Set-off - ISDA Provision

1992 ISDA

The 1992 ISDA contains no provision specifically allowing a right of set off. There is a definition of Set-off, however:

1992 ISDA

Template:ISDA Master Agreement 1992 Set-off Definition
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6(f) Set-Off. Any Early Termination Amount payable to one party (the “Payee”) by the other party (the “Payer”), in circumstances where there is a Defaulting Party or where there is one Affected Party in the case where either a Credit Event Upon Merger has occurred or any other Termination Event in respect of which all outstanding Transactions are Affected Transactions has occurred, will, at the option of the Non-defaulting Party or the Non-affected Party, as the case may be (“X”) (and without prior notice to the Defaulting Party or the Affected Party, as the case may be), be reduced by its set-off against any other amounts (“Other Amounts”) payable by the Payee to the Payer (whether or not arising under this Agreement, matured or contingent and irrespective of the currency, place of payment or place of booking of the obligation). To the extent that any Other Amounts are so set off, those Other Amounts will be discharged promptly and in all respects. X will give notice to the other party of any set-off effected under this Section 6(f).

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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Commentary

In a nutshell ^TM

Without prejudice to its other rights, an Innocent Party may set-off any part of an Early Termination Amount (in respect of all outstanding Transactions) against any “Other Amounts” payable under any agreement between the parties.

To do so it may:

convert one such amount into the other’s currency at a commercially reasonable rate.
make a good faith estimate of any unascertained obligation, provided it accounts for any difference when such an amount is finally ascertained.

The Innocent Party must give notice of any set-off.
This clause does not create a charge or other security interest.

1992 ISDA

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.

2002 ISDA

The 2002 ISDA contains a standard Set-off provision which refers to a “Payer” and “Payee”.

Affiliates: Either the "Payer" or the "Payee" could be the non-Defaulting Party or the non-Affected Party and so to include Affiliates into the 2002 Definition becomes problematic and cumbersome. Generally the market practice when using a 2002 schedule is therefore:
- Where Affiliates are required: to use bespoke wording;
- Where Affiliates are not required: and then fallback to the 2002 standard wording above.
Scope: The 2002 language provides for 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.The [Counterparty] standard wording provides for set-off where there is an Event of Default, CEUM, 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 in such circumstances.
- i.e., if you weren't terminating all Transactions, it would be drastic and counterproductive to a relationship to try to use a set-off clause!
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 Master 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.