The recent decision in DKR Soundshore Oasis Holding v Merrill Lynch International1 is a timely reminder to market participants that one must strictly comply with the prescribed conditions to settlement contained in the 2003 ISDA Credit Derivatives Definitions (the “ISDA Definitions”) before a protection seller will be contractually obliged to pay a physical settlement amount or cash settlement amount, as applicable, to a protection buyer under a credit derivative transaction.
The brief facts were that the plaintiff DKR Soundshore Oasis Holding Fund Ltd. (“Oasis”) claimed a physical settlement amount from the defendant Merrill Lynch International (“Merrill International”) following the alleged occurrence of a restructuring credit event relating to debt obligation issued by Urban Corporation (“Urban”). In particular, the plaintiff alleged that, in the period from March through May 2008, Urban restructured more than one billion japanese yen of certain of its outstanding debt, thereby giving rise to a credit event under the terms of the agreement governing the transaction and triggering Merrill International’s obligation to settle the transaction by paying Oasis the physical settlement amount, which was 1.5 billion Yen.
The credit event notice, containing a notice of publicly available information, sent by Oasis to Merrill International was accompanied by an affidavit from a senior analyst, Mr Seino, employed by Oasis. In such affidavit, Mr. Seino recited that, on the evening of June 5, 2008, he had learned from a deputy president of Urban that Urban had sought to restructure obligations in excess of one billion JPY, and that it had been successful, except with respect to its debts to two banks, one of which Urban had had to repay in full, and the other of which Urban had repaid in part.
Merrill Lynch argued that the credit event notice failed to state and such affidavit failed to confirm that “Urban had restructured obligations in an amount greater than one billion JPY, or that it had done so on or before 11:59 p.m. on May 23, 2008. In particular, defendants argue that Mr. Seino’s Affidavit discloses that Urban’s obligations were refinanced, rather than restructured.”
Judge Kapnick noted as follows:
“Conspicuously missing from Mr. Seino’s Affidavit is a statement that the amount that Urban successfully restructured, as distinguished from the amount that it had sought to restructure, exceeded one billion JPY. Mr. Seino’s Affidavit states that Urban “had successfully persuaded nearly all of its creditor banks holding obligations in excess of JPY 1,000,000,000 to extend the scheduled loan maturity for [those obligations] (emphasis added).” Accordingly, Mr. Seino’s Affidavit failed to reasonably confirm that a Credit Event had occurred prior to the Termination Date. To be sure, the ISDA Definitions specify that only reasonable notice needs to be given of a Credit Event, and that the Publicly Available Information supplied need only reasonably confirm that the Credit Event described in the Notice occurred. However, by failing to specify either the date of the Credit Event upon which [Oasis] was relying, or the sum of the obligations that Urban had actually restructured, both the Notice, and the NPAI, do no more than pointedly raise a question as to whether the events that they purport to report had, in fact, taken place.”
Oasis further alleged that an affiliate team of Merrill International were involved in negotiating the restructuring and that a different affiliate team, of Merrill International were involved in a potential sale of Urban. Accordingly, any knowledge acquired by such affiliates of the restructuring should be imputed to Merrill International for the purposes of determining whether Merrill International had reasonable notice of the credit event. Further, since the plaintiff delivered its credit event notice on 2 July 2008 and physical settlement was only due on 15 August 2008, Merrill International had ample time to investigate whether a restructuring credit event had in fact occurred.
In relation to these latter submissions, Judge Kapnick held:
“the ISDA Definitions place the burden of providing a Notice that complies with specific requirements squarely upon the Buyer. To accept plaintiff’s argument that a Notice that fails to comply with those requirements is, nonetheless, adequate, because it gives the Seller a basis upon which to investigate whether a Credit Event occurred prior to the expiration of the Contract Term, would constitute a substantial modification of the Agreement, and it is well settled that Courts ‘may not by construction add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing’.”
The plaintiff’s claim for payment of the physical settlement amount was accordingly dismissed.