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Derivatives

The Enforceability Of Electronic Signatures

When confirmations are exchanged electronically, whether by facsimile, e-mail, or a secure Web site, a threshold question is whether electronic transmission of the confirmation affects the extent to which the confirmation may be relied upon to evidence the existence and terms of the underlying transaction.

Electronic Signatures Under E-Sign.

When confirmations are exchanged electronically, whether by facsimile, e-mail, or a secure Web site, a threshold question is whether electronic transmission of the confirmation affects the extent to which the confirmation may be relied upon to evidence the existence and terms of the underlying transaction. That question is answered in part by the Electronic Signatures in Global and National Commerce Act (E-Sign) of 2000. Under E-Sign, signatures, contracts, and records relating to any transaction affecting interstate or foreign commerce do not lose their legal effect solely due to their electronic format. However, E-Sign also provides that if any law or regulation requires a written confirmation, the legal effect, validity, or enforceability may be denied if the contract or record is in a form that cannot be retained and accurately reproduced for later reference by all parties entitled to retain it.  

Electronic Signatures Under State Law & UETA

State standards pertaining to electronic records govern so long as they are consistent with E-Sign and do not accord a higher legal status to the use of any particular technology for storing or authenticating electronic records over the use of any other technology. Nor does E-Sign preempt state law to the extent the state law adopts the Uniform Electronic Transactions Act (UETA). UETA's purpose and provisions are similar to those of E-Sign. Both seek to preserve the legal effect of electronic signatures and records by bringing such data within the scope of otherwise applicable law. UETA has been enacted in many states, including New Jersey and Connecticut.

Electronic Signatures Under New York Law

New York State has not adopted or introduced UETA. The enforceability of electronic confirmations under New York law is governed by two statutes: the Electronic Signatures and Records Act (ESRA), for intra-state transactions, and the New York General Obligations Law (N.Y.G.O.L.). ESRA is largely consistent with E-Sign and therefore is likely to be applicable to interstate transactions, including derivatives transactions, governed by New York law. The definition of an electronic signature under ESRA is the same as under E-Sign.

The N.Y.G.O.L. does not require a "qualified financial contract" to be evidenced by a signed writing in order for it to be valid and enforceable. However, N.Y.G.O.L. § 5-701(b)(1)(a) requires that there be "sufficient evidence to indicate that a contract has been made." Under N.Y.G.O.L. § 5-701(b)(3), there is "sufficient evidence" of the making of a contract if, among other things:

a) there is evidence of electronic communication (including,

without limitation, the recording of a telephone call or the

tangible written text produced by computer retrieval),

admissible in evidence under the laws of New York,

sufficient to indicate that in such communication a contract

was made between the parties;

b) a confirmation in writing sufficient to indicate that 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 (or such other period of time as

the parties may agree in writing) and the sender does not

receive, on or before the third business day after such

receipt (or such other period of time as the parties may

agree in writing), a written objection to a material term of

the confirmation... ; or

c) there is a note, memorandum or other writing sufficient to

indicate that a contract has been made, signed by the party

against whom enforcement is sought or by its authorized

agent or broker.

Section 5-701(b)(3) provides that such evidence of the making of a contract "is not insufficient because it omits or incorrectly states one or more material terms agreed upon, so long as such evidence provides a reasonable basis for concluding that a contract was made." Moreover, N.Y.G.O.L. § 5-701(b)(4) makes clear that "any symbol executed or adopted by a party with the present intention to authenticate a writing shall constitute a signing."

International Law

U.S. domiciled companies engaging in derivatives transactions with counterparties in foreign jurisdictions also need to consider the impact of international laws relating to the use of electronic records and signatures. Among these is the E.U. Directive on a Community Framework for Electronic Signatures (E.U. Directive), which is intended to facilitate the use of electronic signatures.

