Mr Justice David Steel :
Introduction
- The first claimant ("MCA") is a sugar broker. The claim arises from trades carried out for the first defendant ("FCO"). Their relationship was governed by the terms of a Customer Agreement. This was dated 1 February 2005. The Customer Agreement was originally with a company called Cane International Corp Ltd ("CIC"). However, it is now common ground that the agreement governs the relationship between MCA and FCO. By a guarantee of the same date the second defendant ("Fluxo Comercio") guaranteed the liabilities of CIC. CIC merged with FCO on 21 December 2006. Both FCO and Fluxo Comercio are owned and controlled by a Mr Manoel Garcia.
- Under these arrangements FCO traded sugar futures and options on the Intercontinental Exchange ("ICE") in New York and on the London International Financial Futures and Options Exchange ("LIFFE") in London. By late 2007 the board of ICE had become concerned as to FCO' exposure because FCO had adopted a substantial short position in regard to the March '08 No. 11 Sugar Contract on ICE.
- By 10 January 2008 FCO's position was such that it was considered by ICE to be short to the extent 80,000 lots and was thus in excess of its permitted limits. There was an issue between the parties as to whether this position was a hedge in relation to FCO's physical obligations to purchase sugar and to what extent it included a purely speculative element. In any event, it was clear that FCO was very exposed in the event of increases in the price of sugar.
- On 14 January 2008 ICE issued a directive to its clearing members to collect an additional 20% margin on FCO's positions. On 16 January ICE instructed its clearing members to reduce FCO's short futures equivalent position on the March '08 No. 11 Sugar Contract. This written instruction was coupled by an announcement on the trading floor that all orders for futures and options in the March '08 No. 11 Sugar Contract for FCO's account would only be accepted from clearing members of ICE.
- In relation to MCA this translated into an instruction to reduce FCO's position with it (held through a clearing member called MF Global) to no more than 8000 futures equivalent contracts by 23 January 2008 such to be accomplished by some reduction each day until the specified levels were achieved.
- The same day ICE wrote to FCO following a special meeting of the board of directors of ICE. In that letter ICE informed FCO that with immediate effect any order for the account of FCO in the March Sugar No. 11 Futures Contract and any options on such contract should only be placed through a clearing member. It was explained that the basis of the decision was that FCO had exceeded its permitted futures equivalent position for all months, had refused to bring its position back into compliance and in fact had increased its short futures equivalent position. The letter also explained that it had given the appropriate instructions to every firm carrying a position for FCO (which of course would have included MCA). The letter also recorded the fact that ICE had decided to take action as a matter of urgency without offering a hearing but indicated that a hearing would be furnished if requested.
- On receipt of the letter from ICE and against the background of the announcement on the trading floor Mr Garcia arranged for a meeting with all the brokers acting for FCO on 17 January in New York. From his perspective the purpose of the meeting was to try and agree a coordinated response without which it was feared by Mr Garcia that there might be a large increase in the price of sugar which would exacerbate FCO's position.
- Mr Garcia flew from Sao Paolo to New York on the following morning and met with the brokers at about 1pm. The brokers were unable to agree on a coordinated reduction of FCO's short position and the meeting was adjourned after the end of trading to allow Mr Garcia to speak to his bankers for the purpose of arranging payment of margin already incurred and to be incurred in the future.
- In the early hours of 18 January MCA began to liquidate FCO's open short positions. This process continued until 14 April 2008. It was MCA's case that the loss occasioned to FCO's account as a consequence including commission and interest amounted to $22,056,154.62. It is this sum which they claim in the action as a debt against both FCO and against Fluxo Comercio under the guarantee.
- The primary issues in the case are first whether the liquidation of FCO's position was justified under the terms of the Customer Agreement and second, if justified, whether it was conducted in a proper fashion. FCO claim that the liquidation was both premature and mismanaged thereby giving rise to losses which form the subject of the counter claim. There is a secondary issue relating to the assignment of part of the debt to the second claimant ("MSI") against whom FCO have a claim in the United States in relation to an unconnected physical sale of sugar. The assigned debt is relied upon as a defence to that claim. Both the legitimacy and effectiveness of that assignment are in dispute.
Witnesses
- MCA called two witnesses:
a) Mr James Jenkins. He was the Managing Director of MCA and other companies in the ED&F Man group of companies ("the MAN group"). He was responsible for the decision to liquidate FCO's position and had overall responsibility for the manner in which it was conducted.
b) Mr Andres Galindo. He was a senior derivatives trader with the MAN group in New York. He undertook the bulk of the trades in regard to the liquidation of FCO's position.
- FCO called one witness, Mr Manoel Garcia, President of FCO and associated companies. He had been in touch with ICE as regards an alleged over-extended short position. He later came to New York to a series of meetings with MCA and his other brokers in the run up to the liquidation.
- MCA's witnesses gave their evidence robustly, clearly and confidently. I felt able to rely on their evidence. Mr Garcia had the difficulty that his English was more expressive than grammatical. But making full allowance for that, his evidence was often evasive and unimpressive in regard to controversial matters. Fortunately there was a wealth of contemporary documentary material (including transcripts of the brokers' meetings and various telephone calls between Mr Garcia and his brokers). This rendered the resolution of any conflicts of fact relatively straightforward.
- As regards expert evidence:
a) MCA called Mr Desmond Fitzgerald.
b) FCO called Peter Nicolescu.
Both witnesses were well qualified in the field of risk management. There was much common ground. Indeed this increased during the trial. But on the crucial issues of controversy, I felt strongly that the evidence of Dr. Fitzgerald was to be preferred for the reasons set out later in this judgment.
Chronology
- In greater detail the sequence of events was broadly as follows. On 1 February 2005 MCA entered into the Customer Agreement with CIC. The relevant terms of business for present purposes are as follows:-
"1 Our particulars
We are regulated by the Financial Services Authority ("FSA") and are therefore an authorised person under the Financial Services and Markets Act 2000.
Our registered office in the UK is Cottons, Centre, Hay's Lane, London SE1 2QE. Our telephone number is 020 7089 8000.
3 Classification
For the purposes of FSA's rules, we will treat you as a market counterparty.
7.6 Best Execution
We do not owe you a duty of best execution under FSA's rules or otherwise in any circumstances.
