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


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

[1995] 1 AC 74).

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


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


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


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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