Miscellaneous - ISDA Provision
2002 ISDA Master Agreement
Section 9 in a Nutshell™
Use at your own risk, campers!
Full text of Section 9
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Template:M comp disc 2002 ISDA 9
What you see is what you get, folks: if it ain’t written down in the ISDA Master Agreement, it don’t count, so no sneaky oral representations. But, anus matronae parvae malas leges faciunt, as we Latin freaks say: good luck in enforcing that if your counterparty is a little old lady.
Note also that liability for a fraudulent warranty or misrepresentation won’t be excluded. So if your oral representation or warranty is a bare-faced lie, the innocent party can maybe still rely on it in entering the agreement, even if it isn’t written down, though good luck parsing the universe of possible scenarios to figure out when that qualification might bite.
Smart-arse point: A warranty is a contractual assurance, made as part of a concluded contract, and cannot, logically, be relied on by the other party when entering into the contract. An assurance on which one relies when deciding to enter into a contract is a representation.
The entire agreement clause is legal boilerplate to nix any unwanted application of the parol evidence rule. Which might be a problem because the time-honoured understanding between all right-thinking derivatives trading folk is that the oral agreement, between the traders is the binding legal agreement, and not the subsequent confirmation, hammered out between middle office and operations folk after the trade is done. Hasten to Section 9(e)(ii) — the Confirmation is only evidence of the binding agreement. Could that be it?
Entire agreement bunk
Section 9(a) isn’t quite as ludicrous as the Entire Agreement clause in the 2010 GMSLA, in that ISDA’s crack drafting squad™ craftily included all Confirmations in the definition of “Agreement” in Section 1(c), but it is still mostly bunk, seeing as (as per the above) the Confirmation isn’t the canonical binding Transaction anyway, and besides an “Entire Agreement” that you freely concede the parties could be orally augmenting or Confirming several times a day for the hereafter really isn’t a fabulously stout hook to hang your hat on should you wish to make a point out of it in forthcoming litigation. Actually, what would be the point you would wish to make about an entire agreement in litigation? Answers on a postcard please.
ISDA’s crack drafting squad™ takes a clause which didn’t really need to be said, and converts it into a monster. If we convert this to symbolic logic it must mean this:
Effective amendment or waiver =In writing AND [EITHER executed by each party OR confirmed by exchange of [EITHER Telex OR electronic message]]
“In writing” means recorded for posterity, in words ingestable by means of the eyes, as opposed to the ears. This is not the OED definition, I grant you — I made it up just now — but it zeroes in on the immutable fact that, whether it is on parchment, paper, cathode ray tube, LED screen or electronic reader, you take in writing by looking at it. Not orally — from the mouth — or for that matter, aurally — to the ears nor, in the JC’s favourite example, via semaphore, by a chap waving flags from a distant hill, but in visible sentences, made up of visual words.
Could “writing” include GIFs? Emojis? We suppose so — but do you “write” them, as such? — but to the wider question “can emojis be contractually significant?” the answer is undoubtedly yes.
Acceptance, to be legally binding, need not be “in writing”. Nor “orally”. Acceptance just needs to be clear. Whether one has accepted is a matter for the laws of evidence. There is little doubt that one who has signed, sealed and delivered a parchment deed by quill in counterpart has accepted its contents — it is about as good evidence as you could ask for, short of the fellow admitting it in cross-examination — but a merchant need not, and often does not, reach this gold standard when concluding commercial arrangements about town.
Who has not stumbled morosely into the newsagent of a Sunday morning, wordlessly pushed a copper across the counter and left with a copy of The Racing Post, not having exchanged as much as a glance with the proprietor? Do we doubt for an instant that a binding contract was formed during that terse interaction?
There is, in theory, a whole ecosystem of non-verbal communications — winks, nods, wags, shaken heads, facial tics and cocked eyebrows — and nor should we forget, those who stand on distant hills and communicate by smoke signal, Greek heroes who mis-communicate their safe return by sail colour or modern admirals who transmit instructions to the fleet by means of flag sequence.
