UK: Sugar Trader Found In Breach Of Obligation To Meet Margin Call

Last Updated: 16 September 2010
Article by Daniel Jones and Reema Shour

Sucden Financial Ltd (formerly Sucden UK Ltd) v (1) Fluxo-Cane Overseas Ltd and (2) Manoel Fernando Garcia [2010] EWHC 2133 (Comm)

Background facts

Sucden, a futures and options broker, was one of a number of brokers acting on behalf of Fluxo-Cane, a company trading in physical sugar and also sugar derivatives on New York's ICE Exchange, a futures and options market. The dispute in this case arose out of Fluxo-Cane's dealings in a standard futures contract traded on ICE , the Sugar No. 11 Contract for March 2008 delivery. The parties dealt with each other on Sucden's standard Terms of Business (TOB). It is worth noting that a number of other brokers have also sued Fluxo-Cane for liquidation amounts arising out of the same events that gave rise to this claim. In particular, Mr Justice Steel in EDF & Man Commodity Advisers Ltd v Fluxo-Cane gave judgment against Fluxo-Cane on one such claim.

In essence, Fluxo-Cane built up a substantial short position at the relevant time through its various brokers, particularly in the March 2008 No. 11 Contract, on the basis of a belief that the price of sugar would fall due to oversupply. Instead, the price of sugar rose. During January 2008, there were various discussions and some correspondence between the ICE Exchange, Fluxo-Cane and the various brokers, including Sucden, who were acting on behalf of Fluxo-Cane.

In summary, the Exchange

  1. considered Fluxo-Cane was over-exposed and asked it to limit its net position;
  2. when Fluxo-Cane failed to do so, the Exchange held the company in violation of its position limit and instructed the various brokers carrying Fluxo-Cane's positions to reduce them (in other words reduce the number of futures-equivalent contracts). This was apparently a very unusual step for the Exchange to take;
  3. made an additional super-margin call of 20 percent on Fluxo-Cane's positions (in other words a cash call), which applied to Sucden among others. Usually, Sucden would pay additional margin after a day's trading on behalf of Fluxo-Cane, send the margin call to the latter the next morning and generally Fluxo-Cane would pay on the same day as the call. In the present case, Fluxo-Cane paid its margin calls up to 16 January 2008 but not thereafter.

An initial meeting between Sucden, the other brokers involved and Mr Garcia, President and sole shareholder of Fluxo-Cane, failed to produce agreement on a co-ordinated reduction in Fluxo-Cane's positions such as to minimise, in Mr Garcia's view, the danger of a spike in prices caused by a forced liquidation of Fluxo-Cane's positions. On 17 January 2008, Sucden made a substantial margin call payment of over US$5 million and entered into some transactions in a bid to comply with the ICE directive to reduce the number of Fluxo-Cane's short positions (which many of the other brokers were also doing). Following a further meeting on 18 January, Sucden's understanding from what Mr Garcia had said was that the 17 January margin call would not be paid. Later that day, therefore, Sucden sent Fluxo-Cane a notice of default relating to its failure to meet the margin call made on 17 January and, on the same day as the notice of default, started closing out its transactions placed on behalf of Fluxo-Cane.

By the time that Fluxo-Cane was back within the limits set by ICE and the Exchange withdrew the "Notice to Liquidate Positions" and the additional margin requirement, it was too late for the brokers to stop the process of liquidating Fluxo-Cane's positions. Sucden subsequently commenced proceedings against Fluxo-Cane in the English High Court to recover the debit balance on the company's account.

Fluxo-Cane contended in its defence that (i) no valid margin calls were outstanding from the company by the time Sucden commenced its liquidation, (ii) that Sucden was not therefore entitled to commence the liquidation at the time that it did and that the liquidation was premature and (iii) that, in any event, even if it was not premature, the liquidation was conducted negligently. Fluxo-Cane counterclaimed the loss caused by the allegedly negligent liquidation.

Commercial Court decision

Was liquidation commenced prematurely?

