Margin Calls Must Observe Notice Period

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1 Margin Calls Must Observe Notice Period Introduction In Lam Chi Kin David v Deutsche Bank AG [2010] SGCA 42, the Court of Appeal dealt with the issue of margin loans, a common subject of dispute in recent cases. The Court considered the questions of what constitutes a valid margin call, and what the required notice period is before the securities under a margin loan can be sold. The plaintiff borrower ( the Plaintiff ) claimed that his securities under a margin loan with the defendant bank ( the Defendant ) were wrongly sold because the margin calls made on him were invalid, or alternatively, that he was entitled to more time to deliver additional collateral. The High Court found in favour of the Defendant, but the Court of Appeal, led by CJ Chan Sek Keong, reversed the decision. It held that certain margin calls were invalid as they were stated to be for discussion purposes only, and did not ask for additional security. The Court also found that the Plaintiff was contractually entitled to at least one day s notice before his securities were sold, and that the Defendant had further promised the Plaintiff an additional 48-hr grace period. The Court here took a strict view of the requirements which a lender must fulfill before the securities under a margin loan agreement may be sold. Margin lenders should thus note that their margin calls should be clear and explicit, and that an adequate notice period must be given. Brief Facts (1) The Plaintiff was a relatively wealthy investor who opened a Private Wealth Management Account ( the Account ) with the Defendant, through which he was active in foreign exchange trading. (2) The Account was healthy until 7 October 2008, when it entered into an account shortfall. The shortfall continued to deteriorate until 10 October 2008, when the Account entered negative equity. (3) The Defendant sent 3 alleged margin calls to the Plaintiff: 1 Rajah & Tann LLP

2 a. On 7 October 2008, the Defendant sent a fax informing the Plaintiff of the margin shortfall. On 8 October 2008, the Defendant sent another fax informing the Plaintiff that the margin shortfall had increased. b. Both these faxes contained a note stating that they were not an official bank s statement or advice, and prepared as a service to provide account information and is intended for discussion purposes only. c. On 10 October 2008, the Defendant sent a letter requiring the Plaintiff to restore the margin shortfall of about US$5.5mil by 5pm that day. (4) The Plaintiff informed the Defendant that he was unable / unwilling to deliver the additional collateral to clear the margin shortfall, and on 10 October 2008, the Defendant sold the Plaintiff s securities. (5) The Plaintiff alleged that the securities had been wrongfully sold. He claimed that he was contractually entitled to a notice period of one business day, and that the Defendant s managing director had promised to grant him a further 48 hr grace period. (6) The High Court found in favour of the Defendant, and the Plaintiff appealed the decision. Issues The Court of Appeal had to consider the following issues that went before the High Court: Whether the margin calls on 7, 8 or 10 October 2008 were valid; (ii) Whether the Plaintiff was contractually entitled to a notice period of one business day; and (iii) Whether the Defendant was estopped from selling the Plaintiff s securities due to its promise of a 48 hr grace period. Holdings Of The Court Of Appeal The Court of Appeal reversed the High Court s decision, holding that the Defendant had breached its contract with the Plaintiff by selling his securities before the required notice period had expired. Validity Of Margin Calls The Court determined that the faxes of 7 October and 8 October were merely notifications of the Plaintiff s collateral availability. 2 Rajah & Tann LLP

3 The note contained in each fax specified that they were for discussion purposes only, and thus not intended to be margin calls. (ii) The High Court had found that the Plaintiff, as a seasoned FX investor, knew what he was required to do in the event of margin shortfall, as evidenced by his instructions to reduce the shortfall after receiving the faxes. (iii) However, the Court of Appeal held that the Plaintiff s knowledge and instructions could not confer on the Defendant the right to sell where the faxes themselves contained no such rights. The 10 October letter was found to be a valid margin call because it was expressed to be a demand for collateral under the margin loan agreement, as the Plaintiff admitted. However, it was a breach of agreement as it failed to give a sufficient notice period; this is elaborated upon below. Notice Period Of One Business Day The contract between the Plaintiff and the Defendant consisted of both a Master Agreement and a Service Agreement. Clause 2.6 of the Master Agreement provided that the Plaintiff would only be obliged to deliver any additional collateral within one business day s notice. (ii) However, the Service Agreement provided that the Defendant could exercise its rights on termination where the collateral value was less than the total exposure, and that it may (but need not) allow you time to restore the Collateral Value The High Court had held that Clause 2.6 of the Master Agreement did not come into play because the 10 October margin call did not invoke Clause 2.6, but was instead a request to clear the shortfall under the Service Agreement. Therefore, the one business day s notice period was not required. On this point, the Court of Appeal again disagreed with the High Court. It held that the Master Agreement, and thus Clause 2.6, did indeed apply to the 10 October margin call. The margin call referred expressly to both the Master Agreement and the Service Agreement, and there was nothing in the Service Agreement which excluded the operation of Clause 2.6. Further, it was held that the Service Agreement did not expressly authorise the Defendant to terminate the Plaintiff s account or close his FX positions without giving any notice, even where the collateral value was less than the total exposure. The Service Agreement only allowed for termination and closing out where there was an Event of Default. 3 Rajah & Tann LLP

