The maxim that a “trade is a trade” is the bedrock for the hundreds of billions of dollars1 traded annually in the secondary loan market. Once the material terms of a trade are agreed to orally, a binding contract is formed. The enforceability of oral loan trades was codified in New York in 2002 when such trades, subject to certain requirements being met, became exempt from the statute of frauds.2 Thus, when traders agree to the material terms of a secondary bank loan trade on the telephone (i.e., identity and amount of bank debt and price), the parties become bound to consummate the transaction.3
Without this now basic tenet, that an oral trade is a trade, parties would be free to ignore or refute oral trades until the parties execute a corresponding written trade confirmation. The “tricky” part for traders, financial institutions, hedge funds and other market participants is the method by which one party provides “sufficient evidence” of a binding oral agreement. Without such evidence, an alleged oral agreement to a trade may be left to the court in a cumbersome “he said, she said” litigation process.
Highland v. Bank of America4
On October 2, 2012, the United States Court of Appeals for the Fifth Circuit held that Highland Capital Management, L.P. (“Highland”) made a viable breach of contract claim against Bank of America, N.A. (“BofA”) in connection with an oral trade agreement. Highland alleged that BofA orally agreed to sell to Highland $15,500,000 of Regency Hospitals, LLC bank debt (the “Regency Debt”) at a purchase rate of 93.5% (the “Purchase Rate”). According to Highland, on December 3, 2009, Highland and BofA agreed via telephone that Highland would purchase the Regency Debt from BofA at the Purchase Rate and no additional terms of trade were communicated between the parties. Later that day, Highland confirmed the trade by e-mail to BofA, stating the parties were “now done on this trade subject to agent and borrower consents.” BofA responded by e-mail to Highland the same day, stating that the transaction was “subject to appropriate consents and documentation.”
Subsequent to these e-mails, Highland alleged that BofA requested off-market terms from Highland, which were not included within the LSTA Standard Terms and Conditions for Par/Near Par Trade Confirmations (the “LSTA Standard Terms”), including agreement to (a) indemnify BofA against any failure by the borrower or agent to consent to the transaction, (b) pay all of BofA’s legal fees associated with the transaction, and (c) waive all legal claims against BofA. Highland contended that such requests were not customary. In order for the parties to be bound by a variation from LSTA Standard Terms, Highland argued that such alterations needed to be addressed at the time of the parties’ phone call, when the material terms of the oral trade were agreed. However, BofA refused to close the trade, arguing that its e-mail stating that the transaction was “subject to appropriate consents and documentation” precluded the formation of a binding oral contract. The Regency Debt was ultimately paid off at par. Had the alleged trade closed, Highland would have profited from such par payout.
The United States District Court dismissed Highland’s breach of contract claim, ruling that although the LSTA Standard Terms allow for trades to be agreed upon orally, because the parties indicated in subsequent e-mails that the trade was “subject to” further consents and documentation, no binding contract was created. Thus, Highland failed to plead facts sufficient to establish a breach of contract claim under New York law.5
The United States Court of Appeals for the Fifth Circuit reversed the District Court, holding that the lower court’s interpretation of the “subject to” language in the parties’ e-mails ignored other facts which, when accepted as true (as required in the context of a motion to dismiss) preserved Highland’s claim. Specifically, the Fifth Circuit focused on Highland’s assertion that the consents and documentation referenced in BofA’s e-mail were constrained by the LSTA Standard Terms, and any deviation from such terms needed to be reserved at the time of trade.6 As to “documentation,” the Fifth Circuit noted that, although bank debt trades typically include execution of a written trade confirmation, it is not required following an oral agreement on material terms.7 In reaching its conclusion, the Court noted that BofA “may argue that the parties never agreed on all the material terms, but that is an issue of fact, and it should not be a basis for dismissing the claim.” The Fifth Circuit went on to say that the “subject to” e-mails following the oral agreement did not “unambiguously” disavow the parties’ intention to be bound. The Court concluded that, “without further evidence regarding the parties’ interactions and industry custom and practice, it is not possible to definitively determine whether the parties intended to be bound by their oral agreement.” Thus, the Fifth Circuit found that Highland had stated a viable claim for breach of an oral contract.
“Sufficient Evidence” Under NY Statute of Frauds Exemption
Given the Courts’ struggle with determining the parties’ intent as to the material terms of the trade, loan market participants must consider best practices to avoid disputes. As noted above, parties are able to enforce oral agreements for loan trades, provided sufficient evidence exists. Thus, the issue becomes whether evidence is “sufficient” under New York law.8
New York General Obligations Law (“NY GOL”) § 5-701(b) (which exempts loan trades from the statute of frauds) provides that “sufficient evidence” exists if:
a. there is evidence of electronic communication (including, without limitation, recorded telephone calls9 or e-mails) sufficient to indicate that in such communication a contract was made between the parties (§ 5-701(b)(3)(a));
b. a written confirmation sufficient to indicate a contract has been made between the parties and sufficient against the sender is received by the party against whom enforcement is sought no later than the fifth business day after such contract is made (i.e., trade date), and the sender does not receive, on or before the third business day after such receipt, written objection to a material term of the confirmation10 (§ 5-701(b)(3)(b)); or
c. there is other writing sufficient to indicate that a contract has been made, signed by the party against whom enforcement is sought or its agent (§ 5-701(b)(3)(d)).
Additionally, the statute provides that an electronic communication or written confirmation may constitute “sufficient evidence” even if it omits or incorrectly states one or more agreed material terms, as long as such evidence provides a reasonable basis for concluding that a contract was made.
