IFI Update London, August/October 2008 - Part 2
Securities lending transactions
A judge in the Federal Court of Australia has considered whether
a securities lending transaction might constitute the giving of
security by the party which "lent" the securities or,
alternatively, whether the recipient of the securities might be
taken to have charged them for performance of its obligation to
transfer back to the lender equivalent securities. The case is
relevant in England, and should be regarded as persuasive
authority, because the Australian judge applied a classic analysis
of English law in finding the answers to those questions. He also
decided that the same result would have followed under the law in
the USA.
The transaction between the parties took place under a
Securities Lending and Borrowing Agreement that they had entered
into, which largely followed the form of standard documentation
that had been prepared by industry bodies, including the
International Stock Lenders Association and its Australian
counterpart. Under the transaction, the provider or lender of the
securities (Party A) agreed to transfer the securities to the
recipient or borrower of the securities (Party B) on the basis that
Party B was under an obligation, at the date when required under
the agreement (the retransfer date), to transfer to Party A
equivalent securities to those originally transferred by Party A
under the agreement (ie. equivalent as to type, nominal value,
description and amount, with adjustments to take account of
dividends, redemptions and such like that occurred in the meantime
in relation to the securities). In consideration of the transfer of
the original securities, and at the same time, Party B was to pay
cash collateral to Party A, calculated by reference to the value of
the original securities at the time they were transferred (although
the cash collateral would not necessarily be the same value as that
of the original securities). Party A was required to pay back to
Party B the cash collateral on the re-transfer date and, in the
meantime, to pay margin or a fee (ie. interest) on the amount of
the cash collateral. There were provisions for topping up or down
in the securities that had been transferred and of the cash
collateral and the margin, depending on movements in market values.
There were also provisions for netting and set-off of obligations
in the event of a default or an insolvency affecting a party. The
agreement also provided that the title to, and ownership of, any
securities or cash collateral transferred under the agreement
should be transferred in full, without any encumbrance or other
impediment, so that full title and ownership would pass.
In pursuance of the agreement, Party A transferred a number of
securities to Party B and received cash collateral in return (but
in a lesser amount than the value of the securities that had been
transferred). Party B had become insolvent (having transferred the
securities to a third party which, it was argued, was on notice of
Party A's rights and thereby bound by them). Party A sought to
argue that it had retained an interest in the securities, as the
transaction was really by way of a mortgage for an advance to it of
the cash collateral. Alternatively, it sought to argue that in so
far as Party B (or the third party which was on notice) retained
the securities that had been transferred to it, Party B had charged
them in favour of Party A to secure the performance of Party
B's obligation to transfer equivalent securities at the
re-transfer date. Party A failed to succeed on those arguments.
The judge applied the principles established in English cases
such as Alderson v. White (1858) 2 De G & J 97,
McEntire v. Crossley Bros Ltd [1895] AC 457, Helby v.
Matthews [1895] AC 471 and Re George Inglefield Ltd [1933]
1 Ch 1, and the Privy Council decision in Chow Yoong Hong v.
Choong Fah Rubber Manufactory [1962] AC 209. The character of
the transaction must be gleaned from the language used in the
documentation, rather than from its economic substance (which might
be seen as a method by which Party A raised funds on the strength
of the transfer of securities to Party B). In addition, he said
that it was relevant to take into account the purpose of the
transaction, which could only be achieved by transferring title in
the securities to Party B, which would thereby be enabled to deal
with them as it wished.
