Québec Court of Appeal affirms the importance of strict interpretation of margin agreements

In a recent decision, the Québec Court of Appeal affirmed that there are strong public policy reasons to uphold the contractual rights of full-service investment dealers under margin agreements¹. This decision complements the established Canadian jurisprudence which has strictly construed and applied “order execution only” dealer margin agreements².

What you need to know

• The Québec Court of Appeal affirmed a Superior Court decision requiring investor clients to pay for margin debts owing to the dealer after margin calls went unanswered and the dealer acted in good faith.
• The Court emphasized the importance of respecting the contractual rights of full-service investment dealers under margin agreements. While the Court confirmed—consistent with recent Supreme Court jurisprudence on good faith in contract (see Torys bulletins here and here)—that an investment dealer’s right to make a margin call must be exercised in good faith, the Court recognized that dealers need to be able to act quickly to enforce debt repayment in a margin call situation because equity values can change, rapidly multiplying losses.

The details

Background

This action was commenced by a full-service dealer against former clients for amounts owing after margin calls and account holding liquidations. The defendants were sophisticated investors and did not rely on their dealer for advice; the dealer’s role was limited to carrying out trades as instructed. The margin calls were made after the dealer realized that a glitch in its brokerage platform had impacted the calculation of available margin, essentially allowing the clients substantially more margin than they were entitled to. At the time the margin calls were made, the defendants’ accounts had equity deficiencies of over $7 million. Even after the securities were liquidated, the defendants’ accounts still had a margin debt of nearly $5 million.

Issue

Should the dealer be entitled to rely on the margin agreement by requiring the clients to pay the margin debt, even though the debt was caused in part by the dealer inadvertently giving the clients more margin than it should have?

Decision

The Québec Court of Appeal strictly construed and enforced the margin agreement, rejecting the defendants’ arguments that the dealer exercised its contractual rights “abusively” by liquidating the securities after making the margin call, and that the dealer’s systems were to blame for allowing the margin overrun to continue for so long. The Court found that the dealer acted in good faith, making an initial mistake and then acting as soon as it became aware of the pricing error. The Court recognized that dealers need to act quickly in a margin call situation because “the exposure of the broker in relation to a margin account can deteriorate very rapidly”³.

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This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

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