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Merrill Lynch Capital Services, Inc v. Apache Structures

July 11, 2012

MERRILL LYNCH CAPITAL SERVICES, INC., PLAINTIFF,
v.
APACHE STRUCTURES, LLC, DEFENDANT.



The opinion of the court was delivered by: Dolly M. Gee United States District Judge

#:1290

FINDINGS OF FACT AND CONCLUSIONS OF LAW

This matter is before the Court following a bench trial which took place on July 6, 2010 through July 9, 2010. Kenneth Mennemeier of Mennemeier, Glassman, & Stroud LLP appeared on behalf of Plaintiff, Merrill Lynch Capital Services, Inc. Niloufar Zakariaie of Zakariaie & Zakariaie appeared on behalf of Defendant, Apache Structures LLC.

Having carefully reviewed the evidence and the arguments of counsel, as presented at trial and in their written submissions, the Court makes the following findings of fact and conclusions of law pursuant to Rule 52 of the Federal Rules of Civil Procedure.

I. FINDINGS OF FACT

1. Plaintiff Merrill Lynch Capital Services, Inc. ("MLCS") is a corporation organized under the laws of the State of Delaware. (Trial Ex. #3, at MLCS 000019.) Its principal place of business is in New York, New York. (Trial Ex. # 3, at MLCS 000025.)

2. Defendant Apache Structures LLC ("Apache") is a limited liability company organized under the laws of the State of Nevada, with business operations in Santa Monica, California. (Trial Ex. #3, at MLCS 000019, MLCS 00025.)

Apache's Swap Contracts With Merrill Lynch

3. In July 2007, Apache sought to enter into interest rate swaps to hedge its real estate investments. (Parties' Proposed Final Pretrial Conference Order [Doc. # 61] ("Admitted Facts"), Admitted Fact #1.) In particular, Apache wanted to reduce the risk to Apache from a variable rate loan with Nevada State Bank. (Amended Mikail Decl. [Doc. # 86] ("Mikail Decl.") ¶ 4, July 6, 2010).*fn1

4. An interest rate "swap" is a contract by which one party exchanges a cash flow stream based on a fixed-rate of interest on some "notional amount" (e.g., $5,000,000) with a "counterparty" who exchanges a cash flow stream based on a "floating" (i.e., variable) rate of interest on that same notional amount. (Admitted Fact # 2.) 5. In or around July 2007, Apache's manager, Halston Mikail, contacted Ramin Alizadeh, a financial advisor at Merrill Lynch, Pierce, Fenner & Smith, Inc. ("MLPFS"). (Admitted Fact # 3.) Alizadeh and his colleague Alan Wong, a MLPFS client associate, assisted Apache in opening accounts through which Apache could enter into interest rate swap contracts. (Admitted Fact #4.)

6. Apache opened a traditional securities brokerage account with MLPFS for the purpose of holding securities and a separate account for the purpose of holding assets that Apache pledged as collateral for its swap transactions. (Wong Decl. [Doc. # 79] ¶ 5, July 6, 2010.) Mikail was the only individual with authority to act on behalf of Apache with regards to its accounts at MLCS. (Admitted Fact # 10.)

7. When Mikail opened Apache's account with MLCS, he had 15 years of investing experience. (Admitted Fact # 14.) Although Mikail claimed at trial that he had no prior experience with swap contracts, he indicated on an April 2008 personal and financial data form sent to MLCS that he had five years of such experience. (Trial Ex. # 26 at MLCS 001023.) Mikail also had experience with two other swap contracts which were terminated in his favor in February and April 2008. (Trial Ex. ## 12, 23.) Regardless of the extent of his experience with swap contracts in particular, Mikail was a sophisticated investor who understood that there would be significant risks involved in swap agreements. (See also Trial Ex. # 3 at MLCS 000041.)

8. MLCS and Apache entered into a written agreement ("Agreement") which was a version of the International Swaps and Derivatives Association, Inc.'s ("ISDA") standard agreement. (Admitted Fact ## 5, 6.) MLPFS served as MCLS's custodian to hold posted collateral under the Agreement. (Trial Ex. # 3 at MLCS 000037-38.) MLCS agreed that it would be liable for the acts or omissions of MLPFS. (Trial Ex. # 3 at MLCS 000959.)

