Parties to securities lending agreements, reciprocal purchase (repo) agreements and other derivative master agreements (such as the ISDA master agreement).
What do you need to do?Consider the two key positive messages from the decision relating to the application of close-out netting provisions in an insolvency.
Partner
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Ian Paterson
Partner
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Sydney
Martin James
Brisbane
Berkeley Cox
Hong Kong
Richard Mazzochi
Beijing
David Olsson
London
Rowan Russell
Authors
Ian Paterson
Scott Farrell
In a decision this month, the Australian Federal Court has affirmed the close-out netting provisions of securities lending agreements based on internationally standard master agreements. The decision should be welcomed by the financial markets as it affirms the breadth of the protection given by Australian netting legislation. Also, it restates that the particular circumstances suffered by a party in insolvency are not of themselves a basis for departing from the express terms of a contract.
The case, In the Matter of Opes Prime Stock Broking Limited (Administrators appointed) and Leveraged Capital Pty Limited, concerned securities lending agreements entered into between Opes Prime (or its related entity) and its clients. The agreements were based on the Australian standard securities lending master agreement called the AMSLA (which itself is based on similar international agreements, such as the OSLA and the GMSLA). Under the transactions entered into under these agreements:
- the client absolutely transferred securities to Opes Prime and Opes Prime transferred collateral to the clients, and
- on a future date, Opes Prime agreed to transfer back to the client securities equivalent to those which were transferred to it and the client agreed to transfer back to Opes Prime collateral equivalent to that which Opes Prime had transferred to it.
The securities lending agreements provided also that, if an “Act of Insolvency” (which included the appointment of an administrator) occurred, the parties’ obligation to deliver equivalent securities and equivalent collateral would be accelerated, their relevant values established and an account taken of what was due from each to the other and the amounts set off so that only the net balance would be payable from one to the other. However, under the agreements’ terms this process would not commence unless notice of the default was served by the client on Opes Prime except where the Act of Insolvency was the appointment of a liquidator or analogous officer.
The issues in the case followed from the appointment of administrators to Opes Prime. The administrators of Opes Prime sought directions from the court on two points:
- Were the securities lending agreements “close-out netting contracts” for the purposes of the Australian Payment Systems and Netting Act? This was important because the Netting Act protects close-out mechanisms in such contracts from a range of general provisions relating to Australian insolvency law, including provisions related to the timing of valuation of claims against a company in administration and liquidation.
- For the purposes of determining the voting entitlement of Opes Prime clients in the administration, should the securities lending agreements be treated as if they had closed out automatically on the appointment of the administrator? Alternatively, should the determination be made by reference to the wording of the contract, ie whether notification of default had been delivered by the client? This was important because at a meeting of creditors in an administration, creditors are not allowed to vote in respect of an unliquidated debt, a contingent debt, an unliquidated or a contingent debt claim or a debt the value of which is not established unless a just estimate of its value has been made. Whether a claim of a client to the net termination amount was a contingent claim depended on whether the termination was taken to occur automatically on the appointment of an administrator to Opes Prime.
Were the agreements close out netting contracts?
Justice Finkelstein found that they were. This was despite the fact that, unlike the Netting Act itself, the agreements did not expressly use the word “terminate” to describe what happens to the future obligations under the transactions. The judge found that the effect of the acceleration and set-off mechanism in the securities lending agreements had the same meaning. The judge also noted:
“The evident purpose of the Netting Act supports my conclusion. It was Parliament’s intention to ensure that close-out netting contracts used in a variety of financial market transactions be effective under insolvency laws.”
Was automatic termination of the transactions on administration to be implied?
Justice Finkelstein found that it did not. Like industry standard securities lending documents, the terms of the securities lending agreement provided for automatic early termination only where the “Act of Insolvency” was “the presentation of a petition for winding up or any analogous proceeding or the appointment of a liquidator or analogous officer of the Defaulting Party”. The court found that appointment of an administrator was not analogous to the appointment of a liquidator (because a liquidator was appointed to preside over the death of a company whilst an administrator was appointed to strive to keep it alive). Importantly, the court was not influenced to find contrary to the express terms of the contract on the basis that automatic termination may arguably have produced a better economic result for the parties on account of later movements in the value of the securities lent. As was noted by the judge:
“While I am not unmindful of the practical considerations raised by the administrators and the harm that might be suffered by the counterparties, I do not think that much can be made of those kinds of issues.”
The judge found that the particular facts surrounding the insolvency of Opes Prime and subsequent movements in value of the lent securities was not a sufficient ground for ignoring the provisions of the securities lending agreement which required that a notice of default be given in order for the close-out process to commence.
The full text of the decision can be found here.