MEMORANDUM OF LAW. British Virgin Islands. 13 December 2013

Transcription

1 MEMORANDUM OF LAW Enforceability of the Liquidation, Setoff, Netting and Credit Support Provisions of Certain Futures Account Agreements and a Cleared Derivatives Addendum upon a Customer s Default or Insolvency, and Enforceability of Certain Offset Provisions Applicable Prior to a Customer s Default or Insolvency British Virgin Islands 13 December 2013 Harney Westwood & Riegels Craigmuir Chambers PO Box 71, Road Town Tortola VG1110, British Virgin Islands Tel: Fax: russell.willings@harneys.com

2 Harney Westwood & Riegels Craigmuir Chambers PO Box 71, Road Town Tortola VG1110, British Virgin Islands Tel: Fax: December 2013 Your Ref Our Ref RW/ Doc ID International Swaps and Derivatives Association, Inc. 360 Madison Avenue, 16th Floor New York, NY10017 Futures Industry Association 2001 Pennsylvania Avenue N.W. Suite 600 Washington, D.C Dear Sirs Enforceability of the Liquidation, Setoff, Netting and Credit Support Provisions of Certain Futures Account Agreements and a Cleared Derivatives Addendum upon a Customer s Default or Insolvency, and Enforceability of Certain Offset Provisions Applicable Prior to a Customer s Default or Insolvency: British Virgin Islands 1 Introduction 1.1 We have been asked to provide a legal opinion to address the enforceability of the liquidation, set-off, netting and credit support provisions of: (a) certain Covered Base Agreements (as defined in Schedule 1) entered into by an entity that is registered with the United States Commodity Futures Trading Commission (the CFTC ) as a futures commission merchant ( FCM ) and is a member of one or more CFTC-registered derivatives clearing organisations (each such FCM, a Clearing Member ) and such Clearing Member s Covered Customer (as defined in Schedule 1), setting forth the right of such Clearing Member, upon the occurrence of an event giving rise to any right of such Clearing Member to liquidate all Futures Transactions (as defined below), to liquidate such transactions and to determine amounts owing with respect thereto, to exercise remedies in respect of Futures Payment Rights (as defined in Schedule 1) and rights of netting and set-off with respect to obligations arising from Futures Transactions and to apply Futures Credit Support (as defined in Schedule 1) transferred by a Covered Customer in connection therewith; and A list of partners is available for inspection at our offices. British Virgin Islands Cayman Islands Cyprus London Hong Kong Montevideo

3 (b) an addendum for Cleared Derivatives Transactions (a CDA ), entered into by a Clearing Member and such Clearing Member s Covered Customer, setting forth the right of such Clearing Member, upon the occurrence of an event giving rise to any right of such Clearing Member to liquidate all Cleared Derivatives Transactions (as defined in Schedule 1) under a Covered Base Agreement, to liquidate such transactions and to determine amounts owing with respect thereto, to exercise remedies in respect of Cleared Derivatives Payment Rights (as defined in Schedule 1) and rights of netting and set-off with respect to obligations arising from Cleared Derivatives Transactions, to apply Cleared Derivatives Credit Support (as defined in Schedule 1) transferred by a Covered Customer in connection therewith and to offset obligations arising from Cleared Derivatives Transactions against Cleared Derivatives Credit Support transferred to the Covered Customer. 1.2 This opinion is given with respect to Futures Transactions and Cleared Derivatives Transactions of the types described in Appendix A ( Covered Transactions ) entered into under Covered Base Agreements and CDAs by Covered Customers organised in the British Virgin Islands as any of the types described in Appendix B (including British Virgin Islands branches of entities organised outside the British Virgin Islands). 1.3 This opinion is subject to the assumptions contained in Schedule 1 and Schedule This opinion is confined to matters of British Virgin Islands law and nothing herein should be construed to express or imply any opinion with regard to any other system of law. While it is a separate legal jurisdiction the British Virgin Islands follows general principles of English common law. The opinion is limited in scope to the matters expressly commented on. 1.5 This opinion is addressed to the International Swaps and Derivatives Association, Inc. ( ISDA ) and the Futures Industry Association ( FIA ) solely for the benefit of their members in relation to their use of one or more of the Agreements. No other person may rely on this opinion for any purpose without our prior written consent. This opinion may, however, be shown by ISDA or FIA or an ISDA or FIA member to their advisors, members advisors or auditors or any competent regulatory or supervisory authority for such members for the purposes of information only, on the basis that we assume no responsibility to such authority or any other person as a result or otherwise. 3

