A New York appellate court recently ruled that two related hedge funds are entitled to receive a sum of approximately $22 million – plus prejudgment interest of approximately $68 million – from their counterparty, a large investment bank, in a credit default swap (CDS). The dispute between the parties arose out of a disagreement concerning the value of the reference assets, which in turn led to the bank refusing to return the collateral posted by the hedge funds. In its decision, the court held that the hedge funds’ arm’s-length transaction with the reference assets’ issuer, and their tendency to pursue their self-interest without regard for adverse effects on the counterparty, did not violate standards of good faith and commercial reasonableness. The court’s decision has far-reaching implications for the rights of parties entering into CDS transactions, particularly where some or all of the assets might be susceptible to valuation disputes in uncertain and rapidly fluctuating markets. To help readers understand the case and its impact on derivatives trading, the Hedge Fund Law Report has prepared a summary of the court’s decision and interviewed Fabien Carruzzo, a financial services partner at Kramer Levin Naftalis & Frankel, with expertise in the derivatives and CDS markets. For insights from Carruzzo, see our two-part series on minimum initial and variation margin requirements for over-the-counter derivatives: “Hedge Funds Face Increased Margin Requirements
” (Feb. 18, 2016); and “Hedge Funds Face Increased Trading Costs
” (Feb. 25, 2016).