Section 2(a)(iii) - ISDA Provision

I’m sorry I asked

Draft ISDA Section 2(a)(iii) Protocol

These amendments are being led by ISDA and are likely to take effect by protocol. These changes are separate to the ones being contemplated under DFA.

Intent of drafting

The revised text looks to address 4 concerns (each arising from English case law):

1. Time Limit: Will now be triggered by the Defaulting Partyserving notice on the Non-defaulting Party. Bank of England, FSA and Fed all keen for the period to be short (UK had suggested 1 month).
2. Gross/Net issue: (per Lomas v Firth Rixson and Marine Trade v Pioneer)
3. Due Date Expiry issue: (per Marine Trade)
4. Extinguishment issue: (Firth Rixson) and the "Terminated Transaction" issue (per Cosco).

Outstanding Issues

The revised language raises a few concerns.

1. Incurable Events of Default: ISDA was looking to apply the time restriction only in respect of "incurable" Events of Default". Not actually sure the list was sufficiently comprehensive to achieve that. Others have suggested to limit to Bankruptcy. Anyway, does not matter because none of that works under English law for capital reasons and so ISDA will be changing to apply the language to all Events of Default (FSA will require this).
2. The language is problematic where, for example, a Defaulting Party informs the Non-defaulting Party of a Misrepresentation. Non-defaulting Party waives the misrep and then the "defaulter" experiences a Default Under Specified Transaction. Would leave a gap on the CP.

Original Text of Section 2(a)(iii)

2002 ISDA 

2(a)(iii) Each obligation of each party under Section 2(a)(i) is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing, (2) the condition precedent that no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated and (3) each other condition specified in this Agreement to be a condition precedent for the purpose of this Section 2(a)(iii).

(view template)

Innocuous looking, isn't it. But then the Protocol of the Elders of ISDA had a go at fixing Metavante concerns. Now look what they've done:

Modified Text as per ISDA draft protocol

Section 2(a)(iii)

2002 ISDA
Template:ISDA Master Agreement 2002 2(a)(iii) Protocol
(view template)

Restatement of Section 9(c) Survival of Obligations in entirety:

2002 ISDA
Template:ISDA Master Agreement 2002 9(c) Protocol
(view template)

Amendment to Section 2(e) of the 1992 ISDA only

1992 ISDA
Template:ISDA Master Agreement 1992 2(e) Protocol
(view template)

NB there isn't a Section 2(e) in 2002 ISDA Master - this amendment is purely to bring the 1992 ISDAit in line with the 2002 provision on Interest and Compensation.

Additional Definitions in Section 14

In gory detail

1992 ISDA Template:ISDA Master Agreement 1992 Terminated Transactions Definition Protocol (view template)

2002 ISDA "Terminated Transactions” means, with respect to any Early Termination Date, (a) if resulting from an Illegality or a Force Majeure Event, all Affected Transactions specified in the notice given pursuant to Section 6(b)(iv), (b) if resulting from any other Termination Event, all Affected Transactions and (c) if resulting from an Event of Default, all Transactions, in each case under which a party has or may have any obligation, including, without limitation, an obligation to pay an amount that became payable (or would have become payable but for Section 2(a)(iii) or due but for Section 5(d)) to the other party under Section 2(a)(i) or 2(d)(i)(4) on or prior to that Early Termination Date and which remains unpaid as at such Early Termination Date. (view template)

In gory detail

1992 ISDA Template:ISDA Master Agreement 1992 Terminated Transactions Definition Protocol (view template)

2002 ISDA "Terminated Transactions” means, with respect to any Early Termination Date, (a) if resulting from an Illegality or a Force Majeure Event, all Affected Transactions specified in the notice given pursuant to Section 6(b)(iv), (b) if resulting from any other Termination Event, all Affected Transactions and (c) if resulting from an Event of Default, all Transactions, in each case under which a party has or may have any obligation, including, without limitation, an obligation to pay an amount that became payable (or would have become payable but for Section 2(a)(iii) or due but for Section 5(d)) to the other party under Section 2(a)(i) or 2(d)(i)(4) on or prior to that Early Termination Date and which remains unpaid as at such Early Termination Date. (view template)

2002 ISDA
Template:ISDA Master Agreement 2002 Condition End Date Definition Protocol
(view template)

Commentary

In a nutshell, what this does is:

• Allows the Defaulting Party to notify of an Event of Default or Potential Event of Default.
• That in turn starts the clock running on a period (to be agreed by the parties but (see Chris' note - likely to be no more than a month) in which the Non-defaulting Party has to decide what to do. During that period the Non-Defaulting retains its traditional right under 2(a)(iii) to suspend payments under the ISDA Master Agreement.
• upon expiry of that period the Event of Default no longer qualifies as a condition precedent to payment under the Section 2(a)(iii), so if the Non-Defaulting Party has not exercised its right to terminate, it must resume performance of the transaction.