4 2 Opinions PART I Netting Under a Covered Base Agreement and CDA 1. Are the provisions of the Covered Base Agreement and CDA permitting the Clearing Member to terminate all the Covered Transactions upon the insolvency of the Covered Customer enforceable under the law of your jurisdiction? 2.1 The right to terminate a contract on the occurrence of a designated event 1 by giving notice is well established in English common law and there is little basis for an argument that the parties do not have the right to dispense with that right 2. Such provisions contained in well-known standard form documentation are known to be accepted with strict application 3. Therefore, subject to the next paragraph, provisions of the Covered Base Agreement and CDA permitting the Clearing Member to terminate all the Covered Transactions upon the insolvency of, or the commencement of Insolvency Proceedings (see Schedule 3) with respect to, the Covered Customer would be enforceable under British Virgin Islands law. 2.2 We understand that in terminating Covered Transactions, the Clearing Member may act as agent of the Covered Customer to cancel Covered Transactions or enter into reverse transactions. We note that there are concerns under English common law that an agency relationship will terminate on commencement of insolvency proceedings in respect of the principal. While English common law will be persuasive authority in the British Virgin Islands, our view is nevertheless that the British Virgin Islands courts would not interfere with the right or obligation of a Clearing Member to cancel or enter into reverse transactions in order to terminate Covered Transactions, whether or not such termination arises from Insolvency Proceedings in respect of the Covered Customer. This is based on the following. (a) (b) Where a Covered Transaction represents a net asset of the Covered Customer (ie termination of a Covered Transaction would result in an amount due to the Covered Customer) then, irrespective of any agency arrangement, the rights of the Cleared Member to liquidate that Covered Transaction in order to arrive at a net termination amount in respect of all Covered Transactions due to or from the Covered Customer under the Covered Base Agreement and CDA arise under the security provisions of the Covered Base Agreement and the CDA. Assets subject to security fall outside the estate available to a liquidator of the Covered Customer and therefore the Covered Customer no longer holds the role of principal in respect of the Cleared Member dealing with those assets. Irrespective of whether termination of a Covered Transaction would result in an amount due from the Clearing Member to the Covered Customer or not, Part XVII (Netting and Financial Contracts) of the Insolvency Act (see Schedule 5) protects contractual 1 We summarise Insolvency Proceedings in respect of British Virgin Islands entities in Schedule 3. Where the Covered Customer is a segregated portfolio company, partnership or trust, consideration should be given to extending insolvency triggers to the company, partner (or general partner in the case of a limited partnership) or trustee as applicable. 2 Were a Covered Transaction to be characterised under its governing law as a contingent debt rather than an executory contract, the payment obligation would lapse through that contingency being unsatisfied rather than through termination of the contract. 3 China National Foreign Trade Transportation Corporation v Eulogia Shipping Co SA of Panama - The Mihalis Xilas [1979] 1 WLR

5 provisions relating to netting (and the enforcement of collateral arrangements) in the insolvency of a BVI Entity. Our view is that it would be inconsistent with Part XVII for British Virgin Islands law to prevent the liquidation of Covered Transactions on termination, and that the British Virgin Islands courts would be very unlikely to interfere with the enforcement of termination and netting provisions which are valid under their governing law. Our view is that a British Virgin Islands court would treat close-out between the Clearing Member and the Covered Customer in the context of their mutual obligations under the Covered Base Agreement and the CDA (or the enforcement of collateral by the Clearing Member as a secured party) and would uphold the termination and netting provisions in accordance with Part XVII notwithstanding the fact that the Clearing Member acts as agent of the Covered Customer in cancelling Covered Transactions or entering into reverse transactions. 2. Are the provisions of the Covered Base Agreement and CDA providing for the netting of termination values and any cash collateral that is viewed as a title transfer, in determining a single lump-sum termination amount upon the insolvency of a Covered Customer enforceable under the law of your jurisdiction? 2.3 Netting and set-off in the context of mutuality between Clearing Member and Covered Customer. The analysis in this paragraph 2.3 is based on mutuality of obligations between Clearing Member and Covered Customer, subject to which, and for the reasons which follow, we believe the provisions of the Covered Base Agreement and CDA providing for bilateral netting of termination values in determining a single lump-sum termination amount upon the insolvency of a Covered Customer organised as a BVI Business Company ( BVIBC, as described in Appendix B) would be enforceable under the laws of the British Virgin Islands and if an Event of Default has occurred, either because of Insolvency Proceedings in respect of a British Virgin Islands entity or following any other default by that party, and there is an election to terminate, the netting provisions would be effective and the effect of those provisions would be that one party would be under a single obligation to pay a net amount to the other party. (a) (b) Contractual accounting. The failure to perform under a Covered Base Agreement and CDA gives rise to a claim for damages in accordance with general principles of contract law. Parties are free (with certain exceptions) to use a prearranged method of arriving at amounts payable on termination of a contract. Prior to the commencement of Insolvency Proceedings therefore netting provisions would be upheld on a contractual basis. Netting agreements. Part XVII provides that notwithstanding anything contained in the Insolvency Act, any rules promulgated under the Insolvency Act or in any rule of law relating to insolvency, the provisions relating to the netting of obligations under a netting agreement shall be enforceable against each party to that contract. Part XVII requires that netting agreements are between two parties only. In our view the transaction types listed in Appendix A would be financial contracts for the purposes of Part XVII (see Schedule 5) and therefore the Covered Base Agreement and CDA would constitute a netting agreement under Part XVII provided Covered Transactions were of the types listed in Appendix A. Section 150 of the Insolvency Act, relating to insolvency set-off, is expressly made subject to Part XVII, and so if the insolvency setoff rules under British Virgin Islands law were to produce a different result from the 5

