Ipso facto clause: Difference between revisions

From The Jolly Contrarian
Jump to navigation Jump to search
Created page with "{{g}}A provision allowing one party to terminate or accelerate a payment if the other party goes bankrupt. Generally invalid under the Bankruptcy Code because a trustee is..."
 
No edit summary
 
(8 intermediate revisions by the same user not shown)
Line 1: Line 1:
{{g}}A provision allowing one party to terminate or accelerate a payment if the other party goes bankrupt. Generally invalid under the [[Bankruptcy Code]] because a trustee is not bound by any provision that is conditioned on the debtor's insolvency.
{{a|netting|}}====Ipso facto clauses ====
Under the US [[Bankruptcy Code]], an insolvency administrator is not bound by a contractual term that is conditioned on the debtor’s insolvency and that allows a solvent party to [[terminate]], [[accelerate]] payments, or somehow take advantage on that other party’s [[bankruptcy]]. Such terms are known as “[[ipso facto clause]]s”.
 
11 USC §365(e)(i) states:
{{quote|
Notwithstanding a provision in an [[executory contract]] or unexpired lease, or in applicable law, an [[executory contract]] or unexpired lease of the debtor may not be terminated or modified, and any right or obligation under such contract or lease may not be terminated or modified at any time after the commencement of the case solely because of a provision in such contract or lease that is conditioned on—
:(A) the insolvency or financial condition of the debtor at any time before the closing of the case;
:(B) the commencement of a case under this title; or
:(C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement.}}
 
Relevant in an {{isdama}} because while the {{isdaprov|Bankruptcy}} {{isdaprov|Event of Default}} itself doesn’t offend the rule, arguably Section {{isdaprov|2(a)(iii)}}, which allows you to ''not'' [[close out]], and instead just cease paying what you owe him on the ISDA until he magically becomes ''un''bankrupt, does.
 
====Example: the “flip” clause in a synthetic CDO====
In {{casenote|Lehman Brothers Financing|BNY Corporate Trustee Services Limited}} the US Bankruptcy Court held a “flip” clause in one of [[Lehman]]’s [[synthetic CDO]]s was an unenforceable [[ipso facto clause]]. Here the [[flip clause]] that inverted the priority of creditors — ordinarily, a swap counterparty ranks ahead of noteholders in a [[credit-linked note]], which figures, since the economic point of the deal is for the noteholder to sell [[credit protection]] to the swap counterparty — so that [[CDO]] noteholders would rank ''ahead'' of the Lehman swap counterparty if Lehman defaulted under its swap with the CDO issuer.
 
====UK: the anti-deprivation principle====
In the United Kingdom, beyond the [[voidable preference]] provision (section 239) in the [[Insolvency Act 1986]] there is no ''statutory'' equivalent of America’s [[ipso facto rule]], but hundreds of years ago resourceful [[common law]] judges “discovered” an [[anti‑deprivation rule]] that, in the honeyed words of Sir William Page Wood V.C., in {{citer|Whitmore|Mason|1861|2J&H|204}}:
:“no person possessed of property can reserve that property to himself until he shall become [[bankrupt]], and then provide that, [[in the event of]] his becoming bankrupt, it shall pass to another and not his creditors”.
 
This required some wilfulness on the bankrupt’s part and not just inadvertence or lucky hap, but if you ''intend'' to defeat the standing bankruptcy laws you will not get away with it. [[Voidable preference]] laws, defeating hastily-contrived security interests over the assets of a sinking merchant, do much the same thing.
 
This feels quite a long way away from exercising a [[Bankruptcy]] [[Event of Default]], and so it has generally been regarded, until the [[coronavirus|global pandemic]] prompted some hasty and ill-thought-out legislative proposals in the spring of 2020.
 
It seems, at any rate, that the {{isdama}}’s Section {{isdaprov|2(a)(iii)}}, might resemble some kind of intended deprivation; merely crystallising one’s existing position and stopping it from going further down the Swanee, as one might do by closing out your {{isdama}} altogether, seems less so.
 
{{sa}}
*Section {{isdaprov|2(a)(iii}}) of the {{isdama}}.
 
{{ref}}

Latest revision as of 11:43, 7 May 2024

Netting resources
Click ᐅ to expand:
Tell me more
Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

Ipso facto clauses

Under the US Bankruptcy Code, an insolvency administrator is not bound by a contractual term that is conditioned on the debtor’s insolvency and that allows a solvent party to terminate, accelerate payments, or somehow take advantage on that other party’s bankruptcy. Such terms are known as “ipso facto clauses”.

11 USC §365(e)(i) states:

Notwithstanding a provision in an executory contract or unexpired lease, or in applicable law, an executory contract or unexpired lease of the debtor may not be terminated or modified, and any right or obligation under such contract or lease may not be terminated or modified at any time after the commencement of the case solely because of a provision in such contract or lease that is conditioned on—

(A) the insolvency or financial condition of the debtor at any time before the closing of the case;
(B) the commencement of a case under this title; or
(C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement.

Relevant in an ISDA Master Agreement because while the Bankruptcy Event of Default itself doesn’t offend the rule, arguably Section 2(a)(iii), which allows you to not close out, and instead just cease paying what you owe him on the ISDA until he magically becomes unbankrupt, does.

Example: the “flip” clause in a synthetic CDO

In Lehman Brothers Financing v BNY Corporate Trustee Services Limited the US Bankruptcy Court held a “flip” clause in one of Lehman’s synthetic CDOs was an unenforceable ipso facto clause. Here the flip clause that inverted the priority of creditors — ordinarily, a swap counterparty ranks ahead of noteholders in a credit-linked note, which figures, since the economic point of the deal is for the noteholder to sell credit protection to the swap counterparty — so that CDO noteholders would rank ahead of the Lehman swap counterparty if Lehman defaulted under its swap with the CDO issuer.

UK: the anti-deprivation principle

In the United Kingdom, beyond the voidable preference provision (section 239) in the Insolvency Act 1986 there is no statutory equivalent of America’s ipso facto rule, but hundreds of years ago resourceful common law judges “discovered” an anti‑deprivation rule that, in the honeyed words of Sir William Page Wood V.C., in Whitmore v Mason (1861) 2J&H 204:

“no person possessed of property can reserve that property to himself until he shall become bankrupt, and then provide that, in the event of his becoming bankrupt, it shall pass to another and not his creditors”.

This required some wilfulness on the bankrupt’s part and not just inadvertence or lucky hap, but if you intend to defeat the standing bankruptcy laws you will not get away with it. Voidable preference laws, defeating hastily-contrived security interests over the assets of a sinking merchant, do much the same thing.

This feels quite a long way away from exercising a Bankruptcy Event of Default, and so it has generally been regarded, until the global pandemic prompted some hasty and ill-thought-out legislative proposals in the spring of 2020.

It seems, at any rate, that the ISDA Master Agreement’s Section 2(a)(iii), might resemble some kind of intended deprivation; merely crystallising one’s existing position and stopping it from going further down the Swanee, as one might do by closing out your ISDA Master Agreement altogether, seems less so.

See also

References