Any of these can, in theory, convey offer, acceptance and consideration as well can a written or oral communication.
So WHAT THE HELL IS “INCLUDING A WRITING EVIDENCED BY A FACSIMILE TRANSMISSION” MEANT TO ADD? What even is “a” writing? But, readers, this brief sentence gets only worse. Then it says “AND executed by each of the parties” — so what, are you saying you have to get them to sign your fax copy, or re-transmit it over a telex?
And note, email does not count as an electronic messaging system. I know it seems odd, but that is the unambiguous text in the definition of “electronic messaging system”. So a waiver of a NAV Trigger by email, even by an exchange of emails, are not strictly enforceable. Though of course waivers unsupported by consideration are generally revocable on fair notice under English law anyway.
As a result ISDA’s crack drafting squad™ can pat itself on the back for having inserted as long ago as 1992 what, at the time, was an unnecessary clause but which turned out to anticipate a rather woeful decision of the Supreme Court in 2018.
“No oral modification” is a self-contradictory stricture on an amendment agreement, until 2018 understood by all to be silly fluff put in a contract to appease the lawyers and guarantee them an annuity of tedious work. But as of 2018 it is no longer, as it ought to be, a vacuous piece of legal flannel — thanks to what we impolitely consider to be an equally vacuous piece of legal reasoning by no less an eminence than Lord Sumption of the Supreme Court in Rock Advertising Limited v MWB Business Exchange Centres Limited if one says one cannot amend a contract except in writing then one will be held to that — even if on the clear evidence the parties to the contract later agreed otherwise.
This is rather like sober me being obliged to act on promises that drunk me made to a handsome rechtsanwältin during a argument about theoretical physics in a nasty bar in Hammersmith after the end-of-year do, which that elegant German attorney can not even remember me making, let alone wishing to see performed. Hold my beer.
In which ISDA’s crack drafting squad™ grapple with the existential question: if I close out all my Transactions because the other guy fundamentally breached the contract, can I still rely on the good bits of the contract to manage my risk position and enforce my bargain?
We are deep into ontological territory here, fellows.
The subtle difference between an event of default and a fundamental breach of contract
A fundamental breach of contract is a failure to perform its terms in such a way that deprives the other party of the basic benefit of the contract. This could be anything — like a duck, you know it when you see it — but beyond being an outright failure to perform one’s material obligations it need not, and logically cannot, be comprehensively articulated in the contract.
An event of default, on the other hand, is articulated, usually at painful length, in the contract, which then contains detailed provisions setting out what should happen, to whom, by when, if an event of default befalls either party.
Now while the same set of circumstances might be an event of default and a fundamental breach of contract — almost certainly will be, in fact — treating a case as an event of default is to see it as “infra-contractual action”, contemplated by and provided for within the four corners of the contract; while treating it as a fundamental breach is thereby to cast the whole contract into the fire. For what good are the promises in it, after all, if the other fellow won’t keep them?
Thus, alleging fundamental breach is to terminate the contract with prejudice to your remaining rights under it, and to prostrate yourself at the feet of the Queen’s Bench Division for redress by way of damages, being the liquidated net present value of those remaining rights, determined by reference to the golden streams of common law precedent, whose terms might not be quite as advantageous to you as those you might have asked for were you able to agree them in advance. These common law principles are about the contract, they are not rules of the contract. The contract itself it a smoldering husk.
Thus, an event of default leaves the contract on foot, while you exercise your options to extract the value of your party’s commitments under it, without resorting to the courts. A fundamental breach requires the intervention of our learned friends
Now in most scenarios, which route you take might not make a whole heap of difference: In a contract between a supplier and consumer, or lender and borrower, there is a fundamental asymmetry you can’t cure with fancy words: if the guy owes you stuff, or money, that he hasn’t ponied up, you will need the court’s help to get it out of him. But master trading contracts are normally more bilateral than that: you have exposure, I have collateral. Maybe, the next day, I have exposure and you have collateral. Close-out is a self-help option, and it is quicker and cleaner than praying for relief from the QBD. But exercising it requires the contract to still be there.