6 netting provisions of the Covered Base Agreement and CDA, the netting provisions would prevail. (c) Insolvency set-off. If Part XVII does not apply, either because the Covered Base Agreement and CDA would not constitute a netting agreement for the purposes of Part XVII or for reasons of fraud or misrepresentation, insolvency set-off would apply to any amounts arising from dealings prior to the commencement of liquidation 4 and prior to the Clearing Member having knowledge of the insolvency of the Covered Customer. The effect of insolvency set-off is likely to have a similar effect to contractual netting provisions 5. Where Part XVII does not apply however, Covered Transactions may be subject to avoidance as a preference or undervalue transaction (see Schedule 4) (though unlikely to be relevant given the assumption at 1.1(d) of Schedule 2). 2.4 Effect of agency characterisation. Neither the Part XVII analysis nor the insolvency set-off provisions would directly uphold a right of a Clearing Member to reduce a payment due to it from a Covered Customer subject to Insolvency Proceedings by netting it with or setting off an amount due to the Covered Customer from a DCO. While our understanding of the Covered Base Agreement and CDA as set out in Schedule 1 does not suggest that such a tri-partite netting arrangement is contemplated, we understand the characterisation of the relationship between the Clearing Member and the Covered Customer may in certain jurisdictions impute an agency role to the Clearing Member implying a principal to principal relationship in respect of certain obligations between the DCO and the Covered Customer 6. The British Virgin Islands court would not impute such an agency role unless this was the case under the governing law of the Covered Base Agreement and CDA: since however it appears that local regulation may affect the characterisation of the role of the Clearing Member and there is uncertainty under New York law how this would be treated 7 we have considered the position where a Clearing Member is not liable for certain obligations to a Covered Customer where a DCO defaults but may nevertheless be liable to a DCO for obligations of a Covered Customer where the Covered Customer defaults. (a) (b) Subject to our discussion of subrogation rights in subparagraph (d) below, on a default by a Covered Customer, a Clearing Member would not be able to reduce obligations owed to it by that Covered Customer by simply netting with or setting off obligations which are owed principal to principal by the Covered Customer to the DCO. A Covered Customer may however create security in favour of the Clearing Member under the Covered Base Agreement and CDA over its right, title and interest in (i) its 4 Commencement of liquidation is not defined in the Insolvency Act, though section 175, in providing that with effect from the commencement of the liquidation the liquidator has custody and control of the assets of the company, implies that the commencement of liquidation is the appointment of a liquidator. This is distinct from onset of liquidation which is statutorily defined in relation to voidable transactions. 5 Section 150(4) of the Insolvency Act provides that a party may before the commencement of liquidation waive the benefit of set-off. The ability to contract out of set-off strengthens the argument that the effect of insolvency set-off is likely to be similar to the contractual provisions. 6 See section VII.A.1. of the opinion of Cleary Gottlieb Steen & Hamilton LLP on matters of New York law for questions of characterisation of the relationship between the Clearing Member and the Covered Customer under the governing law of the Covered Base Agreement and CDA. 7 See in particular p25 and footnote 40 of the opinion of Cleary Gottlieb Steen & Hamilton LLP on matters of New York law. 6

7 contractual rights under its Futures Transactions and Cleared Derivatives Transactions, (ii) its right to payment from DCOs in respect of those Futures Transactions and Cleared Derivatives Transactions and (iii) the proceeds of such rights. The analysis of security arrangements generally is covered in greater detail in Part III, but in broad terms assets of an insolvent Covered Customer subject to security would not be available to a liquidator for distribution to other creditors of the Covered Customer and could therefore be used to reduce or extinguish amounts due from the Covered Customer to the Clearing Member, thereby achieving a result similar to traditional setoff through the grant and perfection of a security interest in, and the exercise of remedies against collateral. (c) (d) Part XVII covers enforcement of collateral arrangements so, even though amounts payable by the DCO to the Covered Customer would not fall under the Part XVII netting agreement between the Covered Customer and the Clearing Member, a security interest granted by the Covered Customer to the Clearing Member would. The fact that the Clearing Member is directly liable to the DCO for obligations ultimately owed by the Covered Customer may give the Clearing Member subrogation rights against the Covered Customer. If for any reason the collateral analysis above were problematic these subrogation rights would allow the necessary mutuality for netting with or set-off against amounts owed by the Clearing Member to the Covered Customer, at least in respect of transactions cleared through a single DCO Segregated portfolio companies. Part XVII defines a netting agreement as an agreement between two parties, party being a person constituting one of the parties to an agreement. There has not yet been any judicial consideration of how far person should extend. Nevertheless we believe that a portfolio of a segregated portfolio company should be treated as a person for these purposes. Although the portfolio itself does not have separate legal personality, it only engages in transactions through the segregated portfolio company itself (which clearly does have separate legal personality). Although the strictures relating to the treatment of portfolio assets and portfolio liabilities would prevent recognition or enforcement of any netting of assets and liabilities outside the specific portfolio in question, we believe that Part XVII should be effective to ensure primacy be given to the netting provisions in the Covered Base Agreement and CDA in the event of any Insolvency Proceedings 9 and the conclusions in relation to BVIBCs above should therefore apply equally to segregated portfolios of SPCs. There is no requirement of British Virgin Islands law that an agreement with an SPC must include contractual terms reflecting the statutory provisions preventing the attribution of liabilities of one portfolio to the assets of a separate portfolio either prior to or after the onset of insolvency 10. However it is 8 The effect of subrogation will not be materially different from that discussed at footnote 40 of the opinion of Cleary Gottlieb Steen & Hamilton LLP on matters of New York law, except that it would allow us to rely on both Part XVII netting and insolvency set-off, both as described in paragraph Consideration should be given as to whether Insolvency Proceedings in respect of the segregated portfolio company itself as well as the specific portfolio are included as close-out triggers. 10 Because of concerns as to how a court in a jurisdiction which does not recognise segregated portfolio or protected cell companies would treat the British Virgin Islands statutory provisions, it is nevertheless not uncommon to see such provisions replicated in agreements with SPCs. This does then raise concerns as to the possible effect on the position of a counterparty relative to other creditors of the SPC were those other creditors not to include such provisions in agreements with the SPC, and this has occasionally resulted in unwieldy provisions which are deemed only to take effect where all other contracts entered into by the SPC contain similar language. Whether there is a real benefit to a counterparty in 7

