Failure to Pay or Deliver - ISDA Provision

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2002 ISDA Master Agreement
A Jolly Contrarian owner’s manual

Section 5(a)(i) in a Nutshell
Use at your own risk, campers!

5(a)(i). Failure to Pay or Deliver. Failure by a party to make any payment or delivery when due under this Agreement which is not remedied by the first Local Business Day or Local Delivery Day after the party receives notice of the failure;

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Section 5(a)(i) in full

5(a)(i) Failure to Pay or Deliver. Failure by the party to make, when due, any payment under this Agreement or delivery under Section 2(a)(i) or 9(h)(i)(2) or 9(h)(i)(4) required to be made by it if such failure is not remedied on or before the first Local Business Day in the case of any such payment or the first Local Delivery Day in the case of any such delivery after, in each case, notice of such failure is given to the party;

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Related agreements and comparisons

Related Agreements
Click here for the text of Section 5(a)(i) in the 1992 ISDA
Comparisons
Click to compare this section in the 1992 ISDA and 2002 ISDA.

Resources and navigation

Resources Wikitext | Nutshell wikitext | 1992 ISDA wikitext | 2002 vs 1992 Showdown | 2006 ISDA Definitions | 2008 ISDA | JC’s ISDA code project
Navigation Preamble | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13 | 14
Events of Default: 5(a)(i) Failure to Pay or Deliver5(a)(ii) Breach of Agreement5(a)(iii) Credit Support Default5(a)(iv) Misrepresentation5(a)(v) Default Under Specified Transaction5(a)(vi) Cross Default5(a)(vii) Bankruptcy5(a)(viii) Merger without Assumption
Termination Events: 5(b)(i) Illegality5(b)(ii) Force Majeure Event5(b)(iii) Tax Event5(b)(iv) Tax Event Upon Merger5(b)(v) Credit Event Upon Merger5(b)(vi) Additional Termination Event

Index — Click ᐅ to expand:

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Content and comparisons

The significant change between 1992 ISDA and 2002 ISDA is the restriction of that grace period from three Local Business Days to one. And a bit of convolutional frippery in introducing Local Delivery Days as well.
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Summary

Failure to Pay under Section 5(a)(i) of the ISDA Master Agreement: where a party fails to pay or deliver on time and does not remedy before the grace period expires. The grace period for a 2002 ISDA is one Local Business Day; shorter than the three Local Business Days in the 1992 ISDA. This fact alone has kept a number of market counterparties on the 1992 form, nearly thirty years after it was upgraded.

CSAs

There’s a technical funny due to the American habit of insisting on a pledge-only 1994 New York law CSA and then designating it as a Credit Support Document (against the hopes and dreams of ISDA’s crack drafting squad™ when it drafted the Users’ Guide, but still), and that is a failure to pay under an English law CSA is a Section 5(a)(i) Failure to Pay or Deliver, whereas a failure to pay under a New York Law CSA is a Section 5(a)(iii) Credit Support Default. Doth any difference it maketh? None, so far as we can see.

Funny old world we live in.

Payments satisfied other ways

One from the tricks for young players department.

Say you have some awkward client who insists on a right to meet a credit support payments some other way? For example, by terminating other in-the-money Transactions, in lieu of ponying up cold, hard, folding spondoolies. Does this convert a hardcore payment obligation into something more vapid, vague and fluffy? Something that the failure to effectively carry out doesn’t quite qualify as a Failure to Pay or Deliver?

“Look, I know I didn’t meet my variation margin, but, Sir, your honour, I didn’t have to actually pay it. I was allowed to terminate something else in lieu. So while I could have sorted this all out with a payment — and I think we can all agree that might have been the most sensible thing to do — and I was obliged to sort this out somehow, I wasn’t obliged to sort it out with a payment. Sir. Your honour.”

Why might this matter? Isn’t it an Event of Default either way? What difference does it make whether it was a Breach of Agreement or a Failure to Pay or Deliver?

I can already see hands shooting up from the ISDA ninjas in the front row. And yes, my little tricoteuses, you are right. Grace periods. That is the difference. A Failure to Pay or Deliver has a grace period of one day.[1] A Breach of Agreement has a thirty day grace period. Even the hyenas will have given up and gone home by then.
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General discussion

There is an inverse relationship between the amount of time you will spend negotiating a point in an ISDA Master Agreement and the practical difference it will make once your ISDA Master Agreement has been inked and stuffed in a filing cabinet in a cleaning cupboard behind the lavatories electronically stored, data-enriched, in a comprehensive online legal data repositary.

Closing out an ISDA Master Agreement following an Event of Default

Here is the JC’s handy guide to closing out an ISDA Master Agreement. We have assumed you are closing out as a result of a Failure to Pay or Deliver under Section 5(a)(i), because — unless you have inadvertently crossed some portal, wormhole into a parallel but stupider universe — if an ISDA Master Agreement had gone toes-up, that’s almost certainly why. That, or at a pinch Bankruptcy. Don’t try telling your credit officers this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved NAV triggers are a waste of space.

In what follows “Close-out Amount” means, well, “Close-out Amount” (if under a 2002 ISDA) or “Loss” or “Market Quotation” amount (if under a 1992 ISDA), and “Early Termination Amount” means, for the 1992 ISDA, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to Section 6(e)”.

So, you will need:

(i) a Failure by the Defaulting Party to make a payment or delivery when due;
(ii) a notice by the Non-Defaulting Party under Section 6(a) to the Defaulting Party that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.
(i) The standard grace periods are set out in Section 5(a)(i). Be careful here: under a 2002 ISDA the standard is one Local Business Day. Under the 1992 ISDA the standard is three Local Business Days. But check the Schedule because in either case this is the sort of thing that counterparties adjust: 2002 ISDAs are often adjusted to conform to the 1992 ISDA standard of three LBDs, for example.
(ii) So: once you have a clear, notified Failure to Pay or Deliver, you have to wait at least one and possibly three or more Local Business Days before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 LBDs (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).
(iii) At the expiry of this grace period, you finally have a fully operational Event of Default. Now Section 6(a) gives you the right, by not more than 20 days’ notice[3] to designate an Early Termination Date for all outstanding Transactions. So, at some point in the next twenty days.
(iv) For this we go to Section 6(e), noting as we fly over it, that Section 6(c) reminds us for the avoidance of doubt that even if the Event of Default which triggers the Early Termination Date evaporates in the meantime — these things happen, okay? — yon Defaulting Party’s goose is still irretrievably cooked. For it not to be (i.e., if Credit suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run that argument unless the market was properly gyrating.

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See also

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References

  1. Three if you are one of those antediluvian types on a 1992 ISDA.
  2. Spod’s note: This notice requirement is key from a cross default perspective (if you have been indelicate enough to widen the scope of your cross default to include derivatives, that is): if you don’t have it, any failure to pay under your ISDA Master Agreement, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close their ISDA Master Agreement with your Defaulting Party because of it defaulted to you, even though (a) the Defaulting Party hasn’t defaulted to them, and (b) you have decided not to take any action against the Defaulting Party yourself.
  3. See discussion on at Section 6(a) about the silliness of that time limit.
  4. Or their equivalents under the 1992 ISDA, of course.
  5. See previous footnote.
  6. Or, in the 1992 ISDA’s estimable prose, “the amount, if any, payable in respect of an Early Termination Date and determined pursuant to this Section”.