A U.S. appeals court in New York has overturned a lower court decision that the industry said undermined credit-default swap contracts.
The case involved a CDS trade between Aon Financial Products and Société Générale where Aon bought USD10 million of protection on the Republic of Philippines from SG. Aon later claimed that the default of a Philippine government agency should trigger the protection payment on the sovereign. SG disputed that the agency was not a reference entity and its bonds were not deliverable under the contract. In 2005 the U.S. District Court for the Southern District of New York ruled in favor of Aon and awarded the firm USD10 million (DW, 5/19).
In May 2006 the International Swaps and Derivatives Association supplied an amicus curiae brief and the appeals court ruled in favor of SG Monday. "As a matter of law and under the unambiguous meaning of the Aon/SG CDS contract, no Credit Event occurred thereunder and SG therefore did not breach that agreement by declining to pay Aon thereunder. We therefore reverse the judgment of the district court and enter judgment in favour of SG," according to the Second Circuit Court's opinion.
"The Second Circuit opinion sets forth a clear-sighted appraisal of this case, upholding the principles of the ISDA documentation," said Robert Pickel, executive director and ceo of ISDA in New York. Legal certainty in the use of ISDA documentation is a significant factor contributing to the rapid growth of the CDS market, he said, adding the lower court ruling undermined this legal certainty by misconstruing the contractual obligations.
An official at Aon said that the firm had not yet received the decision and declined further comment. Jim Galvin, spokesman at SG, said the firm was happy with the decision.