The judge rejected the submission that Sucden began the liquidation of Fluxo-Cane's positions prematurely. He found rather that the trades that were undertaken by Sucden prior to 17 January 2008 were transacted in Sucden's own name and allocated to a Sucden account. They were only applied to Fluxo-Cane's account after the meeting between Fluxo-Cane and the brokers on 18 January and after Sucden sent the 18 January 2008 default letter. The judge added that these trades were undertaken in order to comply with the ICE directive and that as a member of the Exchange, these directions were binding on Sucden and compliance was not optional. Furthermore, the relevant ICE Rules were given effect to as a matter of contract between Sucden and Fluxo-Cane in the former's TOB. Whilst the judge accepted the expert evidence that it was irregular for a broker to buy lots on its own account on one day and allocate them to its customer's account on the next day, "the circumstances in this case were wholly exceptional, and...such irregularity did not itself cause Fluxo-Cane any loss."

Was Sucden entitled to liquidate Fluxo-Cane's positions?

The event of default which Sucden's letter of 18 January 2008 referred to was Fluxo-Cane's failure to meet the margin call made on 17 January 2008. Whilst the TOB gave Sucden the right, in case of any event of default, to liquidate Fluxo-Cane's transactions without further notice, where the event of default in question was a failure to meet a margin call then Sucden had to give Fluxo-Cane one business day's notice before treating failure to pay margin as an event of default. In starting to close out its transactions with Fluxo-Cane on the same day as the notice of default was sent, i.e. without giving one business day's notice, the judge held that Sucden had failed to comply with the applicable procedure under the agreement.

Could Sucden rely on other matters to justify the liquidation?

Whilst only non-payment of margin was given as a reason for the liquidation in the notice of default, the judge said this had to be put into the context of the extraordinary conditions in which the parties found themselves. The judge accepted witness evidence to the effect that at the relevant time, a one-off failure to pay margin was not exclusively what Sucden was thinking of and that its concern was more whether Fluxo-Cane was going to default generally on its ongoing commitments to all of its brokers, thereby triggering a mass liquidation and probably a spike in the market. As the judge said, "margin was therefore not an abstract consideration insulated from wider considerations, but was intrinsically bound up with questions of regulatory compliance and Sucden's own financial exposure". Consequently, the judge found that whilst non-payment of margin did not constitute an event of default at the time Sucden began the liquidation on 18 January 2008, there were other subsisting events of default at that time.

First, one of the events of default provided for in the TOB was where Fluxo-Cane disaffirmed, disclaimed or repudiated any obligations under the agreement. The judge was satisfied that Mr Garcia had repudiated the agreement at the meeting on 18 January, when he indicated that the margin call of 17 January would not be paid. Whilst at common law, Sucden would have been required to give notice accepting the repudiatory conduct as putting an end to the contract, the relevant provision in the TOB, according to the judge, entitled Sucden to liquidate Fluxo-Cane's positions following the repudiation without any notice being required.

Secondly, Sucden was entitled to exercise its rights to liquidate where it considered this necessary or desirable for its own protection and/or if any action was taken or event occurring which Sucden considered might have a material adverse effect on Fluxo-Cane's ability to perform its obligations under the contract. The judge accepted Sucden's evidence that it had been left exposed by open positions and it was necessary to cover that exposure in the absence of margin from Fluxo-Cane by commencing liquidation to minimise its losses.

As a result of these subsisting events of default, the judge held that Sucden was entitled to close out Fluxo-Cane's various transactions when they did, without prior notice. The fact that these events of default were not mentioned in the notice of default did not prevent Sucden from relying on them. Rather, the judge was satisfied that in taking the action that it did, Sucden had in mind both Mr Garcia's repudiatory statement and the necessity to protect itself.

Alleged negligence in conducting the liquidation

The judge dismissed Fluxo-Cane's counterclaim. There was some expert evidence relating to whether more favourable prices could have been obtained had Sucden liquidated the whole account during 22 to 25 January. However, the judge accepted that it had been reasonable for Sucden to await the outcome of a further meeting with Fluxo-Cane on 29 January to discuss the account before putting the liquidation underway in earnest. Furthermore, as one of the experts had testified, it was only with the benefit of hindsight that it could be seen that liquidation during that period would have been most advantageous. The judge concluded that the criticisms made of Sucden's conduct of the liquidation were unfounded and dismissed the counterclaim.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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