SNCB Holding v UBS AG

A sophisticated commercial agreement must be construed as a whole, by reference to its language, structure, commercial purpose and admissible background. A court must not use implication to improve the bargain or substitute a term which would be fair or reasonable. A term is implied only where it spells out the contract’s objective meaning and is necessary to give effect to it.

Where a contract gives one party discretion over collateral, the discretion remains subject to honesty, good faith, proper purpose and the avoidance of arbitrariness or irrationality. Those limits do not prevent the party doing what the contract, properly construed, expressly permits. Security for repayment obligations is not automatically security for separate credit-event settlement obligations.

SNCB paid UBS approximately $39.75 million under an amended deposit agreement linked to the credit risk of specified reference entities. The agreement required UBS to maintain collateral equal to the mark-to-market value of its repayment obligations. Following credit events involving Ambac, UBS removed Ambac municipal bonds from the collateral account, replaced them with cash and later delivered cheaper Ambac bonds as the delivery portfolio.

SNCB claimed damages for breach of contract. It contended that the contractual documents, or implied terms, required UBS to preserve and deliver the Ambac bonds held as collateral and restricted UBS’s discretion to replace them. The central questions concerned construction, implication of terms, the limits of contractual discretion and recoverable loss.

1. Claim dismissed. The court held that UBS was entitled to replace the Ambac municipal bonds with cash or other qualifying collateral, provided that the collateral maintained the required 100 per cent mark-to-market value of UBS’s repayment obligations.
2. The amended deposit agreement superseded the earlier term sheet. The agreement was complete in itself and had to be construed on its own terms. Its credit-event provisions required delivery of qualifying bonds of the affected reference entity, not particular bonds held in the collateral account.
3. The collateral secured UBS’s repayment obligations under the deposit agreement. It was not security for the credit risk assumed by SNCB in respect of the reference entities. The agreement imposed no obligation to match collateral holdings with the current percentages used for the credit-event provisions. Whether bonds of the affected reference entity happened to be held in the collateral account was therefore irrelevant.
4. No term could be implied requiring the collateral account to be frozen after a credit event, after UBS formed an intention to serve a credit-event notice, or while UBS considered whether to serve one. Nor could a term be implied requiring UBS to deliver the affected entity bonds held in the collateral account. Those terms were inconsistent with the express structure of the agreement and were not necessary to give it business efficacy.
5. The contractual discretion remained subject to honesty, good faith, proper purpose and the avoidance of arbitrariness, capriciousness and Wednesbury unreasonableness. In this case UBS acted in accordance with its honest understanding of its contractual rights and for the objective purpose of managing its collateral and business investments. Its commercial motivation did not establish breach.
6. The service of the notice of portfolio crystallised the bonds to be delivered. SNCB had no contractual right to the municipal bonds and therefore could not establish causation or recoverable loss.