Bankruptcy Code

The US bankruptcy code, as feared as it is venerated, is the progenotir of the Chapter 11 process, and also the legendary safe harbor for derivatives.

Safe harbor

The so-called “safe harbor” provisions excuse derivatives from much of the normal operation of the bankruptcy code which would usually afford an insolvent debtor some time to decide which contracts it wants to keep and which it no longer needs. If “contract” in this context, were construed as an “individual Transaction under an ISDA Master Agreement”, you can see how this might challenge close-out netting: not only would it scramble the intent of the flawed asset provision (the famed Section 2(a)(iii)), but the broken counterparty would want to keep those contracts with a value to it, and would insist its counterparty could line up as a creditor to enforce those it did not. This rather buggers up the idea of netting positive and negative values from different trasactions down to a single termination sum.

The Safe Harbor Provisions provide nondebtor counterparties to qualifying agreements with a bundle of rights, including the right to exercise contractual rights of termination and the netting of transaction termination values, as well as the ability to apply collateral to the amounts owed without regard to the automatic stay under section 362 of the Bankruptcy Code.

The safe harbor stipulates that for derivatives, the choice moves to the Non-Defaulting Party, who can choose whether to allow the debtor to keep the contract or close out.