Contract Law in New AIG-Goldman Twist

The latest legal snarl in the financial mega crisis will turn on the meaning of basic contract law concepts of duress and waiver. At stake are the termination agreements between AIG and several large banks, including Goldman Sachs.

Under the termination agreements, orchestrated by the Federal Reserve Bank amid a panic verging on catastrophe, AIG paid the banks one hundred cents on the dollar for its obligations under credit default swaps, including on securities those banks helped to design or market. In the agreements, both sides purport forever to release the other from any and all claims, known or unknown, in any way connected with the devices.

Reports now suggest that AIG overpaid in the settlements and questions arise about whether AIG would have had legal rights to assert against those very banks arising out of the swaps being terminated. That puts the enforceability of the clauses in issue.

Financial termination agreements, as with other settlement agreements, often contain clauses where parties expressly relinquish other rights they may have. The enforceability of such provisions generally follows the law of contacts applicable to all agreements, with a twist.

Of general application, these agreements, like others, would not be enforceable if a party, say AIG, entered into the agreements under duress. That concept does not refer to mere economic straits that may lead a rational person freely to accept the release.

It refers to circumstances in which the other party to the agreement made an unlawful threat depriving the signing party of its volition, its free will. For the government-engineered termination agreements, the issue is whether those banks, along with the government, made any unlawful threats and whether those threats deprived AIG of its free will.

The record so far is limited on the factual environment, but one thing is clear: the release language was not included in the first draft of the termination agreements circulated November 6, 2008, but appeared in the draft circulated the next day. Why it was included, who proposed it, and whether AIG’s formal assent was the product of illegal overreaching remain to be examined.

Easier to analyze is the problem of the scope of the agreements, which expressly contemplate mutual release not only for claims known at the time of signing but for unknown claims, a term defined in the broadest, most abstract terms possible.

But the concept of waiver, a generally enforceable commitment in contracts as elsewhere, means the voluntary relinquishment of a known right. Under that definition, it is simply not possible to waive unknown claims, despite contrary recitations in a written agreement.

The termination agreements are governed by the law of New York state, whose contract law on duress and waiver are as straightforward as the foregoing. It does not seem irresponsible to suppose that AIG could, if it wished, join others now suing Goldman and other banks for misrepresentation and fraud in their sales of some of the securities that are connected to the credit default swaps the termination agreements purported to settle.

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4 Responses

  1. Joey says:

    I’m so sick of hearing about the mess those greedy executives created. They’re still trying to cash in on other people’s misfortunes, yet because of their connections and money, they are allowed to do whatever they want. When will the government finally start changing the corporate code to regulate their pay?: http://lawblog.legalmatch.com/2010/03/10/greedy-ceos-are-overpaid-pigs-also-do-not-fly/

  2. Query says:

    So why do you think AIG hasn’t sued GS yet? It’s getting bad legal counsel? GS is too big and bad to piss off?

  3. mark says:

    This seems premised on the “they overpaid” assertion, which seems legally incorrect. If A owes B $1 million and when it is time to pay, A could plausibly negotiate a lower number but B demands all of it in the nastiest way possible, there is no “overpayment”, just full payment. So there is no claim for money back. And if there is no claim for money back, the rest of this is just a matter of taste and wishful thinking and basically misses the legal point.

  4. Lawrence Cunningham says:

    mark:

    My premise isn’t the overpayment assertion but the issue of the validity of a broad prospective waiver of unknown claims. In your example, if A also says it’ll never sue B for anything whether A knows about its current right to do so or not, and A later finds out B defrauded it earlier in theire relationship, has A given up its right to assert that claim? Maybe so, but that’s an issue, separate from any assertion of overpaying (which, I agree, does not present a legal issue that I can see).