High Court rejects ultra vires defence in ISDA swaps case

Facts 

Stichting Vestia Groep (Vestia) is a foundation, the largest housing association in the Netherlands.

Vestia and Credit Suisse International (CS) entered into a 2002 ISDA Master Agreement and Credit Support Annex on 09 November 2010 (the ISDA Master). The parties entered into 11 Transactions between November 2010 and September 2011. A couple of those trades were plain vanilla interest rate swaps, entered into for hedging purposes. The others comprised swaptions, Constant Maturity Swaps and a Callable Range Accrual Swap.

In addition to the standard representations contained in Section 3 and a management certificate provided by Vestia, the following “Additional Representation” was included in the Schedule to the ISDA Master:

“[Vestia] hereby represents and warrants… that [its] entry into and performance of its obligations under this Agreement and each Transaction hereunder is and will be in compliance with its articles of association (statuten), its financial rules (financieel statuut) and any other laws or regulations applicable to [it]…” (emphasis added).

In June 2012, CS closed out all Transactions under the ISDA Master when Vestia failed to meet a collateral call, which constituted an Event of Default.

In court proceedings, CS claimed approximately €83m from Vestia as the Early Termination Amount. Vestia disputed the claim on the basis that it lacked capacity to enter into 9 of the Transactions, on the basis that they were speculative rather than hedging in nature; that neither of the Vestia employees entering into the Transactions on its behalf had the necessary authority; and that Vestia was not obliged to meet the collateral call due to the operation of Section 2(a)(iii) of the ISDA Master.

Decision

Capacity and authority

The bulk of the judgment (which itself runs to some 102 pages) was taken up with the issues of the capacity of Vestia to enter into the Transactions and the authority of the relevant Vestia employees to enter into the Transactions on behalf of Vestia.

In summary, Smith J found that:

• Vestia had the power to enter into derivatives for hedging purposes only
• some of the Transactions were speculative in nature 
• Vestia therefore did not have capacity to enter into them 
• consequently, those Transactions were ultra vires and invalid, and
• on the same basis, the entry into those Transactions was outside the authority of the relevant Vestia employees.

The following general points are of interest:

• Smith J ruled that the burden of proof lay with CS to prove that Vestia had capacity, not the other way around.
• Although the question of Vestia’s capacity was a matter of Dutch law, the legal consequences of Vestia’s lack of capacity fell to be determined by English law, as the governing law of the putative contract (Haugesund Kommune v Depfa ACS Bank ([2010] EWCA Civ 579, [2012] QB 549) applied). 
• Smith J found that, although there were 9 disputed Transactions, these comprised only 5 contracts: some Transactions were discussed and agreed in the same call; several Transactions were documented in the same Confirmation; and in some cases, the premium payable by Vestia in respect of one transaction had been adjusted in the light of another. This finding was important in this case because “in English law a single contract cannot be in part ultra vires: a contract is either within a party’s capacity or it is not”.

Contractual estoppel

However, the principal area of interest with this case lies with the application of the doctrine of contractual estoppel. In Peekay Intermark Ltd v Australia and New Zealand Banking Group Ltd [2006] EWCA 386, the Court of Appeal held that where contracting parties agreed that certain facts formed the basis of their contract, they were estopped from subsequently asserting that the true facts differed.

Notwithstanding the finding that the disputed Transactions were ultra vires and therefore invalid, Smith J ruled that CS were nevertheless entitled to enforce the provisions of the Transactions and the ISDA Master as if the ultra vires Transactions were valid.

In doing so, Smith J relied upon the doctrine of contractual estoppel, quoting Moore-Bick LJ’s authoritative statement of the principle in Peekay v ANZ:

“There is no reason in principle why parties to a contract should not agree that a certain state of affairs should form the basis for the transaction, whether it be the case or not… Where parties express an agreement of that kind in a contractual agreement neither can subsequently deny the existence of the facts and matters upon which they have agreed… The contract itself gives rise to an estoppel.”

Smith J ruled that:

• The doctrine of contractual estoppel was not confined to statements about a past or present state of affairs, but could also be applied to statements about a future state of affairs.
• The standard representations in Section 3 of the ISDA Master, which are deemed repeated upon the entry into each new Transaction, and the management certificate could not actually have been given by Vestia in respect of the ultra vires Transactions because Vestia did not and could not “enter into” such ultra vires Transactions in the first place.
• Whilst contractual estoppel does not apply to mere representations, the Additional Representation quoted above operated as something more than a mere representation and, on its wording and the facts, was a contractual undertaking and warranty as to a future state of affairs. Therefore the doctrine of contractual estoppel would prevent Vestia from disputing its liability to CS under the ISDA Master on the grounds that the ultra vires Transactions were invalid.

Breach of warranty

In the alternative Smith J also ruled that, if he were wrong in his ruling about the application of the doctrine of contractual estoppel, Vestia was nevertheless in breach of the warranty set out in the Additional Representation.

As such, CS would have a damages claim against Vestia for such breach of warranty, the amount of which would be determined under the ISDA Master as if the ultra vires Transactions were valid.

Section 2(a)(iii)

Vestia had also argued that CS had failed to provide it with an exposure statement (as CS was contractually obliged to do) in the days following the original collateral call and before CS had served the termination notice under the ISDA Master. According to Vestia, as such failure by CS constituted a “Potential Event of Default”. This was defined as “any event which, with the giving of notice or the lapse of time or both, would constitute an Event of Default”.

Vestia claimed that following CS’s Potential Event of Default, it could rely upon the provisions of Section 2(a)(iii) of the ISDA Master to suspend its obligation to deliver the collateral originally called for by CS.

Smith J dismissed this argument out of hand, stating that Section 2(a)(iii) operates as a condition precedent to a party’s payment obligations and that “[a]s a matter of construction, it does not apply so as to suspend payment obligations that have accrued.”

Comment

In applying the doctrine of contractual estoppel to statements as to a future state of affairs, Smith J extended the doctrine, which he justified by stating that “I can see no reason of authority, principle or policy that the doctrine should be confined… or that the law should adopt a different approach where the parties have made an agreement about a state of affairs in the future.”

In doing so, he drew a subtle distinction between, on the one hand, the principle that “an entity cannot achieve what it has no power to do simply by stating or promising that it has the power, and that underlying the doctrine of ultra vires is a policy of protecting the public” and, on the other hand, that there is “no reason that a legal entity should not in a valid contract undertake that the contract will not be used as a vehicle for purported transactions that are invalid because they are outside their capacity.”

In the meantime, the case appears to be authority for the argument that parties can, effectively, draft their way around capacity and authority issues by including provisions in ISDA and other legal documentation that are carefully crafted as warranties and contractual undertakings as to the other party’s capacity and authority.