14.1 Deposits, margins and Payments
You will pay us on demand:
14.1 In relation to all Customer Contracts (other than one for the purchase by you of an non margined option, the premium for which is payable in full immediately on purchase) such sums of money by way of deposit or initial margin or margin or maintenance as we require and will supplement that payment from time to time on demand;
14.4 Failure to provide margin.
If you fail to provide margin when required to do so we (or any applicable exchange, clearing house or counterparty) may close out your positions and exercise the rights described in Clause 17. We will additionally have the right to close out your positions in any other circumstances provided in this Agreement.
16. Default.
16.1 You are warned that, if at any time:
16.1.1 you have not provided any deposit, margin or other payment due in respect of any Customer Contract by the close of business on the Business Day next following the demand, or you have failed to comply with a request made by us; or ...
16.1.11 you are in breach of any representation or warranty made to, or any covenant entered into with us ...
16.1.12 you are in breach of any of the provisions of this Agreement; or
16.1.13 you are declared a defaulter for the purposes of the default rules of any exchange or clearing house.
16.1.14 we reasonably consider it necessary or desirable for our own protection,
Then we may without prejudicing any other rights we might have, take any one or more of the steps [set] out in Clauses 17 to 19.
17 Consequences of default
If any of the events of default specified in Clause 16 above (except for the event of default specified in Clause 16.11.6) occurs we shall be entitled at our discretion and with or without prior notice to you to do any of the following:
17.1 to close out all or any unperformed Customer Contracts notwithstanding that any date fixed for performance of all or any of you [sic] Contracts to be closed out may not have arrived; or ...
24.8 Assignment
24.8.1 Right to Assign
(i) Assignment by us. We may assign this Agreement to any person or associate without your consent, provided that we give you at least seven business days prior written notice.
25 Notices.
25.1 Form
Any notices, instructions, demands, confirmations, contract notes or requests ("Notices") may be given orally unless required in writing by this Agreement, references to writing include electronic mail.
25.2 Method of transmission
Any notice in writing may be given as follows:
(c) by sending by telex, facsimile transmission or any other instantaneous electronic transmission and it will be deemed delivered upon transmission. Proof that it was transmitted to the correct number or destination and the proper answerback was received (in the case of telex) will be sufficient proof of delivery (d) by sending by electronic mail and it will be deemed delivered 12 hours after transmission. Proof that it was sent to the correct electronic mail address will be sufficient proof of delivery.
25.3 Conclusivity
Any contract note, confirmation, account or other statement which we give in writing will, in the absence of manifest error, be deemed correct, conclusive and binding on you if not objected to in writing within five Business Days of despatch by us.
Schedule 1 Interpretation
In these Terms of Business:
(f) "Business Day" shall mean any day which is not a Saturday or Sunday, Christmas day, Good Friday or a Bank Holiday in the United Kingdom."
- On the same day MCA and Fluxo Comercio entered into the guarantee agreement as principal and guarantor respectively.
- By 2 October 2006 MCA had furnished a credit facility to CIC in the sum of US$10 million. On 11 December 2006 lawyers acting for CIC and the two defendants sent an email to MCA stating that CIC planned to merge with FCO to create FCO. The email stated in terms that on the merger the separate corporate existence of CIC would cease and that FCO would become the owner of all rights and property of the merged companies and become subject to all liabilities and penalties. The effective date of this merger was 22 December 2006. Full details of the merger were given by FCO to MCA on 5 April 2007.
- By the second half of 2007 FCO was beginning to establish a substantial short position on the market. This led to ICE writing a letter to FCO on 13 November 2007 expressing concern about the sensitivity of FCO's position to price changes. ICE requested that FCO's net position on all months combined be kept to a maximum of 65,000 futures equivalents and the net position in any single sugar contract month to a maximum of 60,000 futures equivalents. "These limits are based on your bona fide hedging needs that you have presented and documented to the Exchange to date". The Exchange specifically requested FCO not to sell any additional options.
- This prompted a response from lawyers acting for FCO expressing concern about the limits that were being imposed. FCO insisted that its position was materially below its limit. The letter continued:-
"Continuing restriction on Fluxo's option trading is anomalous. Fluxo is a customer in good standing with six exchange clearing member firms, has never missed a margin call, is a long established and successful exporter of sugar, is one of the best capitalised like sugar companies now trading on the exchange and is operating far below the sugar futures contract equivalents hedge limits that the exchange has granted it."
- An earlier letter from ICE to FCO dated 19 November which is not available in the documentation and to which the letter of 20 November is also a reply clearly contained an additional expression of concern about the credit lines available to FCO and as to whether they were revocable or unsecured.
- FCO's lawyers wrote to ICE again on 30 December 2007 giving further information as to FCO's ability to meet margin calls. On 10 January 2008 ICE e-mailed Mr Garcia. In that e-mail Ms Gallant the Managing Director of Market Surveillance stated:
"My calculations show that your futures equivalent position increased yesterday by about 5000 contracts so that your position was in excess of 80,000 lots entering today's trading. My review indicates that increase was primarily the result of additional selling of futures although deltas did have some impact as well. It is hard to understand how you are trying to reduce your position when you continue to sell thousands of lots of futures. As the price of the market contract is down today we expect to see a substantial decrease in your short futures position".
- The same e-mail requested reports on the total position in March'08 futures to which Mr Garcia replied later that same day. The information thus provided as to the activity on 10 January prompted a further e-mail from ICE on 11 January as follows:
"As of receipt of this email, the Exchange is directing you to stop selling the March'08 Sugar 11 futures contract and to cease any other trading strategies that would result in an increase in your Mar '08 short position. You are further directed to immediately cancel all sell orders involving the Mar'08 futures contract as an outright or a spread or any other orders that would increase your short Mar'08 position. These instructions result from your continued violation of your single month position limit and the significant increase in your Mar '08 short position yesterday. Further, data received in this office indicates that you have now exceeded your 65,000 lot all months position limit as well. Please take immediate steps to correct this situation.
In addition, we are currently considering other steps the Exchange may take to ensure that you bring your positions in compliance with your position limits. You have now been in violation of your position limit for 10 business days."
