Credit Suisse First Boston International would be able to present a robust case if it chooses to appeal last week's ruling at the High Court in London, in which it lost a GBP1.2 million (USD1.9 million) credit derivatives case it brought against Nomura International, according to derivatives lawyers. Immediately after handing down judgment in Nomura's favor on Thursday, the Honourable Mr. Justice Langley rejected a request by CSFB's lawyer to refer the case to the appeals court. CSFB can, however, apply directly but would have to shoulder the GBP25,000 cost.
A CSFB spokeswoman said "We will of course study the decision of Mr. Justice Langley further." She declined further comment.
Nomura took CSFB to court last year because the Swiss-U.S. investment bank would not allow Nomura to deliver convertible bonds against credit default swaps (CDS) on Railtrack. CSFB argued that a so-called "widows and orphans" clause allowing trustees to convert the notes into equity meant that they were contingent liabilities, and therefore were not a legitimate deliverable obligation against a CDS contract.
CSFB might use several aspects of the judge's summary to justify bringing a hearing to the appeals court, according to lawyers.
First, the judge ruled that the contingent nature of the widows and orphans clause is immaterial because it would never be exercised against the commercial interests of the bond holder. But in situations in which the convertible bond is trading below the conversion price--and the conversion price is below the par value of the bond--it could be disadvantageous for a market marker with an overall flat position to have the bond converted to equity by the trustee. All of which means that CSFB could present a robust case that the widows and orphans clause means the Railtrack bond is contingent.
Second, the judge said credit-default swaps should not be treated as options, and therefore the vast amount of case law relating to options was not deemed relevant in this case. Lawyers said this point can be argued both ways. A default swap is an option in that it is triggered by a credit event, which is analogous to the strike on an option. But a CDS contract differs from an option in that a seller of protection can also trigger the contract, and therefore the buyer can be forced into fulfilling the contract.
Third, the judge ruled that the chances of a weekend catastrophe destroying the share price of a convertible bond was "mystical." Lawyers argued that a weekend catastrophe could expose convertible bondholders to a precipitous market fall between when the bond is exchanged from debt to equity and when the equity is sold.
James Barratt, head of the credit group at Nomura International in London, said, "We took them to court because they did not pay up on a contract that we thought they should honor."
