A week later, Graceland sent Macquarie a notice to cancel the swap, and refused to sign the LFC.
Several weeks later, Macquarie sent a notice to Graceland stating that an ATE had occurred since Graceland had not concluded an ISDA within 30 days of trade date. The Early Termination Date is set for 8 July.
Macquarie sent a Close-out Amount calculation to Graceland on 11 July (based on the actual replacement cost of this transaction).
The key issues that the court dealt with were as follows:
Was there a binding agreement between the parties?
The LFC was never signed by Graceland. The court held there had been agreement (a meeting of the minds), to which Graceland agreed, but Graceland disputed the terms of the agreement.
The agreement of terms was found in the email correspondence between the parties and was deemed to be in terms of the draft LFC.
What were the terms of the agreement?
Graceland argued that Macquarie had acted as their broker. The court found that the parties acted as principal (as set out in the preamble of the LFC).
Macquarie also tried to argue that they had relied on Section 3(g) – the ‘No agency’ representation. However the court held that since no ISDA had been signed (and therefore the Section 3(g) representation had not been elected in the ISDA schedule), Macquarie could not rely on this. This shows that elective provisions that need to be turned on/off in the schedule will not apply in the context of an LFC.
Was the ATE validly triggered?
The court held that Macquarie was entitled to trigger the ATE since the 30-day period from the date of trade had lapsed without the ISDA being signed.
The court further held that even though the LFC was not signed, the email communication indicated clearly an agreement of minds between the parties, based on the draft terms of the LFC.
A point to learn from the case is it may be pertinent to include a further ATE in all LFCs that states that failure to sign or countersign an LFC constitutes an ATE. This would have ensured that Macquarie was not subject to interpretation by the court on this point. A further practical point on this is that it is advisable for all relevant provisions of the trade to be set out in writing before executing a trade, and then to incorporate the written terms into the agreement that is then signed. As was the case in this example where the court relied on the email communication between the parties to imply agreement of terms, even though the LFC was never signed.
Was the Close-out Amount calculated correctly?
Macquarie was not required to actually enter into replacement transactions.
Macquarie was required to act in a commercially reasonable manner when calculating the Close-out Amount.
The Close-out Amount should have been calculated on the Early Termination Date (otherwise this is not deemed commercially reasonable).
Brokerage costs can be included in the Close-out Amount (the ISDA specifies that one can include losses that a party ‘would incur’ if replacement transactions were entered into).
Internal operational costs that Macquarie incurred in calculating the Close-out Amount were also permitted to be included in the Close-out Amount calculation, since the ISDA states that no actual losses or costs have to be proved. It was sufficient that Macquarie’s records showed commercially reasonable operational costs were incurred.
The case has some key lessons and reiterates some key principles that the ISDA provides for, namely:
It is not fatal if an LFC is not signed, as long as there is written proof that agreement of terms was reached before the trade was done.
An ATE of failure to sign an ISDA within a certain timeframe is enforceable.
The court accepted a commercially reasonable approach to calculating the Close-out Amount in that replacement transactions did not actually have to be entered into in order to claim the replacement costs of the transaction (as the market may make it impossible or difficult to enter into such replacement transactions).
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