- Later the same day ICE instructed Mr Garcia as follows:
"Your March '08 position had been in violation of the single month position limit established for Fluxo-Cane Overseas Ltd. for 10 consecutive days entering today's trading. If your trading activity today did not bring the position in compliance with the position limit, the Exchange will invoke the authority provided by ICE Futures U.S. Rule 6.13 on Monday, January 14, 2008 and instruct firms carrying your positions to reduce such positions by the close of trading on Tuesday, January 15."
- On 13 January Mr Garcia asserted that FCO were "working hard in compliance with the single month limit position".[1] On 14 January Mr Garcia reported on activity in regard to the March 11 futures contract during the course of the 11 January but this was met by a notice from the Vice President of Market Regulation at ICE instructing MF Global the clearing member acting for MCA to collect an additional 20% margin on all the positions.
- This prompted a response from Mr Garcia to the effect that such an increase in margin would give rise to liability of no less that US$80 million given its exposure amongst some ten clearing houses. A call for additional margin was said to be "a sentence of death". ICE came back later that day stating that on the exchanges calculation the margin requirement across all firms was $68 million as of close of business on the 11 January and that accordingly a 20% increase would require an additional deposit not of $80 million but of $14 million and querying whether the figure was a reference to the total margin.
- It appears that the reaction from FCO was to instruct its lawyers to contact ICE on its behalf so as to inform ICE that i) FCO would reduce its position in March 2008 contracts as from 16 January and continue to do so over the next 4 business days until they were at or below the level set by the exchange and ii) that FCO would agree to instruct their clearing firms that if it did not itself reduce a certain number of contract positions each day then the clearing firms were authorised to so themselves.
- On 15 January there was a special meeting of the board of directors of ICE for the purpose of discussing FCO's position. By this time MF Global had informed MCA of ICE's request for a supermargin made on 14 January. This was in fact the first that MCA became aware of any difficulty with the exchange regarding FCO's position.
- Later that same day FCO informed ICE by e-mail that recalculation suggested any additional margin would be in the sum of US$17 million which was "a great deal of cash to be asked to provide on just one day notice". The e-mail went on: "We have a concern now the Exchange's communications with the clearing firms are prejudicing Fluxo Cane's credit lines which makes it more difficult to finance our position. As you know from our earlier correspondence some of our credit lines are revocable. So we ask that the Exchange act reasonably and prudently to achieve its self regulatory objective without unnecessarily imperilling Fluxo Cane's financial abilities."
- Following the board meeting ICE sent Mr Garcia a letter which must be quoted in full:-
"I am writing to advise you that a special meeting of the Board of Directors of ICE Futures U.S., Inc ("the Exchange") was held on January 15,2008, at which the following actions were taken pursuant to Exchange Rule 21.29:
(1) the Board of Directors determined that there is a substantial question as to whether a "Financial Emergency", as such term is defined in Chapter 21 of the Exchange Rules, exists with respect to Fluxo-Cane Overseas, Ltd. and you; and
(2) the Board of Directors determined that all orders for the account of Fluxo-Cane Overseas Ltd. and its affiliates (including you) ("Fluxo") in the Sugar No. 11 Futures Contract and any options on such contract may only be placed or executed by through a clearing member and not by or through any other person.
The decision of the Board of Directors with respect to the placement of order, as specified above, becomes effective on Wednesday, January 16, 2008 upon the posting of a Release to Members of the Exchange's website, and will remain in effect until further notice. The decision of the Board of Directors was based upon the facts, including but not limited to, that: Fluxo has significantly exceeded the position accountability levels established for it by the Exchange with respect to the futures equivalent position permitted to be held by Fluxo in the March 07 Sugar No 11 delivery month and in all delivery months of the Sugar No 11 contract, combined; Fluxo has refused to brings its positions into compliance with the levels established by the Exchange, notwithstanding repeated requests to do so by the Exchange; and Fluxo has increased its short futures equivalent position when instructed to reduce such position in the March 08 delivery month.
Due to the gravity of the situation, it was not practicable for the Exchange to afford you a hearing before taking action. Accordingly, you and Fluxo may request a hearing before the Board regarding the actions described above. Any such request should be made in writing to the undersigned within five business days of the date hereof, and should specify when you would be available for such a hearing and whether you will appear in person or through counsel or other representative.
On a separate but related matter, in addition to the actions described above, please be further advised that, pursuant to Rule 6.13, the Exchange has instructed each firm carrying positions for Fluxo in the Sugar No. 11 Futures Contract and/or options thereon to:
(a) reduce Fluxo's short futures equivalent position in the March 08 Sugar No. 11 delivery month to not more than a specified level, based on the proportion of Fluxo's position carried by such firm, such that by the close of business on January 23, 2008 Fluxo is in compliance with the position limits established for it by the Exchange with respect to the March 08 delivery month and to not increase the futures equivalent position carried in all Sugar no. 11 delivery months combined, beyond its current level.
(b) not to accept any orders, electronic or otherwise, that would result in an increase of Fluxo's short futures equivalent position in the March 08 Sugar No. 11 delivery month or its short futures equivalent position in all delivery months combined; and
(c) not approve the transfer of any Sugar No. 11 futures or options contracts carried for Fluxo to an account at another clearing member, without first notifying the Exchange of the intended transfer.
You may obtain further details directly from your clearing members regarding the position reductions that have been requested of each such firm, or contact Susan Gallant at the Exchange at 212-748-4030.
Please be aware that the foregoing action is not intended in any way to preclude the clearing members from further reducing positions or taking any other action which they may deem necessary or proper in light of the relevant circumstances."
- On the same day ICE wrote to MF Global confirming the fact that FCO's position in the March'08 Contracts was significantly in excess of its limit and indeed that it was also in excess of the limit for all months combined. In those circumstances ICE instructed MF Global to reduce FCO's short futures equivalent position as held at MCA in the March '08 contract to no more than 8000 futures equivalents by no later than the close of trading on 23 January and also not to increase FCO's short futures equivalents position for all months combined. Furthermore MF Global were also instructed not to accept any orders that would increase FCO's short futures equivalent position. Indeed at 11.20 New York time on 16 January ICE made an announcement over the public speaker in its trading pit that FCO's trading rights were being curtailed.
