2002 ISDA Master Agreement
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6(e) in a Nutshell™
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6(e) in all its glory
|6(e) Payments on Early Termination
. If an Early Termination Date
occurs, the amount, if any, payable in respect of that Early Termination Date
(the “Early Termination Amount
”) will be determined pursuant to this Section 6(e)
and will be subject to Section 6(f)
- 6(e)(i) Events of Default. If the Early Termination Date results from an Event of Default, the Early Termination Amount will be an amount equal to (1) the sum of (A) the Termination Currency Equivalent of the Close-out Amount or Close-out Amounts (whether positive or negative) determined by the Non-defaulting Party for each Terminated Transaction or group of Terminated Transactions, as the case may be, and (B) the Termination Currency Equivalent of the Unpaid Amounts owing to the Non-defaulting Party less (2) the Termination Currency Equivalent of the Unpaid Amounts owing to the Defaulting Party. If the Early Termination Amount is a positive number, the Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay the absolute value of the Early Termination Amount to the Defaulting Party.
- 6(e)(ii) Termination Events. If the Early Termination Date results from a Termination Event:―
- (1) One Affected Party. Subject to clause (3) below, if there is one Affected Party, the Early Termination Amount will be determined in accordance with Section 6(e)(i), except that references to the Defaulting Party and to the Non-defaulting Party will be deemed to be references to the Affected Party and to the Non-affected Party, respectively.
- (2) Two Affected Parties. Subject to clause (3) below, if there are two Affected Parties, each party will determine an amount equal to the Termination Currency Equivalent of the sum of the Close-out Amount or Close-out Amounts (whether positive or negative) for each Terminated Transaction or group of Terminated Transactions, as the case may be, and the Early Termination Amount will be an amount equal to (A) the sum of (I) one-half of the difference between the higher amount so determined (by party “X”) and the lower amount so determined (by party “Y”) and (II) the Termination Currency Equivalent of the Unpaid Amounts owing to X less (B) the Termination Currency Equivalent of the Unpaid Amounts owing to Y. If the Early Termination Amount is a positive number, Y will pay it to X; if it is a negative number, X will pay the absolute value of the Early Termination Amount to Y.
- (3) Mid-Market Events. If that Termination Event is an Illegality or a Force Majeure Event, then the Early Termination Amount will be determined in accordance with clause (1) or (2) above, as appropriate, except that, for the purpose of determining a Close-out Amount or Close-out Amounts, the Determining Party will:―
- (A) if obtaining quotations from one or more third parties (or from any of the Determining Party’s Affiliates), ask each third party or Affiliate (I) not to take account of the current creditworthiness of the Determining Party or any existing Credit Support Document and (II) to provide mid-market quotations; and
- (B) in any other case, use mid-market values without regard to the creditworthiness of the Determining Party.
- 6(e)(iii) Adjustment for Bankruptcy. In circumstances where an Early Termination Date occurs because Automatic Early Termination applies in respect of a party, the Early Termination Amount will be subject to such adjustments as are appropriate and permitted by applicable law to reflect any payments or deliveries made by one party to the other under this Agreement (and retained by such other party) during the period from the relevant Early Termination Date to the date for payment determined under Section 6(d)(ii).
- 6(e)(iv) Adjustment for Illegality or Force Majeure Event. The failure by a party or any Credit Support Provider of such party to pay, when due, any Early Termination Amount will not constitute an Event of Default under Section 5(a)(i) or 5(a)(iii)(1) if such failure is due to the occurrence of an event or circumstance which would, if it occurred with respect to payment, delivery or compliance related to a Transaction, constitute or give rise to an Illegality or a Force Majeure Event. Such amount will (1) accrue interest and otherwise be treated as an Unpaid Amount owing to the other party if subsequently an Early Termination Date results from an Event of Default, a Credit Event Upon Merger or an Additional Termination Event in respect of which all outstanding Transactions are Affected Transactions and (2) otherwise accrue interest in accordance with Section 9(h)(ii)(2).
- 6(e)(v) Pre-Estimate. The parties agree that an amount recoverable under this Section 6(e) is a reasonable pre-estimate of loss and not a penalty. Such amount is payable for the loss of bargain and the loss of protection against future risks, and, except as otherwise provided in this Agreement, neither party will be entitled to recover any additional damages as a consequence of the termination of the Terminated Transactions.
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The 1992 ISDA does not define “Early Termination Amount” but refers to it obliquely in Section 6(e) as:
- ...The amount, if any, payable in respect of an Early Termination Date and determined pursuant to this Section ...
Correctly, it is best referred to as a “Section 6(e) Amount” under the 1992 ISDA, although of course everyone does call it the Early Termination Amount. This inevitability was recognised in the 2002 ISDA, where it is defined in Section 6(e) as follows:
- ... the amount, if any, payable in respect of that Early Termination Date.
But the 2002 ISDA also has a “Close-out Amount”, so you may want to know what the difference between the Early Termination Amount and the Close-out Amount, you know, is. Yes?
For our step-by-step guide to closing out an ISDA Master Agreement see Section 6(a).
The effect of Section 6(e)(i) is that in closing out an ISDA Master Agreement, first you must terminate all Transactions to arrive at a Close-out Amount for each one.
The Close-out Amount is the replacement cost for the Transaction, assuming all payments up to the Early Termination Date have been made — but in a closeout scenario, of course, Q.E.D. some of those will not have been made — being the reason you need to close out.
Hence the converse concept of “Unpaid Amounts”, being amounts that should have been paid or delivered under the Transaction on or before the termination date, but weren’t (hence, we presume, why good sir is closing out the ISDA Master Agreement in the first place).
So once you have your theoretical replacement cost for each Transaction, you then have to tot up all the Unpaid Amounts that had fallen due but had not been paid under those Transactions at the time the Transactions terminated. These include, obviously, failures by the Defaulting Party, but also amounts the Non-defaulting Party didn’t pay when it relied on the flawed asset provision of Section 2(a)(iii) to withhold amounts it would otherwise have been due to pay under the Transaction after the default but before it was terminated.
The close out itself happens under Section 6(e) of the ISDA Master Agreement and the recourse is to a net sum. Netting does not happen under the Transactions — on the theory of the game there are no outstanding Transactions at the point of netting; just payables.
Therefore, if your credit support (particularly guarantees or letters of credit) explicitly reference amounts due under specific Transactions, you may lose any credit support at precisely the point you need it.
Which would be a bummer. Further commentary on the Guarantee page.
On the difference between an “Early Termination Amount” and a “Close-out Amount”
The 1992 ISDA features neither an Early Termination Amount or a Close-out Amount, which many would see as a regrettable oversight. The 2002 ISDA has both, which looks like rather an indulgence, until you realise that they do different things.
A Close-out Amount is the termination value for a single Transaction, or a related group of Transactions that a Non-Defaulting Party or Non-Affected Party calculates while closing out an 2002 ISDA, but it is not the final, overall sum due under the ISDA Master Agreement itself. Each of the determined Close-out Amounts summed with the various Unpaid Amounts to arrive at the Early Termination Amount, which is the total net sum due under the ISDA Master Agreement at the conclusion of the close-out process. (See Section 6(e)(i) for more on that).
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- ↑ There is a technical exception here for Parties under a 1992 ISDA under which the First Method applies. But since the First Method is insane and no-one in their right mind would ever have it in a live contract, we mention it only for completeness.
- ↑ This is not to say it isn’t hugely over-engineered, all the same: regular readers will know that the JC would never not say that about the output of ISDA’s crack drafting squad™.