8 important that the Covered Base Agreement and CDA clearly identify for the account of which segregated portfolio the SPC is entering into the Covered Base Agreement and CDA. 2.6 Partnerships. Subject to the above and for the reasons which follow and subject to our comments on mutuality on a change of partners we are of the view that the netting provisions of the Covered Base Agreement and CDA will be enforceable against partners of partnerships. (a) (b) (c) Insolvent partner. A partnership would ordinarily be dissolved on the insolvency of a partner (or in the case of a limited partnership, a general partner). The assets of the partnership would not ordinarily be available to the general creditors or a liquidator of the partner. Where the partnership itself is solvent a British Virgin Islands court would not interfere with the operation of contractual netting provisions. If the partnership were to continue as a going concern, the partner would have to be replaced and we refer to our comments in paragraph (c) below as to issues with mutuality following a change of partner. Insolvent partnership. In the absence of British Virgin Islands law relating to insolvency of partnerships, we believe the most likely result is that a British Virgin Islands court would not interfere with the operation of netting provisions and a counterparty would be able to rely on contractual expectations. Should the partnership be subject to winding-up then a counterparty ought to be able to rely on Part XVII to uphold contractual netting-provisions. Under Part XVII a netting agreement is an agreement defined as between two parties. It does not specify that the parties must be companies or individuals. Notwithstanding it has no separate legal personality, in our view a partnership will still constitute one party for the purposes of Part XVII. Mutuality and changes of partners. Partners are only liable for the partnership debts which accrued during the time when they were a partner. Given that a change in the composition of the partnership would alter both the entitlement to partnership assets and the liabilities of the partners in respect of future obligations, there have historically been concerns that a change in the partnership may destroy the necessary mutuality to allow obligations to be netted or for insolvency set-off to apply 11. These concerns may be reduced for a limited liability partnership for changes in the limited partners as they are not liable for partnership debts, but their entitlement to participate in the benefit of claims of the partnership against third parties obviously ceases when they leave the partnership. Concerns as to mutuality across a change of partners has prompted the use of automatic novation subsequent to any change in the partnership, and although automatic novation provisions have not been tested before the British Virgin Islands courts, in principle a novation of this nature should be effective to allow the obligations of the firm prior to a change in composition of the partnership to be treated as the obligations of the new partners so as to permit set-off 12. It is hoped that when further rules are promulgated under the Insolvency Act, they will expressly extend the scope of Part XVII to netting agreements entered into by partnerships, and provide that parties including such language when dealing with an SPC is therefore a matter of weighing the increased clarity of recourse against the chance of other creditors of the SPC improving their position by not contractually confirming the limits of their recourse. 11 ex parte Christie (1804) Ves Jun 105 and Re Jane (1914) 110 LT see Burgess v Morton (1894) 10 TLR 339 8

