Margin calls in times of market turbulence

Legal principles and practical guidance

In times of increased market volatility, one of the few things that is certain is an increased likelihood of margin calls. As markets fluctuate and asset values move sharply, the parties with rights to demand additional collateral under margin arrangements will often move very quickly to do so. For those caught on the wrong side of these calls, the financial consequences can be swift and severe. In any situation which is leading towards a margin call, the economic interests of the counterparties to the relevant transaction or structures are pitted against each other, and the power balance sits squarely with the party with the power to determine the margin required. This tension can lead to distorted commercial behaviour, and sometimes outright abuse.

This note outlines some of the key legal principles under English law that underpin margin calls, considers the margin call provisions in some of the most frequently used standard documentation and provides practical tips for those subjected to margin calls when considering whether to challenge them in the English courts.

Understanding the legal basis of margin calls

Margin, and margin call mechanisms, are creatures of contract. They commonly arise under the mechanics set out in the industry standard trading agreements such as ISDA Master Agreements (primarily for derivatives), Global Master Repurchase Agreements (GMRA, for repo transactions), or Global Master Stock Lending Agreements (GMSLA, for securities lending transactions). However, the mechanics may well instead be set out in non-industry standard agreements. A commonplace example being prime brokerage agreements, which are subject to bilaterally negotiated terms and conditions heavily centred on the bank’s own standard documentation. These contracts will all typically contain powers to call for variation margin when the value of a portfolio moves against the collateral provider or when credit risk increases.

There are some broad English law principles that will apply when a party is facing a margin call. To some degree, these act as constraints on the (generally very broad) contractual discretion which is given to the margin-calling party to determine when to make a margin call and what amount can be demanded. Their efficacy in redressing the inherent power imbalance should not be overstated, but they should help constrain the most egregious abuses of contractual discretion:
 
1. Contractual discretion must be exercised rationally and in good faith

Under English law, contractual provisions granting a party discretion to make determinations binding on the other party – such as the right to call for a margin payment – are constrained by implied duties, often called Braganza duties, after the Supreme Court’s judgment in Braganza v BP Shipping¹. These limit how discretion is exercised, requiring decisions to be made honestly, in good faith, and for proper purposes, and not arbitrarily or capriciously.

Supporting authorities – Ludgate v Citibank², Gan Insurance v Tai Ping Insurance³, and Paragon Finance v Nash⁴ – had held that discretion must be reasonable and consistent with the contract’s purpose. The Supreme Court in BT v Telefonica O2⁵ confirmed that, unless explicitly stated otherwise, the exercise of such a discretion must align with the overall contractual purpose. Braganza then expanded this duty to cover both the process and the outcome of decision-making.

2. Valuation mechanisms must be followed rigorously

Many agreements require valuation of assets or exposures according to specific contractual methodologies. The discretion conveyed to the margin calling party is limited to a power to act within the corners of those specific procedures. Departing from these methods—whether due to speed, error, or illiquidity—can open the door to challenge.

3. Notice requirements must be met

The contract provisions will generally prescribe formal notice provisions which are applicable to margin calls. A failure to comply with these could render a call invalid. Notice provisions are generally expected to be followed to the letter. The most famous example being LBIE v ExxonMobil⁶ (a notice of default case). In that case, ExxonMobil faxed a notice to a different fax number in the same Lehman office to overcome an inbound call jam on the contractually specified number. The Court held that meant the notice was invalid, but that Lehman had waived the breach because it had raised no objection at the time or indeed until 6 years later. The moral being to register objections to any technical breaches even where they seem pedantic - it may assist later.

4. Misrepresentations and market abuse

In certain cases, margin calls might be based on negligent or deliberate mis-valuations, misrepresentations, or even market manipulative conduct. These more extreme abuses of power are obviously highly fact dependent and penetrating into a proper evidential basis for pursuing such claims is a challenge. However, where an imbalance of power and financial incentives intersect, there is always temptation for abuse so keeping alert for any warning signs is always sensible.

Practical tips for contesting margin calls

The fast-moving nature of events giving rise to margin calls, the speed with which margin calls are issued and frequently repeatedly so in the face of continued volatility, and the grave consequential steps that can follow from a failure to meet even an illegitimate margin call means that delay can seriously jeopardise the legal rights of the party subjected to the margin call. Collateral providers facing the uncertainty of considering a challenge should act quickly and keep the following in mind:

• Document everything: Maintain contemporaneous records of valuations, communications, and internal decision-making processes. Press the margin-calling party for explanations and evidence to support the underlying valuations and calculations, keeping careful records of the responses. Keep contemporaneous screenshots of relevant market values if there is access to live financial data.

• Seek early legal advice: Margin commercial often turn on complex contractual language and the interpretation of technical valuation mechanics. Furthermore, what starts as a margin dispute can quickly escalate to an even more damaging termination and liquidation scenario. Pulling together the key documents which evidence the contractual framework and taking legal advice from litigation specialists experienced in the field is essential.

• Scrutinise the call: Check whether the margin call complies with contractual notice requirements, valuation methodologies, and timing. Register objections to any non-compliance, no matter how technical those may seem. Consider whether the counterparty has acted consistently with past practices or assurances and register complaints about departures if appropriate. Reserve rights and avoid acquiescence and potential waiver.
Consider injunctive relief: In urgent situations – such as those which could lead to an imminent liquidation of a portfolio – it may be possible to apply for an injunction to halt enforcement while a dispute is resolved.

• Engage strategically: In some cases, entering a constructive dialogue with the counterparty can resolve a dispute before litigation becomes necessary. But such engagement must be informed by a clear legal position.

Conclusion

Margin calls are an inherent part of leveraged trading, but they are not immune from legal challenge. In volatile markets, where valuation disputes and liquidity pressures collide, the English courts are quite prepared and well-armed to scrutinise whether margin calls have been properly made in accordance with the parties’ agreed contractual framework. Although the contractual discretion usually enjoyed by margin-calling parties means the starting point is a power imbalance in their favour, it does not provide them with a carte blanche to act as they see fit, although that is commonly the impression conveyed.

The banking and financial markets disputes team at RPC has deep experience in representing many and various clients in complex margin disputes, including institutional borrowers, derivatives counterparties, funds, brokers, and HNW investors in. Whether you are facing an unjustified margin call or preparing to challenge the liquidation of assets, our team is well-placed to provide timely, commercial, and legally robust advice.

1 [2015] UKSC 17.
2 1998] Lloyd’s Rep IR 221.
3 2001] 2 All ER (Comm) 299. 
4 [2001] EWCA Civ 1466.
5 [2002] 1 WLR 685.
6 [2016] EWHC 2699 (Comm).