UK: Closing A Distressed Debt Trade Over The Phone - The Binding Basics

The High Court provided some extremely useful guidance in relation to oral contracts in the context of distressed debt trading in the decision of Bear Stearns Bank plc v Forum Global Equity Ltd [2007] EWHC 1576 (Comm) handed down last week.

For participants in financial markets generally where it is the norm to reach agreement orally after telephone negotiations, this decision provides welcome assurance that once material terms are agreed, such agreements are not easily avoided by claims of uncertainty or incompleteness, the Courts looking to substance over form in assessing whether a valid bargain has been struck. That begs the question of what material terms will be sufficient. What readers are likely to find illuminating and perhaps surprising from this case is that agreement on few very basic terms can be sufficient to create a binding trade - that is, even absent standard terms published by industry associations such as the UK Loan Market Association (the "LMA"). This article makes some observations on the case and gives some tips for best practice

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The High Court provided some extremely useful guidance in relation to oral contracts in the context of distressed debt trading in the decision of Bear Stearns Bank plc v Forum Global Equity Ltd [2007] EWHC 1576 (Comm) handed down last week.

For participants in financial markets generally where it is the norm to reach agreement orally after telephone negotiations, this decision provides welcome assurance that once material terms are agreed, such agreements are not easily avoided by claims of uncertainty or incompleteness, the Courts looking to substance over form in assessing whether a valid bargain has been struck. That begs the question of what material terms will be sufficient. What readers are likely to find illuminating and perhaps surprising from this case is that agreement on few very basic terms can be sufficient to create a binding trade – that is, even absent standard terms published by industry associations such as the UK Loan Market Association (the "LMA")

This case highlights the commercial, ‘substance over form’ approach taken by the courts in resolving contractual disputes. A good example of this was the Judge disregarding several clerical errors in documents passing between the parties’ lawyers for the purposes of ascertaining the parties’ objective intentions. However, cases like this are inevitably fact-sensitive, involving detailed analysis of the available evidence, including expert evidence on market practice. Indeed, the hearing in this case went for 10 days and produced a 50-page judgment. Obviously, best practice is to aim for clarity in deal-making so as to avoid recourse to the courts, while having evidence at the ready to short-circuit disputes. In this regard, the following guidance for best practice emerges from the decision:

• Identify and make clear at the outset what, if any, standard terms will apply to the deal – especially where unusual or complicated instruments are involved.

• It is useful for traders to keep in mind the distinction between reaching an agreement and subsequently reducing that agreement to writing – a concept reflected in clause 2 of the LMA standard terms.

• There are no ‘magic words’ that create a binding contract – courts look at the all of the circumstances to decide whether there is an intention to be legally bound. If in doubt, traders should make it clear that they do not intend to commit themselves to a contract, i.e. a proposal is not intended to be binding.

• If trading on an LMA (or similar) basis, the importance of early trade confirmations cannot be overstated.

• Thou shall not deal on the mobile phone. A cardinal rule drilled into traders everywhere is to avoid negotiations on unrecorded lines. In this case a crucial negotiation was conducted on a party’s mobile telephone instead of his office landline, which was recorded for the very purpose of resolving disputes about what was said. This left the Court to decide which witness it preferred, and here it preferred the BSB witness.

• Safekeeping of recordings – while there was no suggestion of any improper conduct, the Judge was critical of BSB in relation to key recordings, which were lost or destroyed without explanation in the course of having conversations transcribed and translated.

The case concerned the sale by Forum Global Equity ("FGE") to Bear Stearns ("BSB") of loan notes issued by two Parmalat companies, which went into administration in Italy in late 2003 following Parmalat’s collapse earlier that year. In late 2004, FGE successfully submitted claims in the Italian administration to be admitted to the list of creditors for both companies. The value of the notes thus depended on the ultimate dividend paid on the claims in the insolvency.

FGE and BSB negotiated over the period March 2005 to 14 July 2005, when the parties reached agreement on price. The negotiations focussed on price throughout – at an early stage the parties agreed that the formal documentation of the transaction would be left to their respective lawyers to deal with on ‘standard terms’. The parties were aiming for a settlement date of last August/early September, but BSB made it clear that it could not commit to a settlement date until the lawyers could form a view about when the documentation would be settled. The LMA standard terms for distressed debt trading ("LMA standard terms") were then used. A key issue to be resolved was whether the appropriate structure of the deal was a legal transfer of the notes (i.e. assignment/novation) or a subparticipation in the administration claims.

The lawyers’ negotiations continued over the summer, but the documentation was not finalised. On 21 October 2005, FGE notified BSB that it did not wish to continue with the execution of the documents because the process had overrun its expected timeframe. In other words, FGE alleged that no binding trade was afoot. By this time, the debt represented by the Parmalat notes was converted into equity represented by shares in a new Parmalat company. This created upside for FGE, and it began to sell its shares.

The Court had to decide whether there was an agreement and, if so, whether it was on LMA standard terms. FGE argued that if there was an agreement, it was simply ‘an agreement to agree’ without binding force, alternatively it was too uncertain to be enforceable. The thrust of FGE’s argument was that the only term agreed on 14 July 2005 was price, which was insufficient to create a binding contract. In addition, the date of settlement was a material term, and the parties had deferred agreement on that, which meant they had deliberately deferred concluding a binding contract. FGE also denied that the LMA standard terms applied.

The Court held that there was clearly a binding agreement, but not on the LMA standard terms. According to the Judge, the essence of the deal was that, on 14 July 2005, FGE had agreed to sell the economic benefit of the Parmalat notes to BSB for a set price, and the parties tasked their lawyers with settling the appropriate machinery to give effect to this bargain because they recognised that the mechanics of transferring the benefit of the notes to BSB was not a straight-forward matter. That being so, it didn’t matter that the parties deferred the question of transfer method and the settlement date.

• Failure to agree a settlement date did not invalidate the contract for uncertainty because if the LMA standard terms applied, a default settlement date of T + 20 days would apply; for a deal outside that regime (like the present one) the Court would imply a term that settlement occur "within a reasonable time".

• A failure to agree the form of the purchase would not invalidate the contract – it was not unusual in sale contracts for the mechanics of transfer to be worked out later, especially where the subject matter of the sale was complicated. The essential obligation upon FGE was to ensure the BSB obtained the commercial benefit of the notes, and the machinery by which that would occur was left to the parties’ lawyers to agree later.

• The fact that the parties had not agreed representations and warranties on 14 July 2005 did not make the contract too vague or uncertain to be enforced – the law would imply any terms necessary to give business efficacy to what was agreed.

The Judge held that the LMA standard terms did not apply because there had been no express reference to them in the oral discussions. While BSB had in mind that the trade would be done on those terms, this was not communicated to the FGE, whose understanding was that the lawyers would use whichever terms they though appropriate. (In fact, neither party wanted to get bogged down in the ‘legal questions’ once the price had been agreed). Moreover, it could not be assumed that the LMA standard terms obviously applied to the transaction: the novel and complicated nature of the Parmalat notes pointed against any established trading practice, and there were other standard terms that could have been used (e.g. those published by the LMA’s US equivalent, the Loans and Syndicated Market Association or ‘LSTA’). Unlike derivatives trades, which tend to be governed by a pre-existing master agreement between the parties, the trading of distressed debt involves more ad hoc and bespoke arrangements – a point reinforced by the LMA user’s guide which points out that the distressed debt standard terms are only a starting point and they are not designed to be incorporated wholesale into any contract.

Please click here for a copy of the full judgment: http://www.bailii.org/ew/cases/EWHC/Comm/2007/1576.rtf

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 13/07/2007.