4 (ii) An Event of Default required the failure to provide collateral when the Defendant required, implying that prior notice must first be given to the Plaintiff to provide additional collateral. (iii) The Court noted that this was in keeping with commercial sense, as it would be surprising if, in the business of wealth management, banks could give themselves the right to close their clients accounts without giving any notice at all. Therefore, the Plaintiff was entitled to one business day s notice to restore the state of his account. The 10 October margin call was a breach of agreement as it gave less than a day s notice, and the Defendant was in breach of its obligations in closing out the Plaintiff s FX positions on the day of 10 October itself. 48 hr Grace Period The High Court had found that the Defendant s managing director had promised a 48 hr grace period to comply with any margin call. The Court of Appeal then confirmed that the Defendant was estopped from resiling from the promise as it would be inequitable to do so. The Plaintiff s submissions on the grace period had failed in the High Court as no detrimental reliance had been found. However, the Court of Appeal held that there was sufficient detrimental reliance to raise promissory estoppel. The Plaintiff had obtained a very substantial credit line from the Defendant, giving much business and profit to the Defendant. (ii) The Plaintiff provided collateral from other accounts with other banks to the benefit of the Defendant. (iii) The grace period was a very valuable right as exchange rates are unstable, and the extra time would be a great benefit when closing out FX positions. Without the promised grace period, the Plaintiff might not have exposed himself to such large FX positions. The Court further opined that even if there was no detrimental reliance, the Defendant should not be allowed to resile from its promise as it had obtained a clear advantage from its promise. This principle was stated to be especially relevant in the context of private banking, where customers should be able to trust the words of their banks. Variation The Court also noted, in obiter, that the Plaintiff would have been entitled to a 48 hr grace period in any event as the Defendant s promise constituted a variation of the relevant terms of the agreement relating to margin calls. Therefore, the grace period became a contractual term of every FX transaction. 4 Rajah & Tann LLP

5 Before the terms of a contract can be varied, consideration must be provided. The Court found that the consideration here consisted of the Plaintiff entering into the relevant FX contracts (thereby giving both factual and legal benefit to the Defendant), and also of the Plaintiff transferring substantial deposits to the Account to secure credit facilities. It is notable that the Court found that the Plaintiff s transfer of funds for security constituted consideration and acceptance of the Defendant s promise of a 48 hr grace period. On the facts of the case, it did not appear apparent that the transfer of funds was because of the promise of a 48 hr grace period, or whether the Plaintiff would have transferred the funds to secure trading anyway, with the 48 hr grace period serving as an additional bonus. The Court may have been convinced by the volume and significance of funds transferred. It may also have been guided by the principle (as stated above) that banks or financial intermediaries engaged in wealth management should be trusted with their words. Concluding Words The Court of Appeal here took a strict view of the obligations of a lender when managing its borrower s margin loan (and other) accounts. Margin calls must be expressly worded such that they clearly effect a demand for additional collateral under the margin loan agreement. A mere statement of shortfall is insufficient, even if the borrower understands what the requisite action is. Lenders must also give a sufficient notice period before closing out the account; as the Court noted, it is commercially unlikely that a lender would be able to close out an account without giving any notice whatsoever. Further, lenders should note any verbal assurances given in the course of their dealings with their borrowers. The Court observed that obtaining a client s business is a benefit to the lender in and of itself, and the lender will likely be held to any promises given in light of this. 5 Rajah & Tann LLP

6 Contacts Sim Kwan Kiat Partner D (65) F (65) kwan.kiat.sim@rajahtann.com Lionel Tay Partner D (65) F (65) lionel.tay@rajahtann.com Please feel free to also contact the Knowledge and Risk Management Group at eoasis@rajahtann.com Rajah & Tann LLP is one of the largest law firms in Singapore and Asia, with representative offices in Shanghai, Vientiane, Ho Chi Minh City and Bangkok, as well as an associate office (Kamilah & Chong) in Kuala Lumpur. As a full service regional law firm, our knowledge, resources and insight can be your business advantage. Rajah & Tann LLP is firmly committed to the provision of high quality legal services. It places strong emphasis on promptness, accessibility and reliability in dealing with clients. At the same time, the firm strives towards a practical yet creative approach in dealing with business and commercial problems. The contents of this Update are owned by Rajah & Tann LLP and subject to copyright protection under the laws of Singapore and, through international treaties, other countries. No part of this Update may be reproduced, licensed, sold, published, transmitted, modified, adapted, publicly displayed, broadcast (including storage in any medium by electronic means whether or not transiently for any purpose save as permitted herein) without the prior written permission of Rajah & Tann LLP. Please note also that whilst the information in this Update is correct to the best of our knowledge and belief at the time of writing, it is only intended to provide a general guide to the subject matter and should not be treated as a substitute for specific professional advice for any particular course of action as such information may not suit your specific business and operational requirements. It is to your advantage to seek legal advice for your specific situation. In this regard, you may call the lawyer you normally deal with in Rajah & Tann LLP or the Knowledge & Risk Management Group at eoasis@rajahtann.com. 6 Rajah & Tann LLP