Set-off - ISDA Provision

2002 ISDA Master Agreement A Jolly Contrarian owner’s manual™ Resources and navigation [[{{{1}}} - 1992 ISDA Provision|This provision in the 1992]] Resources Wikitext | Nutshell wikitext | 1992 ISDA wikitext | 2002 vs 1992 Showdown | 2006 ISDA Definitions | 2008 ISDA | JC’s ISDA code project Navigation Preamble | 1 • (a) (b) (c) | 2 • (a) (b) (c) (d) | 3 • (a) (b) (c) (d) (e) (f) (g) | 4 • (a) (b) (c) (d) (e) | 5 • 5(a) Events of Default: 5(a)(i) Failure to Pay or Deliver 5(a)(ii) Breach of Agreement 5(a)(iii) Credit Support Default 5(a)(iv) Misrepresentation 5(a)(v) Default Under Specified Transaction 5(a)(vi) Cross Default 5(a)(vii) Bankruptcy 5(a)(viii) Merger Without Assumption 5(b) Termination Events: 5(b)(i) Illegality 5(b)(ii) Force Majeure Event 5(b)(iii) Tax Event 5(b)(iv) Tax Event Upon Merger 5(b)(v) Credit Event Upon Merger 5(b)(vi) Additional Termination Event (c) (d) (e) | 6 • (a) (b) (c) (d) (e) (f) | 7 | 8 • (a) (b) (c) (d) | 9 • (a) (b) (c) (d) (e) (f) (g) (h) | 10 | 11 | 12 • (a) (b) | 13 • (a) (b) (c) (d) | 14 | Index: Click ᐅ to expand: 2002 ISDA 1992 ISDA Section 6(f) in a Nutshell™ Use at your own risk, campers! 6(f) An Innocent Party may, by notice, set-off any part of an Early Termination Amount payable by one party against any Other Amounts payable by the other under any other agreement, converting currencies if necessary and estimating unascertained obligations in good faith, but it must account for any difference between its estimate and the amount when it is finally ascertained. view template Full text of Section 6(f) 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). view template Related agreements and comparisons Click here for the text of Section 6(f) in the 1992 ISDA Click to compare this section in the 1992 ISDA and 2002 ISDA., but be warned they are quite different. Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

Content and comparisons

Neither the 1987 ISDA not the 1992 ISDA has a specific set-off provision, although the 1992 manages to define Set-off anyway.

ISDA published a suggested set-off provision in the 1992 User’s Guide, but no-one liked it, and before long several home-made versions were percolating around the market. These often permitted set-off between the Innocent Party’s Affiliates and the non-performing party.

ISDA’s crack drafting squad™ got the hint and implemented a fully-fledged set-off provision based on this language into the 2002 ISDA — but not without a little boo-boo. As to which, read on —

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Summary

One does not exercise a set-off right willy nilly. Unless one is, mutually, settlement netting (where on a given day I owe you a sum, you owe me a sum, and we agree to settle by one of us paying the other the difference) set-off is a drastic remedy which will be seen as enemy action. You would not do it, without agreement, to any client you expected to keep. So, generally, use set-off as a remedy it only arises following an event of default.

A bit of a bish in the 2002 ISDA

Set-off in the 2002 ISDA borrows from the text used to build it into the 1992 ISDA but still contains a rather elementary fluff-up: it imagines a world like our own, but where the Early Termination Amount is payable one way, while all Other Amounts are only payable the other. Life, as any fule kno, is not always quite that convenient.

For example:

Payer owes Payee an Early Termination Amount of 10 Payee owes Payer Other Amounts of 50 Net: Payee owes Payer 40.

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 Net: Payee owes Payer 40. Whoops: Payee is still owed 40 by Payer so is an unsecured creditor '

Not ideal. But fixable if you’re prepared 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”), ...

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General discussion

Red letter day for ISDA’s crack drafting squad™

Whatever else you might have to say about ISDA’s set off provision — and as this page demonstrates, there’s quite a bit to say — one thing that stands out is how appallingly drafted it is.

The expression, “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 make your head spin, but it is meant to strike two contingencies: All Transactions are being terminated, and one Party is at fault.

The ’squad’s own pedantic approach to drafting, which separates Events of Default from Termination Events, and labels the perpetrators differently (“Defaulting Party” for the former; “Affected Party” for the latter, is to blame here.

In any case one would only impose Section 6(f) set off where your counterparty has gone fully tetas arriba and you have terminated all Transactions. In any other cases you would effect set-offs by mutually-agreed-at-the-time payment netting, which does not require any pre-existing legal right.

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, 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 these 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 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 Master Agreement 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 Master Agreement. 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.

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See also

• Set-off generally
• Settlement netting

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