The Recent Financial Crisis and Its Impact on Interest Rate Swaps: A Road to Recovery through the Frustration of Commercial Purpose Doctrine

The global financial crisis of 2007 and 2008 continues to affect many different aspects of the financial industry; everything from governmental regulations to the number of players in a once robust lending market. In June 2009, the US Department of the Treasury described the situation, saying, “Over the past two years we have faced the most severe financial crisis since the Great Depression.” Different parties pointed the figurative finger at one institution or another as being the culprit responsible for the damage, but it was not a single factor; rather, it was a combination of excessive speculation and egregious wrong-doing by a multitude of entities. The derivatives market was front-and-center in this ordeal, with some of the more detailed and complicated derivatives lying at the heart of the financial meltdown. This Note deals with vanilla interest rate swaps, the simplest form of derivative, and the financial crisis’ effects on both parties to interest rate swap transactions. Despite the so-called simplistic or vanilla nature of traditional interest rate swaps, this Note discusses the financial downturn’s drastic and complicated effect on these transactions. First, this Note provides a general overview of the derivatives market—interest rate swaps more specifically—and the financial crisis’ actual effect on the swaps. Second, this Note discusses the causes of action both American and British parties negatively affected by the swaps have brought in court and the manner in which the courts have disposed of these cases. As this Note will discuss, these traditional causes of action have almost exclusively failed in America, providing little consolation for the losers in these transactions. Third, this Note explains the doctrine of frustration of commercial purpose. Fourth and finally, this Note advocates the effectiveness of the doctrine of frustration of commercial purpose as a means of financial recovery for the losers in interest rate swaps during the