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What does the recent case of Credit Suisse International v Stichting Vestia Groep tell us about how the court determines capacity and authority to enter into derivative contracts?
Credit Suisse International v Stichting Vestia Groep  EWHC 3103 (Comm),  All ER (D) 58 (Oct)
The claimant (Credit Suisse) brought proceedings against the defendant company (Vestia) claiming €83,196,829 as money allegedly due under an International Swaps and Derivatives Association (ISDA) 2002 agreement (the master agreement) in respect of 11 transactions it had allegedly entered with Vestia between November 2010 and September 2011. Credit Suisse contended that it had duly terminated the master agreement after the defendant had failed to provide security due under a credit support annex. The Commercial Court held that, notwithstanding that three of the contracts, comprising six of the disputed transactions, had been outside Vestia's capacity—and therefore invalid because of warranties in additional representations in the master agreement—that did not affect Credit Suisse's rights or Vestia's obligations under the master agreement. Alternatively, Credit Suisse was entitled in damages for breach of the warranties to the amount that they could have recovered under the master agreement if all the agreements were valid and binding on Vestia.
Credit Suisse contended that it had duly terminated the ISDA master agreement on 19 June 2012 after Vestia had failed to provide security under a related credit support annex.
Vestia contended that:
The issues for consideration were, among other things:
The Commercial Court held that, notwithstanding that three of the contracts, comprising six of the disputed transactions, had been outside Vestia's capacity and therefore invalid, the invalidity did not affect Credit Suisse's rights or Vestia's obligations under the master agreement. This was because of the additional representations (which were deemed to be warranties) set out in the Schedule to the master agreement. Alternatively, Credit Suisse was entitled in damages for breach of the warranties to the amount that they could have recovered under the master agreement if all the agreements had been valid and binding on Vestia.
The three key issues that the judge discussed were:
One of the key issues arising from this case was whether Vestia, as a stichting, had capacity to enter into the disputed transactions. The Dutch Civil Code, art 2.285 defines a stichting as:
'a legal person created by a legal act which has no members and whose purpose is to realise an object stated in its articles using capital allocated to such purpose.'
The burden of proof was on Credit Suisse to establish that the transactions were within Vestia's capacity. The question was really whether or not Vestia was acquiring a hedging instrument or a speculative instrument—only if the transaction was a hedging transaction could it be permitted. The judge held that Credit Suisse could prove that certain of the transactions were within Vestia's capacity (eg hedging) but that certain of them could not be proven to have been within Vestia's capacity. The transactions that were outside Vestia's capacity were therefore ultra vires. The judge considered the consequences of this under both English and Dutch law.
Under English law, if the disputed transactions were ultra vires, the contracts would be considered void on the basis that they were made without authority. Credit Suisse argued that just because a transaction was ultra vires did not necessarily mean that it was also invalid.
Under Dutch law, a counterparty can enforce a contract made with a legal entity that lacks capacity unless they knew that the entity's object was transgressed or should have been so aware. It was discussed that because Credit Suisse was aware of Vestia's objects and had obtained external legal advice on them, they did have deemed awareness and they should have been aware that the transactions did not fit in with the objects of Vestia. Therefore, under Dutch law, Credit Suisse would not be able to enforce the ultra vires contracts.
Vestia argued that the two signatories to the transactions did not have authority to enter into those transactions because those transactions were outside the capacity of Vestia. Vestia did not argue that the specific individuals did not have authority but that no individual could have authority where transactions were ultra vires. The judge agreed that if the contracts were outside the scope of Vestia's objects, the contracts would be considered void on the basis that they were made without authority.
Section 3(a) of the ISDA master agreement contains a number of standard representations, including relating to power and authority to execute the master agreement and any related documentation to it. The Schedule to the master agreement negotiated between Credit Suisse and Vestia contained a number of additional representations—including stating that Vestia would provide evidence as to the name, signature and authority of any officers or officials signing the master agreement or confirmations under it. Vestia provided a management certificate to satisfy this condition precedent, within which it detailed that Vestia had authority to enter into a range of derivative transactions and such entry would not violate, among other things, its articles of association. The certificate specifically stated that Credit Suisse could rely on these representations. These additional representations were subject to considerable negotiation leading to the signing of the master agreement. Such representations were deemed to be repeated each time a transaction was entered into. The parties had clearly intended that these additional representations take effect as contractual undertakings as well as representations. This meant that Credit Suisse was entitled to recover what would have been the early termination amount, or damages in that amount.
There was also discussion about whether or not the early termination notice that Credit Suisse had sent was valid. Vestia contended it was not because Credit Suisse had not sent a statement of exposure in time and when they did send the statement, Vestia's exposure had fallen back below the applicable threshold. Vestia argued that by the time they received the notice, because the exposure had fallen back below the threshold, Credit Suisse would have immediately had to repay the amount. Credit Suisse argued that collateral should have still been provided even if the market had moved so that the exposure was below the threshold. They stated that there are commercial benefits in providing collateral even in these circumstances such as showing that a counterparty is willing to comply with their contractual obligations and is a measure of their creditworthiness. The judge rejected Vestia's argument that the master agreement had not been validly terminated.
The most important lesson to learn from this case is how important it is to ensure that your counterparty has capacity to enter into a certain type of transaction. The contested transactions were interest rate swaps, constant maturity swaps, a callable range accrual swap and swaptions. The non-contested transactions were plain vanilla swaps. Therefore, practitioners should always look at the ability of a counterparty to enter into non-vanilla derivative swaps and seek advice as to any reasons why an entity may not be able to enter into such transactions. This is especially important when dealing with legal entities that you are less familiar with, such as, in this instance, a stichting. Credit Suisse had sought external legal advice as to whether Vestia was entitled to enter into derivative swaps and they had also sought to ensure that they negotiated additional representations to confirm that Vestia had capacity to enter into the swaps. Had they not negotiated these additional representations, it is likely that the outcome of the case would have been different.
On the other side, parties should carefully consider provisions that they are negotiating into any master agreement and ensure that what they are saying is accurate. The management certificate clearly stated that the entering into the derivatives did not result in a violation of Vestia's articles (and hence its objects) and further that the management board of Vestia had carefully considered the proposed derivatives and thought that these would help attain Vestia's objects. The additional representations also confirmed that such transactions were entered into for hedging reasons only and were not speculative. Legal advice should always be sought as to whether or not certain transactions are within the objects of a legal entity if there is any doubt.
First published on LexisPSL Banking & Finance. Click here for a free trial.
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Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.
Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.
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