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A recent case [1] highlights the importance of funders completing sufficient due diligence on their customers to be comfortable that those customers have the legal capacity (pursuant to their constitutional documents) to enter into derivative transactions.

What happened?

A Dutch social housing association entered into a series of swap transactions with a bank under a 2002 ISDA Master Agreement, governed by English law.  The association defaulted on its obligation to provide additional security and so the bank exercised its right to terminate the swaps early and claimed €83 million by way of early termination amounts.

The association’s main defence was that it lacked corporate capacity to enter into the swaps  (that is, they were beyond its powers under its constitutional documents or, as lawyers like to say, ultra vires). Therefore, its argument ran, in accordance with usual rules under English law, the Master Agreement was invalid and unenforceable. That might have been the end of the matter;  however…

The bank had negotiated ‘additional representations’ into the Schedule to the Master Agreement, including an undertaking from the association that it would certify the capacity and authority of those officers signing documentation prior to executing future swaps.

The court decided that even though three of the disputed swaps were outside of the association’s capacity and therefore invalid, the bank’s rights and the association’s obligations under the Master Agreement were not affected by this due to the additional representations, which the court held to be warranties (and, effectively, a contractual undertaking as to future conduct). The bank was, therefore, entitled to the early termination amount which fell due under the Master Agreement. Alternatively, it was held that the bank was entitled to damages for breach of the warranties in the amount that they could have recovered under the Master Agreement if all the agreements were valid and binding.

The association has started an appeal against the decision.

Practical implications

There is some value in acknowledging the importance of carefully considering the nature and accuracy of representations, warranties and undertaking given under an ISDA Master Agreement.

Although the case was decided on technical points of English contract law, the message is really much simpler…Know your customer and check their ability to enter into particular transactions.

Where customers are entering into swaps or other derivatives, whether as part of a broader transaction or otherwise, bank counterparties should satisfy themselves with careful due diligence that the relevant entity has the legal capacity to do so.

It is not sufficient to assume that, because an entity can borrow under its constitutional documents, it can enter into swaps or similar instruments.

For more information, email blogs@gateleyuk.com.

[1] Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103


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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.