Thrifty Oil Co. v. Bank of America

• Decision Date: 19 November 2002
• Docket Number: No. 00-56159.,00-56159.
• Citation: 310 F.3d 1188
• Parties: THRIFTY OIL CO., Appellant, v. BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

310 F.3d 1188

THRIFTY OIL CO., Appellant, v. BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, Appellee.

No. 00-56159.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted November 4, 2002.

Filed November 19, 2002.

COPYRIGHT MATERIAL OMITTED

Stephan M. Ray and Robert A. Greenfield, Stutman, Treister & Glatt, Los Angeles, CA, for the appellant.

Matthew S. Walker, Pillsbury Madison & Sutro, San Diego, CA, for the appellee.

Appeal from the United States District Court for the Southern District of California; Thomas J. Whelan, District Judge, Presiding.

Before: HALL, THOMPSON, and WARDLAW, Circuit Judges.

CYNTHIA HOLCOMB HALL, Circuit Judge:

The decision of the District Court granting summary judgment to appellee Bank of America is hereby AFFIRMED for the reasons stated in Judge Whelan's opinion, reported at Thrifty Oil Co. v. Bank of America (In re Thrifty Oil Co.), 249 B.R. 537 (S.D.Cal.2000). The District Court's opinion is set forth below in hæc verba:

"Thrifty Oil Company ("Thrifty") appeals an order of the United States Bankruptcy Court, the Honorable Louise DeCarl Adler presiding, granting a motion for summary judgment brought by Bank of America National Trust & Savings Association ("BofA"). This Court has appellate jurisdiction pursuant to 28 U.S.C. §§ 158(a)(1) & (c)(1)(A).

This appeal presents two questions: (1) whether "termination damages" under an interest rate swap agreement, entered into between a lender and a borrower as part of a larger financing transaction, constitute unmatured interest disallowed under Section 502(b)(2) of the Bankruptcy Code, and (2) whether interest rate swap agreements violate California's Bucket Shop Law. On summary judgment, the Bankruptcy Court answered both questions in the negative and entered judgment in favor of BofA. See In re Thrifty Oil Co., 212 B.R. 147 (Bankr.S.D.Cal. 1997).

The Court has read and considered Thrifty's opening, reply and supplemental briefs, BofA's responsive and supplemental briefs, all attached exhibits, the arguments of counsel and the applicable law. For the reasons expressed below, the Court AFFIRMS the judgment of the Bankruptcy Court.

I. INTRODUCTION

To more thoroughly understand the facts of this case and the legal issues presented, the Court will provide a brief over-view of derivative swap agreements.¹ A "swap" is a contract between two parties ("counterparties") to exchange ("swap") cash flows at specified intervals, calculated by reference to an index. Parties can swap payments based on a number of indices including interest rates, currency rates and security or commodity prices.

The "plain-vanilla" interest rate swap, the simplest and most common type of swap contract, obligates one counter-party to make payments equal to the interest which would accrue on an agreed hypothetical principal amount ("notional amount"), during a given period, at a specified fixed interest rate. The other counterparty must pay an amount equal to the interest which would accrue on the same notional amount, during the same period, but at a floating interest rate. If the fixed rate paid by the first counterparty exceeds the floating rate paid by the second counterparty, then the first counter-party must pay an amount equal to the difference between the two rates multiplied by the notional amount, for the specified interval. Conversely, if the floating rate paid by the second counterparty exceeds the fixed rate paid by the first counter-party, the fixed-rate payor receives payment. The agreed hypothetical or "notional" amount provides the basis for calculating payment obligations, but does not change hands.

For example, suppose Counterparties A and B enter into a five-year interest rate swap with the following characteristics: (1) Counterparty A agrees to pay a floating interest rate equal to LIBOR, the London Interbank Offered Rate;² (2) Counterparty B agrees to pay a 10% fixed interest rate; (3) both counterparties base their payments on a $1 million notional amount and agree to make payments semiannually. If LIBOR is 9% upon commencement of the first payment period, Counterparty B must pay A: (10%-9%) * $1 million * (.5) = $5,000. These net payments vary as LIBOR fluctuates and continue every six months for the term of the swap. If interest rates rise, the position of Counterparty B, the fixed-rate payor, improves because the payments it receives increase. For example, if LIBOR rises to 11% at the beginning of the next payment period, Counterparty B receives a net payment of $5,000 from A. Conversely, the position of Counterparty A, the floating-rate payor, improves when interest rates fall. The party whose position retains positive value under the swap is considered "in the money" while a party with negative value is considered "out of the money." As discussed previously, the $1 million notional amount never changes hands.

