What is being called a complete misunderstanding by a district court judge of a credit derivatives contract is causing some to question the clarity of credit default swap documentation. The Southern District Court of New York in February ruled that the French bank Societe Generale, as a protection seller in a CDS transaction, should pay the buyer and plaintiff Aon Financial Products, a division of Aon Corp., $10.1 million despite its failure to deliver bonds to SG. According to industry professionals, the decision was based on an entirely separate derivatives contract and viewed SG as more of a guarantor than a CDS party. SG filed an appeal to the decision in March, and oral argument is expected to begin in late August or September.

"It was, well, strange," said Lary Stromfeld, a partner in the capital markets department at Cadwalader, Wickersham & Taft LLP and lawyer on behalf of the International Swaps and Derivatives Association, which earlier this month filed an amicus brief on behalf of SG in the case. Although Stromfeld described the decision as an "aberration," he, along with others, said it is in the CDS market's interest that it not be upheld, should it be used as precedent in future cases. "I think the court just didn't understand what they were doing," Stromfeld said. " It is not like the court came up with a clever approach that nobody was thinking of, it just didn't understand this."

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