Singapore High Court: Unravelling the unwind of accumulator contracts.

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1 February 2016 Singapore High Court: Unravelling the unwind of accumulator contracts. Introduction On 10 February 2016, the Singapore High Court in Tan Poh Leng Stanley v UBS AG [2016] SGHC 17 delivered a lengthy judgment on the topic of contractual interpretation. Whilst the conclusions of the court are not surprising, the case is noteworthy because it considered how the various agreements which private banks often enter into with their high net worth clients interact with one other. It is also one of the few cases which discusses the ISDA Master Agreement, albeit on an obiter basis. The case raised many issues and this bulletin will consider only the points which the court discussed in detail. Background The case arose out of the aftermath of the financial crisis in The plaintiff, Tan Poh Leng Stanley ( ST ) entered into a number of equity accumulators with UBS AG ( UBS ) on a leveraged basis between October 2007 and August An accumulator is an equity derivative under which an investor agrees to buy fixed quantities of certain shares at a strike price which is set at a discount to the spot price at the time the transaction is entered into. The accumulator has a fixed term and the investor will pay for the shares it purchases on a periodic basis. The investor takes a directional view that the share price will rise during the term of the transaction and it will benefit by being able to buy the shares at the strike price which is lower than the market price. However, if the share price were to fall, the investor will have to buy the shares at the strike price which is higher than the market price and may incur significant losses. Contents Introduction... 1 Background... 1 Was UBS entitled to unwind the accumulators without notice?... 2 Interaction between ISDA Master Agreement and other documentation... 2 Incorporation by reference 3 Was there any inconsistency between UBS s right to terminate without notice and the ISDA Master Agreement?... 5 Which ISDA Master Agreement governs?... 6 Was the Without Notice Clause onerous and was it brought to the attention of ST?... 7 Breach of Section 6(d)(i)?. 7 Conclusions... 7 In the present case, ST purchased the accumulators on margin, i.e. he borrowed money from UBS to purchase the contracts. UBS required ST to post collateral in the form of cash and/or securities to his account with UBS. The amount of collateral required depends on the loanable value of the collateral and the amount of the mark-to-market losses from the accumulators. Singapore High Court: Unravelling the unwind of accumulator contracts 1

2 As the share price fell, ST received a margin call notice from UBS on 22 October 2008 and, as ST failed to post the requisite margin, UBS liquidated ST s account by selling the collateral shares and unwinding the accumulators. Following the liquidation of ST s account, there was still a shortfall of US$6.7 million and ST was also liable to UBS for unwind costs of approximately US$25.5 million. ST and UBS subsequently entered into a work out agreement on 21 March 2009 to settle ST s outstanding liabilities to UBS and ST paid off his total liabilities to UBS in April In this action, ST disputed UBS s entitlement to unwind the accumulators. In particular, he disputed the ability of UBS to unwind the accumulators without issuing a notice as contemplated by Section 6(a) of the ISDA Master Agreement. ST argued that he would have had sufficient assets to make good the shortfall in his account had UBS given notice to him as required by the ISDA Master Agreement. Was UBS entitled to unwind the accumulators without notice? This was the central issue of the case and the answer turned on whether there was an oral agreement between the parties to liquidate the entire account outside of the ISDA Master Agreement. ST conceded that he consented to the sale of the collateral shares but disputed that he agreed to the unwind of the accumulators. However, the court held that, on the evidence before it: ST did not have sufficient liquid assets to continue to meet the margin calls, in particular, having regard to the falling share price which would widen the margin requirements and increase the mark-tomarket losses on the accumulators; ST had in fact stopped posting margin to his account and had started to sell some of the collateral shares; and ST s lawyer had consented to UBS liquidating the entire account at a meeting with ST s relationship manager, i.e. to selling the collateral shares and unwinding the accumulators. Accordingly, the court held that there was an oral agreement between the parties to unwind the accumulators outside of the ISDA Master Agreement and the requirement to give notice of the unwind under Section 6(a) of the ISDA Master Agreement was not applicable. Interaction between ISDA Master Agreement and other documentation Given that the court found a mutual agreement between the parties to unwind the accumulators outside of the ISDA Master Agreement, it did not strictly speaking have to consider whether the Credit Services Notification Letter ( CSNL ) between the parties gave UBS the right to terminate the accumulators without notice. Singapore High Court: Unravelling the unwind of accumulator contracts 2

