Default Under Specified Transaction - ISDA Provision
|
ISDA Anatomy™
|
5(a)(v) in a Nutshell™ (2002 ISDA edition)
- 5(a)(v) Default Under Specified Transaction. The party or one of its Credit Support Providers or Specified Entities:―
- (1) defaults on any payment due under a Specified Transaction (or any related credit support arrangement) and as a result that Specified Transaction is validly accelerated;
- (2) defaults on any final payment due under a Specified Transaction after one Local Business Day;
- (3) defaults on any delivery due under a Specified Transaction (or any related credit support arrangement) and, all Transactions under the relevant Master Agreement are validly accelerated; or
- (4) repudiates any Specified Transaction (or any related credit support arrangement);
Commentary
This is like Cross Default, but for non "borrowing" style transactions - for example swap agreements agreements and repos, but only transactions between the two counterparties and their referenced Credit Support Providers and Specified Entities.
If a Counterparty (or its Credit Support Provider or Specified Entity) experiences an Event of Default under a swap agreement (or other transaction falling within the definition of Specified Transaction, which is typically wide - but check the Agreement!) with you, this constitutes an Event of Default under the ISDA Master Agreement.
Acceleration, not Default
DUST is triggered by an acceleration following an event of default under the Specified Transaction, not upon default itself (except where that happens on maturity - see drafting point below). Since the Specified Transaction is between you and the other party to the ISDA Master Agreement, there is no great loss - it is within your gift to accelerate the other contract - and to achieve set-off you would have to do so anyway. This is less drastic than the corresponding Cross Default provision, which imports all the Events of Default from all Specified Transactions into the present one, even if the counterparty to the defaulted contract has itself waived its rights to exercise.
Drafting oddities
- Payment acceleration versus delivery acceleration: Upon a payment default under 5(a)(v)(1), only that particular transaction must be accelerated (it doesn't require full close out of the relevant Master Agreement. But on a delivery default under 5(a)(v)(3), that is only triggered if the whole Master Agreement is closed out.
- Final payments: The reason for the second limb of the definition is to catch final payments, which can't be accelerated, since they're already due.
What if I “jump the gun”?
Could a wrongfully submitted notice of default be treated as a repudiation/anticipatory breach by the "non-defaulting party" giving the other party at least the right to withhold payments on the basis that this would constitute a Potential Event of Default by the party submitting the notice? There’s not much law on point, but the starting point is “no” - it would simply be an ineffective notice. However, a non-payment on the basis of an ineffective notice would be impermissible and may itself amount to a Failure to Pay. But as to the mere dispatch of the notice itself, there is relatively recent case law[1] (albeit in the bond world) stating that an acceleration notice that is submitted wrongfully, i.e. when no actual event of default, is merely ineffective and does not give rise to a claim for breach of contract or damages from "defaulting party". Clearly this has not been considered in context of ISDA per se (and may be nuances here that would lead to different result) but at it is a start.
Differences between cross default and DUST
Ideally, cross default and DUST should be mutually exclusive. They are meant to dovetail with each other, not cross over. This will not stop mission creep from over-zealous credit departments, who will try to expand the scope of each, leading to all kinds of cognitive dissonances and righteous[2] indignation from the counterparty’s negotiator. As ammunition for your fruitless attempts to persuade the credit department to live in the real world for once, try these:
- Cross default generally references indebtedness where the exercising counterparty has significant loan-type exposure to the defaulter; DUST references bilateral derivative and trading transactions which tend not to be in the nature of indebtedness (it is true to say that the line between these can be gray, especially in the case of uncollateralised derivative relationships;
- Cross default is only triggered once a certain threshold amount of indebtedness is defaulted upon; DUST is triggered upon any breach;
- Cross default references your Counterparty owes to a third party outside your control; DUST references other obligations your counterparty owes you or an affiliate you can reasonably be expected to be in league with. (ie you can't generally trigger if your counterparty defaults on Specified Transactions it has on with third parties)
- DUST only comes about if the Specified Transaction in question has been actually accelerated, whereas cross default is available whether the primary creditor has accelerated or not. (A cross default which requires acceleration is called “cross acceleration”.)
See also
References
- ↑ Concord Trust v The Law Debenture Trust Corporation plc
- ↑ And, to be candid, rightful.