Netting and close-out
Why should this matter here? Well, because netting, in a word. Here the fabulous nuances of the ISDA Master Agreement come into play. Close-out netting — as we all know, a clever if somewhat artificial and, in practical application, quite tedious concept — is not something that just happens by operation of the common law. Set-off, which does, is a narrower and flakier thing requiring all kinds of mutuality that might not apply to your ISDA Master Agreement.
The contractual device of close-out netting, by contrast, relies on the patient midwifery of ISDA’s crack drafting squad™ and the sophisticated contrivances they popped into the ISDA Master Agreement: especially the parts that say all Transactions form a Single Agreement, and those long and dusty passages in Section 6 which painfully recount how one terminates those Transactions and nets down all the resulting exposures should things go tits up.
Now, it really wouldn’t do if one were found to have thrown those clever legal artifacts on the fire before seeking the common law’s help to manage your way out of a portfolio with a busted counterparty would it. Section 9(c) is there to avoid the doubt that you might have done so: Just because you’ve declared an Early Termination Date, that doesn’t mean all bets are off. Just the live Transactions.
As far as the JC can see, through his fogged-up, purblind spectacles, this doubt, like most, didn’t need avoiding and shouldn’t have been present in the mind of a legal eagle of stout mental fortitude: it is clear on its face that terminating a transaction under pre-specified mechanism in the contract is not to cancel the contract and sue for damages, but to exercise an option arising under it, and all your mechanical firepower remains in place.
Indeed, there is no mechanism for terminating an ISDA Master Agreement itself, at all. Even in peace-time. This has led at least one commentator to hypothesise that this proves that derivatives trading is all some kind of Illuminati conspiracy.
Is this intended to allow concurrent liability between contract and tort? Or is it just harmlessly stating the obvious?
In which the ISDA Master Agreement deals with the pointless topic of counterparts, and the workaday one of Confirmations.
Section 9(e)(i) Counterparts
There is an impassioned essay about the idiocy of counterparts clauses elsewhere. For now, just know this:
Black’s Law Dictionary has the following to say on counterparts:
- “Where an instrument of conveyance, as a lease, is executed in parts, that is, by having several copies or duplicates made and interchangeably executed, that which is executed by the grantor is usually called the “original,” and the rest are “counterparts;” although, where all the parties execute every part, this renders them all originals.”
Sometimes it is important that more than one copy of a document is recognised as an “original” — for tax purposes, for example, or where “the agreement” must be formally lodged with a land registry. But these cases, involving the conveyance of real estate, are rare — non-existent, indeed, when the field you are ploughing overflows with flowering ISDA Master Agreements, confidentiality agreements and so on. If yours does — and if you are still reading, I can only assume it does, or you are otherwise at some kind of low psychological ebb — a “counterparts” clause is as useful to you as a chocolate tea-pot.
Indeed: even for land lawyers, all it does is sort out which, of a scrum of identical documents signed by different people, is the “original”. This is doubtless important if you are registering leases in land registries, or whatever other grim minutiae land lawyers care about — we banking lawyers have our own grim minutiae to obsess about, so you should forgive us for not giving a tinker’s cuss about yours, die Landadler. 
ANYWAY — if your area of legal speciality doesn’t care which of your contracts is the “original” — and seeing as, Q.E.D., they’re identical, why should it? — a counterparts clause is a waste of trees. If the law decrees everyone has to sign the same physical bit of paper (and no legal proposition to our knowledge does, but let’s just say), a clause on that bit of paper saying that they don’t have to, is hardly going to help.
Mark it, nuncle: there is a chicken-and-egg problem here; a temporal paradox — and you know how the JC loves those. For if your contract could only be executed on several pieces of paper if the parties agreed that, then wouldn’t you need them all to sign an agreement, saying just that, on the same piece of paper? And since, to get that agreement, they will have to sign the same piece of paper, why don’t you just have done with it and have them all sign the same copy of the blessèd contract, while you are at it?