3 By way of background, ST entered into an account agreement (the Account Agreement ) when he opened his wealth management account (the Account ) with UBS in ST also accepted credit facilities from UBS and entered into the CSNL in relation to the Account. The Account Agreement was revised in 2008 (the 2008 Revision ) by way of a letter from UBS to ST (the 2008 Revision Letter ) and the CSNL was also revised through to Incorporation by reference First, there was a question as to whether the Confirmations documenting the accumulators incorporated by reference the provision in the CSNL which gave UBS the right to terminate the transactions without notice (the Without Notice Clause ). The court held that this is a matter of contractual interpretation and, in undertaking this exercise, the court, applying the principles of contractual interpretation enunciated in recent cases such as Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 and Y.E.S. F&B Group Pte Ltd v Soup Restaurant Singapore Pte Ltd (formerly known as Soup Restaurant (Causeway Point) Pte Ltd) [2015] SGCA 55, should have regard to the context and the objective circumstances attending the entry into the contract. The court would seek to ascertain the parties intentions and the overlap of obligations between the two contracts could be a very important factor that the court would have to consider in deciding whether a clause had been incorporated. Each of the Confirmations provides as follows: Collateral [ST] shall provide to [UBS] on or before the Trade Date such collateral to secure [ST s] obligations under the Transaction as set out in the [CSNL] as amended from time to time, the Transaction being within the OTC equity and index options trading facility granted pursuant to the CSNL. The CSNL in turn gave UBS the right to sell the collateral shares and close out any Transaction if collateral was not posted. The court attached significance to the fact that both the Confirmations and the CSNL required ST to post collateral. The Confirmation also expressly stated that the accumulator was a Transaction within the OTC facility under the CSNL. The court was of the view that the cross referencing showed very clearly that UBS s right to terminate the accumulator without notice was incorporated into the Confirmation. It would make absolutely no commercial sense for the parties to incorporate the obligation to provide collateral without incorporating the corresponding right of termination. That said, there was a question as to whether the Confirmations in fact incorporated by reference the obligation to provide collateral in the first place, as opposed to merely stating that ST was required to post collateral under the CSNL. However, this may not have made a difference to the outcome Singapore High Court: Unravelling the unwind of accumulator contracts 3

4 because it could be argued that even if the obligation to provide collateral and the right of termination were not incorporated by reference, the Confirmations and the ISDA Master Agreement should be read together with the CSNL given that the entire agreement clause in the ISDA Master Agreement was amended in the Schedule to expressly provide that it was without prejudice to the Account Agreement and all other documents executed ancillary or in connection thereto, which would include the CSNL. Nonetheless, on the basis that the Without Notice Clause had been incorporated by reference, how would such termination work within the framework of the ISDA Master Agreement? The point did not need to be decided on this occasion given that the court found a mutual agreement to terminate outside of the ISDA Master Agreement. However, it is worth considering the point further. Before we do so, it is pertinent to note that there are two versions of the ISDA Master Agreement which govern the accumulators, the version entered into by the parties in 2006 (the 2006 version ) and another version (the 2008 version ) which came into effect as a result of the 2008 Revision. There was a question as to which version governed which accumulators (see below) but for present purposes, it can be assumed that some accumulators are governed by the 2006 version and some are governed by the 2008 version. The 2006 version contained an Additional Termination Event ( ATE ) clause which appeared to permit UBS to terminate any Transaction at any time by giving notice. The court treated the ATE clause as superseding the requirement in Section 6(b)(i) of the ISDA Master Agreement (which obliges an Affected Party to notify the other party promptly upon becoming aware of the occurrence of a Termination Event) but it was not clear why Section 6(b)(i) was relevant. It was also not clear why the court was of the view that the ATE clause was relevant because the ATE clause is in substance an optional early termination right which was given to UBS and it requires UBS to give notice. What was more pertinent is the ATE clause contained in the 2008 version. That ATE clause provided that termination by UBS without notice of any Transaction will be an ATE and the Early Termination Date will be deemed to have occurred immediately upon the termination by UBS of the relevant Transactions. Again, the court examined this ATE clause in the context of Section 6(b)(i) of the ISDA Master Agreement and it is not clear why Section 6(b)(i) was relevant. On the basis of the foregoing, if UBS had terminated the accumulators by relying on the Without Notice Clause, there are two scenarios. Under the 2006 version, it is not clear how the termination should have operated because the 2006 version appears to lack an ATE clause granting UBS the right to terminate without notice under the CSNL. The court discussed the fact that under the CSNL, ST had charged all the securities deposited with UBS as collateral and UBS was entitled to enforce the charge upon the occurrence of a Default Event. Although ST s expert Singapore High Court: Unravelling the unwind of accumulator contracts 4