- Later that day at about 17.30 New York time there was a telephone consultation between Mr Garcia and representatives of some of the clearing brokers acting for FCO including MCA. In the course of the conversation which lasted about 20 minutes Mr Garcia's Brazilian lawyer proposed a meeting early the following morning in New York so as to achieve if possible "a very organised plan to comply with the liquidation requirements of the Exchange and the least damage way for everyone of course". The content of this telephone conversation was recorded and a transcript is available.
- The likely difficulty in achieving any agreement is reflected in the exchange between two brokers during the course of the discussions:
"JB: ….this is Jeff. I have a question for you, or something I would like you to consider. Since there is multiple clearing houses involved, perhaps it would be in the best interests of everyone involved that if a decision is made to buy or minimise the positions that all the trading be done through one house. Whoever that house is that we can decide. Instead of having 5, 6, or 7 people er, er, chasing the market at the same time, It might be in all of our best interests to have one entity buying.
…..
JK: Sorry, this is James at Fortis. At this stage I am not clear whether the responsibility and the instructions to close out are to come from Fluxo or are to come from the clearers? Think that each clearer, if it is the responsibility of the clearer, should be looking out for his own, er, for himself rather than it being in the hand of a third party. That's my initial observation. And am not clear at this stage, but I haven't seen the letter, er, whether, er, you know I assume that Fluxo if you like they have price destiny in their hands they just know what the timetable is rather than us deciding what the timetable is. "
- Although unknown to MCA at the time, there was at this stage a separate telephone call between a broker at Fortis and Mr Garcia. Various points emerge from that phone conversation:-
i) that Mr Garcia regarded himself as being 26,000 or 27,000 lots too short.
ii) that from the point of view of paying margin calls the critical level was 12 cents.
iii) given the likely impact of purchases on the market it was best as Mr Garcia saw it to be at "the front of the queue" in liquidating the FCO position.
iv) that payment of margin by FCO would have to await "looking at the numbers".
- At 20.17 New York time, MCA sent out a trade confirmation showing a total margin default of $7,525,179.39. It was part of MCA's case that this was in fact a margin call. During the course of the night at 05.23 New York time an e-mail was dispatched by MCA to FCO recording a "margin call" of US$9,468,847.79 which reflected the additional 20% margin requirements. The e-mail ended "please remit funds to cover this amount confirming a payment amount and value date by return".
- The brokers meeting with Mr Garcia duly took place on 17 January. Again there is a transcript of the discussion. It started at about 11am New York time and Mr Garcia joined it at about 1300. The overall meeting lasted about 3 ½ hours with Mr Garcia present for about 2 hours. The question of how to reduce the FCO short position was discussed at some length as well as whether FCO was in a position to and would meet margin calls. During the course of the discussions one of the brokers spoke to the President of ICE about the situation.
- In due course a dispute arose on the pleadings as to whether an agreement was reached at this meeting to the effect that FCO's short position would be reduced in a coordinated manner with one clearing house carrying out all the necessary transactions on the exchange including the use of spreads. This issue was the subject of a summary judgment application by the claimants. In due course it was held by the Court of Appeal that no such agreement or indeed any agreement had been reached and accordingly this issue has fallen away: see [2009] EWCA Civ 406.
- During the course of the meeting Mr Garcia accepted that FCO had been out of its limit for some 11 days and further that he had given a commitment to start buying between 26,000 and 28,000 lots at a rate of about 6,000 a day. (Mr Garcia accepted in evidence that it was a deliberate ploy not to tell MCA (and presumably the other brokers) about the situation for fear that resultant activity by the brokers would move the market against him.) As regards the issue of margin Mr Garcia recognised that there was a significant sum owed but no payment would be made until the attitude of the other brokers became clear and in particular whether they were minded to cooperate.
- In fact before Mr Garcia joined the meeting a representative of MCA had spoken to a member of FCO's back office in Brazil to be told that no margin would be paid until the meeting in New York had been concluded. By 13:00 New York time MCA had started to hedge FCO's position and other brokers in fact began to liquidate the position held by FCO. At 01:30 on 18 January MCA decided to reverse out of the hedge position that had been taken on 17 but at 02:24 MCA started to reduce FCO's position in line with the ICE directive. This was followed at 05:37 by a demand from MCA for a margin payment of $29,783,602.29.
- At 08:35 on 18 January the brokers met again. Mr Garcia eventually joined them at about 09:13 and in a brief intervention expressed dissatisfaction with the brokers' decision to liquidate. His English was somewhat confused but his meaning was clear:-
"My financial situation deteriorated each minute, because also information was coming from the Exchange or people linked with the Exchange showed everywhere including my Counsel that I was prepared with millions contracts to put the market down. And they, heroes, protect the market. All my lines in Brazil was blocked yesterday, and my effort now will be rebuilding my relation and will be not possible by phone during early morning of this day like I did yesterday and the day before yesterday and I don't think we have too much to talk about coordination, everyone made their own decision. Someone also sold hedge linked with long time strategy. I don't know if it is the proper time to tell, but without strategy many of my position was sold with huge loss. Then coordination, it is funny to talk about. Your only concern is if I will have money to pay this crazy system to liquidate or not, and I need to tell you that I need to go to my Counsel and with my face in front of the Bank try to rebuild the relation in order to have condition to support this crazy loss that was provoked since the beginning by some strange and unusual system to liquidate from the Exchange and your decision and your desire to accelerate the problem by buying my position back without criteria and asking every second. I provoke you more hundred million dollars, can I receive today? Then I have no more things to do; I only need to tell you that you made a good and excellent service providing me nearby bankruptcy. Thank you all of you and I never imagined that serious people like you was capable to meet me and in the same time talking about coordination at the same time making authorization to buy back or to sell call likes crazy thousands and thousands and thousands in a relatively small market (or moment?). And it is very easy to understand that because the volatility of yesterday made the market between 12 to 13 today the market went down because there was no more guys to buy back under 12 in few minutes and came back upside then the next liquidator starts one more time to execute crazy order. That's it, I have no more consideration to tell."
