Misrepresentation - ISDA Provision
2002 ISDA Master Agreement
Section 5(a)(iv) in a Nutshell™
Use at your own risk, campers!
Full text of Section 5(a)(iv)
Related agreements and comparisons
Content and comparisons
No change between 1992 ISDA and 2002 ISDA. Nothing to see here, folks. Move along please.
The purist’s objection is that, since a representation is a pre-contractual statement which induced the wronged party to enter the contract and (ergo) was not, and could not be, itself, a contractual term at all — its bolt was shot before minds met, so to speak — and as such, one’s remedy for misrepresentation ought to be to set aside the contract altogether — ab initio, as Latin lovers would say — voiding it on grounds of lack of consensus, and not suing for damages for breach of something which, by your own argument, never made it into the cold hard light of legal reality. The JC is nothing if not a purist. We feel that, as written, this provision is a mite misconceived.
Giving our friends at ISDA the benefit of the doubt we think ISDA’s crack drafting squad™ means “breach of warranty”, and were really just being loose with terminology. There again, unlike other, more fundamental obligations, misrepresentation as an Event of Default has neither a materiality threshold or the accomodation to the wrongdoer in the form of a grace period or even a warning notice, so perhaps not. Anyway.
This is where that mystifying Section 3(d) representation comes in.
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:
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
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 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”.
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.
How material is “material”?
What is a “material” respect? This is key, since some of the general representations (Consents, for example) are quite wide, and in this world of regulatory perma-change, the risk that one is, for example, outside technical compliance with a new regulation as it is implemented, notwithstanding a competent regulator’s informal indication that no action will be taken if you get your skates on and remediate quickly — it happened for MiFID II as thousands of financial firms raced headlong at the brick wall of that 3 January 2017 implementation date but it seems reasonable to suppose that materially must somehow impact your ability to carry out your obligations under a Transaction or the ISDA Master Agreement.
Representations by agents on agent’s own behalf
Where your client’s obligations under the ISDA Master Agreement are stewarded by an agent — quite common for an investment manager trading on behalf of a fund — a broker might think about having the agent represent, on its own behalf, about its role as agent. It might ask the agent to do this in the ISDA. The sound of an asset manager confirming its ongoing authority to bind its principal gladdens a broker’s heart. A full-throated assertion of its own regulatory authorisation; its continued good standing with the companies office; the continued involvement of its key persons in making investment decisions — each is sure to put a jaunt in a broker’s stride. Imaginative in-house counsel for the broker will doubtless dream up others.
But tarry a while. Firstly, your investment manager will sign as agent, for the client, not on its own behalf. For many this will be an article of profound faith: they will be at some pains, which they will willingly inflict on you, to avoid the barest hint they are speaking for themselves. “When an agent, as agent opens its mouth,” they will tell you, “it becomes its principal for all purposes that interest the law.”
And so it does. As far as the Courts of Chancery are concerned, to be an agent is to be wholly transubstantiated into the person of one’s principal. Transmogrified. It is, for all forensic intents to disappear; one’s ghostly outline may still be there, but it is a chimera: one exists only to be the earthly representation of another.
Which cast a pall over the representations you are being asked to make.
Take the one that “the principal has duly authorised the agent to act on its behalf”. For the principal to say that, through the person of the very one whose agency is in question, is some kind of Möbius loop. The very comfort you might draw from what is being said is taken away by the person who is saying it.
Even if the fact of the agency is in no doubt, the statements as to the agent’s character may be problematic. The agent is speaking for the principal, remember.
The exchange might go something like this:
- Agent (as agent): Why would I be authorised by the FCA? I am not advising anyone. In fact, my investment manager is advising me. Why don’t you ask her?
- Broker (rubbing its eyes and peering at the agent): But I am asking her. I mean you.
- Agent (as agent): Who?
- Broker: You! The investment manager for this blessed fund!
- Agent (as agent): Ah, but I am not me, for now, you see. I am the earthly representative of the fund. In my own personal capacity, I don’t exist.
- Broker: But you are here, aren’t you? Can’t I just quickly ask you? Can’t you just, you know, be yourself for a moment? It won’t take a mo —
- Agent (as itself): What? Here? In this ISDA? You must be joking. I told you under no circumstances will I act as principal.
- Broker (A light-bulb comes on): Aha! I've got it! All right then: can you make representations on behalf of your principal?
- Agent (as agent) (Thinks for a moment.): Why yes! Yes, I can! That’s what I’m here, as agent, to do! What would you like me to represent?
- Broker: Could you represent that your investment manager is duly authorised by the FCA?
- Agent (as agent): WELL HOW THE HELL AM I SUPPOSED TO KNOW THAT??
- Broker: What?
- Agent (as agent): Look: why don’t you ask the agent?
Assuming you can persuade your agent to represent, on its own behalf, about itself, as to these matters (whether in the master agreement itself or in a side letter):
- Due appointment, authority etc: This goes to the agent’s ostensible authority to bind its principal. If an investment manager breaches this kind or representation, then worst case the broker risks having no claim at all against the fund – if it can’t make out that there was ostensible authority.
- Now if (notwithstanding breach of this rep) the broker does still have a claim against the fund, then no harm no foul: we shouldn’t need to close out vs the fund unless/until there’s an independent failure to pay, in which case rely on that. But now we have actual knowledge of the agent’s lack of authority we may find we have a second problem: that there is no no-one with ostensible authority to bind the fund, and it is drifting rudderless towards a wall. If so, see below.
- If we don’t then our action is necessarily against the agent in its personal capacity and against its own assets, not the fund’s. It’s a claim in tort for negligent misstatement. Put yourself in the fund’s position here. Being itself a victim of the agent’s mendacity it will feel it is more sinn’d against than sinning and will not see why this should be a 3(d) representation under the ISDA Master Agreement. The fund will say “well hang on: I didn’t do anything wrong here: this asset manager is taking my name in vain without my consent – so how is it that you’re purporting to close out against me?
- Loss of manager’s regulatory status, no manager, no good standing etc: The other typical representations goes to a duly authorised manager’s continued ability to to act on the fund’s behalf: to manage positions, monitor risk tolerances and keep the ship steady. If the agent goes AWOL a [[[broker]] has some call to reduce risk against the fund. If the fund is a sports car, the broker’s ATEs are the measures it can take to prevent the car hitting a wall. As long as here is a competent agent driving the car, the broker can have some confidence the car will avoid walls by itself. If the driver is prevented from steering, the car will, eventually, hit the wall. So it is fair enough for the broker to say “okay: you are out of control: unless you name a new driver, within a given period ~ and here you may treat yourself to a fun exchange with your counterpart about how long that period should be ~ we can call this an ATE”.
- ↑ You are welcome.
- ↑ Swiss stay too, for that matter.
- ↑ Other than the representation itself, of course. That would be meta, and actually a bit of a strange loop.
- ↑ Yes; the whys and wherefores of ostensible authority are an endless delight; but we can at least say the risk is increased.