Curtin on Metavante and Contract Limitations

Curtin on Metavante and Contract Limitations


A swap agreement between Metavante and Lehman excused Metavante from making scheduled swap payments to Lehman in the event of a default. In Lehman’s Chapter 11 bankruptcy case, Metavante declined to make the scheduled payments to Lehman. In response, Lehman sought an order compelling performance by Metavante notwithstanding the agreement. In In re Lehman Brothers et al., Case No. 08-13555 (JMP), the United States Bankruptcy Court for the Southern District of New York denied the Bankruptcy Code "safe harbor" afforded to swaps and ordered Metavante to make a lump sum payment. The bankruptcy court addressed the following question: what freedom do the parties to a contract have to agree that (subject to and in accordance with the terms of the International Swaps and Derivatives Association (ISDA) Master Agreement) the claims of a party (if bankrupt) on its solvent counterparty may be limited or impaired in connection with the bankruptcy? The answer is: less freedom than those terms ostensibly grant. In this Analysis, Edmond J. Curtin discusses the dispute between Lehman and Metavante and examines the agreement between the parties. He writes:
 
Background
 
     Each over-the-counter derivatives transaction (a "Transaction") is a contract between two parties that contemplates future exchanges of money or assets (perhaps in variable amounts), but subject to applicable conditions and contingencies. In theory, the market value of the Transaction upon execution is zero. If, over time, the market value of that contract moves in favor of one of the parties ("Party A" for our purposes), then Party A is said to have made a profit.
 
     This profit for Party A is a notional one--in the sense that it has yet to be monetized or turned into cash. Party A may monetize this profit in a number of ways. Firstly, Party A may agree with the counterparty to terminate or close-out the Transaction, whereupon the counterparty pays to Party A an agreed amount equivalent to this notional profit. Secondly, Party A may agree with the counterparty that Party A may transfer his position under the Transaction to another party, whereupon the other party pays an amount to Party A equivalent to this notional profit and the former "steps into the shoes" of the latter. Thirdly, Party A may leave the Transaction untouched, but may enter into an off-setting transaction with a third party.
 
     If the Transaction is a profitable one for Party A, it becomes an "asset" of Party A--but this creates its own problem. That is, Party A now has an exposure to the counterparty ("Party B") for the amount of the profit. If Party B fails to perform, then this ostensible profit disappears. Hence, Party A's invariable question to its counsel: is there any legal reason why Party B should be excused from performance? This is the subject matter of this short note--specifically, what are the circumstances in which this Party B may decline to make a payment under section 2(a)(iii) of the ISDA Master Agreement? 1 In anticipation of this, there is a brief analysis of some important elements of that ISDA Master Agreement (the "Agreement").
 
Section 1(c) Single Agreement
 
     Section 1(c) of the Agreement reads as follows:
 
     All Transactions are entered into in reliance on the fact that this Master Agreement and all Confirmations form a single agreement between the parties (collectively referred to as this "Agreement"), and the parties would not otherwise enter into any Transactions.
 
     Any two parties to an Agreement may have a number of Transactions outstanding between them. This Section 1(c) provides that each such Transaction does not constitute a separate legal relationship between the parties; rather all those Transactions (under the Agreement) constitute a single legal relationship between those parties. Accordingly, the individual payment and delivery duties contemplated by the various Transactions together constitute merely aspects of one legal relationship. This "single agreement" concept advances the theory underlying the Agreement that it creates a single net exposure between the parties (rather than multiple exposures arising under individual Transactions).