At the Intersection of Bank and Finance Derivatives: Who Has the Right of Way?

Abstract

This article begins in Part I with a discussion of the present status of Over-the-Counter (OTC) derivatives market. It focuses on the basic structure of a typical derivative transaction between a lender/counterparty and its borrower. This article describes the different basic types of derivative transactions presently being used in the OTC derivatives market. Further, the article describes the procedure of documenting a derivative transaction. Part II of the article develops the reasons behind a lender's often conflicting goals to both limit and encourage a borrower's use of derivative transactions. Part III explores the process of drafting loan documentation to limit the possibility of a borrower suffering financial losses from derivative transactions. Part IV discusses the role of a lender as a counterparty in a derivative transaction with its borrower. Through the lens of the holding of In re: Thrifty Oil Company, Part V primarily focuses the unique legal issue of unmatured interest in the bankruptcy area and how this may affect a lender/counterparty's ability to claim damages under derivative transactions previously entered into with its now bankrupt borrower.

Keywords: Derivative, Over the Counter, OTC, Bankruptcy, Derivative Documentation, Lender, Loan, bank, Thrifty Oil, Damages, setoff, ISDA, international swaps and derivatives association, master agreement

JEL Classification: G2, G21, G28, G29