Investment Bank Special Administration Does Not Trigger Repo Event of Default

Introduction

On 1 November 2012, the High Court judgment of Richards J in the case of Heis and others (Administrators of MF Global UK Ltd) v MF Global Inc[1] was published.  The judgment is of interest as it provides clarity on the application of the Investment Bank Special Administration Regulations 2011 (the “Regulations”) to boilerplate clauses within standard repo documentation.  The Regulations came into force in February 2011 pursuant to powers conferred under the Banking Act 2009, constituting a response to the financial crisis of 2008 and particularly the collapse of Lehman Brothers.  They included, for the first time, special procedures specifically designed to deal with the issues arising in relation to insolvent banks.

Background

The formal insolvency proceedings relating to the collapse of the MF Global group commenced on 31 October 2011 when MF Global Holdings Ltd (“MFG Holdings”), the US incorporated group holding company, filed for bankruptcy protection under Chapter 11 in the US.  This was followed a few hours later by the appointment of administrators pursuant to the Regulations over MF Global UK Limited (“MFG UK”), the main trading entity for the MF Global group in Europe, on the application of its directors.  Subsequently, still on the same day, a trustee was appointed under the Securities Investor Protection Act 1970 with respect to MF Global Inc (“MFG Inc”), the main trading entity of the MF Global group in the US.

The collapse of the MF Global group was attributed largely to a failed investment in European sovereign debt securities in the period between 2009 and 2011.  As part of this investment policy, MFG UK purchased securities and sold them to MFG Inc via repo transactions documented under a standard 2000 Global Master Repurchase Agreement (“GMRA”) governed by English law.

The GMRA

Paragraph 10 of the GMRA defines Events of Default.  Most default circumstances require the non-Defaulting Party to serve a “Default Notice” on the Defaulting Party before the circumstance itself crystallises into an actual Event of Default for the purposes of the GMRA.  The exception to this rule is the case of:

“…an Act of Insolvency…which is the presentation of a petition for winding-up or any analogous proceeding or the appointment of a liquidator or analogous officer of the Defaulting Party …”

An “Act of Insolvency” is defined in paragraph 2(a) of the GMRA and includes the appointment of any trustee, administrator, receiver, liquidator or analogous officer over a party to the GMRA or any material part of its property.  Broadly speaking, following the occurrence of an Event of Default, valuations for the purposes of closing-out transactions are performed by the non-Defaulting Party.

The Issues

MFG Inc conceded that the appointment of the SIPA Trustee constituted the ‘appointment of an officer analogous to a liquidator’ and that this would automatically lead to an Event of Default under the GMRA.  Ordinarily, this would also have resulted in MFG Inc being the Defaulting Party and MFG UK being the non-Defaulting Party under the GMRA.  However, MFG Inc argued that the earlier appointment of an administrator in relation to MGF UK under the Regulations also constituted ‘the appointment of an officer analogous to a liquidator’.  As such, MFG Inc claimed that the automatic Event of Default had actually occurred at this earlier point, with the result that MFG Inc was actually the non-Defaulting Party and MFG UK was the Defaulting Party.  The fact that MFG UK would have to make payment to MFG Inc was not in dispute.  However, the identity of the non-Defaulting Party was of key importance given that MFG Inc valued its claim at GBP 286.7 million, whereas MFG UK valued the claim at only GBP 37 million.

Broadly, therefore, the issue to be considered by the court was whether the appointment of an administrator in relation to MFG UK was analogous to the appointment of a liquidator and therefore automatically constituted an Event of Default under the GMRA without the need for service of a Default Notice by MFG Inc.

The Judgment

The court considered the nature of liquidation versus administration.  It concluded that the sole purpose of a liquidation is to realise the assets of a company and to distribute proceeds to creditors.  In doing so, the business of the company is brought to an end.  It acknowledged that an administration may also result in the realisation of a company’s assets and a distribution of proceeds among creditors, but noted that administration can also entail the rescue of the company as a going concern.  In reaching this conclusion, the court took support from the objectives of the Regulations, which are:

• to ensure the return of client assets as soon as reasonably practicable;
• to ensure timely engagement with market infrastructure bodes and Authorities; and
• either to:
  • rescue the investment bank as a going concern, or
  • wind it up in the best interests of the creditors.

The court also referred to Australian authority[2] in which the appointment of statutory administrators and receivers appointed by secured creditors was held not to be analogous to the appointment of a liquidator, their relative positions being summarised as follows:

“The function of a liquidator…is to preside over the death of a company.  An administrator…strives for the opposite result (even though the company may yet in the end die).  A receiver appointed by a secured creditor does neither of those things, being largely unconcerned about the fate of the company.”

The court contrasted the unqualified power of an administrator “to carry on the business of the company”, establish subsidiaries, borrow money and do “all other things incidental to the exercise of the foregoing powers” against the more restricted powers of a liquidator.  This, it felt, was consistent with the differing nature and objectives of the two regimes.  It also drew further support from the drafting of the GMRA itself, commenting that it was understandable that a non-Defaulting Party would wish to have an opportunity to wait and see how administration proceedings develop before deciding whether to exercise its right to serve a Default Notice.  In contrast, in a liquidation scenario where the company will cease to carry on business, it is equally understandable that an Event of Default occurred automatically without the need to serve notice.

Accordingly, the court held that the appointment of a special administrator under the Regulations was not analogous to the appointment of a liquidator and furthermore that an application under the Regulations for a special administration order was not analogous to a petition for a winding-up for the purposes of paragraph 10(a)(iv) of the GMRA.  Accordingly the appointment of administrators with respect to MFG UK on 31 October 2011 did not constitute an Event of Default under the GMRA.

Conclusion

This case provides useful insight into the operation of the Regulations and their interaction with standard repo documentation.  Thankfully, the Bankruptcy Events of Default under both the 1992 and 2002 ISDA Master Agreements would seem less susceptible to this issue, due to the manner in which “Automatic Early Termination” operates under the ISDA Master Agreement and the specific drafting of the standard ISDA Bankruptcy Event of Default.  Nonetheless, the conclusions of the court provide a timely reminder of the way in which legal risk can develop when portfolios of documentation fail to keep pace with changing circumstances and the benefits of performing period reviews in managing that risk.

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