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ARTICLE · 22 MARCH 2007

Second Circuit Strictly Construes Credit Default Swap Contract

Pillsbury Winthrop Shaw Pittman
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On February 5, 2007, the United States Court of Appeals for the Second Circuit issued an important credit default swap (CDS) opinion indicating that such transactions should be strictly construed according to the terms of the contract at issue, without resort to the parties’ overall hedging strategy.

United StatesFinance and Banking
David Lindley
David Lindley
Dennis Callahan
Dennis Callahan

On February 5, 2007, the United States Court of Appeals for the Second Circuit issued an important credit default swap (CDS) opinion indicating that such transactions should be strictly construed according to the terms of the contract at issue, without resort to the parties’ overall hedging strategy. The court’s decision in Aon v. Société Générale1 reinforces traders’ reliance on the terms of the CDS form documentation promulgated by the International Swaps and Derivatives Association (ISDA).

CDSs are derivative instruments by which financial institutions and other businesses manage their exposure to credit risk. In a CDS, a buyer of risk protection negotiates with a risk protection seller for the seller to assume certain specified default risks. The risks specified in the CDS are taken by the seller in exchange for periodic payments by the CDS buyer. If a designated "credit event" occurs, the CDS buyer is able to put a specified deliverable obligation(s) to the CDS seller in

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