One lesson for market participants from the Fifth Circuit’s decision is that an e-mail confirmation of an oral trade stating that it is “subject to” further conditions may create ambiguity as to whether the parties intended to enter into a binding oral contract. If secondary loan market participants endeavor to deviate from LSTA Standard Terms, such deviation should be stated specifically, clearly and unambiguously at the time of trade. The more specific one is with a counterparty with respect to deviations from LSTA Standard Terms, the better position one will be in later to prove whether certain conditions were required to be met in connection with having an enforceable, binding agreement. For example, to the extent BofA was aware that it would require certain terms not included within the LSTA Standard Terms, best practices would have been to state clearly and specifically such terms orally at the time of trade.
To the extent a party has agreed to a “vanilla” oral loan trade and wants confirmation, a simple and unambiguous e-mail to its counterparty which (A) specifies that the trade shall settle pursuant to LSTA Standard Terms (or “distressed” LSTA standard terms, as the case may be), and (B) memorializes the material terms, including (i) trade date, (ii) counterparty name, (iii) identity and amount of debt being purchased or sold and (iv) purchase rate, should constitute “sufficient evidence.” To the extent the “safe harbor” provision set forth in NY GOL § 5-701(b)(3)(b) is utilized, the e-mail message (or, alternatively, delivery of an LSTA standard trade confirmation without any “other terms of trade” inserted) would be delivered to a counterparty against whom enforcement is (or could be) sought within five business days of the trade date. If a written objection from a counterparty is not received within three business days of receipt of such e-mail (or receipt of such LSTA trade confirmation), a very strong case exists that you have a binding contractual agreement.
Another practice employed by many loan market participants is to have recorded phone lines, which can be admissible evidence supporting a party’s contention that the material terms of a trade were (or were not) agreed. Traders should be aware that counterparties often record phone lines and exercise appropriate caution when entering into an oral trade agreement to ensure clear expressions of intent. Also, to be better positioned to prove oral trade terms, loan market participants should standardize procedures for creating sufficient evidence of such terms.11 Electronic communications, Bloomberg messages and traders’ notes are all sources of evidence supporting contract formation. Loan market participants should create and regularly monitor systems to record and preserve such evidence.
As a final takeaway, parties should recognize that, although orally agreed LSTA loan trades are binding under New York law, without good systems and practices in place to evidence a binding contractual agreement, parties leave themselves open to unnecessary risk and uncertainty. To alleviate such risk, use of clear and specific language that sets forth the material terms of the trade, coupled with the safe harbor provisions under NY GOL § 5-701(b)(3)(b), will greatly assist parties when a dispute arises.
1. Trading volumes equaled approximately $98 billion in the second quarter of 2012, based upon the Loan Syndications and Trading Association Inc.’s (the “LSTA”) market settlement data published on July 25, 2012.
2. See N.Y. Gen. Oblig. Law § 5-701(b) (McKinney 2012).
3. Unlike bonds, bank loans do not settle in a T+3 environment and delays in settlement may arise for various reasons including obtaining agent or borrower consents, agency freezes due to pending amendments under the credit agreement, etc. The median settlement time for par bank loans (generally performing loans) in the second quarter of 2012 was T+12 (trade date plus 12 business days) and for distressed bank loans (generally loans that are in default or where borrower having material difficulties) was T+34 (trade date plus 34 business days).
4. Highland Capital Management, L.P. v. Bank of America, Nat. Ass’n., No 11-11139, 2012 WL 4498518 (5th Cir. 2012).
5. Highland Capital Management, L.P. v. Bank of America, Nat. Ass’n., No. 3:10-CV-1632-L, 2011 WL 5428779 (N.D. Texas 2011). The District Court’s decision only considered whether viable claims existed under New York law. The Court noted that in determining whether a contract had been formed, the contracting parties’ intentions and reasonable expectations and industry practice may be considered in determining whether a binding contract existed.
6. As to BofA’s position that the trade was subject to “consents” the Fifth Circuit noted that although all bank debt trades typically require consent of the agent and/or borrower, if consents could not be obtained the LSTA standard terms require the parties to close the transaction as a participation in lieu of an assignment. Thus, according to Highland’s complaint, consents of the borrower and/or agent are not a condition precedent to the formation of a binding oral trade.
7. One interesting point omitted in Highland’s complaint was the fact that the “documentation” required to settle LSTA par bank debt trades generally is perfunctory in nature and only requires the execution of a form assignment and acceptance agreement which is rarely subject to negotiation and often executed by the parties on electronic platforms such as ClearPar. Typically, the only modifications to the form of assignment and acceptance agreement are the name of the assignor, the name of the assignee and the amount and identification of the debt being purchased.
8. LSTA trading documents are governed by New York law.
9. Under New York law, taped phone conversations are generally admissible evidence. See N.V. Simons’ Metaalhandel v. Hyman-Michaels Co., 7 A.D. 2d 840 (1st Dept. 1959); 57 N.Y. Jur. 2D Evidence § 190 (2012) (“[N]o statutory provisions place any restriction upon the right of one participating in a conversation by telephone to have it recorded or upon the admissibility of such recording in evidence”).
10. If a counterparty does respond within such three business day period with modifications, the issue then becomes whether the changes pertain to material or non-material terms.
11. The LSTA Standard Terms provides that “[e]ach of Buyer and Seller shall record on the trade date of each transaction between the parties and retain in its files a written or electronically recorded trade ticket or similar internal record containing or reflecting evidence of agreement to such transaction, including (a) the date of the agreement, (b) a description of the type of debt including obligor(s) and purchase amount, (c) the identity of the other party to the transaction and (d) the purchase price or purchase rate.”© 2013 Andrews Kurth LLP