The E.U. Directive distinguishes between the legal significance of electronic signatures and advanced electronic signatures, based on the level of security attached to the signature. Under the E.U. Directive, an electronic signature is "data in electronic form which [is] attached to or logically associated with other electronic data and which [serves] as a method of authentication." In contrast, an advanced electronic signature is an electronic signature that: is uniquely linked to the signatory; identifies the signatory; is created by means that the signatory can maintain under his or her sole control; and is linked to the data to which it relates in such a manner that any subsequent change of the data is detectable.

As in the U.S., courts in E.U. member states cannot deny the legal effectiveness or admissibility of an electronic signature based solely on its electronic form or the fact that it was not created through use of what is referred to as a "secure signature-creation device." They can, however, deny effectiveness or admissibility on other grounds, such as that the electronic signature does not meet the traditional requirements of a signature. Advanced electronic signatures, however, automatically are presumed to meet the legal requirements of a signature.

What Types Of Signatures Can Bind The Counterparty?

Intent As An Important Determinant Of Effectiveness

Intent is an important determinant of whether a signature is effective. Intent, however, can be problematic for confirmations of derivatives trades, which are created and exchanged within short time frames, typically by non-lawyers.

Under general contract law, the requisite intent for valid manual signatures is inferred merely from the fact that the person to whom they are attributed has made them. When using an electronic format, one must consider whether that signature can be attributed to the correct person ­ that is, someone who is authorized to create a binding agreement between the parties.

Defining Electronic Signature

E-Sign defines an electronic signature as an electronic sound, symbol or process attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record.

Under New York Law, Complete Signature Not Necessary For Authentication

New York courts have held that markings other than manual signatures can be effective as signatures. A signature can be any symbol executed or adopted by a party with the present intention to authenticate the writing. For example, a typed subscription and the letterhead of the party on the confirmation or a name typed at the end of an e-mail message could indicate the requisite intent to be bound.

Similarly, comments to UETA suggest that leaving one's voice on an answering machine, pressing a particular number on a telephone Keypad, clicking a Web site button labeled "I Accept," or entering a PIN or an encrypted digital signature, may be sufficient to constitute agreement if the required intention is present. This is underscored by the inclusion of the concept of authentication in the definition of the term "signed" in Section 1-201(39) of the New York Uniform Commercial Code (UCC).

Attribution To Authorized Signatory

A frequent question is what would happen in an ongoing derivatives trading relationship if, after a password was provided to authorized persons of a counterparty for access to a secure Web site, one of the authorized persons left his or her computer unattended while the Web site was open, enabling an unauthorized person to make unauthorized changes to a confirmation, electronically sign the confirmation, and send it to the other party?

Under both E-Sign and UETA, the counterparty might be bound to the changed terms even though such terms were not actually agreed to by an authorized person. E-Sign does not include criteria for attributing the source of a signature. Under UETA, an electronic signature will be attributed to a person if it resulted from his or her action, including the actions of his or her human or electronic agent (e.g., the person's computer, programmed to perform certain tasks on his or her behalf). Thus, in the example of the unattended computer, the counterparty might have difficulty proving that the electronic signature on the confirmation was not that of an authorized person. In a paper format, handwriting samples would make it easier to disclaim the allegedly authorized signature on the basis that the recipient's reliance on the handwritten signature was not reasonable.

Security & Technological Issues

The core question for transactions conducted electronically is whether they are trustworthy. Laws such as E-Sign and the UETA have buoyed the confidence of commercial parties that these transactions will be enforced, but when transactions are highly structured and embedded with several carefully matched commercial positions, the concern is whether the electronic document will accurately reflect the agreed-upon terms. Precautions may be taken in the form of physical or technological security measures to minimize the operational risks that arise in an electronic context.

This weeks Learning Curve was written by Claude Szyfer, a litigation partner, and Sherri Venokur, a special counsel in the Commodities and Derivatives Practice Group, both at Stroock & Stroock & Lavan and Jamila Roos, formerly an associate with Stroock & Stroock & Lavan.

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