Event of default
The Jolly Contrarian’s Glossary
The snippy guide to financial services lingo.™
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 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
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.
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.
- Cross default
- Termination Event: a special type of half-arsed Event of Default arising under the ISDA Master Agreement.
- Events of Default and Termination Events generally under the ISDA Master Agreement.
- I just made that expression up, by the way