Against a backdrop of difficult market conditions, brokers will take comfort from the decision in Euroption Strategic Fund Limited v Skandinaviska Enskilda Banken AB (2012), which provided essential guidance on the scope of the duties owed when conducting a forced close out. Most significantly, the Court held that brokers do not owe a duty of care when conducting a close out following a client's default.
Swedish investment bank Skandinaviska Enskilda Banken ("SEB") acted as a clearing broker for Euroption Strategic Fund Ltd ("Euroption"), a BVI-domiciled investment fund whose principal activity involved trading European equity options. Pursuant to the Exchange Traded Futures & Options Mandate (the "Mandate") which existed between them, Euroption was obliged to make margin payments when asked to do so by SEB, to support their exposure on Euroption's portfolio. Where sufficient margin was not provided, SEB was entitled to close out any open contract without reference to Euroption. SEB also had the right to close out Euroption's portfolio at any time it deemed necessary for its own protection.
Global instability and market volatility in October 2008 left Euroption with considerable exposure on its open positions. As a result, Euroption's margin commitments rose dramatically over a short period of time. From 7 October 2008 SEB made calls for Euroption to make increased margin payments, several of which were missed. As a result, SEB exercised its contractual right to conduct a forced close out of Euroption's portfolio. However, Euroption's positions were not all closed out until after global markets plummeted, reducing the value of the portfolio by around €28m by the time the markets opened on 10 October 2008. Euroption claimed damages against SEB for breach of contract and negligence.
Although it was agreed that SEB had acted rationally and in good faith, Euroption argued that SEB was subject to a contractual and tortious duty to act competently and with reasonable care, and that it had breached this duty by delaying in conducting the close out.
The Court rejected these claims. In relation to the argument that SEB owed a contractual duty of care, the Court held that it was not appropriate to imply a term into the Mandate that SEB would conduct the close out using reasonable care and to a suitably professional standard. Such a term was not necessary to give business efficacy to the contract, nor was it certain how such a duty could be defined given that SEB needed to act urgently to protect its position. In addition, Euroption's argument that SEB owed a tortious duty to take reasonable care in conducting the close out was also rejected. Particularly in light of the modest commission SEB received for clearing services, it was not clear why any closing broker would assume such a responsibility in tort, putting itself at risk of having trading decisions second guessed when faced with an unwanted portfolio as a result of a customer's default.
Instead, the Court found that SEB had a wide discretion to act as it thought appropriate to affect the close out. The liquidation of Euroption's portfolio had been carried out to reduce the risk to which SEB was exposed by their default. In seeking to protect its position, SEB was entitled to act urgently and to put its own interests first, subject only to the limitations of good faith and rationality.
The case provides important clarification on the limits of the duties owed by clearing brokers when exercising their right to close out positions following a customer's default. Brokers are not obliged to carry out an exhaustive analysis of every single trading decision, measured against every available alternative but, as this judgment demonstrates, have considerable discretion to act quickly to protect their positions in times of financial turmoil.