Potential Event of Default - 1992 ISDA Provision
Content and comparisons
See especially how the inclusion of Potential Event of Default makes the much talked-about, seldom understood Section 2(a)(iii) condition to payments far more sensitive than it has any right to be.
Summary
A Potential Event of Default is a Failure to Pay or Deliver, Breach of Agreement (or other Event of Default) with an unexpired grace period, or where the grace period has expired but the Non-defaulting Party hasn’t (yet) given a notice of default actually accelerating the default into an actual Event of Default.
That means, 2(a)(iii) defenders, that any formal breach of the ISDA Master Agreement, if notified by the Non-defaulting Party, renders the Section 2(a)(iii) conditions precedent unfulfilled, and means you can suspend performance of your obligations under all outstanding Transactions. I don’t make the rules, folks.
Actually, courtesy of that parenthetical “, or both,” it is worse even than that, though we think common courtesy (or at any rate, sense} would intervene to prevent non-notified formal breaches being acted upon. But not the literal terms of the ISDA: A formal breach — any non-compliance with its terms more grievous than a failure to provide tax certificates (that is specifically carved out) on commission suspends the other Party’s obligations until cured.
This is truly a custom more honoured in the breach than th’observance, and just as well: if ISDAs locked up every time a party was late with its annual Sox attestation only half the world’s swap financing would ever get paid.
General discussion
Grace periods and notice requirements for each Event of Default
A JC cut-out-and-keep™ guide. Useful if you are fretting about Potential Event of Default. Don’t feel embarrassed: we all do, every now and then, when spring is upon us.
- Failure to Pay or Deliver has both a short grace period and requires notice from the Non-defaulting Party before it becomes a full EOD;
- Breach of Agreement has an unusably, epochally long grace period — I mean thirty fricking days! — and requires notice from the Non-defaulting Party before it becomes a full EOD;
- Credit Support Default has no grace period or notice requirement, but there’s a good argument that any grace periods and notice requirements under the Credit Support Document in question would get pulled in by reference, so they are there in effect;
- Misrepresentation has neither a grace period or a notice requirement. The theory being a representation — any representation other than a tax one — being a statement inducing one to enter into the contract in the first place —is of such fundamental moment that its untruth justifies summary execution. Careful here, though, misrepresentations are a bit of a minefield to step through. See especially section 3(d).
- DUST references notice requirements and grace periods under the Specified Transaction (where there is has been a default) but not where it is a repudiation, but that kind of figures.
- Cross Default, that most absurd of all Events of Default, has no notice requirement, no grace period, and doesn't even require the lender of the Specified Indebtedness to have exercised a termination right — though any grace period under the Specified Indebtedness still applies.
- Bankruptcy has no notice requirement or grace period (indeed, on Automatic Termination Event applies it may happens even without the Non-defaulting Party’s knowledge), though there are some grace periods under the various tedious limbs of Bankruptcy definition[1], and these vary by edition of the ISDA Master Agreement[2];
- Merger Without Assumption has neither notice requirement or grace period — again not unreasonable, since a merger without assumption is tantamount to a repudiation of contract, and if you’re no longer playing the game, I don’t see why I should.