But was there ever a logical cul-de-sac so neat, so compelling, that it stopped a legal eagle insisting on stating it anyway, on pain of cratering the trade? There are little eaglets to feed, my friends.
Section 9(e)(ii) Confirmations
Trade versus confirmation: celebrity death-match
If a trader agrees one thing, and the confirmation the parties subsequently sign says another, which gives? A 15 second dealing-floor exchange on a crackly taped line, or the carefully-wrought ten page, counterpart-executed legal epistle that follows it?
TL;DR: The original oral trade prevails.
The confirmation is evidence of the transaction, but it does not override the original transaction terms, if they are different.
That is, the binding trade may be a phone call or a bloomberg chat. (This sits kind of uneasily with that Entire Agreement clause, but still.)
If there is a dispute about the terms of your confirmation, you are going to have to pull the tapes.
There are some very good reasons for this. Firstly, the original trade was done by the trader with the trading mandate. The confirmation will be punted out by some dude in ops who might not be able to read the trader’s handwriting. Ops can and will get things wrong. That is correctable on the record. The trader doesn’t “get things wrong”. If she does, you’re into mistake territory. The law on contractual mistakes is beloved by students of the law and misunderstood by everyone else. But, generally, if the trader erroneously executes a trade, and the trader’s counterparty understands it correctly, the trader, and the firm she works for, will be bound by the error. That’s not a contractual mistake. It’s just a bad trade.
By contrast, a settlements and reconciliations dude who sends out a confirm which carelessly misinterprets the trade log is not making a contractual mistake: he is incorrectly recording the contract. That wasn’t the trade (good or bad) that the trader did.
Similarly, the reconciliations dude who sends out a confirm which corrects an error made by the trader has no mandate to make that change. The error is the trader’s. The trader should live with it, and throw herself at the mercy of the jurisprudence of contractual mistakes if need be: it is not for said reconciliations dude to pull her out of a hole.
Dare we mention ... email?
Note also the addition of e-mail as a means of communication to the 2002 ISDA (email not really having been a “thing” in 1992). This caused all kinds of fear and loathing among the judiciary, when asked about it, as can be seen in the frightful case of Greenclose v National Westminster Bank plc.Oh dear, oh dear, oh dear.
Timely confirmation regulations and deemed consent
Both EMIR and Dodd Frank have timely confirmation requirements obliging parties to have confirmed their scratchy tape recordings within a short period (around 3 days). This fell out of a huge backlog in confirming structured credit derivatives trades following the Lehman collapse.
Roger Moore indahouse
Lastly, a rare opportunity to praise those maestros of legal word-wrangelry, ISDA’s crack drafting squad™. In Section 9(e)(ii), they contemplate that one might agree a Transaction “orally or otherwise”. This is a smidgen wider than the usual legal eagle formulation of orally or in writing. It shows that while the swaps whizzes were conservative about how to close out a Transaction, when putting one on you are constrained only by the bounds of your imagination and the limits of interpersonal ambiguity: not just written words, nor even oral ones, but the whole panoply of possible human communications: semaphore, naval flags, Morse code, waggled eyebrows, embarrassed smiles and any other kinds of physical gesture.
Waiver: a place where the laws of the New World and the Old diverge. Does one really need a contractual provision dealing with the consequences of a fellow’s good-natured indulgence when carrying on commerce under an ISDA Master Agreement? Those with an English qualification will snort, barking reference to Hughes v Metropolitan Railway and say this Section 9(f) is inconsequential fluff that goes without saying; those acquainted with the Uniform Commercial Code and the monstrous slabs of Manhattan will tread more carefully, lest they create a “course of dealing”.
Since the ISDA Master Agreement was designed with either legal system in mind, ISDA’s crack drafting squad™ came up with something that would work in either. To be sure, it is calculated to offend literary stylists and those wholse attention span favours minimalism amongst those who ply their trade in the old country, but it does no harm.
