Contractual Currency - 1992 ISDA Provision
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1992 ISDA Master Agreement
Section 8 in a Nutshell™ Use at your own risk, campers!
Full text of Section 8
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But for a burst of excitement and vigour by dint of which ISDA’s crack drafting squad™ found itself desirous of moving the obvious-stating “rate of exchange” definition from Section 8(b) to the main definitions section — a result of that unnecessarily defined expression also showing up in the 2002 ISDA’s new Section 6(f) — and for a mildly different way of expressing the idea of “commercial reasonableness” — Section 8 of the 1992 ISDA survived unscathed when overhauled for the 2002 ISDA.
There is no definition of Non-Contractual Currency in the ISDA Master Agreement. But I made one, because it makes life easier. Just go with me on this one.
Summary
This is what, in the bond world, they call a currency indemnity. A currency indemnity is a part of the boilerplate that is so deeply entrenched, a piece of cod that passeth so much understanding, that generations of legal eagles have just abided by it, never asking what it is or why it is there. The young JC was one such eagle.
The currency indemnity just is. You will find in in the ISDA, in loans, bonds, repacks — in fact sprayed wordily over almost any kind of financial instrument; a kind of comfy textual furniture to make it all seem serious and important.
In a nutshell: roll with it
So if you are in a hurry, stop there: a currency indemnity is fine; people don’t usually fiddle with it: leave it; carry on.
Do not expect much by way of negotiation (among others, for the same reason: no-one else knows any better than you do what one should negotiate in a currency indemnity).
For those who remain curious
For those with the time and deep natural curiosity, or who are vexed about the “i” word, we offer the following. Take it with a pinch of salt; after all, we wrote it with one.
Let’s say I borrow from you, in euros.
Being an OG in the international capital markets, in the course of my business I will truck in all kinds of flakey currencies, payments in kind and weird securities — but I will still promise to repay my loan from you, in euros. That is my resting, fundamental contractual obligation. Euros.
Now, being an OG, I will have a sophisticated treasury function to watch lovingly over my cashflows, and it will execute such hedges currency conversions and otherwise work whatever magic I need to meet my outgoings, including the principal and interest I owe you.
This much should not really be a surprise: I borrow in euros, I repay in euros.
But all this goes out the window if — heaven forfend, and all that — I go titten hoch. At this point my treasury team would find it hard to execute the necessary hedges and conversions, even if they weren’t wandering around outside the building, woozily clutching Iron Mountain boxes full of gonks, deal toys, tombstones, pilfered stationery and personal effects. But, alas and alack, they will be. This is the whole of the law.
Now the receivers and administrators will busily be calling in, converting and collecting and liquidating my remaining assets, cash balances and generally figuring out how to best sort out my creditors, of which you are but one. There is a disaster scenario in which a failed, or failing, debtor — me — has no euros and instead offers up cash in non-contractual currencies, by way of full or partial satisfaction of what I owe. This isn’t Local courts which administer my insolvency might oblige them to do this.
No, that isn’t what the contract preferred, but it is a fact of life, so the contract allows it. That is what the currency indemnity does. It gudgingly, grants that this sort of thing can happen and puts some parameters around what goes down in such a case.
Components of a normal currency indemnity
This will boil down to the following:
Limited discharge: A non-contractual currency will only discharge the debt to the value in the contractual currency that the creditor achieves by converting it into the contractual currency in the market on reasonable terms.
No prejudice re the shortfall: If there is a shortfall, the debtor remains immediately liable for the balance: that is, the partial payment in the non-contractual currency doesn’t somehow hamstring the creditor’s legal rights to go after the rest
Reimburse excess: If there is an excess — happy days, right? — the creditor should promptly return it. Ie the non-currency payment is only am unconditional payment to the extent of the debt. This is quite a complicated ontological concept which it is best not to think about, so call this an absolute payment with a contingent reimbursement right.
Court judgments: If you are imprudent to litigate with a capital markets OG in its own jurisdiction, and you are awarded damages in a non-contractual currency (the JC is no litigator but is given to understand local courts can do this sort of thing, whether the victor likes it or not), then the same issue arises, and it is treated the same way.
Separate indemnities: Just to bring home the point, if accepting the non-contractual currency does somehow operate to undermine or waive the primary obligation to pay in full in the contractual currency, then the obligations created by the currency indemnity clause stand as separate indemnity payments. (This, by the way, is “indemnity” in its narrow sense, as “a unilateral obligation to pay a defined sum of money not by way of recompense or damages for some other failure, but just because you have agreed to pay it” and not in its “Help! Help! We are all going to die under a Cardozan excess of indeterminate liability” sense.) This is probably most important in the context of judgment debts, where the debtor might (rightly) complain that it had no choice but to pay in the local currency, and therefore try to argue that that local currency judgment, if paid in full, should discharge the debt ad to hell with the vagaries of the foreign exchange markets. The currency indemnity should put, er, paid to that argument by constructing an entirely independent obligation to pay the balance.
