Court clarifies key provision of 2002 ISDA Master Agreement

In the first case directly addressing the requirements of section 5(a)(i) of the 2002 ISDA Master Agreement, the Commercial Court rules that mistakes in such notices will not invalidate the notice, so long as a “reasonable recipient” would understand its intended meaning.

The Commercial Court has handed down summary judgment in the case of Macquarie Bank Limited v Phelan Energy Group Limited [2022] EWHC 2616 (Comm), a dispute arising out of a foreign exchange transaction on the terms of the ISDA 2002 Master Agreement.

The case involves factual disputes as to the terms upon which the parties agreed to trade. For the purposes of the summary judgment application, the Court assumed those facts in favour of the Defendant. In that way, the Court assumed that the Notice of Failure to Pay contained two “errors” (as to the amount of the non-payment, and the trade reference number), and the Court was asked to rule whether the Notice was nonetheless valid.

In a judgment which deals with the requirements for a valid Notice of Failure to Pay under section 5(a)(i) of the 2002 ISDA Master Agreement, the Court ruled that the mistakes were not fatal to the notice being effective, as long as the Notice:

• communicated “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 would 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
• enabled the “reasonable recipient” to identify what the relevant trade requires it to do in order to cure any failure to pay within the grace period.

Background

The dispute concerned a foreign exchange transaction on the terms of the ISDA 2002 Master Agreement. Macquarie Bank Limited (“Macquarie”) and Phelan Energy Group Limited (“Phelan”) had entered into a transaction on 14 May 2021 with a first settlement date on 28 May 2021. Phelan failed to pay on that date, after which Macquarie issued a notice of default under Section 5(a)(i) (the “Default Notice”).

In the claim, Phelan contends that the particular amount stated in the Default Notice (calculated by reference to what Phelan says was an incorrect strike price) was not due, and therefore the Default Notice was invalid as it referred to an incorrect amount and the wrong transaction. Consequently, Phelan claims that Macquarie failed to serve a compliant Default Notice, therefore had no right to early termination of the ISDA Master Agreement or to the resulting early termination payment.

Summary judgment application

The summary judgment application proceeded on the basis that the transaction was concluded on the terms asserted by Phelan, but Macquarie nevertheless maintained that the Default Notice was valid.

In opposing that application, Phelan argued that section 5(a)(i) imposes, as indispensable conditions of the validity of a Default Notice, that such notice must correctly identify the precise amount of the non-payment, and must correctly specify the confirming evidence by which the relevant trade was agreed (for example the trade confirmation).

Phelan further sought to argue (applying the test in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749) that on the assumptions made for the purposes of the application, a reasonable recipient in the same position as Phelan would not have understood the Default Notice, nor what the recipient was required to do in order to remedy its failure to pay.

Judgment

The Court agreed with Macquarie’s arguments, and held that a valid notice under Section 5(a)(i) did not require the correct identification of (a) the trade confirmation; (b) the amount of the payment or delivery which was not made; or (c) the currency of the payment.

In the Court’s view, a valid notice under Section 5(a)(i) must:

• 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
• enable the “reasonable recipient” to identify what the relevant trade requires it to do in order to cure any failure to pay within the grace period.

Mr Justice Foxton found that Phelan’s construction of section 5(a)(i) would result in a situation in which even minor errors could invalidate a default notice, and that the language of the ISDA Agreement and its commercial context did not compel such construction.

Applying that approach, on the assumptions made for the purposes of the application, the Court found that the Default Notice was valid. The parties only concluded one set of trades under the ISDA Agreement, there was only one settlement arising on the date in question, and the Default Notice followed a series of communications in which the amount of Phelan’s payment obligation had been specified. Therefore, the failure to pay had been sufficiently identified (even on the assumed facts), and the action needed to remedy this failure would have been unambiguously clear to Phelan when it received the Default Notice.

Commentary

The judgment is likely to be of comfort to regular users of the 2002 ISDA Master Agreement. A Notice of Failure to Pay is often issued during times of stress, either affecting the counterparty, or markets generally. The Court’s ruling gives a common sense and commercial interpretation of the Master Agreement, thereby rejecting the suggestion that minor errors could invalidate an entire process of termination.

This judgment is highly topical in light of current market conditions. The prices of currencies, rates and commodities have been highly volatile, and derivative transactions have resulted in large exposures. Market participants will need to consider carefully their processes for termination, whether for failure to pay or on other grounds. Following the termination procedures set out in the Master Agreement remains crucial to avoiding disputes.

The full judgment is available here.

The team acting for Macquarie in this case, and for other clients in relation to contested ISDA close out issues, can be contacted here.