Periods of increased market fluctuation, such as the fluctuations in the equities, gold and silver markets at the start of this year or the stock market volatility during the Covid-19 pandemic, are the usual precursors to an increased number of margin calls by financial institutions, including lenders.

In this article, we set out the types of disputes that can arise from margin calls, as well as key practical considerations for parties to financial transactions that may be affected by them.

What is a margin call, and what triggers it?

A margin call is a request from your broker or lender to deposit further collateral (“margin”), such as cash or securities, to keep a leveraged position or a margin lending facility open. Margin calls serve as a risk management tool for financial institutions as they protect against the risk of counterparties defaulting.

Common scenarios that may lead to margin calls include holding positions through market turmoil or major economic developments and opening new positions without enough free margin.

The contractual framework

The requirement for margin and the ability of the financial institution to call for more margin will be defined in a contract.

Where a transaction involves some form of derivative connected to movements, for example, in foreign exchange (FX) rates or equities, this will ordinarily be subject to industry-standard trading agreements, such as the International Swaps and Derivatives Association (ISDA) Master Agreement.

However, margin lending facilities, under which the lender agrees to lend to the borrower against a portfolio of market-traded assets such as equities, bonds or debt securities deposited as collateral, are likely to be subject to negotiated contractual terms based on the financial institution’s standard documentation. Cryptocurrency transactions are also likely to be subject to the standard terms and conditions of the relevant exchange or platform.

Areas of potential dispute

Disputes relating to margin calls usually centre on whether the lender (or equivalent) has followed the relevant contractual provisions. Most commonly, this will involve disputes about the margin call process itself or early termination rights for missed margin calls.

Disputes relating to the margin call process

Validity of the margin call: The validity of a margin call is a matter of applying the relevant contractual provisions. Those provisions will typically contain formal notice requirements applicable to margin calls. Non-compliance with these would render a call invalid. This arose in Lehman Brothers International (Europe) v Exxonmobil Financial Services BV [2016] EWHC 2699 (Comm), where the court held that a notice was invalid as it was faxed to a different fax number than the one specified in the contract.

Calculation of the margin call amount or collateral posted: Disputes could also arise out of the way the amount of a margin call or posted collateral was calculated or valued. Any relevant contractual provisions regarding calculations/valuations would have to be followed strictly, including specific valuation methodologies, to minimise the risk of dispute. Valuation disputes may particularly arise where the collateral is illiquid, for example, real estate or shares in a private company.

The contract would normally provide a mechanism to be used by the parties in the event of a dispute relating to calculations or valuations. This would normally include notification provisions, a consultation requirement and the involvement of a valuation agent. The process is unlikely to last longer than a few days. While it lasts (and depending on the precise terms of the relevant contract), a failure to post disputed collateral is unlikely to be considered a breach of the relevant contract resulting in termination rights.

In Deutsche Bank AG v Sebastian Holdings Inc [2013] EWHC 3463 (Comm), the court considered the approach to calculating a margin call amount under the 1995 ISDA Credit Support Annex. The case related to Deutsche Bank’s close-out of FX trades following the counterparty’s failure to meet in full a margin call of approximately US$500m. The FX trades included sophisticated derivatives transactions and other complex transactions. The defendants argued that the margin call was invalid as the bank’s systems could not properly calculate these transactions.

The court held that any deficiencies in effecting proper margin calculations did not render the margin call invalid. However, where these calculations could not be effected in accordance with the 1995 ISDA Credit Support Annex, the “commercially reasonable course” by the bank would have been to “produce figures by reference to the best available information and to inform the client of the difficulty with a view to sitting down and negotiating sensible margin figures”. The court therefore held that the requirement of good faith and commercial reasonableness in clause 9(b) of the Credit Support Annex had not been met.

Cumulative margin calls: Where multiple margin calls have been made on the same account, any earlier margin calls remain valid and need to be satisfied. They are not superseded by subsequent margin calls unless there has been a clear indication to the contrary. This issue arose in Goldman Sachs International v Videocon Global Ltd [2013] EWHC 2843 (Comm), where the court held that a “Notice of Potential Event of Default” and an “Early Termination Date” notice regarding an unpaid margin call were effective despite there being further margin calls in different amounts. The initial margin call was still effective and had to be satisfied.

Disputes arising out of termination rights for missed margin calls

Most disputes in the English courts to date have arisen from a margin call being missed, which has led to an early termination on the part of the counterparty or lender.

Such disputes would normally arise due to a margin call being made in breach of contract, for example, an invalid margin call against the relevant contractual framework, or because of an impermissible valuation of the underlying assets. In such instances, a claim for wrongful termination may arise, leading to the counterparty/lender having to pay damages for any losses suffered by their contractual counterparty resulting from that wrongful termination. This may include losses relating to the wrongful sale of the underlying assets, which may be particularly problematic when it comes to illiquid assets or ones with special rights attached to them, such as equity positions.

Contractual discretion and the Braganza duty

As set out above, one of the key takeaways is that lenders (or their equivalents) should follow the relevant contractual framework meticulously to minimise the risk of any margin calls or related actions being challenged down the line.

When contractual provisions allow for some discretion, ie, are not expressed in unqualified or absolute terms, the exercise of such provisions or rights will be subject to the implied Braganza duty. This duty arises out of the Supreme Court’s judgment in Braganza v BP Shipping [2015] UKSC 17. It provides that, where contractual discretion exists, for example, regarding a right to call for a margin payment, it ought to be exercised honestly, in good faith, and for proper purposes, and not arbitrarily or capriciously.

This duty covers both the process and the outcome of the decision-making. In Sucden Financial Ltd v TMT Metals AG & Ors [2024] EWHC 1051 (Comm), the court held that such an implied duty may be established even where the contract contains an express duty for the financial institution to act reasonably. Proving such a duty has been complied with, the financial institution will be assisted by being able to show the rationale behind its actions, including the reasons for its decisions and the process it followed.

Practical considerations for market players

Given that margin calls are typically connected to increased market volatility or economic turmoil where investors’ financial position may change rapidly, any decisions regarding whether to make or respond to a margin call are likely to need to be made quickly, often over hours or days. An advanced understanding of the relevant contractual matrix, including applicable notice provisions and valuation methodologies, is key in enabling parties to make informed decisions and act quickly and appropriately if and when the time comes. Stewarts can assist with that process.

As discussed above, for financial institutions, the ability to show why certain actions were taken would be key in defending potential disputes. Comprehensive record keeping, including details of any relevant discussions, committee meetings and decisions and calculations regarding a portfolio, is highly advisable. The same applies to documenting any discussions with the counterparty and keeping a record of any relevant correspondence.

For investors, disclosure of those documents will be critical. Further, apart from scrutinising the contractual provisions to identify any non-compliance with, for example, notice or valuation provisions, collecting any market data for the underlying assets would assist if a dispute relating to calculations were to arise. In addition, where a portfolio may be liquidated imminently by the financial institution, investors may need to seek injunctive relief to prevent such liquidation, pending resolution of the dispute.

Finally, it is important for affected investors to be able to clearly identify their loss and causation arising from the counterparty’s breach, as well as take any available steps to mitigate those losses.