A recent case in the English High Court has provided a timely reminder to broker dealers and investment funds trading high yield bond and loan tranches on the secondary market of the problems that can arise if a chain of trades breaks down.

Molton Street Capital LLP v Shooters Hill Capital Partners and Odeon Capital Group LLC involved a chain of trades for a tranche of heavily discounted sub-prime RMBS securities. The chain broke down, and the buyer’s trade ticket contained the get-out that “trades cannot be considered ‘good trades’ without express consent of the Principals of the firms”. The court regarded this as a condition precedent allowing Odeon to avoid going ahead with the trade. It followed that Molton Street’s claim failed for the loss of a substantial profit it would have made on an already agreed downstream trade to Morgan Stanley.

The result is surprising. Although Odeon (through Shooters Hill) had agreed an apparently unqualified trade by phone, the condition precedent effectively rendered it not so much a firm trade as a zero-cost put option allowing Odeon to sell the bonds, or to decline to do so for any reason whatsoever, presumably at any time before settlement on T+3. It is hard to see how Molton Street would have intentionally entered into such a trade. Indeed, Molton Street argued before the court that this interpretation was at odds with the true nature and terms of the intended transaction – a binding trade concluded by phone and documented by a trade confirmation that proceeded on the basis that Odeon would settle the trade agreed on the settlement date.

It may be that the court’s findings against Molton Street trader Rajat Rohailla coloured the approach. The court did not seem to want Molton Street to have the benefit of a trade in which Rohailla had dishonestly concealed from the upstream and downstream parties that he was buying the bonds at 22 and selling at 35, entailing a US$1.1 million profit for Molton Street. But even so the case is a reminder for firms to take care scrutinizing trade tickets, and not to turn a blind eye to seemingly innocuous boilerplate wording like the words that tripped up the buyer here. Lost profits or claims from downstream counterparties on more robust trades can easily result.