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 applicable

condition precedent specified in this Agreement. 

(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 

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 applicable
condition precedent specified in this Agreement. The condition precedent in Section 2(a)(iii)(1) will
cease to be a condition precedent to each obligation of the Non-defaulting Party on the Condition End Date,
if any.

(vi) For the avoidance of doubt, Section 2(a)(iii) applies to each obligation of each party under
Section 2(a)(i), after the application of Section 2(c) [i.e. Netting].

(vi)	For the avoidance of doubt, if the condition precedent in Section 2(a)(iii)(1) is not satisfied
with respect to a party (“X”) when an obligation of the other party (“Y”) would (but for such condition
precedent) become payable or deliverable to X under Section 2(a)(i), then the obligation of Y will become
payable or deliverable on the first to occur of (A) the date on which all applicable conditions precedent
to such obligation under Section 2(a)(iii) are satisfied, (B) the Condition End Date or (C) the date on
which all applicable conditions precedent cease to apply under any other provision of this Agreement. 

(view template)

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

2002 ISDA 

9(c) Survival of Obligations. Without prejudice to Sections 2(a)(iii) and 6(c)(ii), the obligations of the

parties under this Agreement will survive the termination of any Transaction.  For the avoidance of doubt,

notwithstanding the occurrence of the last scheduled due date for performance by a party under a Transaction,

any obligation of a party that would have become due under that Transaction but for Section 2(a)(iii) will:

 

(1) prior to the occurrence or effective designation of an Early Termination Date in respect of such

Transaction become due (together with interest in accordance with Section (9(h) (i)(3)(A)  2(e)) on

the first to occur of (A) the date on which all applicable conditions precedent to such obligation under

Section 2(a)(iii) are satisfied, (B) the Condition End Date or (C) the date on which all applicable conditions

precedent cease to apply under any other provision of this Agreement, and


(2) following the occurrence or effective designation of an Early Termination Date in respect of such

Transaction be taken into account in determining the amount payable in respect of such

Early Termination Date pursuant to Section 6(e). 

(view template)

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

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:

1992 ISDA 

2(e) Default Interest; Other Amounts. Prior to the occurrence or effective designation of an Early

Termination Date in respect of the relevant Transaction, a party that defaults in the performance of any

payment obligation will, to the extent permitted by law and subject to Section 6(c), be required to pay interest
 (before as well as after judgment) on the overdue amount to the other party on demand in the same currency

as such overdue amount, for the period from (and including) the original due date for payment to (but

excluding) the date of actual payment, at the Default Rate. Such interest will be calculated on the basis of

daily compounding and the actual number of days elapsed. If, prior to the occurrence or effective designation

of an Early Termination Date in respect of the relevant Transaction, a party defaults in the performance of

any obligation required to be settled by delivery, it will compensate the other party on demand if and to the

extent provided for in the relevant Confirmation or elsewhere in this Agreement. If a party does not pay 

any amount that, but for Section 2(a)(iii), would have been payable, it will, to the extent permitted by

applicable law and subject to Section 6(c), pay interest (before as well as after judgment) on that

amount to the other party on demand (after such amount becomes payable) in the same currency as the amount,

for the period from (and including) the date the amount would, but for Section 2(a)(iii), have been payable

to (but excluding) the date the amount actually becomes payable, at the rate  certified by the payer to be a

rate offered to the payer by a major bank in a relevant interbank market for overnight deposits in the

applicable currency, such bank to be selected in good faith by the payer for the purpose of obtaining

a representative rate that will reasonably reflect conditions prevailing at the time in that relevant market. 

(view template)

Additional Definitions in Section 14

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.

"Condition End Date" means the first Local Business Day after the date falling [   ] days after notice

is given by the Defaulting Party to the Non-defaulting Party that an Event of Default [specified in Section

5(a)(iv), 5(a)(v), 5(a)(vi) or 5(a)(vii)] or[, in the case of Section 5(a)(vii)(4),] Potential Event of Default

has occurred with respect to the Defaulting Party. 

(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.