Enforceability Of Oral Contracts For Loan And Claim Trades

The Loan Syndications and Trading Association (the "LSTA") scored a major victory in 2002 when New York adopted LSTA-sponsored legislation designed to make oral agreements to trade bank loans and claims arising from business debts legally binding. Since then, participants in both the syndicated loan market and the claims trading market have come to rely upon the idea that trades entered over the phone are binding, so long as the parties agreed to the material terms of the trade.

A 2014 Fifth Circuit Court of Appeals decision calls this assumption into question for loan trading, and a case that is currently pending in New York state court could extend the uncertainty to business debt claim trades as well.

Background: The Statute of Frauds and Loan Trading

One basic tenet of U.S. contract law holds that a party should not be bound to certain types of agreements (such as real estate contracts or contracts that cannot be performed within one year) unless the material terms are put into writing and signed by the party against whom relief is sought. This concept, based on a 17th century English law, is known as the "Statute of Frauds." Since 1994, New York's statutory version of the Statute of Frauds has included an exemption that allows financial institutions to enter into binding oral agreements with respect to certain types of financial contracts, such as currency swaps and futures contracts. At the urging of the LSTA, New York expanded this exemption in 2002 to include contracts for the purchase and sale of bank loans and claims arising from business debts.1 Shortly thereafter, the LSTA's general counsel commented that the updated exemption brought New York commercial law "into conformity with market practice" and that, as a result of the new legislation, "when agreement is reached on the phone, the law provides clear support for enforcement of the trade, so long as all material terms have been established."2

The LSTA Standard Terms

As a result of the New York amendment to its Statute of Frauds in 2002, the LSTA made corresponding amendments to its standard documents. One amendment, which is still in effect today, requires any two parties who execute an LSTA trade confirmation with one another to use LSTA documents in future trades and to agree to be bound upon reaching agreement to the terms thereof, "whether by telephone, exchange of electronic messages or otherwise, directly or through their respective agents, and whether the subject of a confirmation." This provision also contains a waiver of defenses based upon the Statute of Frauds.3The LSTA explained at the time that as a result of these changes, "a party who fails to sign a trade confirm cannot use that failure to claim that the trade is unenforceable."4

The LSTA standard terms5 anticipate that trade parties will enter into binding oral agreements first and then negotiate transfer documentation based on the appropriate LSTA standard documents.6 In many cases, this process is a simple matter of filling in trade and administrative details and checking boxes. However, in some cases, negotiating transfer documentation requires a significant amount of negotiation back and forth. The LSTA standard terms contemplate that even parties who fail to agree on transfer documentation are nevertheless bound to settle the underlying trade so long as they agreed to all of the material terms at trade time.

Highland Capital Cases: The 2012 Highland Fifth Circuit Case

According to the record, during a telephone call on December 3, 2009, Highland Capital Management, L.P. ("Highland") agreed to purchase $15.5 million of Regency Hospital, LLC bank loans at a purchase rate of 93.5% of par value from Bank of America, N.A. ("BofA"). During the call, BofA did not notify Highland that trade documentation would require non-LSTA or other non-industry standard terms or...