High Court rules that errors and/or omissions in ISDA 2002 Master Agreement notice of default will not necessarily result in the notice being invalid
The England and Wales High Court gave summary judgment in favour of Macquarie Bank Limited (“Macquarie”) ruling that Macquarie had given Phelan Energy Group Limited (“Phelan”) valid notice of default in respect of a “Failure to Pay or Deliver” pursuant to Section 5(a)(i) of the ISDA 2002 Master Agreement, despite the notice containing factual errors. The High Court favoured a purposive interpretation of Section 5(a)(i)1 and placed weight on whether the notice, ultimately, was clear to the recipient. On the facts, the High Court concluded that the notice would have been “unambiguously clear” as to the trade that it related to, despite it showing the wrong amount and failing to identify the corresponding trade confirmation. The judgment thus provides helpful clarification of the requirements for a valid notice of default for the purposes of Section 5(a)(i).
The full High Court judgment is available here.
Background
The dispute arises out of a foreign exchange swap (USD/ZAR) entered into between the parties on the terms of a ISDA 2002 Master Agreement (the “Master Agreement”). Macquarie and Phelan had entered into the swap in question on 14 May 2021 with a first settlement date on 28 May 2021. There is a dispute between the parties as to what strike price was agreed for that swap, with Phelan contending that the agreed strike price was 1:22.05, and Macquarie contending that it was 1:22.16.
On 28 May 2021, Macquarie emailed Phelan stating that it was due to receive ZAR 117,780,488.64 under the terms of the swap (a figure arrived at using the exchange rate of 1:22.16). Phelan responded that it disputes the amount and let the payment date pass without making any payment at all. Subsequently, Macquarie issued (i) a notice of default under Section 5(a)(i) (the “Default Notice”), (ii) a notice designating an early termination date in respect of all outstanding transactions, as per Section 6(a) (the “ETDN”), and (iii) a statement of the payments due under Section 6(d)(i).
Phelan contended that the Default Notice was invalid. Its position is that the 14 May 2021 transaction was concluded by reference to a different exchange rate from the one stipulated in the Default Notice. It argued that section 5(a)(i) requires that the notice of default must correctly identify amongst other things the precise and “entirely accurate” amount of the alleged non-payment, and must correctly specify the confirming evidence by which the relevant trade was agreed (i.e. the trade confirmation). The Default Notice did not meet these requirements since it referred to the wrong amount and the wrong transaction and was therefore invalid. Because the Default Notice was invalid, Phelan contended that Macquarie had no right to designate an Early Termination Date and consequently no debt in respect of the Early Termination Amount had accrued.
For the purposes of the application, Macquarie invited the court to assume that Phelan’s version of events in respect of the agreed strike price is accurate (i.e. that the parties had agreed to execute the swap at the lower strike price and that the Default Notice therefore contained errors). Macquarie then sought a declaration that even on the facts as presented by Phelan, an event of default had occurred (since Phelan had made no payment at all, as opposed to e.g. a payment at the lower (contested) strike price), the Default Notice was valid, and the Early Termination Date had been validly designated.
The High Court clarified the requirements for a valid notice of termination under Section 5(a)(i).
Phelan alleged that Section 5(a)(i) requires a default notice to (a) contain express and wholly accurate statements identifying the documents confirming the relevant trade, (b) a precise and entirely accurate statement of the amount of the payment not made, and (c) the currency of the payment. The High Court disagreed. Instead, the High Court found that a valid notice under Section 5(a)(i) must:
- communicate “clearly, readily and unambiguously to the reasonable recipient” such that the reasonable recipient will clearly understand the trade under which the obligation to pay has arisen and the particular obligation has not been performed; and
- enable the reasonable recipient to identify what the relevant trade requires it to do in order to cure any failure to pay within the applicable grace period.
On the facts, the High Court concluded that there was only one trade due between the parties on the relevant date on which the Default Notice asserted that Phelan had failed to make a payment. It would therefore have been unambiguously clear to Phelan which trade Macquarie was referring to in the Default Notice. This was true even if Macquarie had overstated the amount payable. The Judge concluded that if Phelan’s strict interpretation were followed, it would result in a situation in which minor errors could invalidate a default notice. In the Judge’s view, the language of the ISDA Master Agreement did not compel such construction. Macquarie’s Default Notice and ETDN were therefore valid.
If the Default Notice and ETDN are valid, when is the debt payable? There is a distinction in the ISDA Master Agreement between the events necessary for a debt to arise, and those necessary for the debt to become payable. The judgment discusses (but does not resolve) the position where notice is given in respect of an amount that a party claims to be payable following determination of an Early Termination Date, but which is disputed and subsequently determined to be incorrect. It is well established that a debt is due from the validly designated Early Termination Date, but the judge did not resolve the question whether the debt would also become payable (albeit in the amount that is eventually determined to be due). This is relevant to the calculation of interest, which may accrue at a higher rate after this time. This being a summary judgment application, the Judge concluded that it would not be appropriate to resolve these questions without the benefit of full argument and the issue may be revisited during the full trial which is listed for March 2023.
This ruling provides helpful clarification regarding the specific “notice of default” requirements in the ISDA 2002 Master Agreement. In taking a practical approach, the Judge rejected the suggestion that minor errors should permit a party to invalidate the ISDA 2002 Master Agreement termination process in circumstances where the recipient of the notice understands the issue in question. This approach of “substance over form” should be particularly reassuring to market participants who trade high volumes of derivates.