5 witness made the point that the enforcement of the charge under the CSNL is not a complete termination framework (as compared to the close-out procedure under the ISDA Master Agreement), he accepted that terms may be implied in fact to deal with post-termination matters such as valuation method. As a result of this concession, the court did not consider further how termination would have worked (and it would have been unnecessary for the court to do so in any case). In practice, UBS would not simply be relying on the CSNL to terminate the accumulators because it would have to determine the termination values and net the amounts in accordance with Section 6 of the ISDA Master Agreement. The court could conceivably have reached the same outcome by reading the CSNL together with the ISDA Master Agreement as opposed to implying terms into the CSNL. This would also be consistent with the entire agreement clause in the ISDA Master Agreement which, as amended by the Schedule, suggests that all the documents should be read together as a whole. However, the absence of a Iinking ATE clause in the 2006 version remains a difficulty. Under the 2008 version, although the court did not comment on the point, the position is arguably clearer. It is submitted that the real significance of the ATE clause in the 2008 version is the fact that it was intended to reflect UBS s right to terminate without notice under the CSNL. Although the drafting is not 100% clear, the effect of the ATE clause appears to be that if UBS exercises its right to terminate without notice under the CSNL, this would trigger the ATE and Section 6 of the ISDA Master Agreement would apply. Normally, UBS would be required to give a notice pursuant to Section 6(b)(iv) of the ISDA Master Agreement to trigger the ATE. Although the ATE clause did not expressly state that no notice under Section 6(b)(iv) is required, the deemed occurrence of the Early Termination Date suggests that no such notice is required. Was there any inconsistency between UBS s right to terminate without notice and the ISDA Master Agreement? Having held that UBS s right to terminate without notice was incorporated into the Confirmations, it was clear that the hierarchy of the documents in the ISDA framework meant that if there were any inconsistency, the Confirmation would prevail. However, the court in fact held that there was no such inconsistency. The court recognised that to reject a clause as inconsistent with another involves rewriting the contract, which can only be justified in circumstances where the two clauses are in truth irreconcilable. Where a contract has been drafted as a coherent whole, it should be read to support that intention. The overwhelming probability is that an apparent inconsistency will be resolved by the ordinary processes of construction. Relying on Geys v Société Générale, London Branch [2013] 1 AC 523, the approach that the court would take when a contract, or a series of contracts Singapore High Court: Unravelling the unwind of accumulator contracts 5

6 which form part of the transactional relationship of the parties, provide alternative rights of termination is to: ask itself if any provisions are framed mandatorily or permissively. In the latter case, the court can conclude that the use of permissive language in one document amounts to a reservation of that party s rights to provide for alternative means in other documents or within the same contract; or do its best to see if the seemingly inconsistent provisions can be reconciled. Applying the law to the facts, the court held that UBS s right to terminate all outstanding Transactions under Section 6(a) of the ISDA Master Agreement is framed permissively, as with UBS s right to terminate without notice under the CSNL. These rights can therefore exist in parallel and the court noted that the entire agreement clause in Section 9(a) of the ISDA Master Agreement (as amended in the Schedule) supported the same conclusion, as it expressly provided that the terms of the ISDA Master Agreement were without prejudice to the Account Agreement and all other documents executed ancillary or in connection thereto, which would include the CSNL. Which ISDA Master Agreement governs? There was also an issue regarding the fact that the accumulators were potentially governed by two versions of the ISDA Master Agreement between the parties. The point arose because the 2008 Revision Letter stated that a new version of the ISDA Master Agreement would replace the existing one and would apply to transactions entered into after 23 July The 2008 Revision Letter was a notice from UBS which was not executed by ST. However, the Account Agreement provided that UBS might amend or supplement the terms and conditions by notice to ST. In addition, Section 9(b) of the ISDA Master Agreement which required all amendments to be executed by each of the parties did not apply because the application of the new ISDA Master Agreement to future transactions was not an amendment to the existing ISDA Master Agreement. As a matter of contract, the parties can agree that an agreement in an identified form will come into effect between them without the need for formal execution. In fact, this is precisely how long form confirmations work, i.e. by deeming that the parties have entered into an ISDA Master Agreement in the preprinted form as if they had executed an agreement in such form, incorporating the relevant elections as set forth in the long form confirmation. It is therefore a welcome judicial affirmation that the deemed ISDA Master Agreement approach that is widely used in the market accords with the basic principles of contractual interpretation. Singapore High Court: Unravelling the unwind of accumulator contracts 6