Almost all interest rate swaps are documented with (1) a confirmation and (2) master agreement. Typically, master agreements are standard form agreements prepared by the International Swaps and Derivatives Association ("ISDA"). The master agreement governs all interest swap transactions between the counterparties. It includes provisions generally applicable to all swap transactions including: payment netting, events of default, cross-default provisions, early termination events and closeout netting.

Most master agreements provide that, in the event of an early termination or default, the party in the money is entitled to collect "termination damages." Termination damages represent the replacement cost of the terminated swap contract and are generally determined by obtaining market quotations for the cost of replacing the swap at the time of termination. Some master agreements, such as those at issue here, do not permit the defaulting party to collect termination damages.

Interest rate swap agreements provide a powerful tool for altering the character of assets and liabilities, fine tuning risk exposure, lowering the cost of financing or speculating on interest rate fluctuations. Borrowers can rely on interest rate swaps to reduce exposure to adverse changes in interest rates or to obtain financing characteristics unavailable through conventional lending. Interest rate swaps can modify a borrower's all-in funding costs from fixed-to-floating, floating-to-fixed or a combination of both.

Interest rate swaps have become an important part of international and domestic commerce, and the market for these instruments has experienced explosive growth. The ISDA has estimated that the collective notional amount on interest rate swaps reached $2.3 trillion in 1990, $12.8 trillion in 1995 and $22.3 trillion in 1997.³

II. FACTUAL AND PROCEDURAL BACKGROUND

1. FACTUAL OVERVIEW

In August 1989, Golden West Refining Company ("GWR"), a Thrifty subsidiary, solicited proposals for a $75 million term loan from BofA and other potential lenders. GWR sought the loan to refinance a $52.1 million secured note that bore interest at an 11% fixed rate, and to finance capital improvements. GWR's financing goals included obtaining a commitment for up to $75 million in medium-term debt, with a fixed interest rate below 11% on the initial $50 million borrowing. On September 29, 1989, BofA submitted a written proposal to GWR. Working from the BofA proposal as a baseline, GWR and BofA negotiated a term sheet and exchanged several drafts between October 1989 and January 1990.

On January 12, 1990 GWR accepted a final term sheet for the loan. The term sheet provided a floating-rate term loan and required GWR to enter into one or more interest rate swaps to hedge the term loan's interest rate fluctuations. BofA permitted GWR to obtain the swaps up to six months after the term loan closed, from any suitable swap dealer. The term sheet further stated that BofA would syndicate the loan and act as agent. Syndication refers to a process whereby several lenders make a loan and one lender, the agent, maintains responsibility for loan administration. BofA agreed to fully fund the term loan pending syndication.

On July 30, 1990, BofA and GWR entered into a term loan agreement that incorporated these provisions. The agreement required GWR to draw down at least $43 million under the term loan and enter into at least $43 million in interest rate swaps. The agreement provided that the loan and swaps would be cross-collateralized and cross-defaulted. On the same day, Thrifty executed an unsecured guaranty in which it guaranteed GWR's obligations arising out of the term loan and swap agreements. The next day, BofA funded an initial $45 million borrowing.

Between June 20, 1990, and August 1, 1990, GWR executed three separate interest rate swaps with BofA aggregating $45 million. The effective dates for the three swap agreements ranged between August 1 and August 3, 1990, substantially coinciding with the closing of the term loan.⁴ All three swaps followed an amortization schedule that closely followed the payment schedule of the term loan,⁵ and all three swaps had termination dates of December 31, 1997 — the maturity date for the term loan. Thus, within three days after the term loan closed, the parties had matched the loan with swaps in the same notional amount, for the same term, and following approximately the same amortization schedule.⁶

BofA sent GWR a confirmation for each interest rate swap that provided that BofA and GWR would sign a standard form agreement recommended by the ISDA. BofA and GWR signed a standard ISDA Master Agreement in January 1992. The agreement provided that the bankruptcy of either party would terminate the swaps and entitle the non-bankrupt party to recover termination damages, if any.

Through the combination of the term loan and the three swaps, GWR synthetically obtained $45 million in medium-term, fixed-rate financing. Under the term loan, GWR paid interest on $45 million computed at a floating rate plus...