9. The Agreement sets forth the following pertinent terms:

a. "Governing Law. This Agreement will be governed by and construed in accordance with the laws of the State of New York without reference to choice of law doctrine." (Admitted Fact # 7; Trial Ex. # 3 at MLCS 000026.)

b. Paragraph 2, Subsection (a)(i): "Each party will make each payment or delivery specified in each Confirmation to be made by it, subject to the other provisions in this Agreement." (Trial Ex. # 3 at MLCS 000001.)

c. Paragraph 2, Subsection (a)(iii): "Each obligation of each party under Section 2(a)(i) is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing . . . ." (Id.)

d. Paragraph 5, Subsection (a)(iv) defines an "Event of Default" as follows: "A representation (other than a representation made under Section 3(e) or (f)) made or repeated or deemed to have been made or repeated by the party or any Credit Support Provider of such party in this Agreement or any Credit Support Document proves to have been incorrect or misleading in any material respect when made or repeated or deemed to have been made or repeated." (Trial Ex. # 3 at MLCS 000005.)

e. Paragraph 11 regarding "Expenses": "A Defaulting Party will, on demand, indemnify and hold harmless the other party for and against all reasonable out-of-pocket expenses, including legal fees and Stamp Tax, incurred by such other party by reason of the enforcement and protection of its rights under this Agreement or any Credit Support Document to which the Defaulting Party is a party or by reason of the early termination of any Transaction, including, but not limited to, costs of collection." (Trial Ex. # 3 at MLCS 000012-13.)

10. In August 2007, Apache entered into a swap contract with MLCS with a notional amount of $5 million. (Admitted Fact #15.) The contract had an effective date of February 19, 2008 and was to terminate ten years later on February 19, 2018. (Trial Ex. # 6.)

11. In October 2007, Apache entered into a swap contract with MLCS with a notional amount of $5.1 million. (Admitted Fact # 16.) The contract had an effective date of April 23, 2008 and was to terminate 10 years later on April 23, 2018. (Trial Ex. # 8.)

12. For each of these swap contracts, MLCS served as Apache's counterparty. Apache agreed to be the "Fixed Rate Payer" while MLCS served as the "Floating Rate Payer." (Trial Ex. ## 6-9.) As counterparties, MLCS and Apache acted in their own respective self-interest in an arm's length transaction and were not in the relationship of, for example, a broker and customer. (Fortgang Decl. [Doc. # 80], Ex. C at 000005, July 6, 2010; Trial Ex. # 103 at 5.)

13. MLCS required Apache to post two types of collateral in order to protect MLCS against the risk that Apache would be unable to pay for the value of its contracts. (Atwood Decl. [Doc. # 78] ¶¶ 10-11, July 6, 2010.) Apache posted "upfront collateral" at the beginning of the contract and MLCS kept this collateral for the duration of the contract. (Id.) MLCS required Apache to post 4% of the notional amount of the two swap contracts at issue (i.e., $404,000) as upfront collateral. (Trial Ex. ## 7, 9; Mikail Decl. ¶ 9.) MLCS also required Apache to post additional collateral depending on the fluctuations in the market. (Atwood Decl. ¶¶ 11, 18; Mikail Decl. ¶ 10.) These occurrences are commonly referred to as "collateral" or "margin" calls. (Id.) The two terms are used interchangeably herein.

14. If Apache failed to meet a collateral call, MLCS had the right to liquidate or "unwind" the swap agreement. (Mikail Decl. ¶ 10.) Mikail was very concerned about meeting collateral calls because he understood that failure to do so could result in MLCS exercising its right to unwind the swap agreement, which could prevent Apache from recouping its losses over the 10-year life of the contract. (See also Trial Ex. # 18 at MLCS 001230.)

15. When MLCS issued collateral calls, Alan Wong would typically inform Apache via email and attach a Counterparty Deal Detail Report showing the status of Apache's Collateral Account at the time MLCS generated the report. (Wong Decl. ¶ 9.)

16. Citibank held all cash collateral posted by counter-parties in a single account under the name of Merrill Lynch & Co. (Atwood Decl. ¶ 13.) MLCS and Citibank kept track of the amount of money paid into the account by each counterparty through a series of book entries. (Atwood Decl. ¶ 14.) Once a counterparty informed MLCS that it intended to meet a given collateral call, MLCS would issue a "preadvise" to Citibank. This preadvise alerted Citibank that a certain amount of money would be wired to Merrill Lynch's account. Citibank could not determine, however, which counterparty was going to send in the money based on MLCS' preadvise.

17. In April 2008, Apache requested and began receiving regular reports from Merrill Lynch's Client Valuation Group ("CVG Reports"). (Mikail Decl. ΒΆ 14.) These reports informed Apache of the "Mark-to-Market" ("MTM") or present value of the swap contracts as of the closing of the market on the prior day. This value was not available to Apache online or in any other form. Only Merrill Lynch could calculate the MTM and the value could fluctuate by thousands of dollars overnight. The CVG reports did not disclose the amount of cash ...


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