- Mr Garcia then abruptly left the room. What he had said was precisely the opposite of what the brokers had expected or at least hoped for. In effect they had been abandoned to cope as best they could. Thus in the light of this intervention MCA decided to start a full scale liquidation of FCO's position with them at 09:30 New York time. This decision was reflected in a letter of that day to Mr Garcia which reads as follows:
"We refer to our messages this week demanding margin payments in respect of your accounts with us. Due to your failure to make the required margin payments we have exercised, are now exercising, and shall continue to exercise our right to liquidate all of your accounts with us. All resulting loss, cost and expense incurred by us shall be solely your responsibility."
- In response FCO sent an email to all ten brokers including MCA noting that all had commenced a forced liquidation of the sugar futures position and requesting a daily report as regards the time, quantity and price of each contract purchased sold or transferred. The liquidation was sufficiently effective that by the close of business ICE announced on its website that the restrictions imposed on FCO on the 16 January had been lifted albeit any orders still had to be placed through clearing members of the exchange. The weekend then intervened with a bank holiday on Monday 21. The same day FCO requested a hearing before the board of ICE as had been offered in the ICE letter of 16 January. The request was withdrawn the following day. FCO sought to resign from ICE on 30 January, a resignation which ICE refused to accept.
- On 4 February MCA made a demand under the Customer Agreement for the sum of $41,961,982.07. A similar demand was made under the guarantee. In due course on 20th March 2008 proceedings were commenced by MCA. The liquidation of FCO's position was not in fact completed until 14 April 2008 whereby on MCA's case the loss crystallised in the sum of $22,056,154.62.
Default
- The first issue which needs to be dealt with is the contractual legitimacy or otherwise of the closing out of the FCO book by MCA. The focus here is on the period between 02:24 and 12:48 NY time on 18 January 2008. The balance of the book was closed out between 22 January and 14 April but no separate issue arises in regard to MCA's entitlement during this period.
- These trades had been preceded by hedging operations effected by MCA for its own account as from 13:00 on 17 January. This hedge was liquidated at 01:30 on 18 January. Although FCO sought to derive some marginal assistance in defending MCA's claim by reference to this hedging activity, no claim (or counterclaim) is based upon it and there is no need to pursue the matter further.
- It is accordingly appropriate to start with the trades from 02:24 to 06:58 and the question whether MCA was entitled to take steps to reduce FCO's short position during that period. There can be little doubt that the expressed justification for liquidating FCO's position was the failure to pay margin. This in turn raises two issues:
i) Was FCO in default in respect of margin payments?
ii) Can MCA rely ex post facto on other provisions in the Customer Agreement as justifying the liquidation?
- The margin provisions in the Customer Agreement required payment of margin on demand failing which MCA was entitled to close out the position: Clause 14. This was supplemented by the default provisions in Clause 16 whereby in the absence of the provision of margin by "close of business on the Business Day next following the demand" MCA was entitled to close out the position.
- MCA relies upon two e-mails as constituting a qualifying demand. The first timed 01:17 London time on 17 January and the second timed 10:37 London time on 18 January.
- As regards the first e-mail, this contained a detailed statement of the trades as at the close of business on 16 January. The last page was a short consolidated financial statement which included an item "TOTAL MARGIN EXCESS/DEFAULT" which showed a debit of $7,525,179.
- This was a standard form of daily statement and, in my judgment does not constitute a demand for the purposes of the Customer Agreement. In any event given the obligation to pay at the close of business the next day as discussed below the issue is redundant. I reject the submission that where a demand is made in the early hours out of business hours the next business day is that which is about start.
- In accord with usual practice it was followed up by an e-mail the subject of which was expressly "margin call" for the close of business on 16 January. It noted "a margin call today" of $9,468,847[2] and concluded "please remit funds to cover this amount". This is manifestly a contractual demand. It is not, as suggested by MCA, simply a reminder.
- It is fair to say that there is no reason to think that this email was not delivered (and read) almost instantaneously. However, the Customer Agreement makes special provision with regard to the delivery of electronic mail. By virtue of Clause 25.2, such is "deemed delivered 12 hours after transmission". Thus the demand was delivered at 22:23 London time on 17 January.
- When was the margin thus demanded to be paid? There is some discordance between Clauses 14 and 16 on the topic. But I conclude that on its proper construction the Customer Agreement makes clear that payment was due "by the close of business on the Business Day[3] next following the demand." It follows that FCO had until the close of business in London on 18 January to pay the margin demanded on 17 January. The mere fact that previous margin calls were usually paid on the same day as the call is irrelevant.
- It was MCA's case that FCO had forgone any entitlement to the prescribed contractual period for payment by virtue of having made it plain at the meeting on 17 January that it was unable to meet the call which had been made. But this is not a fair reflection of what Mr Garcia had said at the meeting. To the contrary he was maintaining the stance that FCO was in a position to meet the margin call albeit he would need to speak to "the banks" before giving an ongoing commitment. The outcome was the arrangement for a further meeting the following day to discuss the topic.
- FCO sought to take a further point with regard to the legitimacy of the margin call (or at least as regards the need for an extended period for arranging payment). It was submitted that it was defective in two respects:
i) It failed to give credit for options held by FCO.
ii) It added an additional margin greater than the 20% required by ICE.
- These points can be disregarded:
i) They were not pleaded.
ii) No objection was taken by FCO to the margin call on either basis.
But in any event having accepted FCO's primary case on the period allowed for the payment of margin, the point is academic.
- Despite a premature reliance on the failure to pay margin, is MCA entitled to justify the liquidation on the basis of Clause 16.1.14 of the Customer Agreement to the effect that closing out FCO's position was permitted if MCA were to "reasonably consider it necessary or desirable for our own protection"?
- The first point taken by FCO is that, on the basis that MCA did not rely on (or even have in mind) Clause 16.1.14 in embarking on the liquidation, it cannot now rely on the clause. This, it was said, was further exemplified by the threshold to Clause 17 to the effect that the entitlement to liquidate in such event was "at [MCA's] discretion".
- I am unable to accept this submission. The discretion relates to the various options available to MCA in the event of default. There is no question that MCA exercised its purported discretion to liquidate FCO's position under Clause 17.1. This could be effected with or without notice. The issue is whether MCA was entitled to exercise that discretion. The justification advanced by MCA was non-payment of margin. No such default had occurred. But there is nothing to inhibit reliance on any other event of default.