9 dealing with a partnership will be entitled to net obligations owed to the partnership with obligations owed by the partnership notwithstanding any change in the composition of the partnership. However, until such rules are brought into force 13 and this aspect of British Virgin Islands law is clarified, parties wishing to enter into agreements which include netting provisions with partnerships should prohibit changes in the partnership 14 or include market approved provisions for automatic novation. 2.7 Trusts and unit trusts. Subject to the above and for the reasons which follow and subject to our comments on mutuality on a change of trustee we are of the view that the netting provisions of the Covered Base Agreement and CDA will be enforceable against trustees of trusts. (a) (b) (c) Pre-insolvency. On the assumption that the Covered Transactions are within the powers of the trustees and permitted by the terms of the trust and are properly entered into and the Clearing Member is not aware after due enquiry of any breach by the trustees, we are of the view that the netting provisions of the Covered Base Agreement and CDA would be enforceable under British Virgin Islands law in accordance with their terms in the absence of a single trustee insolvency, the insolvency of all trustees or trust insolvency. Single trustee insolvency. For the purposes of this opinion, a trustee insolvency means the trustee s winding-up, administration, administrative receivership or bankruptcy. Where a single trustee becomes insolvent but there are other solvent trustees who are jointly or jointly and severally liable for the obligations under the Covered Base Agreement and CDA, the third party would be entitled to proceed against any of the remaining solvent trustees who would have recourse to the assets of the trust to meet that liability, or if applicable, the third party would have direct recourse to the trust assets pursuant to section 97 of the Trustee Act. Accordingly, a single trustee insolvency would not affect the enforceability of the netting provisions. Where the Covered Base Agreement and CDA is silent on whether the trustees are jointly and severally liable there is a presumption that the trustees who execute such agreement will be jointly liable for the obligations under it. However specific language is required in the Covered Base Agreement and CDA if the trustees are to be jointly and severally liable, which would improve the third party s position in the event of a single trustee becoming insolvent, because the third party s claim against a jointly liable trustee could be potentially lost whereas it would not be lost against jointly and severally liable trustees. Insolvency of all trustees. In practice the insolvency of multiple individual trustees would be a rare occurrence. Where there is a sole corporate trustee which becomes insolvent, the trust instrument would normally provide for the appointment of a new trustee. Following such substitution, the third party, by subrogation to the original trustee s right of indemnity, would be entitled to enforce its subrogated right of indemnity against the trust assets directly, regardless of the fact that the newly appointed trustee would not be liable for the previous trustee s liabilities. Such right of indemnity would of course, be limited to the extent of the original trustee s right of 13 There has been no indication from the legislature that this will take place in the foreseeable future. 14 In practice the majority of British Virgin Islands partnerships entering into derivative arrangements are limited partnerships with a single corporate general partner and there should rarely be a need to change the general partner. 9

10 indemnity and the third party will be in a better position in relation to a trust created after 1 March 2004 where the indemnity contained in section 100 of the Trustee Act will apply. Note however our concerns in paragraph (e) below as to issues with mutuality following a change of trustee. (d) (e) Trust insolvency. If the trust itself (rather than its trustees) were to become insolvent the trust will not be wound up under the British Virgin Islands insolvency legislation as it is not a separate legal entity. On a trust insolvency a creditor or other party claiming a beneficial interest under the trust may however apply to the British Virgin Islands court under Part 67 of the Civil Procedure Rules for an Order for the execution of a Trust to be carried out under the direction of the Court, referred to as an administration order (but not to be confused with an administration order under Part III of the Insolvency Act). The administration procedure is entirely discretionary and the trust s assets will be administered by the court as its discretion may direct in accordance with principles of justice and equitability. It is important to note that Part 67 of the Civil Procedure Rules contains no mandatory set-off rules, and that section 150 of the Insolvency Act dealing with insolvency set-off is only applicable in the liquidation of companies and the bankruptcy of individuals and does not apply to trusts. However, as discussed above in respect of partnerships the provisions of Part XVII of the Insolvency Act are not so limited. Mutuality and changes of trustees. For similar reasons to those given for partnerships (see paragraph 2.6(c)) we have reservations as to whether mutuality will be preserved across a change of trustee and therefore recommend that parties wishing to enter into agreements which include netting provisions with trusts should prohibit changes of trustees. 3. Assuming the parties have entered into a Covered Base Agreement and CDA, the Covered Customer is insolvent and the Clearing Member has determined a lump-sum termination amount in a currency other than the currency of the jurisdiction in which the insolvent party is organized: (1) would a court in your jurisdiction enforce a claim for the net termination amount in the currency in which it was determined? (2) can a claim for the net termination amount be proved in insolvency proceedings in your jurisdiction without conversion into the local currency? 2.8 Since the British Virgin Islands courts have power to grant a monetary judgment expressed otherwise than in the currency of the British Virgin Islands, any monetary judgment 15 in a court 15 Any final and conclusive monetary judgment for a definite sum obtained in the English High Court may be registered and enforced as a judgment of the British Virgin Islands court under the Reciprocal Enforcement of Judgments Act (Cap 65) (the REJA ) provided that (i) application for registration of the judgment is made within twelve months of its date (or such longer period as the British Virgin Islands court may allow), (ii) the relevant party is not appealing and does not have the right and intention to appeal and (iii) the British Virgin Islands court considers it just and convenient that the judgment be so enforced. Judgments of the English County Courts and the New York courts (and the courts of most other jurisdictions) may not be registered under the REJA. However, a judgment obtained in the English County Courts or the New York courts may be treated as a cause of action in itself and sued upon as a debt at common law so no retrial of the issues would be necessary. In this case an appeal is irrelevant unless a stay of execution has been granted. An English High Court judgment may also be enforced in this way, but the applicant may be penalised on costs. Whether registering a judgment under the REJA or suing upon a judgment as a debt at common law, it will be necessary that (i) the relevant court had jurisdiction in the matter and the parties either submitted to such jurisdiction or was resident or carrying on business 10

