Editor’s Note: This story was originally published in The New York Law Journal on Oct. 25.
Barclays Bank PLC breached a swap agreement with hedge fund BDC Finance LLC in 2008 when it did not return $40 million in collateral requested by BDC, instead paying only $5 million a day late and failing to dispute the amount using agreed-upon dispute resolution procedures, a divided state appeals panel ruled.
The 3-2 ruling in BDC v. Barclays, 650375/08, which reversed an August 2012 decision by Manhattan Supreme Court Justice Eileen Bransten (See Profile), means that Barclays may have to return nearly $300 million in collateral it still holds, plus interest, to BDC.
Justices David Saxe (See Profile), Leland DeGrasse (See Profile) and Rosalyn Richter (See Profile) joined in the unsigned majority opinion. Justice Richard Andrias (See Profile) dissented, joined by Justice Judith Gische (See Profile).
In 2005, BDC and Barclays entered into a kind of derivative transaction called a total return swap. Under their agreement, BDC assumed the risks and benefits of a portfolio of investment debt instruments owned by Barclays, in exchange for financing fees.
BDC also delivered collateral to Barclays. The agreement allowed either party to demand collateral from the other based on changes to the value of the debt instruments. If Barclays determined that it needed more collateral, it could demand that BDC deliver it. Conversely, if BDC determined that Barclays was over-collateralized, it could demand some of its collateral back.
The swap agreement included procedures for resolving disputes. One document, called the Credit Support Annex, provided that if a party disagreed with a collateral call, it must pay the undisputed amount and then enter discussions to resolve the dispute. That provision says that the collateral payment must be made by the end of the following business day if the collateral call is made before 1 p.m., or by the end of the day after that if the collateral call is made after 1 p.m.
Another document, called the Master Confirmation, says that “notwithstanding” anything in the Credit Support Annex to the contrary, Barclays must return any collateral requested by BDC by the end of the following business day, even if the collateral call is after 1 p.m.
BDC maintains that this provision means that if Barclays disagrees with a collateral call, it must pay the whole amount anyway, and dispute it later. Barclays, on the other hand, maintains that it affects only the timing of payments.
On Oct. 6, 2008, BDC made a collateral call for more than $40 million. Barclays believed it was obligated to pay only $5.08 million, and made no payment until Oct. 8, when it paid a flat $5 million. The dispute arose because Barclays changed its method for calculating the collateral in the wake of Lehman Brothers Holdings Inc.’s bankruptcy and the ensuing rapid drop in financial asset values, according to Andrias’s dissent.
That same day, Oct. 8, BDC told Barclays that it would consider Barclays in default and terminate the swap agreement if it did not pay the rest of the $40 million in two business days. Barclays did not do so, and BDC declared the agreement terminated. It demanded that Barclays return the rest of the collateral it held, $297 million, but Barclays never did.
BDC sued Barclays to recover the money. Barclays filed counterclaims seeking to enforce collateral calls it made later in October, after BDC already declared the agreement in default.
Both sides moved for summary judgment. Bransten, adopting Barclays’ interpretation of the contract, denied BDC’s motion for summary judgment, and granted Barclays’ to the extent of ruling that Barclays was not required to pay the full $40 million amount. She did not rule on Barclays’ counterclaims.
On appeal, the majority of the First Department panel adopted BDC’s interpretation of the contract.
“The plain and unambiguous language of the Delivery of Collateral clause requires Barclays to transfer any Return Amount demanded by BDC no later than the business day following the demand,” they said.
Furthermore, they said, even if Barclays was not required to pay the full amount, it waited an extra day before paying anything, which was clearly not allowed by the contract.
Andrias, in the dissent, said that the majority’s interpretation tilted the contract too far in favor of BDC.
“As both parties were allowed to act as valuation agents with respect to collateral, it is illogical that the agreements would require only one party to pay first and dispute later,” he said.
Andrias also noted that BDC itself seemed to understand the contract the same way Barclay did at the time. He quoted an Oct. 7, 2008 email in which BDC told Barcalys that it must “either pay the amount set out in the request or exercise its dispute rights” (emphasis added), suggesting that it recognized Barclays’ right to pay the undisputed amount and then dispute the rest.
The majority addressed Andrias’ objection in its opinion.
“We recognize that the Delivery of Collateral provision is unilateral and requires Barclays, and not BDC, to pay first and dispute later,” the majority said. “We disagree, however, with the dissent’s conclusion that this results in a harshly uneven allocation of economic power requiring this Court to, in effect, rewrite the parties’ contact.”
Craig Newman, a partner at Richards Kibbe & Orbe, who represents BDC, declined to comment.
Robinson Lacy, a partner at Sullivan & Cromwell, who represents Barclays, could not be reached.
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