Right to Terminate Following Termination Event - ISDA Provision
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2002 ISDA Master Agreement A Jolly Contrarian owner’s manual™
6(b) in all its glory
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Overview
Between the 1987 ISDA and the 1992 ISDA the changes were very superficial, as this comparison demonstrates.
Between the 1992 ISDA and the 2002 ISDA, there was a but more re-engineering, largely to account for the new Force Majeure Event and some tidying up, but beyond that Section 6(b) works in the same general way under the 1992 ISDA and 2002 ISDA. Here is a comparison of that.
Section 6(b)(i)
Updated in 2002 with special pleadings relating to the newly-introduced Force Majeure Termination Event.
Section 6(b)(ii)
Note in the 2002 ISDA there is no reference to Illegality (or for that matter Force Majeure, which did not exist under the 1992 ISDA but tends to treated rather like a special case of Illegality and therefore, we think, would have been included in this provision of the 1992 ISDA if it had existed ... if you see what I mean).
When the 2002 ISDA gets on to the topic of Illegality and Force Majeure it allows the Unaffected Party to cherry-pick which Affected Transactions it will terminate, but then seems almost immediately to regret it (see especially in Section 6(b)(iv)). Under the 1992 ISDA if you wanted to pull the trigger on any Termination Event, you had to pull all Affected Transactions. Under the 2002 ISDA it is only binary for the credit- and tax-related Termination Events.
Otherwise, but for one consequential change — 1992’s “excluding” became 2002’s “other than” — I mean, you can just imagine the barney they must have had in the drafting committee for that one, can’t you — the provisions are identical.
Section 6(b)(iii)
Be careful here: Under the 1992 ISDA, if your Failure to Pay is also an Illegality it is treated as an Illegality: if there are two Affected Parties you will face a significant delay when closing out. A bit of a trick for young players.
Note also that reference to Illegality has been excised from the 2002 ISDA version. They changed this because, in practice, it turned out to too be hard to implement a transfer or amendment after an Illegality. Folks realised that if an Illegality happens you don’t want to have to wait 30 days to terminate, especially if you can’t rely on 2(a)(iii) to withhold payments in the meantime.
Section 6(b)(iv)
Oh, this section 6(b)(iv) stuff
Is sure stirring up some ghosts for me.
She said, “There’s one thing you gotta learn
Is not to be afraid of it.”
I said, “No, I like it, I like it, it’s good.”
She said, “You like it now —
But you’ll learn to love it later”
- — Robbie Robertson[1]
One’s right to terminate early following an Illegality or the newly introduced Force Majeure Termination Event get a proper makeover in the 2002 ISDA, but otherwise, the provisions are the same, but for some formal fiddling in the drafting.
Summary
There is a difference between Termination Events that are non-catastrophic, and usually Transaction-specific, and those that are catastrophic, which are usually counterparty specific.
Non-catastrophic ones affecting just a subset of Transactions might be caused by, say, a Tax Event or a local Illegality, but in any weather do not concern the solvency, creditworthiness or basic mendacity of your counterparty. They generally won’t have much, directly, to do with your counterparty at all beyond the jurisdictions it inhabits and the laws it is subject to. These are generally the Termination Events, but not Additional Termination Events.
The catastrophic ones are by their nature affect — that is, “Affect” — all Transactions. These generally are the bespoke Additional Termination Events your credit department insisted on — or theirs did; they will have something to do with the naughtiness of lack of fibre of your counterparty (or you!), and these function for most respects a lot more like Events of Default.
Thus, in the drafting of ISDA Schedules, CSAs and so on, you will often find laboured reference to Events of Default and/or Termination Events which lead to Early Termination Dates with respect to all outstanding Transactions as some kind of special, hyper-exciting, class of Termination Event.
Lucky premium content subscribers get a lot more discussion about the practical implications of all the above and a table comparing the events.
Section 6(b)(i)
Note the difficulty of practical compliance with this provision, given a sizeable ISDA portfolio, and the requirement for actively monitoring not only standard Termination Events, but also Additional Termination Events, which may be counterparty or even Transaction-specific.
Be aware of the notices provision of the ISDA Master Agreement, especially if you’re using a 1992 ISDA and you were thinking of serving by email — NatWest Bank could tell you a thing or two about that, as this lengthy article explains — or if the world happens to be in the grip of madness, hysteria, pandemic or something equally improbable[2] like an alien invasion.