- The context of MCA's decision is very striking:
i) On 16 January, ICE had ordered each clearing member to reduce FCO's position[4].
ii) MF Global's obligation in this regard was in turn MCA's obligation.
iii) Compliance with ICE directives was of itself reasonably necessary or desirable from MCA's perspective.
iv) Yet by the end of 17 January no reduction had been made.
v) MCA learned from the letter of 16 January forwarded to them that:
a) FCO had significantly exceeded its permitted limits.
b) FCO had refused to rectify the position despite ICE demands.
c) FCO had on the contrary increased its short position.
vi) In the meantime it had emerged that FCO had no less than 9 other brokers all required to reduce FCO's position (albeit on an unknown scale).
vii) By the time of the meeting on 17 January (and indeed during the meeting) it was apparent that some brokers were already embarking on the process of closing the excess positions.
viii) Mr Garcia was somewhat coy during the meeting as regards his willingness to pay margin calls, a feature enhanced by the indication from the back office of FCO that any margin payment would have to await the outcome of 17 January meeting.
- Mr Jenkins dealt with the position in the course of his evidence. He described the ICE instruction as "unprecedented". The basis upon which ICE had issued the instruction was not challenged or even commented on by FCO. The mark to market accounting of the FCO position had a deficit as at 17 January of $13 million and a value at risk of $19 million. Indeed the margin due to MCA at the close of business on 17 January was calculated at $27 million.
- Against that background, I accept that MCA considered that liquidation of FCO's position was highly desirable if not necessary and had reasonable grounds for so concluding.
- In this regard a further point is taken by FCO. If and so far as it can be accepted that MCA was seeking to obey ICE's instructions to commence liquidation of FCO's position, that instruction was the direction of a reduction in the March 08 futures equivalent position. Yet the trades in the early hours of 18 January were May trades. I reject this complaint:
i) The instruction was also directed at not increasing the short futures equivalent for all months.
ii) The strategy of MCA was to purchase May futures, the market being more liquid than for March, and then switch back into March.
- But be that as it may, any argument as to the legitimacy of the process of liquidation as from 02:24 on 18 January is entirely redundant. The period up to 8:00am on 18 January was a very good time to trade. The market was declining and, in consequence, a better result was achieved for FCO than if liquidation had commenced after say 9:30. Accordingly, if and to the extent that a liquidation could only legitimately be begun any the later hour, no loss has been sustained.
- What then changed by 9:30? The meeting on 18 January was joined by Mr Garcia at about 9:13. His intervention was brief and to the point. Having read the transcript in conjunction with the recording there can be no doubt in my judgment that he was making it quite plain that he could not or certainly would not meet the margin requirements.
- Mr Garcia had left the meeting on 17 January with the indication that he was going to speak to his bankers to see how he was placed in regard to the payment of margin. In fact on leaving the meeting and on learning that some brokers had already commence liquidating FCO's position he decided not to contact his bankers at all.
- He told the meeting on 18 January:
i) The market price had increased as a result of purchases made by his brokers.
ii) The market was fully aware of his short position.
iii) His financial position had accordingly deteriorated.
iv) His finance lines in Brazil had been blocked.
v) The absence of any coordinated response by brokers had made him nearly bankrupt.
With that he left the room.
- I have already set out the context of the liquidation earlier that morning which I will not repeat. But now (i.e. 9:30), as MCA put it, the "game was up":
i) The extent of FCO's exposure was increasingly apparent.
ii) The Exchange had been complaining for some considerable time that FCO was in excess of its limits yet nothing had been disclosed FCO to MCA about the situation (whether disputed or not).
iii) Now it was being made apparent that whether already due or not the margin calls would not be met.
- It is difficult to imagine a situation in which it could be more obvious that it was in MCA's interests to liquidate the position so as to limit its own exposure. FCO had evinced the clearest possible intention not to comply with the contractual terms against a background of taking a speculative position so large as to create a "Financial Emergency" from the perspective of ICE. There can be no doubt in my judgment that MCA was entitled to rely on Clause 16.1.14 as from the end of the meeting and the closing out of positions thereafter was legitimate.
Conduct of liquidation
- I turn now to the question whether such part of the liquidation was conducted in a proper and contractually compliant manner. It is worth noting at the outset that FCO's complaint about the manner in which the trades were performed has undergone a number of formulations:
i) The initial complaints were set out in some detail in Appendix 1 to the Defence and Counterclaim. This identified a very large number of trades said to demonstrate mismanagement of the closing as from 18 January through to 25 February. All these complaints were in due course abandoned.
ii) At the commencement of the trial FCO appeared to be relying on their expert's statement to the effect that MCA should have deferred any liquidation until after 18 January at which stage the market would have stabilised.
iii) This position in turn did not survive cross-examination. Mr Nicolescu's position became one of making a complaint simply about the scale of trading on 18 January.[5] In his view whilst closing out 20% of the position would have been acceptable some 36% was not.
- These changes of tack somewhat undermine the credibility of FCO's critique. But before turning to the question of whether the final formulation of the complaint was justified I must deal with a preparatory issue as to the terms on which MCA were required to conduct the liquidation.
- The point here is whether the relevant provisions[6] of the Customer Agreement to the effect that MCA did not owe a duty of best execution was overridden by obligations imposed by the FSA. This in turn leads to the threshold question of whether FCO was an "Eligible Counterparty" within the meaning of Annex 1 to the FSA New Conduct of Business Sourcebook ("COBS"). COBS makes provision for a best execution obligation which would override Clause 7.6. But such might not be the case if FCO was an "eligible counterparty".
- The background is as follows. On 27 October 2007 MCA wrote to FCO setting out some amendments to the terms of business and stating that: "As a result of MIFID [the Market in Financial Instruments Directive] as from 1 November 2007 we will categorise you as an eligible counterparty." The letter pointed out that FCO could request a different categorisation. It invited FCO to countersign a copy of the letter and ended: "If we do not received back that copy signed by on or after 1 November and you continue to accept services from us, you will be deemed to have agreed to the new terms".
- In fact the categorisation constituted no change from FCO's status under the previous regulations. As explained by MCA on 12 November the categorisation had simply been "grandfathered" into the new scheme. MCA pointed out that the most significant change would be the absence of any best execution policy.
