Macquarie Bank Ltd v Phelan Energy Group Ltd  EWHC 2616 (Comm) is the first English High Court judgment which directly considers the requirements for a notice of Failure to Pay under Section 5(a)(i) of the 2002 ISDA Master Agreement to be valid.
The Court decided that a notice does not need to be entirely accurate to be valid. What matters is that a reasonable recipient would understand what was required in order to remedy the failure to pay or deliver.
Macquarie Bank Ltd (Macquarie) and Phelan Energy Group Ltd (Phelan) entered into a 2002 ISDA Master Agreement. Pursuant to the Master Agreement, the parties entered into foreign exchange swap in which USD would be swapped for ZAR (South African Rand).
On the first settlement date, Phelan was due to pay an amount of around ZAR 117m to Macquarie. The precise amount was disputed because the parties disagreed on what strike price had been agreed. Phelan considered ZAR 117.2m was due. Macquarie considered ZAR 117.8m was due. During the day, the parties discussed by email the amount due, and disagreed.
Phelan did not pay any amount on the settlement day. Macquarie then sent a notice of failure to pay (Failure to Pay Notice). Macquarie's Failure to Pay Notice stated the amount that it considered to be due – ZAR 117.8m. Macquarie's Failure to Pay Notice also referred to Macquarie's internal reference code to identify the trade. Phelan informed Macquarie that the amount was disputed, and Phelan did not pay any ZAR.
Macquarie then sent a notice which stated that it was terminating all outstanding transactions under the ISDA Master Agreement by designating an Early Termination Date, on the grounds that Phelan had not paid the ZAR due to Macquarie.
The Failure to Pay Notice was sent pursuant to Section 5(a)(i) of the ISDA Master Agreement, which provides for the following event of default:
'Failure by the party to make, when due, any payment under this Agreement ... required to be made by it if such failure is not remedied on or before the first Local Business Day ... after ... notice of such failure is given to the party.' [emphasis added]
The sending of a valid notice is a requirement to determine whether an Event of Default has occurred on the ground of failure to pay. Once an Event of Default has occurred, the Non-Defaulting Party can terminate all outstanding transactions under the ISDA Master Agreement by sending a further notice designating an Early Termination Date, pursuant to Section 6(a) of the ISDA Master Agreement.
Macquarie brought a claim seeking payment for the Early Termination Amount due upon the designation of the Early Termination Date.
The procedural background, involving summary judgment and various assumptions, was complex, but in essence the parties' positions were as follows:
- Macquarie's position was that its Failure to Pay Notice was a valid notice. Further, as Phelan did not pay any ZAR, Macquarie was entitled to terminate all outstanding transactions by serving the notice designating an Early Termination Date.
- Phelan disputed this claim on the ground that the Failure to Pay Notice was invalid because it specified the wrong amount of ZAR. Phelan said that only ZAR 117.2m was owed, whereas the Failure to Pay Notice stated 117.8m. (The difference is equivalent to around USD 42,000.) Phelan also argued that, in the circumstances, Macquarie's Failure to Pay Notice was invalid because it referred to Macquarie's internal reference code and this identified the wrong trade.
The issue was therefore: was Macquarie's Failure to Pay Notice sufficiently clear to constitute a notice of failure to pay or deliver under Section 5(a)(i), even if it the Failure to Pay Notice inaccurately referred to ZAR 117.8m instead of ZAR 117.2 and used Macquarie's internal reference code?
The Court (Mr Justice Foxton) held that the test for a valid notice of event of default was as follows:
"In my view, a valid notice under Section 5(a)(i) must be such as to:
- communicate clearly, readily and unambiguously to the reasonable recipient in the context in which it is received the failure to pay or deliver in question (such that the reasonable recipient will clearly understand the trade under which the obligation to pay or deliver has arisen, and the particular obligation which it is said has not been performed); and
- thereby enable the reasonable recipient to identify what the relevant trade requires it to do in order to cure any failure to pay or deliver (if it accepts that there has been such a failure) within the applicable grace period."
This means that some inaccuracies are not fatal to the notice. The purpose of the notice is to give the Defaulting Party an opportunity to remedy the failure. An inaccuracy would not necessarily prevent that purpose. Further, a notice may be valid even though it is inaccurate as to the identification of the Confirmation, the precise amount of the payment to be made, or the currency of payment. Otherwise, very small errors would invalidate the notice, which would be uncommercial and would not support the purpose of the notice.
The Court went on to decide that Macquarie's Failure to Pay Notice met this threshold. The Failure to Pay Notice was valid. The only outstanding transaction between Macquarie and Phelan in May 2021 was this transaction. Macquarie and Phelan had been in email contact, so each knew the amount that the other considered to be due. Phelan knew that (in its view) the amount it was required to pay to remedy the failure to pay was ZAR 117.2m. For the same reasons, Macquarie's use of an internal reference code did not prevent the Failure to Pay Notice being valid.
The Court, therefore, agreed with Macquarie: its Failure to Pay Notice was valid, and it was entitled to send a further notice terminating all outstanding transactions by specifying an Early Termination Date.
This case gives important guidance to financial institutions and participants in derivatives trading about the level of accuracy required in notices sent pursuant to an ISDA Master Agreement.
It is striking that notwithstanding that the Courts have repeatedly emphasised the importance of certainty when interpreting ISDA Master Agreement obligations, this did not compel the Court to require total accuracy. The Court emphasised commercial practicality – a notice does not need to be completely accurate as long as it can be understood sufficiently for the purpose of remedying the failure to pay or deliver. What matters is that the reasonable recipient in the position of the counterparty would understand what was needed to remedy the failure to pay or deliver.
However, it is important not to interpret the case as a general gateway to allowing inaccurate notices to stand. For one thing, if Phelan was right that ZAR 117.2m was owed, then it was not required to pay the ZAR 117.8m demanded in the Failure to Pay Notice. A payment of ZAR 117.2m would have been sufficient. Where the parties disagree on the amount due, and the party which has failed to pay or deliver pays money to remedy such failure and says it has paid the correct amount, the Non-Defaulting Party should think very carefully before attempting to terminate on the ground of the disputed difference. If the Non-Defaulting Party is mistaken, then it will not be entitled to terminate.
Even more importantly, on the facts, there was only one outstanding transaction in the month in which the Failure to Pay Notice was sent, and the parties had already been in email contact on the subject. The judge therefore concluded that the reasonable person in Phelan's position would understand the Failure to Pay Notice.
But other facts could lead to a different result. It sometimes happens that parties enter into hundreds of trades under the ISDA Master Agreement. If so, any inaccuracies in a notice might mean that the notice would fail to communicate clearly and unambiguously the failure to pay in question. It might follow that the reasonable recipient would not be able to identify the relevant trade and what is required to remedy such failure. If so, the notice would be invalid, and any ensuing attempt to terminate all outstanding transactions under the ISDA Master Agreement also would be invalid.
It is also worth emphasising that the English Court has established a specific body of case law concerning how the ISDA Master Agreement should be interpreted, which is often treated as a special category of contract by the Courts, so the guidance in this case is not necessarily applicable to notices of events of default under other types of contract.
Finally, the decision (although about events in 2021) follows a number of other recent ISDA decisions which are among the last legacy litigation from the 2007-2008 financial crisis. This includes a couple of Italian local authority derivatives cases against banks and an important decision providing new guidance on when an Event of Default is continuing (covered here).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.