The construction of Section 6(d) of the 1992 ISDA Master Agreement and close-out mechanics

Background

The appeal turned on a point of construction of Section 6(d) of the 1992 (Multicurrency – Cross Border) ISDA Master Agreement relating to the payment of amounts following the close-out of transactions under the ISDA Master Agreement. Section 6(d) reads:

“(d) Calculations. 

(i) Statement. On or as soon as reasonably practicable following the occurrence of an Early Termination Date, each party will make the calculations on its part, if any, contemplated by Section 6(e) and will provide to the other party a statement (1) showing, in reasonable detail, such calculations (including all relevant quotations and specifying any amount payable under Section 6(e)) and (2) giving details of the relevant account to which any amount payable to it is to be paid. In the absence of written confirmation from the source of a quotation obtained in determining a Market Quotation, the records of the party obtaining such quotation will be conclusive evidence of the existence and accuracy of such quotation. 

(ii) Payment Date. An amount calculated as being due in respect of any Early Termination Date under Section 6(e) will be payable on the day that notice of the amount payable is effective (in the case of an Early Termination Date which is designated or occurs as a result of an Event of Default) and on the day which is two Local Business Days after the day on which notice of the amount payable is effective (in the case of an Early Termination Date which is designated as a result of a Termination Event). Such amount will be paid together with (to the extent permitted under applicable law) interest thereon (before as well as after judgment) in the Termination Currency, from (and including) the relevant Early Termination Date to (but excluding) the date such amount is paid, at the Applicable Rate. Such interest will be calculated on the basis of daily compounding and the actual number of days elapsed.”

The first appellant (Videocon Global Limited or Videocon) entered into a 1992 (Multicurrency – Cross Border) ISDA Master Agreement together with a Schedule and a Credit Support Annex (the Master Agreement) with Goldman Sachs International (the Respondent) on 26 October 2010. The obligations of Videocon under the Master Agreement were guaranteed by its parent, Videocon Industries Limited (together with Videocon, the Appellants). Two currency swap transactions (each a Transaction) were entered into under the Master Agreement.

As a result of Videocon failing to pay a margin call made by the Respondent under the Transactions, the Respondent served notice on 2 December 2011 (designating 2 December 2011 as the Early Termination Date) to early terminate the Transactions under the Master Agreement. For the purposes of the Master Agreement, “Loss” and “Second Method” were elected as the payment measure and payment method respectively. By a letter dated 14 December 2011, the Respondent served a statement pursuant to Section 6(d) of the Master Agreement, in which it stated the amount payable under Section 6(e) (together with interest and costs) (the Early Termination Amount), set out certain details of its calculations and gave details of the account to which the amount payable was to be paid (the Original Section 6(d) Statement). The Respondent stated in the Original Section 6(d) Statement that such Early Termination Amount was due “on the date of this letter (or, if later, the date on which this letter is effective)”.

The Respondent issued proceedings in the Commercial Court on 6 August 2012 following the Appellants’ failure to pay the Early Termination Amount and proceeded to seek summary judgment. One of the issues raised by the Appellants in defending the application (although not pleaded) was that the Original Section 6(d) Statement lacked certain details required under Section 6(d)(i). The judge hearing the summary judgment application (Mr Robin Knowles QC) concurred, noting that, in his view, it did not show, among other things, reasonable details of the calculations the Respondent had made or details of the quotations used in determining Loss. The Judge held that the purpose of the requirements as to the content of a statement under Section 6(d)(i) was to provide to the party receiving a statement the information required to enable a reasonable understanding of how the figures stated were arrived at, and to form a view as to whether the determination of Loss satisfied the contractual requirements of reasonableness and of good faith.

The Judge therefore granted summary judgment to the Respondent in respect of issues of liability but did not grant summary judgment in respect of the quantum of the sum claimed.

Rather than pursuing its originally pleaded claim to a trial on quantum, the Respondent delivered to Videocon a second notice under Section 6(d)(i) of the Master Agreement in March 2014 (the Second Section 6(d) Statement). The Second Section 6(d) Statement was expressly stated to supersede the Original Section 6(d) Statement. It provided further details of matters required under Section 6(d)(i) but claimed the same sum as that set out in the Original Section 6(d) Statement served in December 2011. The Respondent then sought summary judgment on the issue of quantum. In their defence, the Appellants contended that the Second Section 6(d) Statement had not been provided “on or as soon as reasonably practicable” following the Early Termination Date as required under section 6(d)(i) and, as a result, the Respondent could not claim the Early Termination Amount.

Teare J gave judgment in favour of the Respondent. He ruled that even if the Second section 6(d) Statement had not been served “on or as soon as reasonably practicable” following the Early Termination Date, the Early Termination Amount was payable. In coming to this conclusion, Teare J considered that it would make no commercial sense to conclude that following a failure to serve the notice “on or as soon as reasonably practicable” following the Early Termination Date, any later notice will inevitably be ineffective with the result that the sum claimed will never be payable. The Appellants appealed the judgment.

The appeal

In a unanimous judgment, the Court of Appeal dismissed the Appellants’ appeal without hearing submissions from the Respondent.

When is the debt obligation in respect of the Early Termination Amount due?

