Resolution Of Problems Arising From Option And Forward Transactions

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Wardyński & Partners
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Wardyński & Partners
There was much publicity at the start of this year on the subject of companies embroiled in unfavourable currency futures contracts and options transactions. The weakening Zloty resulted in enormous losses for entrepreneurs who in extreme instances were threatened with bankruptcy.
Poland Finance and Banking
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Article by Danuta Pajewska, Łukasz Szegda and Patrycja Jacaszek

There was much publicity at the start of this year on the subject of companies embroiled in unfavourable currency futures contracts and options transactions. The weakening Zloty resulted in enormous losses for entrepreneurs who in extreme instances were threatened with bankruptcy. The scale of this phenomenon elicited public debate in which lawyers referred to various legal grounds to challenge these transactions. Specific provisions of the Civil Code were subjected to extensive analysis, including, among others, those dealing with error, deception, exploitation, extraordinary change of relations, together with an already-known directive on financial instruments markets (MiFID).

These issues are vital to consider in specific cases, although it should be stated that violations allowing, for example, the charge of error or exploitation are indeed rare. Moreover, an exact analysis of a legal violation of this type is only imperative in the event of a decision to commence court proceedings. Meanwhile, as arises from press reports, only a limited number of entrepreneurs have filed suit against banks, whereby most opted for negotiations and restructuring of debt arising from forward type futures contracts and currency options.

It is obvious that argumentation is constructed differently in negotiations than in litigation. Above all, it should be pointed out that business issues and hitherto client relations with a bank play a larger role in negotiations. Every argument, even minor, which strengthens the position of a party, is important in negotiations. Several vital issues that appear as arguments in negotiations between banks and entrepreneurs therefore require greater scrutiny.

Analysis of documentation

Banks have adopted various forms of regulating the conclusion and implementation of currency transactions, thus every contractual documentation differs. The basic issue is whether documentation is complete, i.e. whether an entrepreneur received all documents listed in a framework agreement or appropriately attached regulations. It should be recalled that only documents delivered in the manner accepted between banks and an entrepreneur until the date of transaction conclusion comprise a part of contractual documentation. Since contractual documentation is usually multi-stage, in particular, requires verification of whether appropriate regulations were provided. It is also worth verifying whether a description was attached of risks related to a given financial product.

The interdependence of documentation elements is also worth analysing, particularly at the terminological level. An essential issue is determination of the nature of transactions, that is, their classification as forward or option type, depending on whether the acquirer of an instrument has the obligation or right to demand a given supply of currency. Without going into detail it should be noted that it is vital in the case of options to analyse the course of procedure during the implementation of contracts since an agreement may impose the condition of employing a certain notification procedure for the purpose of benefiting from a given right.

In addition to contractual documentation, an entrepreneur could have also received presentations, forecasts or other information in the exchange of correspondence on a given financial product. Banks frequently prepare and provide such information to a client in various forms. In this context attention should be drawn to Principles of Sound Banking Practices approved by the Association of Polish Banks, in particular, point 4, chapter II, which states: a bank should inform a client of the types and terms of rendered services by clarifying differences between specific offered services and with indication of the benefits provided by a given services together with its related risks". Although the Sound Practices are not commonly binding law, banks place great emphasis on the application of professional standards in relations with clients and, in this connection, it is vital for them to observe the Sound Practices.

Withdrawal from a transaction

Monthly losses may induce an entrepreneur to immediately halt all currency transactions. It is worth noting that the effect of a unilateral termination of all transaction is their settlement on the date of closing (that is, according to the exchange rate binding on this date) and immediate payment of the transaction settlement sum.

Also, a party does not always have the ability to independently sever a transaction. There are two types of documentations in this regard. According to the first type, a party does not always have the ability to terminate and immediately settle a transaction, whereby under the second type the termination of such transaction prior to the date of settlement may ensue only with mutual consent of the parties.

It should be additionally noted that banks reserve themselves the ability to terminate all transactions with immediate settlement in the event of a contract violation on the part of the client. Failure of an entrepreneur to repay amounts due is, in principle, deemed a violation. Yet, even mere financial difficulties experienced by a client can also serve as a basis for banks to unilaterally terminate a transaction.

Negotiation aims

As in all negotiations, parties should clearly formulate their aims and ability prior to commencement. Two possible solutions to the problem of currency transactions have arisen from our hitherto negotiation experience and that of our clients. In the face of further risk from currency fluctuations, parties may simultaneously close all transactions and convert liabilities into fixed debt. The second scenario is based, in turn, on the conviction of a gradual strengthening of the Zloty and, as a consequence, a reduction in client liabilities toward a bank. In such case, an entrepreneur assumes credit at a bank that is utilised in the form of draws for repayment of individual transactions. There is also an indirect solution popularly referred to as transaction dilution. In such case, a part of the nominal transaction amount is converted into debt, whereas the second part immediately becomes the nominal amount of new transactions commenced on the same terms as previously.

In preparing for negotiations, consideration should be given to a series of additional factors such as the state of collateral and twin" transactions that a bank concluded with other institutions to secure its option transaction position with its own clients. A multi-fold and exact preparation for negotiations with sensibly structured argumentation and clearly defined demands increases the chance of success in negotiations and, as a result, a resolution of the currency transaction problem.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Resolution Of Problems Arising From Option And Forward Transactions

Poland Finance and Banking
Contributor
Wardyński & Partners
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