No requirement to actually convert: You may see a rider, as in the ISDA, that one should not have to actually convert the currency you received at a loss to prove a loss: it is okay to keep your money in the tendered currency and not crystallise the position.
General discussion
Section 8(a)
One could have stopped after the first sentence, but it is a rare ISDA ninja that can help himself babbling. ISDA ninjas would make terrible used-car salespeople.
Why the ISDA Master Agreement feels the need to contemplate the discharge of obligations in one currency by payment of an amount in another — non-compliance with the clear terms of the contract in other words — we can only guess. The payer’s ability to plow this obverse furrow still depends on the payee’s good humour: the payee is not obliged to indulge the payer, but may, by converting the tendered amount into the Contractual Currency.
If there is a shortfall, the payer must pay it immediately — fair, since the payer is craving the recipient’s indulgence in the first place and is really courting a Failure to Pay or Deliver by his cavalier behaviour.
If there is an excess, the recipient must return it promptly — also fair, seeing as she didn’t ask to be paid in Brazilian Real, and had to go to all the trouble of converting it and faffing around at the FX counter at that little shop in the arcade near Liverpool Street.
Section 8(b)
Enforcing judgments in far-flung places
It is a fact of life that when enforcing a cross-border contract, you may find yourself journeying to foreign climes in a bid to prise assets and payments out of a foreign counterparty. Places like Italy. With the best will in the world, and the firmest written intentions that the agreement be governed by English law and justiciable exclusively by her majesty’s courts[1], that may still mean engaging with, and obtaining judgments from foreign court systems, if that is where your counterparty and its financial resources are located. Those courts may be obliged to award their judgments, about your judgment, in their local currency. That exposes you to FX risk. This clause requires the parties to true up — immediately, should the windfall accrue to the Defaulting Party, only promptly if it accrues to the innocent one — by reference to a fairly determined “rate of exchange”.
Nerd’s point: This obligation is, strictly speaking, an indemnity obligation, in the true sense of that concept, in that is a payment that becomes due by reference to an externality that was not caused by breach of contract (even though originally it might have arisen out of one). So that’s nice.
Rate of exchange
Abvout that “rate of exchange” — in the 1992 ISDA defined on the spot; in the 2002 ISDA promoted to the big league and featuring in the main Definitions section. Allow the JC a pet moan. Goddamn “definitions”.
You could scarcely ask for a less necessary definition. In their hearts, you sense ISDA’s crack drafting squad™ knew this, for they couldn’t find it in themselves to even capitalise it. In the 1992 ISDA, rate of exchange didn’t even make the Definitions section, but was half-heartedly tacked onto the end of a clause halfway through the Contractual Currency section. It made it into the 2002 ISDA’s Definitions Section only because it somehow wangled its unecessary way into the new Set-off clause (Section 6(f) of the 2002 ISDA).
But if two guiding principles of defining terms are (i) don’t, for terms you only use once or twice, and (ii) don’t, if the meaning of the thing you are considering defining is patently obvious — then “rate of exchange” comprehensively fails the main criteria of a good definition.
The JC’s general view is, all other things being equal, to ease comprehension, eschew definitions.
Also, could they not have used “exchange rate”, instead of rate of exchange?
Section 8(c)
So who even knew the things in Section 8(a) and 8(b) were indemnities?
They are, in the strict literal sense of an indemnity: a contractual promise to pay a sum of money (the difference between the amount paid in the Non-Contractual Currency and the actual amount owed in the Contractual Currency) in circumstances not (strictly) amounting to a breach; they are not in the popular (but misconceived) conception of an indemnity as some kind of all-conquering smart bomb.
Now, we must hush, if we want to get home at a reasonable hour, because the Indemnity is one of the JC’s pet subjects. Get him started and that’s the evening gone.
Section 8(d)
So if your clottish counterparty can’t follow simple instructions and sends you Lire rather than Pesetas, and thereby fails to cover your loss, as long as you can prove what the exchange rate was at the time you would have exchanged it into the Contractual Currency, you can recover a loss, even if you didn’t.
Now this, to me, seems a little controversial. What if the exchange rate dropped through the floor, then recovered, and the Non-Affected Party held his nerve. Can he then cherry-pick?
See also
References
- ↑ Yes, yes: or American law, before Judge Wapner in the People’s Court. I know.