naked capitalism

Tonight provides yet another example of a blogger who brought an important stories to light not being credited by the MSM, in this case, a harsh preliminary ruling against JP Morgan in a dispute involving its client Televisa.

I was going to post on Felix Salmon’s story, which discussed some extraordinarily dishonest conduct by JP Morgan, for two reasons: first, to remind readers that the obsession with Goldman chicanery is providing a nice smokescreen for the rest of the industry, and second, for its larger legal implications. And now we have a third reason, the MSM not giving Felix the credit it would provide to a conventional reporter. Felix pointed out two days ago that the decision was made last month, yet the story was peculiarly ignored by the MSM; suddenly, the story graces the front page of the Wall Street Journal.

JP Morgan in particular is being treated with a degree of respect that it does not deserve. For instance, banking industry expert Chris Whalen derides the notion that JP Morgan was in better shape than the broker-dealers that teetered on the verge of failure in 2008. He describes JP Morgan as a $76 trillion (notional) derivatives exchange with a $1.3 trillion bank attached, and that serious turbulence in the derivatives markets would have been fatal to JPM. And let us not forget that while Goldman has become the bank that everyone loves to hate, there is no reason to think its behavior was materially worse than that of its peers (its brazenness and tone-deafness, however, are a completely different matter).

The second reason was the reasoning behind the in the smackdown by Judge Jed Rakoff against JP Morgan for its conduct involving a loan to a long-standing Mexican client, Televisa.

And now there is a third wrinkle, the Wall Street Journal’s belated interest in the piece and how the WSJ version leaves out some key details presented by Felix, and the omissions are all of items that make JP Morgan look even worse. Although I’ll give a recap and discuss some of the additional issues this case raises, I encourage readers to look at both pieces in their entirety. I think you’ll agree that Felix’s version is, hands down, a better job of reporting.

Brief synopsis: longstanding JP Morgan client Televisa raised $225 million in a loan through its subsidiary Cablevision to fund the acquisition of a fiber optics company. But the loan closed in 2008 and JPM was unable to syndicate it. JP Morgan turns to a bank owned by Carlos Slim…..who happens to be Televisa’s biggest and fiercest competitor….for help.

As Felix explains, JP Morgan could either assign the loan to the Carlos Slim’s bank, Inbursa, or sell it a participation. But an assignment required Televisa’s consent, which it refused to give. JP Morgan then threatened Televisa, saying it would proceed and sell a 90% participation. Televisa responded in writing that it believed this move would violate the credit agreement. But it gets better. Televisa said it was willing to give the same discount to buy back the entire loan that that Inbursa had offered for 90%. JP Morgan led Televisa to believe it was no longer negotiating with Inbursa when it is in fact finalizing that deal. (Note: the Wall Street neglected to mention the buyback offer and that JP Morgan misrepresented its dealings with Inbursa).

Felix adds:

….this was no ordinary participation agreement, either. It had all manner of extra bells and whistles in it, all of which were designed to (a) make it look very much like an assignment rather than a participation; and (b) extract information from Cablevisión and hand it over to Inbursa. As Rakoff says, “the agreement permits Inbursa to request and receive nearly unlimited information from Cablevisión”. And what’s more, if Cablevisión for any reason refuses to hand over such information, Inbursa can declare Cablevisión in default, and automatically convert the participation to a fully-fledged assignment.

Yves here. The Journal failed to say that the participation agreement was unusual, which could leave the reader with the impression that the information demands were typical. Without this key tidbit plus the Televisa offer to buy the loan back, it simply looks like Televisa is balking at JP Morgan, which wants to get out of the loan, having Inbursa as its only exit. Thus a reader might conclude that the information provided was reasonable, and JP Morgan was guilty of putting its interest ahead of its client’s only by having gone to Inbursa. The article completely leaves out the most duplicitous, destructive action: that JP Morgan rejected what on paper was a BETTER out, selling the entire loan back to Televisa, and instead conspired with Televisa’s biggest competitor in a scheme to suck competitively sensitive information out of Televisa.

Judge Rakoff, the same judge who rejected the initial settlement that the SEC and Bank of America had negotiated over the Charlotte bank’s failure to disclose Merrill’s deteriorating to shareholders pre the vote on the acquisition, was again unafraid to deliver a sharp rebuke:

JP Morgan, acting in bad faith, used the guise of a purported “participation” to effectuate what is in substance a forbidden assignment, with unusual provisions demanded by Inbursa that are calculated to give Inbursa exactly what the assignment veto in the Credit Agreement was designed to prevent. JP Morgan thereby violated, at a minimum, the covenant of good faith and fair dealing automatically implied by law in the Credit Agreement…

Yves here. I’m actually a bit gobsmacked to see this as the basis for a ruling, and hope it stands. I welcome input from corporate litgators, but this is my non-expert reading on what happened.

The normal basis for litigation under a contract are violations of the terms of the agreement (although counter suits can bring in issues outside the agreement. For instance, a colleague hired a decorator who proceeded to draft grandiose plans and refused to come up with anything within the budget stipulated at the outset. When he fired her, she submitted an outrageous final bill, what the entire project had he completed it with her should have cost. His attorney looked her drawings, which were blueprints and called for plumbing and walls to be moved. They sued her for practicing architecture without a license. She suddenly became much more willing to negotiate).

Now notice what happened here. Televisa had told JP Morgan in writing that it regarded going ahead as a breach of good faith and fair dealing. JP Morgan went ahead anyhow, because it clearly regarded this as a weak line of attack, one it thought would not fly in court. And my understanding is that good faith and fair dealing arguments are not common outside employment law.

A “bad faith” argument does not claim that the other side violated a particular contractual provision, but rather operated in a way that might be permissible on a narrow, technical reading. but flies in the face of the logic of the larger objectives of the agreement. Good faith and fair dealing is an assumption that undergrids all contracts. And before the “sanctity of contracts” crowd starts hooting and hollering, a general premise that parties will behave reasonably and perform in accordance with the objectives presupposed by the contracts is necessary for any system based on agreements to work. It is simply impossible for contractual system to function if both parties can easily resort to narrow, legalistic readings of the deal to screw the other side. As much as contracts often contemplate various scenarios, it would far too costly, both in negotiation and drafting costs, to devise contracts detailed enough to address all the ways sneaky people might welch on a deal.

This is merely a preliminary injunction, and Judge Rakoff has scheduled further hearings, but certainly looks like he is not buying what JP Morgan was selling.

This is a very encouraging sign, because the financial services industry has made an art form of sneaky practices and if good faith and fair dealings arguments become more successful as a tactic (possible given how badly the industry has overplayed its hand) that would be a badly needed counterbalance. Unfortunately, it is far too early to tell. This is only the first skirmish in this suit: JP Morgan might settle. But even if the case goes to trial, JP Morgan may believe that it can get the ruling overturned on appeal. I would not regard pursuing this suit as a wise move; Televisa could demand that JP Morgan and Inbursa produce their documents and e-mails about the the proposed “participation”, particularly those unusual terms that would have required Televisa to cough up sensitive information to its biggest competitor. Given that Televisa offered to match Inbursa’s purchase price, it isn’t hard to imagine that JP Morgan was willing to sacrifice (literally in this case) its client for either some fees or a promise of future business.

Even if JP Morgan might get a verdict against it overturned on appeal, the damage to its reputation of exposing the gory details of its double-dealing would outweigh any financial winnings. Bankers Trust made that error of judgment in a suit brought by Proctor & Gamble, and it never recovered from the repercussions of the public getting a full view of its predatory conduct.