7 Was the Without Notice Clause onerous and was it brought to the attention of ST? Counsel for ST also attempted to argue that the Without Notice Clause was unusual and onerous and should have been drawn to ST s attention. Whether the Without Notice Clause was unusual and onerous is a question of fact and the court took account of all the circumstances, including the experience of the parties. The court found that ST was a sophisticated investor and in multiple documents ST had acknowledged that he entered into the accumulators with a full understanding of the terms and conditions and the risks relating to them. The enforcement of such representations by the Singapore court in the context of more sophisticated products is important for claims of this kind which often rely on an allegation of unsuitability of the product for the particular investor The court also held that in the context of derivatives transactions, there are many legitimate reasons why a bank might have to look towards the Without Notice Clause to act urgently in the client s interest and ST s expert witness conceded at trial that the Without Notice Clause was reasonable. Even if the Without Notice Clause was found to be onerous, the court found that it was specifically drawn to ST s attention in the 2008 Revision Letter. Breach of Section 6(d)(i)? ST also alleged that UBS breached Section 6(d)(i) of the ISDA Master Agreement because it sent details of the unwind of the accumulators to ST by . Section 6(d)(i) provides that UBS is required to provide a statement showing in reasonable detail the calculations it made following the occurrence of an Early Termination Date and Section 12(a) provides that such statement may not be given by facsimile transmission or electronic messaging system. As the court held that the unwind of the accumulators was pursuant to a mutual agreement outside of the ISDA Master Agreement, Section 6(d)(i) and the notice provisions in the ISDA Master Agreement did not strictly speaking apply. That said, it was interesting to note that the court readily implied a term that UBS was obliged to notify ST of the unwind costs and the price at which the accumulators were unwound. This was so notwithstanding ST s expert witness conceding that there was no necessity to do so and the court endorsing the necessity test for implied terms as set out in Sembcorp Marine Ltd v PPL Holdings Pte Ltd [2013] 4 SLR 193. However, the court was of the view that there was no reason why such information could not have been sent by . Conclusions As it can be seen, the case threw up numerous issues but the key issue was the mutual agreement to unwind the accumulators. Having concluded that the parties agreed to unwind the accumulators outside of the ISDA Master Agreement, the court did not strictly speaking have to decide the points relating to the provisions of the ISDA Master Agreement and the other Singapore High Court: Unravelling the unwind of accumulator contracts 7

8 documents. However, it is interesting to note that the court did not focus on the terms of the unwind beyond implying an obligation on UBS to provide a statement of calculations. For example, the court did not address whether UBS was obliged to determine the termination amount in connection with the unwind on the basis of Section 6(e) of the ISDA Master Agreement. Although the case suggests that there may be merit in conducting an unwind by agreement if multiple and potentially inconsistent documentation is involved, it should be noted that if the counterparty is in financial difficulties, such agreement may be subject to challenge by a liquidator. In the present case, an agreed unwind might not have been an issue if ST was not then in financial difficulties. It also appeared that the mutual agreement was limited to an agreement to permit UBS to unwind the accumulators without having to give notice, rather than (i) an agreement to terminate the accumulators when UBS had no right to do so and/or (ii) an agreement of a termination amount, either of which might have been challenged as an undervalue or a preference. The manner in which the court dealt with the incorporation by reference point is also not without difficulty. It appeared to overlook the importance of having to consider all the documents as a whole and the commentary in certain parts of the judgment suggested that the significance of certain provisions was not considered. This lack of clarity might have resulted from the multiplicity of documents between the parties but we hope that the point can be considered more directly on another occasion, even if it would not have affected the outcome of this case. Singapore High Court: Unravelling the unwind of accumulator contracts 8

9 Contacts For further information please contact: Victor Wan Partner, Capital Markets (+852) Jelita Pandjaitan Partner, Dispute Resolution (+65) Melvin Sng Partner, Dispute Resolution (+65) Kai Loon Loh Managing Associate, Capital Markets (+65) Henry Lobb Managing Associate, Capital Markets (+65) Author: Kai Loon Loh This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters Singapore Pte. Ltd.. All Rights reserved 2016 Linklaters Singapore Pte. Ltd. (Company Registration No C) is a qualifying foreign law practice, incorporated with limited liability in Singapore. Linklaters Singapore Pte. Ltd. is affiliated with Linklaters LLP, a limited liability partnership registered in England and Wales with registered number OC Linklaters LLP is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. A Li Ling Tan Associate, Capital Markets (+65) li_ling.tan@linklaters.com One George Street #17-01 Singapore Telephone (+65) Facsimile (+65) Linklaters.com Singapore High Court: Unravelling the unwind of accumulator contracts 9