Section 6(b)(ii)
Once the Waiting Period expires, it will be a Termination Event entitling either party to terminate some or all Affected Transactions. Partial termination is permitted because the impact on an event on each Transaction may differ from case to case (eg transactions forming part of a structured finance deal like a repack or a CDO) might not be easily replaced, so the disadvantages of terminating may outweigh the advantages.
As far as branches are concerned this is relatively uncontroversial, especially if yours is a multi-branch ISDA Master Agreement. But there is an interesting philosophical question here, for, without an express pre-existing contractual right to do so, a party may not unilaterally transfer its obligations under a contract to someone else. That, being a novation, requires the other party’s consent. This is deep contractual lore, predating the First Men and even the Children of the Woods. So if the Affected Party identifies an affiliate to whom it can transfer its rights and obligations, the Non-affected Party still may withhold consent. True, it is obliged to provide consent if its policies permit but — well — y’know. Polices? Given the credit department’s proclivities for the fantastical, it’s a fairly safe bet they’ll be able to find something if they don’t feel up to it.
That is to say, this commitment falls some wat short of the JC’s favourite confection: “in good faith and a commercially reasonable manner”.
Note also that if an Non-Affected Party does elect partial termination, the Affected Party has the right to terminate some or all of the remaining Transactions: this prevents Non-Affected Parties being opportunistic. Heaven forfend.
Section 6(b)(iii)
Handwaving appeals to one another’s good natures with this talk of reasonableness and, of course, both parties will probably be incentivised to keep the trade on foot if some unfortunate tax eventuality comes about — seeing as they were incentivised enough to start it —but ultimately, this is an agreement to agree, however you dress it up, and is as contractually enforceable as one. That is, not very.
Section 6(b)(iv)
What a beast. If you track it through in Nutshell™ terms, it isn’t as bad as it looks, but you have the ISDA ninja’s gift for over-complication, and ISDA’s crack drafting squad™’s yen for dismal drafting, to thank for this being the trial it is.
To make it easier, we’ve invented some concepts and taken a few liberties:
“Unaffected Transaction”, which saves you all that mucking around saying “Transactions other than those that are, or are deemed, to be Affected Transactions” and so on;
Termination Event Notice: An elegant and self-explanatory alternative to “after an Affected Party gives notice under Section 6(b)(i)”.
We take it as logically true that you can’t give 20 days’ notice of something which you then say will happen in fewer than 20 days. Therefore, there is no need for all this “designate a day not earlier than the day such notice is effective” nonsense.
So with that all out the way, here is how it works. Keep in mind that, unlike Events of Default, Termination Events can arise through no fault of the Affected Party and, therefore, are not always as apocalyptic in consequence. Depending what they are, they may be cured or worked-around, and dented Transactions that can’t be panel-beaten back into shape may be surgically excised, allowing the remainder of the ISDA Master Agreement, and all Unaffected Transactions under it, to carry on as normal. So here goes:
Divide up the types of Termination Event
Tax ones: If a Tax Event or a TEUM[3] where the party merging is the one that suffers the tax, the parties have a month to try to rearrange matters between them, their offices and affiliates to avoid the tax issue. Only once that has failed are you in Termination Event territory. See Section 6(b)(ii) and 6(b)(iii).
Non-Affected Party ones: If it’s a CEUM[4], an ATE or a TEUM where the Non-Affected Party suffers the tax, then if the other guy is a Non-Affected Party, then (whether or not you are) you may designate an Early Termination date for the Affected Transactions.
Illegality and Force Majeure: Here, if you are on a 2002 ISDA, there may be a Waiting Period to sit through, to see whether the difficulty clears. For Force Majeure Event it is eight Local Business Days; for Illegality other than one preventing performance of a Credit Support Document: three Local Business Days. So, sit through it. Why is there exception for Illegality on a Credit Support Document? Because, even though it wasn’t your fault, illegality of a Credit Support Document profoundly changes your credit assessment (in a way that arguably, even a payment or delivery obligation doesn’t), and that is the most fundamental risk you are managing under the ISDA Master Agreement.
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- The JC’s famous Nutshell™ summary of this clause