Accuracy of Specified Information - ISDA Provision
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2002 ISDA Master Agreement
Section 3(d) in a Nutshell™ Use at your own risk, campers!
Full text of Section 3(d)
Related agreements and comparisons
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Content and comparisons
ISDA’s crack drafting squad™ must have got this spot-on in their first attempt in 1992, because their successors in 2002 could not find so much as an inverted comma to change.
Summary
The fabulous Section 3(d) representation, giving one’s counterparty the right to close out should any so-designated representations turn out not to be true. This is sure to occupy an inordinate amount of your negotiation time — in that it occupies any time at all — because you are as likely to be hit in the face by a live starfish in the Gobi Desert as you are to close out an ISDA Master Agreement because your counterparty is late in preparing its annual accounts. But that’s a personal view and you may not rely on it.
The 3(d) representation, in the documents for delivery table in the Schedule, therefore covers only the accuracy and completeness of Specified Information and not (for example) whether Specified Information is delivered at all. For that, see Section 4(a) - Furnish Specified Information.
“Covered by the Section 3(d) Representation”
If one is required to “furnish” Specified Information under Section 4, two things can go wrong:
No show
One can fail to provide it, at all, in which case there is a Breach of Agreement, but be warned: the period before one can enforce such a failure, judged by the yardstick of modern financial contracts, is long enough for a whole kingdom of dinosaurs to evolve and be wiped out; or
It’s cobblers
One can provide the Specified Information, on time, but it can be a total pile of horse ordure. Now, here is a trick for young players: if your Specified Information is, or turns out to be, false, you have no remedy unless you have designated that it is “subject to the Section 3(d) representation”. That is the one that promises it is accurate and not misleading.
Might Section 3(d) not cover a representation?
Now you might ask what good an item of Specified Information can possibly be, if Section 3(d) didn’t apply and it could be just made up on the spot without fear of retribution — as a youngster, the JC certainly asked that question, and has repeated it over many years, and is yet to hear a good answer — but all we can presume is that in its tireless quest to cater for the unguessable predilections of the negotiating community, ISDA’s crack drafting squad™ left this preposterous option open just in case. It wouldn’t be the first time.
Legal opinions, and Credit Support Documents
A trawl through the SEC’s “Edgar” archive[1] reveals that the sorts of things to which “Covered by Section 3(d) Representation” results in a “No.” outcome are rare but not non-existent. It is things like “Legal opinion from counsel concerning due authorization, enforceability and related matters, addressed to the other party and reasonably acceptable to such other party”, or “Credit Support Documents”.
Annual reports
The other little fiddle — and it is a little fidgety fiddle — is to remark of annual reports that, yes, they are covered by that Section 3(d) representation, but with a proviso:
“Yes; provided that the phrase “is, as of the date of the information, true, accurate and complete in every material respect” in Section 3(d) shall be deleted and the phrase “fairly presents, in all material respects, the financial condition and results of operations as of their respective dates and for the respective periods covered thereby” shall be inserted in lieu thereof.”
As to these all, we go into further detail in the section below.
General discussion
More on “covered by the Section 3(d) Representation”
We went digging a little deeper. These are the only examples we could find before we got bored looking. In each case we are not persuaded these caveats accommodate anyone other than our value-adding learned friends:
Legal opinions
We suppose this is excluded because the Party to the ISDA is not the author of the legal opinion, nor professionally competent to pass on its contents (hence the need for the legal opinion in the first place), so should hardly be expected to be held to account should it turn out to be wrong.
But this, we submit, is to misunderstand in a profound way the point of a legal contract. Unlike criminal or even tort law, the law of contract is not an instrument of moral judgment. It cares only about economics: that one does, or does not, do what one has promised or — as in this case — that what one has represented to you is, or is not, true. The law of contract is broadly incurious about why.
The object of a legal opinion is to confirm the accuracy of a legal representation. Instead of simply representing that, for example, you have the regulatory permission to act as a swap dealer, you have a legal opinion to confirms that fact, from one who should know. If what that that legal opinion says is not true — if that one who should know in fact does not — then regardless of whose fault this is, or how egregious has been her negligence in being at fault, the regulatory permission required does not obtain, and the comfort your counterparty seeks from that legal opinion is misplaced. The representation is false, and the counterparty should be allowed out as a result.
Credit Support Documents
We imagine here the perceived fear is that a Credit Support Document, being an executed legal contract, does not have a truth or falsity independent of itself the bargain it represents and evidences, so cannot really be a misrepresentation. But in a funny sense a legal contract constitutes the agreement it evidences: sure; the legal accord is an immaterial, intellectual thing, a consensus ad idem that inhabits the incarcerated space that separates us, and it cannot be fully delimited by mortal, combustible paper.[2] But all the same, its written form can hardly contradict it. If the written agreement incontrovertibly says “I must go up” our legal compact can hardly require me to go down; the paper format surely constrains what one can take from, or give to, a contract.
That being the case, there is not really a meaningful sense in which a contract can “misrepresent” the actual accord it represents. or be “false”. There is something faintly, but elusively, paradoxical about this.
What might happen is that a counterparty submits a form that has been superseded, or terminated and thus is but a husk of an ex-contract; one that once existed but now does not. Alternatively, a truly mendacious counterparty might offer up a form that is not really a contract, or even evidence of one, at all: a forgery, or a fraud.
But in those cases, the operating cause of the falsehood is the party submitting the document, not the document offered by way of representation itself, and in each an innocent party is better protected if Section 3(d) Representation does apply.
Audited financial statements
Your adversary may try to crowbar in something like this, to satisfy her yen to make a difference and please her clients with her acumen and commercial fortitude:
- “or, in the case of financial information, a fair representation of the financial condition of the relevant party, provided that the other party may rely on any such information when determining whether an Additional Termination Event has occurred.”
This is predicated on the following reasoning: “In publishing the audit, the auditor itself is not making any greater representation than that the statements are a fair representation of the financial conditions. I’m no accountant. I didn’t even write the stupid audit. How am I supposed to know? Why should I give any representation about the content of the audit at all, let alone a stronger representation than the expert? I am not underwriting the work of some bean-counter at Deloitte.”
Fair questions, but they misapprehend what is being asked. The riposte is this: The Part 3 information you must supply is “Party B’s annual audited financial statements.” So the representation we are after is that you have handed over a fair, accurate and complete copy of those audited statements, not that the statements themselves, as prepared by the auditor, are necessarily fair, accurate and complete. To get that comfort, we have the auditor’s own representation of the company’s financial condition, and we don’t need yours.
For details freaks
Not providing documents for delivery is an Event of Default ... eventually
The importance of promptly furnishing[3] the documents for delivery goes as follows:
- By dint of Section 4(a) you agree to furnish each other Specified Information set out in Part 3 of the Schedule.
- By dint of Section 5(a)(ii) if you don’t then that can be a Breach of Agreement Event of Default (Section 5(a)(ii)). Be warned: you must pursue a tortured chain of nested double negatives and carefully parse the interplay between Sections 4(a) and 5(a)(ii) to grasp this, but it is true.
- But, Section 5(a)(ii) imposes a thirty freaking day grace period following notice before a Breach of Agreement counts as an Event of Default allowing termination. (A Failure to Pay or Deliver is excluded from that definition, by the way, because it has its own EOD with a much tighter grace period).
- So if you need a document “furnished” urgently and can’t wait a month for it (you might not, if you are a credit officer and it is a monthly NAV statement, for example) then you must upgrade a simple 5(a)(ii) Breach of Agreement to a full-blown Additional Termination Event.