Different approaches to evidence of the contract in the UK and US
England and the US have taken different paths when it comes to respecting the sanctity of that four-cornered document representing the contract. Whereas the parol evidence rule gives the written form a kind of “epistemic priority” over any other articulation of the abstract deal in the common law, in the new world greater regard will be had of how the parties behave when performing their contract, and less significance on what at the outset they wrote down.
So whereas in England action to not insist upon strict contractual rights will have scarce effect on those rights (at best a waiver by estoppel might arise, at least until it is withdrawn), in the United States Uniform Commercial Code a “course of dealing” between the parties at variance with the written terms of their bargain will tend to override those written terms. Thus, by not insisting on the strict terms of her deal, an American risks losing that deal, and will be taken by the course of dealing to have agreed something else; whereas an Englishman, by granting such an indulgence, at worst suspends his strict contractual rights but does not lose them.
In this way the parol evidence rule is less persuasive in American jurisprudence than in British.
So suddenly, in Section 9(g) of all places, the members of ISDA’s crack drafting squad™ wake up out of their collective fever dream, and this is what they say: It’s like, “okay, so we wrote them; we did put them here — hands up, we admit it — but we don’t mean anything by them”. And what is a fellow to make of the headings before Section 9 that, short days ago, being a logical fellow, I read, enjoyed and imbued with symbolic meaning? Am I supposed to just throw that crystalline construct away now? It just seems such a waste.
Don’t you just love lawyers?
Template:M summ 2002 ISDA 9(h)
Three lookouts here.
One: Email isn’t included. According to her majesty’s judiciary, email is not included and does not count as an electronic messaging system. Let your klaxons blare. But at least the 1992 ISDA is equivocal about it: in the 2002 ISDA it is written into the definition of “electronic messaging system” that it doesn’t include email. I know it seems absurd at first glance — some would say it seems absurd having read the whole judgment in Greenclose v National Westminster Bank plc and thought about it at length over a hearty walk in the woods — but there it is: that is the law of the land at the time of writing.
Two: This might not so much matter were it not for another spectacular outing for her majesty's judiciary, in which Lord Sumption decided that a “no oral modification” clause means what it says. Hitherto is had been assumed to be an easy concession to pedantic lawyers to let then can march in triumph back to their clients having had their iatrogenic way, but it now actually means something. Strictly interpreting a NOM clause probably makes sense if you are contemplating the eternal verities on the hard benches of a law library — or your judicial chambers — but it makes none if your job is to manage the cut and thrust of daily operational contract management.
To be sure, most financial institutions have a military-industrial complex handling the negotiation of ISDA Master Agreements and other trading contracts, so a formal amendment is not likely to pass without copperplate script execution in any case. And where the agreement contains a manifest error, and the parties perform to its true intent, notwithstanding misdirected written text, does this give one side a free, unconscionable option? — who can say?
And as for waivers — especially when your credit department is in the thrall of setting NAV triggers it doesn’t monitor and isn’t likely to to exercise — by the lights of this clause you must formally confirm these waivers in writing, which is a profound waste of everyone’s time.
Three: Good luck reconciling the above with the Counterparts and Confirmations clause, which says, rightly, that the binding action on a Transaction is the moment the parties first agree it — that is, as likely as not, a phone call or Bloomberg chat, or in volume products, an electronic handshake between booking systems. Since a Transaction is a modification to the ISDA Master Agreement, the words above ring a bit hollow.
- ↑ Students of the absurd may enjoy our essay on that topic, here.
- ↑ Sail configuration can be tricky especially if you are absent-minded, however, as Theseus’ father-in-law might have told you, had he been around to do so.
- ↑ I know this sounds oddly, verisimilitudinally specific, but it actually isn’t. I really did just make it up.
- ↑ I just made that expression up, by the way
- ↑ In the counterparts article, as a matter of fact.
- ↑ The JC has great friends in the land law game, back home in New Zealand, and he doesn’t want to upset them — not that they are the easily upset types.
- ↑ Hughes v Metropolitan Railway
- ↑ § 1-303. Course of Performance, Course of Dealing, and Usage of Trade.
- ↑ Rock Advertising Limited v MWB Business Exchange Centres Limited