Opinion ID: 786891
Heading Depth: 2
Heading Rank: 3

Heading: Eternity's Credit Default Swaps

Text: 14 Eternity's Global Master Fund is managed by HFW Capital, L.P., including its Chief Investment Officer, Alberto Franco. In 2001, Franco engaged Morgan to facilitate Eternity's participation in the Argentine corporate debt market. Fearing that a government debt crisis would impair the value of Eternity's Argentine investments, Franco sought to hedge using credit default swaps written on Argentine sovereign bonds. In October 2001, the Fund entered into three such contracts. Each CDS incorporated (i) the ISDA Master Swap Agreement, and (ii) the 1999 ISDA Definitions. The total value of the contracts was $14 million, as follows: 15 CDS Entry Date Termination Date Value October 17, 2001 October 22, 2006 $ 2 million October 19, 2001 December 17, 2001 $ 3 million October 24, 2001 March 31, 2002 $ 9 million Total Value: $14 million 16 Except as to value and duration, the terms were virtually identical, as follows: 17 (i) Eternity would pay Morgan a fixed periodic fee tied to the notional value of each respective credit default swap. 18 (ii) The swaps would be triggered upon occurrence of any one of four credit events — as defined by the 1999 ISDA Credit Derivative Definitions — with respect to the Argentine sovereign bonds: Failure to pay, Obligation Acceleration, Repudiation/Moratorium, and Restructuring. 19 (iii) Each CDS called for physical settlement following a credit event, specifically: 20 (a) Upon notification (by either party to the other) of a credit event, and confirmation via two publicly available sources of information ( e.g., the Wall Street Journal), and 21 (b) delivery to Morgan of the requisite amount of Argentine sovereign bonds, 22 (c) Morgan would pay Eternity par value for the obligations tendered. 23 It is alleged (and we therefore assume) that Eternity entered the swaps in reliance on Morgan's representations that it would provide access to a liquid secondary market that would enable the Fund to divest the contracts prior to termination. 24 The parties dispute whether any of certain actions taken by Argentina with respect to its debt obligations in November and December 2001 constituted a credit event. The district court thought not, and dismissed Eternity's contract claim at the pleading stage. Eternity II, 2003 WL 21305355, at -6. With the background and structure of the disputed CDS contracts in mind, we turn to Eternity's principal allegations. II 25 Because we assume plaintiff's factual allegations to be true on review of a motion to dismiss pursuant to Rule 12(b)(6), DeMuria v. Hawkes, 328 F.3d 704, 706 (2d Cir.2003), the facts relating to Argentina's financial collapse are taken from Eternity's Second Amended Complaint and any documents upon which it relies, see Rothman v. Gregor, 220 F.3d 81, 88-89 (2d Cir.2000) (citations omitted). 26 The contracts at issue were signed in October 2001. By then, international financial markets had been speculating for months that Argentina might default on its $132 billion in government and other public debt. At an August 2001 meeting of bondholders in New York, Morgan acknowledged the possibility of a sovereign-debt default and advised that it was working with the Argentine government on restructuring scenarios. On October 31, 2001 — after the effective date of the swap contracts at issue on this appeal — Morgan sent Eternity a research report noting that there was a high implied probability of [a] restructuring in which bondholders would likely receive replacement securities with a less-favorable rate of return. One day later, Argentine President Fernando de la Rua asked sovereign-bond holders to accept lower interest rates and longer maturities on approximately $95 billion of government debt. 27 On November 19, 2001, the Argentine government announced that a voluntary debt exchange would be offered to sovereign-bond holders. According to various public decrees, willing bondholders could exchange their obligations for secured loans that would pay a lower rate of return over a longer term, but that would be secured by certain federal tax revenues. So long as the government made timely payments on the loans, the original obligations would be held in trust for the benefit of Argentina 22 ; if the government defaulted, however, bondholders would have recourse to the original obligations, which were to remain effective for the duration of their life-in-trust. From late November through early December 2001, billions of dollars in sovereign bonds were exchanged for the lower-interest loans. 28 The complaint alleges that the debt exchange amounted to a default because local creditors had no choice but to participate, and that the financial press adopted that characterization. On November 8, 2001 Eternity served the first of three notices on Morgan asserting that the planned debt exchange was a restructuring credit event as to all three CDS contracts; but Morgan demurred. 29 On December 24, newly-installed interim President Adolfo Rodriguez Saa — appointed by the Argentine Congress on December 23 to replace President de la Rua— announced a public-debt moratorium. On December 27, Morgan notified Eternity that the moratorium constituted a credit event and subsequently settled the outstanding $2 million and $9 million credit default swaps (otherwise set to terminate on October 22, 2006 and March 31, 2002, respectively). According to Morgan, the third swap (valued at $3 million) had expired without being triggered, on December 17, 2001. 30 It is undisputed that the December 24 public-debt moratorium was a trigger of Eternity's outstanding swaps; in Eternity's view, however, the voluntary debt exchange had triggered Morgan's settlement obligations as early as November 8, 2001, as the Fund had been insisting throughout November and December of that year. In that same period, Eternity asked Morgan to liquidate the swaps on a secondary market. Notwithstanding Morgan's representations in February 2001 regarding the existence of a secondary market for the CDSs, it refused to quote Eternity any secondary-market pricing, though it did offer to unwind the contracts by returning the premiums Eternity had paid from October through November 2001. III 31 On February 19, 2002, Eternity commenced this action alleging breach of contract and fraudulent and negligent misrepresentation. An amended complaint was filed three months later. Morgan moved against the amended complaint pursuant to Rules 9(b) and 12(b)(6). In support of the motion, Morgan made voluminous submissions, including the relevant CDS contracts, the 1999 ISDA Credit Derivatives Definitions, and English translations of portions of relevant Argentine public decrees. In an unreported decision, Judge McKenna ruled that Eternity had stated a claim for breach of contract, but that the misrepresentation claims had not been pleaded with the requisite particularity and dismissed those claims with leave to replead. Eternity I, 2002 WL 31426310, at -6. 32 On November 15, 2002, Eternity filed a second amended complaint, primarily to supplement facts bearing on its misrepresentation claims. Morgan again moved to dismiss. In June 2003, the district court ruled: (i) that Eternity again failed to plead fraud and negligent misrepresentation with the necessary particularity; and (ii) upon reconsideration of its prior contrary decision, that Eternity also failed to state a claim for breach of contract. Eternity II, 2003 WL 21305355, at -6. 33 Judge McKenna dismissed the contract claim on the ground that Argentina's voluntary debt exchange was not a restructuring credit event, as a matter of law. Id. at -6. The misrepresentation claims failed for want of particularity, Eternity having failed to allege facts to show that, as of the time Eternity entered the CDS contracts, Morgan knew or should have known that no secondary market would be available if Eternity decided (as it did) to liquidate its position. See id. at -4. This appeal followed. 34 For the reasons set out below, we (i) reverse the district court's dismissal of Eternity's contract claim and remand for further proceedings; and (ii) affirm the dismissal of the claims for fraudulent and negligent misrepresentation.