Set-off - ISDA Provision
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ISDA Anatomy™
For this purpose, either the Early Termination Amount or the Other Amounts (or the relevant portion of such amounts) may be converted by X into the currency in which the other is denominated at the rate of exchange at which such party would be able, in good faith and using commercially reasonable procedures, to purchase the relevant amount of such currency. If an obligation is unascertained, X may in good faith estimate that obligation and set off in respect of the estimate, subject to the relevant party accounting to the other when the obligation is ascertained. Nothing in this Section 6(f) will be effective to create a charge or other security interest. This Section 6(f) will be without prejudice and in addition to any right of set-off, offset, combination of accounts, lien, right of retention or withholding or similar right or requirement to which any party is at any time otherwise entitled or subject (whether by operation of law, contract or otherwise).
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2002 ISDA
Set-off in the 2002 ISDA borrows from the text used to build it into the 1992 ISDA (see below) but still contains a rather elementary fluff. It imagines a world where the Early Termination Amount is payable one way, while all Other Amounts are payable the other.
For example:
- Payer owes Payee an Early Termination Amount of 10
- Payee owes Payer Other Amounts of 50
But what if there are Other Amounts payable the same way as the Early Termination Amount?
- Payer owes Payee an Early Termination Amount of 10
- Payer owes Payee Other Amounts of 40
- Payee owes Payer Other Amounts of 50
Not ideal. But fixable if you’re prepare to add some dramatically anal language:
- 6(f) Set-Off. Any Early Termination Amount (or any other amounts, whether or not arising under this Agreement, matured, contingent and irrespective of the currency, place of payment of booking of the obligation)” payable to one party (the “Payee”) by the other party (the “Payer”), ...}}
Cross-affiliate set-off
The 2002 ISDA’s Set-off provision refers to a “Payer” and “Payee”. Since either the “Payer” or the “Payee” could be the Innocent Party[1], including Affiliates into the 2002 definition becomes problematic and cumbersome.
Generally, market practice is therefore to do the following:
- Where Affiliates are required: to use bespoke wording.
- Where Affiliates are not required: use the 2002 ISDA standard set-off wording above.
But cross affiliate set-off is a pretty rum affair in any case. Generally set-off requires mutuality of payment, currency, time and counterparty, so setting off between affiliates is liable to challenge anyway (unless you have cross-guarantee arrangements). And in this modern days of bank recovery and resolution, conjoining claims between entities which are supposed to be siloed and independent isn't really the thing.
Scope of Set-off
The 2002 ISDA set-off wording allows set-off following an Event of Default, CEUM, or any other Termination Event where there is one Affected Party and all outstanding transactions are Affected Transactions.
Often brokers will also want to set-off where there is an Illegality or ATE. There is no specific reference to all Transactions being Affected Transactions but this is implied in any set-off provision by its nature:
- If only some transactions are Affected Transactions and so only a portion of outstanding transactions are being terminated then there is an on-going relationship and unilateral set-off is not appropriate.
- i.e., if you weren't terminating all Transactions, it would be drastic and counterproductive to a relationship to use a set-off.
- As such, the standard ISDA provision and the [Counterparty] provision are very similar in scope - the Tax Event and Tax Event Upon Merger provisions (those not caught by your wording) are more likely to only affect certain transactions and not all Transactions and therefore set-off is not likely to be relevant in such instances.
- Force Majeure: The 1992 ISDA contains no Force Majeure provision. Commercially, it is not likely that an ISDA would be closed-out as a result of a Termination Event as these are generally viewed as non-fault and set-off would generally not be relevant.
- Illegality does allow either party to terminate but this is limited to all Affected Transactions which may not result in a close-out of the entire ISDA. In fact, the definition used of Affected Transactions makes it clear that in the cases of Illegality, Tax Event Upon Merger or Tax Event then it will only be transactions affected by the Termination Event that are closed-out. In relation to ATEs and CEUM this will be all Transactions and so set-off is relevant.
1992 ISDA
The 1992 ISDA does not have a specific set off provision, although it manages to define Set-off, however:
Template:ISDA Master Agreement 1992 Set-off Definition ISDA published a provision in the Users Guide but several bespoke versions of a set-off provision developed and were used in the market. These often provided for the inclusion of Affiliates in relation to the Non-defaulting Party or Non-affected Party. It goes something like this:
- “Set-off. Without affecting the provisions of the Agreement requiring the calculation of certain net payment amounts, all payments under this Agreement will be made without set-off or counterclaim; provided, however, that upon the designation of an Early Termination Date following an Event of Default, or a Termination Event under Section 5(b)(iv) or Section 5(b)(v), in addition to and not in limitation of any other right or remedy (including any right to set off, counterclaim, or otherwise withhold payment or any recourse to any Credit Support Document) under applicable law the Non-defaulting Party or non-Affected Party}} (in either case, “X”) may without prior notice to any person set off any sum or obligation (whether or not arising under this Agreement and whether matured or unmatured, whether or not contingent and irrespective of the currency, place of payment or booking office of the sum or obligation) owed by the Defaulting Party or Affected Party (in either case, “Y”) to X or any Affiliate of X against any sum or obligation (whether or not arising under this Agreement, whether matured or unmatured, whether or not contingent and irrespective of the currency, place of payment or booking office of the sum or obligation) owed by X or any Affiliate of X to Y and, for this purpose, may convert one currency into another at a market rate determined by X. If any sum or obligation is unascertained, X may ingood faith estimate that sum or obligation and set-off in respect of that estimate, subject to X or Y, as the case may be, accounting to the other party when such sum or obligation is ascertained. Nothing in this Agreement shall create or be deemed to create any charge under English law.”
- ↑ i.e., non-Defaulting Party or the non-Affected Party.