11 of the British Virgin Islands in respect of a claim for the net termination amount is likely to be expressed in the currency in which such net amount is determined, assuming that is the currency in which such claim is made. 2.9 Any claim in the liquidation of a BVIBC 16 based on a liability incurred or payable in a currency other than US dollars must be converted into US dollars. PART II Netting for Multibranch Parties 1. Would there be any change in your conclusions concerning the enforceability of netting under the Covered Base Agreement and CDA based upon the fact that the local bank has entered into a Covered Base Agreement and CDA on a multibranch basis and then entered into Covered Transactions under that Covered Base Agreement and CDA through the bank in your jurisdiction and also through one or more branches located in other countries prior to its insolvency? 2.10 There would be no change to our conclusions if a bank organised in the British Virgin Islands entered into a Covered Base Agreement and CDA on a multibranch basis. In a liquidation of a British Virgin Islands company, the liquidator would have regard to assets of the company wherever located and both local and foreign creditors may claim against the company. The British Virgin Islands company and its branches in other jurisdictions would be looked at as a single legal entity. 2. Would there be a separate proceeding in your jurisdiction with respect to the assets and liabilities of the Local Branch at the start of the insolvency proceeding for Bank F in Country H? Or would the relevant authorities in your jurisdiction defer to the proceedings in Country H so that the assets and liabilities of the Local Branch would be handled as part of the proceeding for Bank F in Country H? Could local creditors of the Local Branch initiate a separate proceeding in your jurisdiction even if the relevant authorities in your jurisdiction did not do so? 2.11 The British Virgin Islands courts may, on the application of the company, a creditor, a shareholder, the supervisor of a creditors arrangement in respect of the company, the Financial Services Commission or the Attorney General, appoint a liquidator of a company incorporated outside the British Virgin Islands if the court is satisfied that the company has a connection with the British Virgin Islands. A company incorporated outside the British Virgin Islands has a connection with the British Virgin Islands only if: (a) (b) it has or appears to have assets in the British Virgin Islands; it is carrying on, or has carried on, business in the British Virgin Islands; or within such jurisdiction and was duly served with process, (ii) the judgment was not in respect of penalties, fines, taxes or similar fiscal or revenue obligations, (iii) in obtaining judgment there was no fraud on the part of the person in whose favour judgment was given or on the part of the court, (iv) recognition or enforcement in the British Virgin Islands would not be contrary to public policy and (v) the proceedings pursuant to which judgment was obtained were not contrary to the principles of natural justice. 16 Since there are no statutory insolvency proceedings for partnerships or trusts, there is no equivalent provision for claims in their liquidation. However to the extent the partner or trustee were a BVIBC which was being liquidated, claims would have to be converted into US dollars. 11

12 (c) there is a reasonable prospect that the appointment of a liquidator in the British Virgin Islands will benefit the creditors of the company Even if such a connection is established, the British Virgin Islands court retains a discretion whether or not to appoint a liquidator An application for the appointment of a liquidator of a company incorporated outside the British Virgin Islands may be made: (a) (b) notwithstanding that the company has been dissolved or has otherwise ceased to exist under or by virtue of the laws of any other country; and whether or not the company is or has been registered as a foreign company under Part XI of the BVI Business Companies Act The provisions for voluntary liquidation referred to in paragraph 1.4(a) of Schedule 3 are not applicable to companies incorporated outside the British Virgin Islands, so the only mechanism in the British Virgin Islands for liquidation of Bank F is by a court appointed liquidator as described above It is therefore possible that the British Virgin Islands courts would institute (for example on the application of local creditors of the Local Branch) separate insolvency proceedings in the British Virgin Islands with respect to the assets and liabilities of the Local Branch at the start of the insolvency proceeding for Bank F in Country H. However the British Virgin Islands court would generally defer to proceedings in Country H so that the assets and liabilities of the Local Branch would be handled as part of the proceeding for Bank F in Country H. 3. If there would be a separate proceeding in your jurisdiction with respect to the assets and liabilities of the Local Branch, would the receiver or liquidator in your jurisdiction and the courts of your jurisdiction, on the facts above, include Bank F s position under a Covered Base Agreement and CDA, in whole or in part, among the assets of the Local Branch and, if so, would the receiver or liquidator and the courts of your jurisdiction recognize the netting provisions of the Covered Base Agreement and CDA in accordance with their terms? 2.16 In a liquidation commenced in the British Virgin Islands in respect of the Local Branch of Bank F, the liquidator will have jurisdiction to collect all assets of the company and will permit any British Virgin Islands or foreign creditor to prove for its claim in the British Virgin Islands liquidation, whether or not that creditor had dealt with the Local Branch. In relation to the conduct of the British Virgin Islands proceedings, British Virgin Islands insolvency law would be applied in the winding up of Bank F, and this is true regardless of whether or not these proceedings are conducted as ancillary to the proceedings in Country H Where insolvency proceedings are also proceeding in Country H, the British Virgin Islands liquidation would ordinarily be considered ancillary to the principal proceedings being conducted in Country H. The British Virgin Islands courts will seek the most appropriate means of ensuring substantial equality between creditors of an insolvent entity in different countries and where there are proceedings in Country H, the British Virgin Islands court will generally view Country H as the most appropriate forum and will therefore limit the British Virgin Islands liquidator s role to remitting the assets of Bank F collected by the British Virgin 12

