AON Financial Products, Inc. v. Société Générale

United States Court of Appeals for the Second Circuit · Corporations

CorporationsContract interpretationCredit default swapscredit default swapplain meaningreference entitysovereign eventfailure to pay

Facts

BSIL made a loan to Ecobel and obtained a GSIS surety bond to guarantee repayment, then bought CDS protection from Aon against GSIS's failure to pay that bond. Aon separately bought CDS protection from SG, but the Aon/SG contract defined the Reference Entity as the Republic of the Philippines and the Reference Obligation as a Philippine treasury bond, not the GSIS surety bond. After Ecobel defaulted, GSIS refused to honor the surety bond, and Aon sought payment from SG on the theory that this refusal triggered a Credit Event under the Aon/SG CDS contract. The district court agreed on a Sovereign Event theory, but SG argued that GSIS was not the Reference Entity and that no defined Credit Event occurred under the Aon/SG contract.

Issue

Did GSIS's refusal to pay on the surety bond constitute a Credit Event under the Aon/SG CDS contract—either as a Sovereign Event or a Failure to Pay—so that SG breached the contract by refusing to pay Aon? Also, did Aon's March 22, 2000 letter qualify as the required Credit Event Notice?

Rule

When a CDS contract is unambiguous, courts must enforce it as written. Whether a Credit Event occurred depends on the specific definitions in that particular CDS agreement, not on another related swap or on economic similarity between transactions; a sovereign named as Reference Entity does not automatically include separate government agencies, and notice provisions requiring an irrevocable Credit Event Notice must be strictly satisfied.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In New York, Harbor Crest Capital bought protection from Meridian Structured Risk under a CDS that defined the Reference Entity as the "Kingdom of Norland" and the Reference Obligation as a Norland sovereign bond. Harbor Crest sought payment after Norland Rail Authority, a state-owned corporation with power to sue and be sued, missed a payment on its own debenture.

Under the majority's approach, is Meridian most likely obligated to pay on a Failure to Pay theory?

Explanation. The contract must be enforced according to its unambiguous terms. A Failure to Pay requires failure by the Reference Entity itself to pay its own obligations. A separately incorporated government instrumentality does not become the sovereign merely because it is state-owned. The majority rejected treating a sovereign and its agency as the same absent contract language doing so.