Event of default

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An event of default is an action a counterparty takes which justifies the innocent party terminating the contract under its terms, closing out open transactions, and raining down fiery hell on the wronger and its affiliates, directors, officers, employees, agents and delegates.

Not the same as an enforcement event

Especially where the obligation in question is a repackaging, securitisation or asset-backed security, but even where it is not, an Event of Default is not the same as an “Enforcement Event”. Enforcement is the exercise of ones security rights under a security interest granted as credit support to the obligation. There are many reasons why, even upon an event of default, one might not want to enforce security, but in the case of an SPV, generally enforcing the security won’t do anything, because the diminution in value of the creditors claim will be to the secured assets themselves, not the solvency of the vehicle holding them so the presence or absence of the security is rather beside the point. More in our article on enforcing security.

Not (quite) the same as a fundamental breach of contract

An Event of Default has a different consequence to a repudiatory, or fundamental, breach of contract, even though the two are largely the same, and a “repudiation of contract” may even be characterised as an event of default.

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”,[1] 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.

Do termination mechanics override common law rights on breach?

If the contract stipulates “events of default” or sets out an express termination mechanism to be followed when events of default occur, does this override common law termination rights?

A question of some import as more ordinary contracts succumb to finance contract envy and contain unnecessary termination mechanisms, especially where negotiating power is not even, and institutional service providers flatly insist on unreasonably contractual rights.

Let us take an example. A paying agent may require 90 days’ notice of termination of its appointment, regardless of reason.

We might argue, “Well, we can live with that unless you have materially breached your contract. In that case, we would like to terminate at once.”

This does no more than state our common law rights. But the agent says no. We ask why, but it flatly shrugs and just says, “Well, that is not our standard. If you don’t like it you can always use another agent.” We may as well accept this: we have more chance of persuading a legless donkey to have another drink. And the other agents are likely to have equally ludicrous stances, if not on this exactly, then on similar topics.

It might occur to us that, whether we agree to this or not, as a philosophical matter, she who breaks a contract is in no position to insist on her counterparty observing it. The jig is up; by refusing to pay, the agent has detonated our fundamental bargain; what we wrote on this paper is no longer a live covenant, but is only good for evaluating our loss of the bargain we struck. We can terminate in a funk and sue for damages, regardless of the contract.

The alternative is to say, well, we anticipated non-performance and provided for it in the contract. We set out special rules: that is what each agreed to, so that is what must happen. The rules are that you must provide the necessary notice, come what may.

Deviation, fundamental breach and repudiation of contract

There are no contracts precisely on point, but some come close. Lord Denning MR — yes, that Lord Denning — made a heroic attempt to build a common law doctrine of “fundamental breach” in the sixties and seventies, wherein if a party’s breach of contract was so fundamental it would automatically discharge the whole contract, taking with it any remaining terms.

He did this to set aside warranties of merchantability on goods sold where there was clearly fraud and misrepresentation in their sale (possibly after sale and before delivery), holding that these fundamental breaches invalidated the whole contract and therefore warranty.

He picked a thread out of some old shipping cases, where a vessel contracted to carry goods on one route between two points sank whilst on an un-agreed deviation, thereby invalidating limitations on its liability which were predicated on it taking the agreed route, to a general principal. The notable case was Karsales v Wallis [1956] EWCA Civ 4.

While there was something admirable in the justice of Lord Denning’s outcome, its actual legal pedigree was suspect and, over a series of cases, the House of Lords had a different view: first, gently, in Suisse Atlantique Societe d’Armement Maritime S.A. v N.V. Rotterdamsche Kolen Centrale [1966] 1 Lloyd’s Rep 529 and then, when Lord Denning didn’t take that hint (and, in fact, rather mendaciously misconstrued it) bluntly in Photo Production Ltd. v Securicor Transport Ltd [1980] UKHL 2, overruling Lord Denning’s doctrine and holding that what happens to contractual terms on breach depends on what the contract says. This position was the law at least until the Unfair Contract Terms Act 1977.

For our purposes it seems worthwhile treating as separate the performed part of the contract and the unperformed part. A breach of contract does not void a contract from inception: anything you have agreed to and have already performed, or received, stays that way. It is the remainder of the fruit of the contract that matters. So, in Photoshop v Securicor, there was an exclusion for liability for damage caused by the defendant’s employees’ actions, and as these actions had happened before the termination of the contract, that was that. Photoshop’s entitlement was to be relieved from the obligation to continue to pay for Securicor’s property surveillance services, which it didn’t in any case need since Securicor’s employee had burned its premises to the ground.

Our case, as above, seems different: a notice period for no-fault termination of contract, and an absence of an explicit right to terminate “for cause” is a part of the contract that remains to be performed after the breach. If you, dear agent, have declared you will not make payments on my behalf, notwithstanding your clear obligation to do so, you have repudiated the contract, and cannot subsequently hold me to the terms that ask of me a notice period before terminating. I am entitled to treat the contract, now, as at an end. The notice period no longer applies. I am applying a common-law, extra-contractual right. Your protections and indemnities for what you did to that point still apply — there is no need to invoke Lord Denning or a total avoidance of the contract.

Under the master trading agreements

There is specific idiosyncratic lore attaching to the events of default under differing market standard master agreements, so go with alacrity to:

ISDA Master Agreement: Event of Default
2010 GMSLA: Event of Default
Global Master Repurchase Agreement: Event of Default

Not to be, although easily, confused with Termination Events under the ISDA Master Agreement. These are (in the main) kinder and gentler than Events of Default, arise from factors outside the parties control (Force Majeure, Tax Events, Credit Event Upon Mergers, Illegality and so on), and in many cases relate to some only and not all of the Transactions under the ISDA Master Agreement. They justify termination but at less punitive mid market terms. There are some Termination Events which are more like Events of Default, though: most of these are the tailored ones the parties agree as Additional Termination Events.

See also


  1. I just made that expression up, by the way