The court referred to the decision of the Court of Appeal in Lomas v JFB Firth Rixson Inc [2012] 1 CLC 713 (CA), in which the Court of Appeal had to decide on the proper construction of Section 2(a)(iii) of the Master Agreement. In Lomas v Firth Rixson, the Court of Appeal distinguished between the underlying indebtedness obligation and the payment obligation, and the different dates on which those obligations can arise.

Gloster LJ in the present appeal adopted the same approach and ruled that a similar distinction may be found in Section 6 in respect of the amount which becomes due in respect of an Early Termination Date and subsequently payable. In particular, the court decided that the debt obligation in respect of an Early Termination Date (ie the Early Termination Amount) arises, or accrues due on, or as at, the Early Termination Date for the following reasons:

• by the operation of Section 6(c)(ii), the Early Termination Date is the date on which the numerous obligations under the terminated Transactions are replaced by the single obligation to pay the Early Termination Amount;
• under the definition of “Loss”, Loss is determined as of the relevant Early Termination Date or, if that is not reasonably practicable, as at the earliest date thereafter as is reasonably practicable; and
• pursuant to Section 6(d)(ii), interest is payable on the amount due in respect of an Early Termination Date from (and including) the relevant Early Termination Date to (but excluding) the date of payment. Accordingly, the debt obligation necessarily arises prior to the service of the statement referred to in Section 6(d) and the debt obligation cannot be discharged by reason of a failure to serve a statement that is  compliant with the requirements of Section 6(d) or failure to serve “as soon as reasonably practicable”.

When is the Early Termination Amount payable?

Gloster LJ then proceeded to consider when the Early Termination Amount is payable under Section 6(d).

Gloster LJ referred to Section 6(d)(ii) which provides that the amount calculated as being due in respect of any Early Termination Date under Section 6(e) will be payable (in the case of an Early Termination Date which is designated or occurs as a result of an Event of Default) on the day that “notice of the amount payable is effective”. Gloster LJ concluded that the words “notice of the amount payable” do not refer to the detailed statement of the relevant calculations and quotations as contemplated by the Section 6(d)(i) statement. There is no reference in Section 6(d)(ii) that stipulates that only when a statement compliant with Section 6(d)(i) has been served will the payment obligation be triggered. The reference to “effective” in Section 6(d)(ii) is a reference to the language of Section 12, and the effectiveness of the notice does not depend on “sufficient details” of both the calculation of the sum claimed and of the bank account into which the sum is to be paid having been set out.

Is the payment obligation subject to a condition precedent that the statement required under Section 6(d)(i) has been served “as soon as reasonably practicable”?

Gloster LJ firmly dismissed this submission by the Appellants, holding that there was no basis whatsoever for construing the requirement to serve a statement under Section 6(d)(i) “on or as soon as reasonably practicable following the occurrence of an Early Termination Date” as imposing a condition precedent that time is of the essence, so that in the absence of timely compliance by the Non-defaulting Party, no payment obligation is ever triggered and the Non-defaulting Party is left to pursue its remedy at common law to establish its loss.

This construction did not mean that the obligation to serve “on or as soon as reasonably practicable following the occurrence of an Early Termination Date” had no legal consequence. It is certainly possible to conceive of circumstances in which, by reason of changes in market or financial conditions, such as interest or other rates, or lending criteria, a Defaulting Party might well have suffered loss as a result of delay in the provision of a Section 6(d)(i) compliant notice, which would enable it to bring an action for damages.

COMMENT

The decision by the Court of Appeal is interesting in a number of respects. 

First, this is the first decision of the English courts which has considered when a debt due under Section 6(e) of the ISDA Master Agreement is payable. Market practice has typically proceeded on the basis that the debt is payable following service of a statement under Section 6(d)(i). The Court of Appeal’s decision accepts the possibility that two separate notices in the close-out process will be delivered. We expect, however, that counterparties in the derivatives market will continue to deliver just one Section 6(d)(i) statement containing both payment amount and calculation methodology. From a timing perspective, there would not normally be a large gap in time between the dates when the two could be delivered since it will be necessary to undertake the calculation (reasonable details of which are required to be given under Section 6(d)(i)) before one could deliver a notice under Section 6(d)(ii). More importantly, if a claim is commenced on the back of a Section 6(d)(ii) payment notice where no detailed Section 6(d)(i) statement has been delivered, we would expect quantum to be challenged, leading to disclosure of the details that would have been delivered under Section 6(d)(i) in any event. Delivering a Section 6(d)(i) statement is the means by which a counterparty can seek to control the delivery of the details of the calculation to reduce the scope for challenge.  

Second, Gloster LJ envisages that, in a case where a Section 6(d)(i) statement is not served “on or as soon as reasonably practicable”, a damages claim may be found for breach of Section 6(d)(i). However, if a Section 6(d)(ii) payment notice is delivered and an Early Termination Amount is claimed in such notice which the court ultimately upholds as being a valid determination and calculation of the debt claimed, then it is not clear in practice what loss would arise if a Section 6(d)(i) statement is not delivered as the amounts payable and time for payment would remain the same, although ultimately this would be a question of fact to be determined by the court. 

Allen & Overy acted for the Respondent in these proceedings.  

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 20 3088 3710.