Focus: Margin lending and securitisation – the return of certainty?
19 January 2011
In brief: In a judgment that will be welcomed by securitisers, syndicated lenders and other buyers and sellers of financial assets, the full bench of the Federal Court has handed down its decision in the Goodridge appeal. In this article, Partner Matthew Allchurch examines the appeal judgment and its ramifications.
- Background and points at issue
- The first instance decision
- The appeal decision
- Implications for margin lenders and borrowers
- Implications for securitisers and buyers and sellers of financial assets
- Our role
How does it affect you?
The case highlights:
- the nature of the relationship between a margin lender and a margin borrower;
- the rights of a margin lender to act expeditiously provided it does so in accordance with its rights;
- the crucial importance of the drafting of documentation, particularly standard forms which give rise to systemic risk issues;
- the courts will give effect to contractual provisions permitting the assignment of contractual rights except in very limited circumstances;
- there is nothing in principle which restricts a transfer of rights and obligations by way of novation without the further consent or agreement of the other party, provided the novation is sufficiently clearly authorised by the contract; and
- the established techniques commonly used in securitisation and sales of financial assets in the Australian market are effective, and can be used with confidence.
This case arose out of the exercise by Leveraged Equities (LE) of its rights under a margin loan made to Mr Goodridge. LE had acquired Mr Goodridge's margin loan when it purchased Macquarie Bank's margin loan book in early 2009. At the depths of the share market crash in February 2009, LE made a number of margin calls on Mr Goodridge. When these were not satisfied, LE sold all of the securities in his margin lending account.
Mr Goodridge sued LE and Macquarie Bank (MBL) on a number of grounds.
The case raised a number of legal questions, including:
- whether a term of the margin loan agreement providing for the borrower to consent, in advance, to the novation by the lender of its obligations to an unidentified third party was effective; and
- whether the rights under the margin loan agreement were capable of assignment, even if it was expressly provided in the agreement that all or any of those rights could be assigned without consent.
At first instance1, the trial judge upheld Mr Goodridge's claims, deciding that, on the facts of the case:
- no valid margin calls had been made by LE;
- the lender was not entitled to exercise its rights to sell securities in the absence of a valid margin call;
- accordingly, LE was not entitled to sell the securities. The sale was a breach of contract, a breach of trust and a misuse of the power of sale;
- there was no novation of Mr Goodridge's margin loan from MBL to LE; and
- the purported assignment by MBL of its rights under the margin loan agreement, including to repayment of the margin loan, without a transfer of obligations was not effective because:
- certain of those rights (for example, the right to determine the amount of margin calls) were 'inherent and necessary' to, and could not be 'bifurcated' from, the performance of MBL's obligations to make further advances; and
- the contractual arrangements between MBL and LE, which provided various mechanisms by which LE would receive the benefit of the rights to the repayment of further advances and would be responsible for reimbursing MBL for any further advances funded by it, were 'unworkable'.
The full bench of the Federal Court unanimously allowed the appeals by LE and MBL in full2, finding:
- the margin calls made by LE were validly made in accordance with the terms of the margin loan agreement;
- LE's sales of securities were made in accordance with its powers under the margin loan agreement;
- while novation of a contract may ordinarily require the agreement of the original and substituted party, a contract may authorise one party to a contract to substitute another party in its place without the need for a further tripartite agreement;
- the terms of the margin loan agreement were sufficiently clear to authorise MBL to novate Mr Goodridge's loan to LE, and the documents under which MBL sold its margin loan book (including Mr Goodridge's loan) to LE clearly gave effect to a valid novation;
- the benefit of a contractual obligation may be incapable of assignment where it is so closely linked to the identity of the person to whom it is owed that the court should imply an intention that the benefit cannot be assigned. The character of the relationship of margin lender and borrower, and the nature of the obligations of the parties, was not such as to put the rights under the margin loan agreement in the category of personal rights, which are incapable of assignment;
- even if the rights had been of a personal nature, the terms of the margin loan agreement made it abundantly clear that they were capable of assignment;
- there was no difficulty in MBL continuing to be bound to make advances and with LE having the benefit, as a result of the assignment, of the right to receive repayment of those advances;
- accordingly, even if there had been no valid novation, the terms of the documents under which MBL sold its margin loan book to LE, the terms of the sale to LE gave effect to a valid assignment of all of MBL's rights, including the rights to make determinations as to the quantum of margin calls and to make them. The sale documents may have been complex, but they were effective and workable; and
- in the absence of some conduct on the part of LE or MBL that could be characterised as taking improper advantage of Mr Goodridge (which there was not), there is nothing unconscionable in a margin lender enforcing its rights to protect itself against a fall in the value of its security.