- There was no further exchange between the parties. In the circumstances I accept MCA's submission that, given the continued use by FCO of MCA's services, the terms of business are to be treated as those notified in the letter of 26 October and thus FCO cannot pray in aid the best execution requirement in para. 11.2 of COBS.
- This conclusion is not as significant as might appear. Annex 1 does exclude COBS 11.2 from application to eligible counterparty business. But COBS 11.2 merely imposes an obligation to execute orders on terms most favourable to the client. But the closing out operation was not the result of executing orders from FCO: indeed to the contrary in that MCA had (as with the other brokers) been abandoned by FCO and left to cope as best it could with the outstanding position (and the existing margin).
- COBS 2.1.1 provides: "A firm must act honestly, fairly and professionally in accordance with the client's best interest" but COBS 2 is also excluded from counterparty business. Even if applicable, it is not suggested as such that MCA acted other then honestly, fairly and professionally. As regards the best interests of the client, this is a difficult concept in circumstances where the client is refusing to pay margin and expecting MCA to close out as best it can. MCA was in effect trading on its own account. Furthermore the interests of MCA were in common with FCO namely to limit the loss that might be sustained as a result of the liquidation. Thus I reject the suggestion if it be made that MCA were obliged by COBS 2.1.1 to manage FCO's position as if still acting as FCO's broker but at its own risk and without the provision of margin.
- The correct view may well be that Clause 7.6 of the Customer Agreement makes it clear that any duty of best execution is not owed in any circumstances. Whether or not the best execution provisions under COBS 1.2.1 were applicable or not, there was no bar to excluding such responsibilities when not acting for a client. Indeed COBS 1.1 provides that the rules are applicable to all firms carrying on designated investment business (which included managing investments as an agent).
- But once again those considerations are, in my judgment, largely redundant. Here it was suggested by FCO's expert Mr Nicolescu as his evidence was finally formulated that extent of trading on 18 January was unreasonable. On this topic he accepted that trades up to 20% of the portfolio were acceptable but 36% was unacceptable.
- I fear I never understood what criteria were being applied in assessing this position. I do not regard it as made out:
i) There had already been a significant delay in complying with ICE's instructions.
ii) The weekend and a U.S. national holiday was about to intervene.
iii) All the dealings were executed at the best price available on the market from time to time.
iv) All (or almost all) of the other 9 brokers retained by FCO were liquidating their position in whole or in large part (indeed there are a range of other proceedings both in this jurisdiction and in the U.S. in which the same complaint is made by FCO of premature and/or excessive trading).
v) The motivation for all brokers (including MCA) was to reduce risk and reduce the book.
- The outcome was precisely as anticipated by Mr Garcia in complaining to the New York court that ICE's very public insistence on a reduction in the overall risk would lead to large scale liquidation by his brokers. Mr Nicolescu sought to suggest that MCA was acting contrary to the proper stance to be expected from a reasonably competent broker. But they were acting in the context of a range of similar activities being undertaken by other (reasonable) brokers. In the result MCA dramatically reduced the Value At Risk on the FCO account by the end of the 18th January. I am quite unable to conclude that MCA overstepped the mark by liquidating 36% of FCO's position on 18 January.
Quantum
- The last point is the question of the quantum of MCA's loss. This is put forward at a figure of US$22,056,154.62. This figure is derived from spreadsheets provided to FCO in June 2008 under cover of a letter from MCA's solicitors giving particulars of the trades conducted to close out FCO's position. The spreadsheets give a summary or overview of the trades which had earlier been included in the daily trade summaries provided by MCA to FCO from 18 January to 16 April.
- The claim thus calculated and presented was "not admitted" by FCO. There matters largely rested until November 2009[7] when FCO made a wide ranging application for further discovery. This application included two items of particular note:
i) Documents relating to the operation of MCA's "error account" for 18 January.
ii) All trading tickets relating to the liquidation of FCO's position.
- I refused the application:
i) The request was unacceptably late, some 5 months after standard disclosure and very close to the trial.
ii) As regards the error account, documents relating to trades which had been in the error account (as a result of administrative confusion or lack of information) but subsequently allocated to FCO had been disclosed and there was no allegation of mis-allocation of trades made on behalf of another customer.
iii) As regards the trading tickets, full details of the trades made to close FCO's account had been produced in the spreadsheets in May 2008: there had been considerable correspondence relating to the same: concerns about apparent discrepancies between MCA and ICE had been resolved: corrections to the timing of certain trades (recorded as Chicago time as opposed to N.Y. time) hade been made: no allegation had been made that any, let alone any significant, trades were wrongly allocated or recorded: the task of isolating and producing the underlying trade tickets was wholly disproportionate.
- Despite all this, FCO sought to keep alive concerns that numerous mistakes had been made in allocating trades and that without the disclosure sought, it was impossible to be satisfied that the claim had been substantiated.
- My approach to the disclosure issue remains the same. On the material available there is no dispute as I understand it about the figures. As regards allocation, I reject the half-hearted suggestion that Mr Galindo and Mr Jenkins have deliberately or otherwise accorded to FCO's account trades that were conducted for another client or for MCA itself.
- It is of particular note that despite the despatch of daily reports to FCO as the trades were undertaken no objection was taken other than those points which were abandoned at the commencement of the trial. This in turn leads to Clause 25[8] of the Customer Agreement:
"25.3 Conclusivity
Any contract note, account or other statement which we give in writing will in the absence of manifest error, be deemed correct, conclusive and binding on you if not objected to in writing within five Business Days of despatch by us."
This precludes any new challenge on a different basis.
Guarantee
- At the commencement of the trial there was an issue as to the validity of the alleged guarantee furnished by the Second Defendant. The challenge appeared to centre on the effect of the earlier merger between CIC and Fluxo Overseas associated with the change of name to FCO.
- Whilst no formal concession was made, FCO's final oral and written submission did no more than put MCA to proof on the issue. I conclude that MCA have readily established the validity of the guarantee. The issue reflects more the willingness of FCO to take any point in its determination to try and avoid or restrict its exposure to MCA.