13 Islands liquidator to the Country H liquidator so that the claims of all the creditors of Bank F may, as far as possible, be dealt with in a single set of proceedings. A liquidator in Country H may request the assistance of the British Virgin Islands court (see Schedule 6) The conduct of an ancillary liquidation will always be subject to the direction of the court. There are no rigid rules distinguishing ancillary proceedings from an ordinary liquidation, and the court will therefore give its directions to the liquidator to suit the relevant circumstances In these circumstances the question of enforceability of the netting provisions in the British Virgin Islands would not arise. However where substantive British Virgin Islands insolvency proceedings took place and claims were filed in the British Virgin Islands, the British Virgin Islands liquidator would be bound to act in accordance with British Virgin Islands insolvency law, and the conclusions of this opinion would be applicable. In either case we do not believe that there are any circumstances in which a British Virgin Islands liquidator could claim that an amount was due under a Covered Base Agreement and CDA to the Local Branch free from the effect of close-out netting provisions. 4. We would like you to confirm that your answers to Issues 1, 2 and 3 immediately above remain the same, notwithstanding possible actions that could be taken by an insolvency official or court in another jurisdiction where netting may be unenforceable (the Non-Netting Jurisdiction ). Such actions taken by an insolvency official of a Non-Netting Jurisdiction include the following scenarios: (1) In the case of an insolvency proceeding for a local bank (a bank organised under the laws of your jurisdiction), the local bank, acting on a multibranch basis, has booked Covered Transactions through its home office and one or more branches located in Non-Netting Jurisdictions (the Non-Netting Branches ). (2) In the case of an insolvency proceeding for a Local Branch of Bank F, Bank F acting on a multibranch basis, has booked Covered Transactions through (i) its home office, (ii) its Local Branch and (iii) one or more Non-Netting Branches in other jurisdictions The previous answers remain the same notwithstanding that actions may be taken by insolvency officials in other jurisdictions unless those actions would also have the effect of vitiating the Netting Provisions under their governing law. (a) (b) (c) If the effect of proceedings in a forum outside the British Virgin Islands is to extinguish claims or liabilities under the governing law of those claims or liabilities, the courts of the British Virgin Islands may recognise the extinction of those claims or liabilities. When a debt is extinguished under the proper law governing the liability no claim may be made in British Virgin Islands insolvency proceedings 17. If a foreign court made a determination on a matter relating to the netting provisions, the parties may be prevented from reopening that enquiry in the British Virgin Islands under the doctrine of res judicata. Under British Virgin Islands conflicts of laws rules all or part of the netting provisions may be held to be unenforceable, voidable or void for failure to comply with applicable foreign laws. 17 Wight v Eckhardt Marine GMBH [2004] 1 AC

14 (d) There are no decisions by the British Virgin Islands courts of which we are aware indicating to what extent British Virgin Islands law would recognise the right of a foreign liquidator (or analogous officer) of a company to disclaim all or part of a contract, but in the absence of authority our view is that this is a matter for the law governing the contract Where the insolvent party is organised in the British Virgin Islands and an order has been made for its winding up, no suit, action or other proceeding may be commenced or proceeded with against it without the leave of the court. It is our view that Insolvency Proceedings in relation to the insolvent party and/or its branches in the British Virgin Islands may be commenced and/or continued in the British Virgin Islands notwithstanding that equivalent proceedings may be commenced and/or continuing concurrently in other jurisdictions. However, it would be open to the British Virgin Islands court to exercise its discretion to stay proceedings in favour of another forum where related matters could be adjudicated upon If the insolvent party is incorporated or organised in the British Virgin Islands and has entered into a Covered Base Agreement and CDA and designated an office in the British Virgin Islands and a number of offices in other jurisdictions (including jurisdictions where the legal basis for netting is not clear) all or some of which offices have outstanding Covered Transactions governed by the Covered Base Agreement and CDA, this would not affect the ability of the solvent party to enforce such Covered Base Agreement and CDA in accordance with its terms against the insolvent party in Insolvency Proceedings in the British Virgin Islands Insolvency Proceedings purport to affect all property of the insolvent party wherever located. A British Virgin Islands court sitting in insolvency may seek to enjoin the disposition of foreign assets and defiance of such an injunction would render the creditor in contempt of court. In addition, a liquidator would have the power to bring an action in a foreign court to recover foreign assets of the insolvent party, but only to the extent foreign law permits Where the insolvent party is incorporated or organised in another jurisdiction and has entered into a Covered Base Agreement and CDA and designated an office in the British Virgin Islands and a number of offices in other jurisdictions all or some of which offices have outstanding Covered Transactions governed by such a Covered Base Agreement and CDA and Insolvency Proceedings are initiated against the insolvent party in the British Virgin Islands, such Insolvency Proceedings would deal with the assets and liabilities of the insolvent party and its office in the British Virgin Islands, such that the global assets and liabilities of the insolvent party would be considered in any proceedings. In Insolvency Proceedings no distinction is drawn between assets located in the British Virgin Islands and those which are located in other jurisdictions There is no danger that the existence of such Insolvency Proceedings could challenge or undermine the global nature of the netting provisions by, for instance, requiring Covered Transactions entered into through the office in the British Virgin Islands to be treated separately from other Covered Transactions. The answer to this question is not dependent on whether there are concurrent insolvency proceedings in a jurisdiction other than the British Virgin Islands. PART III Collateral Under a Covered Base Agreement and CDA The three principal fact patterns concern (a) whether or not the Location (as defined below) of the 14

