February 3, 2016
In a significant trial victory, two hedge funds managed by Wilk Auslander client Good Hill Partners were awarded a judgment on February 3, 2016 against Deutsche Bank in the amount of $22.1 million, plus interest from 2009, as well as attorneys’ fees. The decision followed a five day trial before Justice O. Peter Sherwood in the Commercial Division of the Supreme Court, New York County (Index # 600858/2010).
The hotly contested dispute involved a breach of contract claim by the two Good Hill funds seeking the return of collateral they had posted with Deutsche Bank under several credit default swap (CDS) trades totaling $30 million, dating back to just before the financial crisis in 2008. Under the trades, the hedge funds sold credit protection to Deutsche Bank, agreeing to pay the bank if there was a write-down of the underlying mortgage-backed bonds that had been issued by Bank of America. At the time, Deutsche Bank was taking many “short” positions in the mortgage-backed securities market.
Deutsche Bank bet wrong in this swap trade. It then tried to avoid its obligation to return $22 million in collateral to the Good Hill funds by falsely claiming that the hedge funds did not act in good faith or in a commercially reasonable manner under the swap contracts when they sold the bonds back to Bank of America. Because Bank of America needed the bonds to unwind its entire securitization, it purchased the bonds from the Good Hill funds at a price greater than that at which the securities had been “marked” at the time during the turbulent financial crisis. Bank of America’s subsequent write-down of a percentage of the principal of the bonds in a lesser amount pegged to their relatively higher purchase price, and not to the more discounted but questionable “market” value, resulted in Deutsche Bank realizing much less than it expected from the CDS trades.
In a 19 page decision, the trial court ruled that the Good Hill funds acted properly, entirely within their contractual rights and in good faith. Nothing in the swap contract (comprising the ISDA standard forms used by most in the derivatives marketplace), nor under the common law’s covenant to act in good faith, prohibited the hedge funds from negotiating with and selling the bonds to Bank of America at a favorable price in an arms-length transaction, even though the result might have had an adverse effect on Deutsche Bank’s CDS position. The court expanded upon and confirmed a long line of authority establishing that the implied covenant of good faith and fair dealing cannot override specific contractual provisions of the parties. The court also cited the critical provision in the ISDA CDS contract granting each party the right to deal in its economic self-interest, in the same manner as each of them could as if such CDS trade did not exist, regardless of whether any such action might adversely affect the position of the other party.
The court’s decision is significant in this area of securities and derivatives litigation given the detailed discussion about the doctrines of commercial reasonableness and the implied covenant of good faith and fair dealing under the ISDA standard swap agreements.