- In summary the position is as follows:
i) Mr Garcia was the President and sole shareholder of both CIC and Fluxo Commercio.
ii) The guarantee formed part of the consideration for the credit facility granted to CIC under the Customer Agreement.
iii) The same credit facility remained in place after the merger.
iv) MCA was informed by Fluxo's lawyers on 11 December 2006:
"Considering the e-mails received about the merge of Cane/Fluxo Overseas, I would like to clarify as follows:
It is a merge of a parent company (Fluxo Overseas) and it's subsidiary (Cane). As you will see in the plan of merge and in accordance with the BVI laws, upon the merger, the separate corporate existence of Cane shall cease and Fluxo Overseas shall: (i) become the owner, without other transfer, of all the rights and property of Cane; and (i) become subject to all liabilities, claims, debts, obligations and penalties of Cane. So, all the existing contracts of Cane will remain in full force. That's why I our opinion, there's no need, or at least no hurry, to execute new contracts. The surviving company name will be Fluxo-Cane Overseas Ltd and, of course you will receive all documents related to the merge and to the surviving company for your files."
v) It is not challenged that MCA relied on these statements and accordingly continued to supply credit to FCO.
Assignment
- FCO has a claim against MSI (an associate company of MCA) which is proceeding in the U.S. courts. That claim is for $6,013,149.93. It arises out of a contract for 25,000 mt of physical sugar dated 7 January 2008. The contract provided for payment by cash against documents.
- Loading took place at two ports, Recife and Maceio. MSI paid for the sugar loaded at the first load port but not for the larger parcel loaded at the second port. On 4 February 2008 MCA sought to assign to MSI $6,013,149.93 of the sums due to MCA "in respect of margin calls". This was followed by a second assignment of $598,802.90 on 4 April 2008.
- The relevant provision of the Customer Agreement is Clause 24.8 which reads as follows:
"Assignment
24.8.1 Right to assign
(i) Assignment by us
We may assign this Agreement to any person or associate without your consent, provided that we give you at least seven business days prior notice.
(ii) Assignment by you
Your rights under this agreement are personal to you and not capable of assignment
24.8.2 Successors and assigns
The obligations under this Agreement bind, and the rights will be enforceable by you and us and our respective successors, permitted assigns and personal representatives."
- Accordingly two points arise:
i) Is a partial assignment or an assignment of rights permitted?
ii) If so, what is the effect of the absence of notice?
- As regards the first question, FCO submits as follows:
i) Clause 24.8.2 provides for the enforceability of rights by permitted assigns: it follows that where not permitted, assignments are prohibited.
ii) Clause 24.8.1(1) concerns the agreement as a whole.
iii) Rights under the agreement as opposed to the agreement itself are accordingly not assignable as in the case of Clause 24.8.1(ii).
iv) In the result, MCA can seek to assign the agreement to another company in the group (or an outside group) the notice period permitting FCO to engage a different broker if so advised.
- In contrast MCA submit as follows:
i) The starting point should be a chose in action is assignable unless prohibited.
ii) Clause 24.8.1(1) permits FCO a reasonable opportunity to make alternative arrangements if MCA wishes to transfer the broking arrangements.
iii) It follows that the clause is solely directed to the entire agreement.
iv) There is accordingly no prohibition against assigning accrued debts under it (and indeed there would be no commercial purpose to such a prohibition).
- Before taking matters further it is desirable to consider the authorities although obviously each case turns on the specific terms of the relevant clause permitting or prohibiting assignments.
- As regards the authorities, the leading case is Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85. A lessee had entered into a contract with a contractor to remove the asbestos from premises. It was on the JCT standard form. Clause 17 provided: "1. The employer shall not without the written consent of the contractor assign his contract. 2. The contractor shall not without the written consent of the employer assign the contract and shall not without the written account of the architect … sublet any portion of the works."
- In due course the lessee assigned its leasehold interest to the claimants and thereafter issued proceedings for breach of contract. The lessee then assigned its rights of action as pleaded to the claimant. The contractor was not asked to and did not consent to the assignment. It was held that on its true construction Clause 17(1) prohibited the assignment (absent consent) of the benefit of the contract and of any chose of action arising thereunder.
- The Court of Appeal had held that Clause 17 only prohibited the assignment of the right to future performance but not the assignment of benefits under the contract such as accrued causes of action. This was reversed in the House of Lords. Lord Browne Wilkinson gave the leading speech and stated at p.105 as follows:
"The question is to what extent does clause 17 on its true construction restrict rights of assignment which would otherwise exist? In the context of a complicated building contract, I find it impossible to construe clause 17 as prohibiting only the assignment of rights to future performance, leaving each party free to assign the fruits of the contract. The reason for including the contractual prohibition viewed from the contractor's point of view must be that the contractor wishes to ensure that he deals, and deals only, with the particular employer with whom he has chosen to enter into a contract. Building contracts are pregnant with disputes: some employers are much more reasonable than others in dealing with such disputes. The disputes frequently arise in the context of the contractor suing for the price and being met by a claim for abatement of the price or cross-claims founded on an allegation that the performance of the contract has been defective. Say that, before the final instalment of the price has been paid, the employer has assigned the benefits under the contract to a third party, there being at the time existing rights of action for defective work. On the Court of Appeal's view, those rights of action would have vested in the assignee. Would the original employer be entitled to an abatement of the price, even though the cross-claims would be vested in the assignee? If so, would the assignee be a necessary party to any settlement or litigation of the claims for defective work, thereby requiring the contractor to deal with two parties (one not of his choice) in order to recover the price for the works from the employer? I cannot believe that the parties ever intended to permit such a confused position to arise."
- The issue before the court thus turns on the proper construction of Clause 24.8.1(1). In my judgment it does not preclude the assignment of accrued rights of action in the form of a margin claim:
i) The clause does not prohibit assignment: it indeed expressly permits assignment of the Agreement even absent consent (subject to notice).
ii) As 28.8.1(ii) makes clear a distinction is being drawn between assignment of the Agreement and assignment of rights under the Agreement.
iii) As regards MCA there is no implicit bar to assignment of accrued rights of action: it is simply implicit that no prior notice is required.
iv) The complication and confusion that could arise in a building contract are not to the point: it is not remotely perverse for MCA to be permitted to assign accrual claims to a third party.
- I conclude that the assignment was valid.
