Borrowed money

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“Borrowed money” — often confused with indebtedness, although indebtedness is a wider concept — is a term of art used in financial contracts. It is a key part of the definition of Specified Indebtedness in the ISDA Master Agreement, which in turn is a key part of the definition of Cross Default.

“Borrowed money” is money another person paid you a propos nothing except the expectation that you will, at some point, pay it back. Your obligation to repay is a form of “indebtedness” to the lender. Indebtedness can arise without borrowed money, however: any legally binding obligation to pay another person a sum of money, however it arose, is indebtedness. Trade debts; tax liabilities, swap payments: all are types of indebtedness.

In the capital structure, unsecured borrowed money ranks equally (pari passu, in the lingo) with all unsecured payment obligations to creditors in the insolvency of the company that owes it, and ahead of amounts owed to shareholders, preferential shareholders and holders of subordinated debt.

Borrowed money and cross default

Borrowed money is the main difference in scope between Cross Default and Default under Specified Transaction — the former includes it, the latter (unless you monkey around with your definition) does not.

Are stock loans and repo trades “borrowed money”? The term is not generally defined: you are expected to know it when you see it. Quoth that sage old eminence gris, Simon Firth, in his book Derivatives Law and Practice:

“Borrowed money” ... means money which has been paid on the basis that it is to be repaid at a future date. It therefore excludes amounts that are due to ordinary trade creditors and financing arrangements (such as repos and the discounting of bills of exchange).

Mr Firth cites Transport & General Credit Corp. v Morgan [1939] CH 531 as authority for this point. But there's a better reason: because of their respective collateral structures — both are daily margined with a small haircut — neither involved significant indebtedness. The Borrower of a stock loan typically gives up more in value of Collateral than she “borrows” in stock. She isn’t really a borrower.

Furthermore — and this is a tail-wags-dog argument, but still — it is important that repo and stock lending are excluded from the compass of Borrowed Money, because otherwise the Cross Default provisions of an ISDA Master Agreement may be triggered by a failure under a repo. Even though they wouldn’t ordinarily be, even by another ISDA Master Agreement. Also this nugget, per Lord Devlin in Chow Yoong Hong v Choong Fah Rubber Manufactory [1962] AC 209:

“The task of the court in such cases is clear. It must first look at the nature of the transaction which the parties have agreed. If in form it is not a loan, it is not to the point to say that its object was to raise money for one of them or that the parties could have produced the same result more conveniently by borrowing and lending money. But if the court comes to the conclusion that the form of the transaction is only a sham and that what the parties really agreed upon was a loan which they disguised, for example, as a discounting operation, then the court will call it by its real name and act accordingly.”

See also

• Capital structure
• Cross Default
• Specified Indebtedness