The judgment has a number of implications for margin lenders and borrowers:
- the benefits of clarity of drafting, particularly in standard form documents with systemic risk issues, cannot be overstated. The effectiveness of the margin call provisions was upheld. However, many of the difficulties in the case could have been avoided by greater clarity in the drafting. Justice Jacobsen, in the principal judgment of the court, emphasised that a number of his important findings were arrived at ultimately on a construction of the language of the particular provisions, and on a 'semantic and syntactical analysis', rather than 'business commonsense' approach (although the commercial purpose and object of the transaction were clearly important);
- similarly, the case highlights the importance for lenders of ensuring that their operational procedures are closely aligned to their documents. A telephone conversation followed up by an email in friendly and informal terms may have benefits in terms of customer relationship management. However, if what was intended was to make a formal margin call, it may have risk management implications if not clearly stated;
- the court recognised that a margin lender is not a 'co-speculator' with a margin borrower. The nature of the relationship was not that of banker and customer, but of lender and borrower under a 'special form' of revolving credit facility under which both lender and borrower had substantial exposure to movements in market prices for securities. It was legitimate for the lender to seek to protect itself against a fall in the value of securities purchased by the borrower, and the normal rule requiring a lender to give a borrower a reasonable time to satisfy 'on demand' obligations did not apply;
- the decision will give significant comfort to lenders that, provided they comply with the terms of their margin lending documents, and do not act in a way which seeks to take improper advantage of a borrower, it will be difficult for margin borrowers to challenge forced sales of margined securities on the grounds that they were precipitate, that the market might have rallied or that they were somehow unfair; and
- lenders should consider carefully the notice provisions of their standard form documents. Both court hearings involved detailed consideration of the evidence of what notices Mr Goodridge had received and how they had been given. Lenders should consider the relative merits of provisions enabling notices to be given by email or other electronic means, which were shown by the case to be much easier to prove than service by post or other manual means.
The judgment will be welcomed by securitisers, syndicated lenders and other buyers and sellers of financial assets. In particular:
- the assignment and novation questions arose out of the complex structure of the transaction under which MBL sold its margin loan book to LE. MBL had previously securitised a significant portion of its margin loans, and both the securitised and non-securitised loans were sold to LE using securitisation techniques considered orthodox in the Australian market. The efficacy of these arrangements was cast into doubt by the first instance decision, but has been comprehensively endorsed by the Full Court;
- securitisers can now be confident that structures using generally accepted assignment techniques with respect to the assignment and funding of future advances will be upheld by the Australian courts;
- similarly, the decision affirms the effectiveness of the widely accepted technique of selling down or transferring participations in syndicated loan agreements through a substitution certificate or other technique that does not involve the participation of the borrower. If anything, the decision is progressive in its findings on novation, citing with apparent approval the English Court of Appeal's recent criticisms in the Habibsons Bank case of an uncommercial and purist approach to novation; and
- other loan book and financial asset sales, whether by way of equitable or legal assignment, will benefit similarly from the restoration of certainty in this area.
Allens Arthur Robinson acted for MBL on the sale of its margin loan book to LE, and on the first instance case and the appeal. We did not advise MBL on the drafting of its margin loan documentation. LE was separately advised on the first instance case and the appeal.
- Goodridge v Macquarie Bank Limited  FCA 67.
- Leveraged Equities Limited v Goodridge  FCAFC 3.
- Diccon LoxtonConsultant,
Ph: +61 2 9230 4791
- Matthew McLennanPartner,
Ph: +61 2 9230 4732
- Guy FosterPartner,
Ph: +61 2 9230 4798
- John GallimoreConsultant,
Ph: +61 7 3334 3135
- Tim LesterPartner, Sector Leader, Japan,
Ph: +61 8 9488 3841
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