In brief

  • The Full Court of the Federal Court in Leveraged Equities v Goodridge [2011] FCAFC 31 has reversed the first instance decision of Rares J and in doing so has upheld the conduct of the margin lender, Leveraged Equities Limited (LE), in selling down the securities underlying the margin loan. Jacobson, Stone and Finkelstein JJ were unanimous in overturning the first instance decision.
  • Freehills acted for LE on appeal (but not at first instance).
  • The judgment contains some important comments which have applicability in a margin lending context. It also has implications for participants in syndicated loan and securitisation markets.
  • We have also prepared a detailed note of the judgment.2 A summary of the judgment, as well as its key implications is set out below.  

Background to the proceedings

The proceedings arose out of margin calls made by LE to Mr Goodridge in early 2009 under the terms of his margin loan agreement (LSA). The margin calls were made at a time when the value of the underlying securities held by Mr Goodridge was dropping. When Mr Goodridge failed to meet the margin calls, LE sold the securities.

In the months prior, LE had purchased Macquarie Bank Limited’s (MBL) margin loan book (including Mr Goodridge’s loan) under a complex series of transaction documents. The validity of the transfer of the loan book was questioned at first instance.

The appeal can be conveniently split into two cases:

  • a ‘margin call case’ — predominantly an appeal against the primary judge’s finding that the margin calls made by LE were invalid, and
  • a ‘transaction case’ — an appeal against the primary judge’s finding that the transaction documents under which MBL sold its margin loan book to LE were ineffective to novate or assign the LSA to LE, such that LE was not entitled to exercise any rights under the LSA.  

Margin calls were validly made

In relation to the margin call case, the Full Court held that LE’s margin calls to Mr Goodridge were in fact valid and that LE was entitled to sell his securities.

Key to this conclusion was a finding by the court that the lender was entitled, under the construction of particular terms of the LSA, to reduce the time for meeting a margin call from three days to one day.

Macquarie had effectively transferred its margin loan book to LE

The Full Court held, on the transaction case, that MBL had effectively transferred its margin loan book (including Mr Goodridge’s loan) to LE.

In relation to the arguments that the loan book had been novated, the court held:

  • consistent with UK and US authorities, the law in Australia is such that a contracting party can prospectively authorise a novation to be made by another party unilaterally
  • on the proper construction of the LSA, Mr Goodridge authorised MBL to novate its duties and obligations under the LSA to a third party without obtaining the further consent of Mr Goodridge. This included the introduction of a new lender on the same terms and conditions, and
  • the novation in the circumstances was validly effected by the transaction documents.  

In relation to the alternative arguments that the loan book had been assigned, the court held that:

  • the rights in question were capable of assignment for a number of reasons, including that the LSA specifically contemplated that assignment may occur
  • MBL assigned its rights to LE in the circumstances by the transaction documents, and
  • actual notice of the assignment was given to Mr Goodridge (overturning a factual finding by the primary judge).

The court also overturned the primary judge’s finding that LE had engaged in unconscionable conduct for the purposes of section 12CB of the ASIC Act 2001 (Cth) because:

  • section 12CB applies only to financial services of a kind ordinarily acquired for personal, domestic or household use: section 12CB(5). Relevantly, when Mr Goodridge entered the LSA, he acknowledged that the funds would be applied wholly or predominantly for business or investment purposes, and
  • there was nothing unconscionable about LE enforcing its legal rights to protect itself against a fall in the value of its security.

Key implications

The key implications emerging from the judgment are as follows:

  • Parties can consent to prospective novation — The primary judge had held that it was ‘impossible’ for one party to a contract to prospectively authorise a novation to be made by another party unilaterally. The decision makes clear the Australian legal position that parties can enter into a contract which allows one contracting party to prospectively authorise a novation to be made by another party unilaterally at some future occasion, so long as the words of the contract are clear. This aspect of the Full Court’s decision will alleviate concerns raised by participants in syndicated loan and securitisation markets as a consequence of Rares J’s decision. Rares J’s decision had raised questions as to the effectiveness of mechanisms used in many syndicated loan and securitisation markets.
  • A margin lender is not a co-speculator — The court accepted, referring to Canadian authorities, that the lender under a margin call facility is not a ‘co-speculator’, as the lender does not share in the upside of the underlying securities. It is therefore not intended that the lender be exposed to downside risk and, accordingly, the lender is entitled to exercise its rights to protect its security. While any court will, of course, look closely at the wording in a margin loan agreement, the court discussed the nature of margin lending and identified it in the context of interpreting the clause of the margin loan agreement that allowed the lender to sell down the borrower’s securities in the event of a margin call. The nature of the securities being purchased and the volatility of the market for those securities mean that provisions entitling margin lenders to act promptly should be respected.
  • Form of margin call notices — The court notes that, out of an abundance of caution, margin call notices should be drafted in such a manner so as to put the issue of the meaning of the notice beyond any doubt. To be clear, a consistent format and form should be employed so that there is no question as to whether a communication constitutes a margin call.