There had not been a mortgage of the securities originally
transferred for a number of reasons. First, the agreement required
that unencumbered title should pass on delivery of the securities
and the cash collateral, so that Party B could use the securities
for its own purposes. Secondly (and, it might be observed,
crucially) there was no obligation to retransfer the original
securities or cash collateral. Thirdly, the agreement provided for
netting and set-off provisions which came into effect on default,
as a means of mitigating credit risk, which converted delivery
obligations into payment obligations. It would be inconsistent with
the concept that Party A had retained an equitable interest in
property, by virtue of a mortgage, if its position on default
changed so that it became one for payment under a netting
arrangement, as that would amount to an impermissible clogg on its
equity of redemption under such a mortgage (note: this particular
point might be analysed differently under English law because of
the Financial Collateral Arrangements (No 2) Regs 2003 (SI
2003.3226)). The judge also commented, in relation to identifying
the legal nature of the transactions, that it did not matter how
one might characterise the type of market in which the transactions
had taken place, such as whether they had taken place on a retail
or an institutional market, nor was it relevant to consider the
nature of those involved in such markets or this particular
transaction.
The argument as to the charge in favour of Party A failed,
principally because the obligation on Party B to transfer
equivalent securities did not amount to an obligation to transfer
exactly the same securities as those originally transferred to
Party B. Party B was free to dispose of the original securities and
merely had a contractual obligation, at the retransfer date, to
then transfer securities which amounted to equivalent securities.
It was not even possible to imply a term that they should be
precisely the same securities and that Party B should hold on to
them to satisfy its obligation, as the agreement worked perfectly
well without such a term. Indeed, such an implied term would be
inconsistent with the purpose of the agreement and the reason for
Party B's acquisition of securities under it. Party B was to be
free to do whatever if wished with the securities. Furthermore,
Party A could not acquire any interest in the equivalent securities
until the point at which they were appropriated to it under the
agreement (Hoare v. Dresser (1859) 7 HLC 290,
Citizens' Bank of Louisiana v. First National Bank of New
Orleans (1873) LR 6 HL 352, Re Goldcorp Exchange Ltd
Beaconwood Securities Pty Ltd v. Australia & New Zealand
Banking Group Ltd [2008] FCA 594 (Finkelstein J 2/5/2008).
Authority to bind a principal to a contractual
obligation
A case has come before Andrew Smith J in the High Court which
illustrates the need to ensure that a person or entity which
purports to act on behalf of a principal has the authority to do
so. The case concerned a refund guarantee purportedly issued by a
bank in the Ukraine. The guarantee was expressed to be governed by
English law and was in favour of a foreign beneficiary. The
guarantee was signed and issued on behalf of the bank by one of its
employees, who was the head of one of its regional departments. It
was held that the employee lacked any actual authority expressly
given to him to sign and issue the guarantee, nor could any
authority be implied from the articles of association of the bank.
It was also held that he did not have any ostensible authority to
sign and issue the guarantee on behalf of the bank, as it was not
within the usual scope of authority of an employee in his position
to enter into a large commitment of the type represented by the
guarantee. Nor could it be said that the bank had held out the
employee as having authority to issue the guarantee on its
behalf.
There was no discussion in the decision of the conflict of laws
issues that arise when considering this type of question. It was
simply accepted by the parties that the issue in the case as to
actual authority should be decided in accordance with Ukrainian law
and that the issue as to ostensible authority and holding out
should be decided in accordance with English law.
The generally accepted position under English conflict of laws
rules is that where authority is conferred by a contract between
the principal and agent, then the existence and scope of that
authority should be governed by the law that governs the contract
(see Dicey, Morris & Collins, The Conflict of Laws
(14th Edn) at paras 33R-428 to 33-445). It has been said that the
issue as to whether an agent had apparent or ostensible authority
to enter into a contract with a third party on behalf of his
principal will be governed by the governing law of the contract
purportedly entered into by the agent with the third party (see
Marubeni Hong Kong & South China Ltd v. The Mongolian
Government [2004] EWHC 472 (Comm), [2004] 2 Lloyd's Rep
198).
It is submitted, however, that where it is argued that an
officer of a corporation or other type of entity has authority
conferred upon him by virtue of his office in pursuance of the
constitutional documents of the corporation or entity, that matter
would be governed by the law of the place of incorporation or
establishment of the corporation or entity, which would also
include the issue as to whether his authority could be amplified or
modified by contract (see, for instance, the approach that was
taken in Base Metal...
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