15 Covered Customer is in the British Virgin Islands and (b) whether or not the Location of the Futures Credit Support or Cleared Derivatives Credit Support ( Collateral ) is in the British Virgin Islands. We distinguish between the following three fact patterns: I. The Location of the Covered Customer is in the British Virgin Islands and the Location of the Collateral is outside the British Virgin Islands. II. III. The Location of the Covered Customer is in the British Virgin Islands and the Location of the Collateral is in the British Virgin Islands. The Location of the Covered Customer is outside the British Virgin Islands and the Location of the Collateral is in the British Virgin Islands. For the foregoing purposes: (a) (b) the Location of the Covered Customer is in the British Virgin Islands if it is incorporated or otherwise organized in the British Virgin Islands and/or if it has a branch or other place of business in the British Virgin Islands; and the Location of Collateral is the place where an asset of that type is located under the private international law rules of the British Virgin Islands. Located when used below in relation to a Covered Customer or any Collateral is construed accordingly. Validity of Security Interests 1. Under the laws of your jurisdiction, what law governs the contractual aspects of a security interest in the various forms of Eligible Collateral under the Covered Base Agreement and CDA? Would the courts of your jurisdiction recognize the validity of a security interest created under each Covered Base Agreement and CDA, assuming it is valid under the governing law of such Covered Base Agreement and CDA? 2.26 If the security interest is to be given by a BVIBC over Eligible Collateral (other than Eligible Collateral comprising shares in a BVIBC (as to which see below)), the laws of the British Virgin Islands do not impose any additional requirements of form or otherwise for the recognition or validity of the security interest. The security interest is binding on a BVIBC to the extent, and in accordance with the requirements, of the chosen law If the Eligible Collateral comprises shares in a BVIBC, in order to create a valid mortgage or charge, the BVIBC Act requires that there must be a written instrument which clearly indicates (a) the intention to create a mortgage or charge; and (b) the amount secured by the mortgage or charge or how that amount is to be calculated. Where the collateral comprises bearer shares in a BVIBC the share certificates must be deposited with a custodian which is either recognised or authorised under British Virgin Islands law. However, the BVIBC Act also expressly provides that the parties may select their own law to govern the instrument and that in such an event the rights and remedies of the mortgage or charge are to be determined by the governing law. 15

16 2.28 The difficulty that may sometimes arise is that a number of foreign laws (including English law) provide that matters relating to the constitution of companies are so intimately connected with the country of incorporation that they must fall to be adjudicated by that country s (i.e., British Virgin Islands) law. Our view is that British Virgin Islands law mandates the application of the foreign law chosen by agreement, even when the consequence is that the foreign jurisdiction would apply British Virgin Islands law in its own courts. Usually the governing law will be recognised when necessary by the courts of the British Virgin Islands applying Section 161(2) 1 of the BVIBC Act which reads: The governing law of a charge created by a company may be the law of such jurisdiction that may be agreed between the company and the chargee and the charge shall be binding on the company to the extent, and in accordance with the requirements, of the chosen law As a matter of common law, the selection of a foreign law in a contract serves to select the territorial rules of that jurisdiction and not its conflicts of laws rules Assuming that the choice of New York law in the Covered Base Agreement and CDA is a valid and proper choice of law, the British Virgin Islands courts would recognise the validity of a security interest created under the Covered Base Agreement and CDA if that security interest was valid under the New York law Rights to manage Collateral (a) (b) Where a Clearing Member allows a Covered Customer to manage the Collateral posted by that Covered Customer, the British Virgin Islands courts may treat this as a right of substitution. A British Virgin Islands court will not generally attempt to recharacterise a security interest that would not be recharacterised under its governing law. However given the distinction between fixed and floating security under British Virgin Islands law and the possibility of different treatments of the two types of security interest in insolvency, a British Virgin Islands court might be asked by a liquidator to characterise security interests under the Agreements on the insolvency of a Customer. The British Virgin Islands is an English common law jurisdiction and as such the distinction between fixed and floating security interests is the same as under English law 18, and a right of substitution without control by the Clearing Member may therefore result in characterisation as floating security. The actual characterisation of security interests, including in accounts, contract rights and payment rights will depend on the way in which they are managed. Although the BVIBC registration regime (see our response to question 15) is not affected by characterisation as a floating charge, a registered floating charge is postponed to a subsequently registered fixed charge over the same assets unless the floating charge contains a prohibition or restriction on the power of the company to create any future charge ranking in priority to or equally with the charge over the same 18 See in particular Evans v Rival Granite Quarries Ltd [1910] 2 K.B. 979 and Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch