Illegality - ISDA Provision
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2002 ISDA Master Agreement A Jolly Contrarian owner’s manual™ 5(b)(i) in all its glory
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Overview
As its clause numbering indicates, Illegality is a Section 5(b) Termination Event — being one of those irritating vicissitudes of life that are no-one’s fault but which mean things cannot go on, and not a Section 5(a) Event of Default, being those perfidious actions of one or other Party which bring matters to an end which, but for that behaviour, ought really to have been avoided.
Note also the impact of Illegality and Force Majeure on a party’s obligations to perform through another branch under Section 5(e), which in turn folds into the spectacular optional representation a party may make under 10(a) to state the blindingly obvious, namely that the law as to corporate legal personality is as is commonly understood by first year law students. Who knows — maybe it is different in emerging markets and former Communist states?
For the silent great majority of swap entities for whom it is not, the curious proposition arises: what is the legal, and contractual, consequence of electing not to state the blindingly obvious? Does that mean it is deemed not to be true?
Summary
If the rules change, that is beyond your control, so it can’t be helped and hence Illegality is a Termination Event not an Event of Default. The 2002 ISDA develops the language of the 1992 ISDA to cater for insomniacs and paranoiacs but does not really add a great deal of substance.
An Illegality may only be triggered after exhausting the fallbacks and remedies specified in the ISDA Master Agreement.
Note the effect of section 6(b)(iv)(2) in the 2002 ISDA is to impose a Waiting Period of three Local Business Days before one can terminate for Illegality. There is no such waiting period in the 1992 ISDA.
The 2002 ISDA adds a Force Majeure termination event — Illegality is of course a sub-species of force majeure, so it is then obliged to artfully explain what happens when you have a Force Majeure that is also an Illegality. Section 5(c) (Hierarchy of Events) deals with this, providing that (i) Illegality trumps Force Majeure and (ii) Illegality and Force Majeure both trump the Failure to Pay and Breach of Agreement Events of Default. Given that Illegality is no longer subject to the “two Affected Parties” delay on termination (as it was in the 1992 ISDA), this is significant.
Since the 1992 ISDA is still in widespread use, especially in the New World, and Americans are not entirely blind to what goes on beyond their shores, they have seen the sense of the Force Majeure concept and often reverse engineer an equivalent Force Majeure provision in to their 1992s via the Schedule (I know, I know: why not just use the 2002 ISDA?) If yours is like that, then all this hierarchy chat may be useful to you.
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- The JC’s famous Nutshell™ summary of this clause
- Section 5(e): the head office and the branch
- Legal personality: the nature of head offices, branches and affiliates, and so on: a handy guide for when you can’t bring yourself to explain to the head of credit again why you don’t need a contract between two branches of the same entity.