The Court of Appeal has upheld the High Court's decision that 'negative interest' is not payable by a Transferor of cash collateral under the standard form ISDA 1995 Credit Support Annex ("CSA"): The State of the Netherlands v Deutsche Bank AG [2019] EWCA Civ 771.

The Court of Appeal's confirmation of this point is useful, because the lack of any express terms in the CSA in relation to the payment of negative interest had given rise to significant uncertainty (leading to publication of the ISDA 2014 Collateral Agreement Negative Interest Protocol). However, while the Court of Appeal reached the same result as the High Court, it commented that the High Court had adopted "too simplistic an approach" (see our banking litigation e-bulletin on the High Court's decision).

The Court of Appeal gave three key reasons for its judgment. Firstly, the Court of Appeal agreed with the central reason given by the High Court, which was in summary: that paragraph 5(c)(ii) of the CSA covered positive (but not negative) interest; that this paragraph was the most obvious place to find a reference to negative interest if it had been intended; and the fact that negative interest was actually excluded from paragraph 5(c)(ii) was a powerful indicator that it was not contemplated as payable.

Secondly, both the High Court and Court of Appeal relied on the User’s Guide to the ISDA Credit Support Documents under English Law (published in 1999) as an aid to interpretation. However, the Court of Appeal also relied on other "background materials", including a Best Practice statement issued just after the CSA was amended in 2010, which said in express terms that interest rates under the CSA should be floored at zero and not drop into a negative figure. The Court of Appeal noted that it would not normally be possible to look at post-contractual documentation as being indicative of factual matrix, but said this was significant as it showed ISDA's thinking around the time of the CSA.

Finally, as a general and overarching reason, the Court of Appeal could see nothing in the CSA read as a whole that gave the impression that negative interest was contemplated or intended. It suggested this may be a situation of the kind envisaged in Arnold v Britton & Ors [2015] UKSC 36 (see our litigation blog post) where an event subsequently occurs which was plainly not intended or contemplated by the parties – or in this case the market - judging from the language of their contract. Excluding negative interest was not unfair, as was argued, it was just a function of what was actually agreed and not agreed.

The Court of Appeal therefore concluded that the CSA did not provide for the payment of negative, as opposed to positive interest, and dismissed the appeal.

Background

In March 2001 the State of the Netherlands (the "State") and Deutsche Bank (the "Bank") entered into an agreement comprising the 1992 ISDA Master Agreement, Schedule and CSA. The CSA was amended in 2010 to delete and replace paragraph 11.

The parties subsequently entered into a number of derivative transactions pursuant to these contractual arrangements. Under these transactions, where the State had a net credit exposure to the Bank: (i) the Bank was required to provide credit support to the State by way of cash collateral; and (ii) the State was required to pay the Bank interest on the collateral.

The State did, in fact, have a net credit exposure to the Bank and the Bank accordingly posted collateral. However, from June 2014, the interest rate applicable to the State's obligation to pay interest on the collateral was less than zero. The State brought a claim against the Bank for negative interest in respect of the collateral.

High Court decision

The High Court held that the State's claim for negative interest failed. For a detailed explanation of the High Court's decision, please see our banking litigation e-bulletin.

The main reason for the High Court's decision was that paragraph 5(c)(ii) of the CSA only required the Transferee (the State) to pay interest to the Transferor (the Bank); there was no express reciprocal obligation for negative interest to be paid by the Bank to the State, in that paragraph or elsewhere in the CSA. The High Court agreed with the Bank that if there was an obligation to pay negative interest "it would be spelled out". In the High Court's view, had the parties wished to, they could have included an obligation on the Bank to pay negative interest, and paragraph 5(c)(ii) was the obvious place for such an obligation to appear.

Grounds of appeal

The State appealed. It contended that while paragraph 5(c)(ii) of the CSA provided only for the transfer of positive interest from the State to the Bank, other provisions of the CSA required that negative interest was accounted for. In essence, the State submitted that the defined term “Interest Amount” could include negative interest, and the definition of “Credit Support Balance” required that that negative interest should “form part of” that Credit Support Balance.

Court of Appeal decision

The Court of Appeal dismissed the appeal, holding that on its true interpretation the CSA could not be taken as providing for the payment of negative (as opposed to positive) interest. However, the reasoning of the Court of Appeal differed quite significantly to the High Court, which it felt had adopted "too simplistic an approach".

Considering the authorities on contractual interpretation relied on by the parties, the Court of Appeal first addressed Re Lehman Brothers (No 8) [2016] EWHC 2417 (Ch), which stated in an ISDA context that the focus should be on the words used “which should be taken to have been selected after considerable thought and with the benefit of the input and continuing review of users of the standard forms and of knowledge of the market”. It commented that while this was undoubtedly right to say, it did not take the matter much further in the instant case. Rather, in the Court of Appeal's view, Wood v Capita Insurance Services Limited [2017] 2 WLR 1095 was more instructive (see our banking litigation e-bulletin). That case emphasised the need to consider the contract as a whole, consider rival meanings in the context of what is more consistent with business common sense, and consider the quality of the drafting when striking a balance between the language of the clause and its commercial implications.

With those points on the authorities in mind, the Court of Appeal gave three key reasons for its judgment, which are summarised below.

1. User's Guide and background materials

In the Court of Appeal's view, the User’s Guide to the ISDA Credit Support Documents under English Law (published in 1999) and background materials did not show that ISDA thought that negative interest was intended to be payable. The Court of Appeal said it was significant that the User's Guide made no reference to negative interest being provided for. It is worth noting here that the User's Guide was accepted before the High Court as being admissible factual matrix in relation to the interpretation of the CSA, having been published both before the original CSA was entered into in 2001 and amended in 2010.

Interestingly, the other "background materials" referred to by the Court of Appeal, and treated as influential in its thinking, actually post-dated the amendment of the CSA in 2010. The Court of Appeal noted that it would not normally be possible to look at post-contractual documentation as being indicative of factual matrix. However, a Best Practice statement issued just after the CSA was amended in 2010 expressly stated: “[a]t no point should the interest accrual (rate minus spread) drop into a negative figure. If this occurs the rate should be floored at zero”. The Court of Appeal said this was significant as it showed ISDA's thinking around the time of the CSA (and even though it was not placed before the trial judge, it had been publicly available since 2010). The Court of Appeal accepted that while these (and later) documents were not conclusive, they could not be ignored.

2. Asymmetries created by the State's interpretation

The Court of Appeal agreed with the Bank that there were a number of asymmetries created by the State's interpretation of the CSA. The most significant of these was that paragraph 5(c)(ii) covered positive, but not negative, interest. The Court of Appeal agreed with the High Court that this paragraph was certainly the most obvious place to find a reference to negative interest if it were intended. It said the fact that negative interest was actually excluded from paragraph 5(c)(ii) was a powerful indicator that it was not contemplated as payable.

3. Negative interest not contemplated by the parties

As a general and overarching reason, the Court of Appeal could see nothing in the CSA read as a whole that gave the impression that negative interest was contemplated or intended. It suggested this may be a situation of the kind envisaged in Arnold v Britton where an event subsequently occurs which was plainly not intended or contemplated by the parties – or in this case the market - judging from the language of their contract. The result (that negative interest was not payable) was not unfair to the State and was simply a function of what had been agreed and not agreed.

The Court of Appeal accepted that the commercial background could be argued both ways. Having undertaken the process of iterative checking and re-checking of the competing interpretations against each part of the CSA, it concluded that the CSA did not provide for the payment of negative, as opposed to positive interest, and dismissed the appeal.