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Event of default: Difference between revisions
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{{a|glossary| | {{a|glossary|{{image|Default in our Stars|png|Look, ''you'' try illustrating the idea of default.}}}}An [[event of default]] is an action a counterparty takes which justifies the innocent party terminating the contract ''under its terms'', [[close out|closing out]] open transactions, and raining down fiery hell on the wronger and its affiliates, directors, officers, employees, agents and delegates. | ||
}}An [[event of default]] is an action a counterparty takes which justifies the innocent party terminating the contract ''under its terms'', [[close out|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=== | ====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 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]]. | 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 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=== | ===Not (quite) the same as a fundamental breach of contract=== | ||
An Event of Default has a different consequence to a [[repudiatory breach|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]]. | An Event of Default has a different consequence to a [[repudiatory breach|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]]. | ||
{{Event of default vs fundamental breach}} | {{Event of default vs fundamental breach}} | ||
====Do termination mechanics override common law rights on breach?==== | |||
If the contract stipulates “events of default” or sets out an express termination mechanism to be followed when events of default occur, does this override common law termination rights? | |||
===Under the [[master agreements|master trading agreements]]=== | A question of some import as more ordinary contracts succumb to [[finance contract envy]] and contain unnecessary termination mechanisms, especially where negotiating power is not even, and institutional service providers flatly insist on unreasonably contractual rights. | ||
Let us take an example. A paying agent may require 90 days’ notice of termination of its appointment, regardless of reason. | |||
We might argue, “Well, we can live with that unless you have materially breached your contract. In that case, we would like to terminate at once.” | |||
This does no more than state our [[common law]] rights. ''But the agent says no''. We ask why, but it flatly shrugs and just says, “Well, that is not our standard. If you don’t like it you can always use another agent.” We may as well accept this: we have more chance of persuading a legless donkey to have another drink. And the other agents are likely to have equally ludicrous stances, if not on this exactly, then on similar topics. | |||
It might occur to us that, whether we agree to this or not, as a philosophical matter, she who breaks a contract is in no position to insist on her counterparty observing it. The jig is up; by refusing to pay, the agent has detonated our fundamental bargain; what we wrote on this paper is no longer a live covenant, but is only good for evaluating our loss of the bargain we struck. We can terminate in a funk and sue for damages, regardless of the contract. | |||
The alternative is to say, well, we anticipated non-performance and provided for it in the contract. We set out special rules: that is what each agreed to, so that is what must happen. The rules are that you must provide the necessary notice, come what may. | |||
=====Deviation, fundamental breach and repudiation of contract | |||
There are no contracts precisely on point, but some come close. Lord Denning MR — yes, that Lord Denning — made a heroic attempt to build a common law doctrine of “fundamental breach” in the sixties and seventies, wherein if a party’s breach of contract was ''so'' fundamental it would automatically discharge the whole contract, taking with it any remaining terms. | |||
He did this to set aside warranties of merchantability on goods sold where there was clearly fraud and misrepresentation in their sale (possibly after sale and before delivery), holding that these fundamental breaches invalidated the whole contract and therefore warranty. | |||
He picked a thread out of some old shipping cases, where a vessel contracted to carry goods on one route between two points sank whilst on an un-agreed deviation, thereby invalidating limitations on its liability which were predicated on it taking the agreed route, to a general principal. The notable case was {{cite|Karsales|Wallis|1956|EWCA Civ|4}}. | |||
While there was something admirable in the justice of Lord Denning’s outcome, its actual legal pedigree was suspect and, over a series of cases, the House of Lords had a different view: first, gently, in {{cite|Suisse Atlantique Societe d’Armement Maritime S.A.|N.V. Rotterdamsche Kolen Centrale|1966|1 Lloyd’s Rep|529}} and then, when Lord Denning didn’t take that hint (and, in fact, rather mendaciously misconstrued it) bluntly in {{cite|Photo Production Ltd.|Securicor Transport Ltd|1980|UKHL|2}}, overruling Lord Denning’s doctrine and holding that what happens to contractual terms on breach depends on what the contract says. This position was the law at least until the [[Unfair Contract Terms Act 1977]]. | |||
For our purposes it seems worthwhile treating as separate the performed part of the contract and the unperformed part. A breach of contract does not void a contract from inception: anything you have agreed to and have already performed, or received, stays that way. It is the remainder of the fruit of the contract that matters. So, in {{Casenote|Photoshop|Securicor}}, there was an exclusion for liability for damage caused by the defendant’s employees’ actions, and as these actions had happened before the termination of the contract, that was that. Photoshop’s entitlement was to be relieved from the obligation to continue to pay for Securicor’s property surveillance services, which it didn’t in any case need since Securicor’s employee had burned its premises to the ground. | |||
Our case, as above, seems different: a notice period for no-fault termination of contract, and an absence of an explicit right to terminate “for cause” is a part of the contract that ''remains'' to be performed ''after the breach''. If you, dear agent, have declared you will not make payments on my behalf, notwithstanding your clear obligation to do so, you have repudiated the contract, and cannot subsequently hold me to the terms that ask of me a notice period before terminating. I am entitled to treat the contract, now, as at an end. The notice period no longer applies. I am applying a common-law, extra-contractual right. Your protections and indemnities for what you did to that point still apply — there is no need to invoke Lord Denning or a total avoidance of the contract. | |||
====Under the [[master agreements|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: | There is specific idiosyncratic lore attaching to the events of default under differing market standard master agreements, so go with alacrity to: | ||
''{{isdama}}'': {{isdaprov|Event of Default}} <br> | |||
''{{gmsla}}'': {{gmslaprov|Event of Default}} <br> | |||
''{{gmra}}'': {{gmraprov|Event of Default}} <br> | |||
Not to be, although easily, confused with {{isdaprov|Termination Events}} under the {{isdama}}. These are (in the main) kinder and gentler than {{isdaprov|Events of Default}}, arise from factors outside the parties control ({{isdaprov|Force Majeure}}, {{isdaprov|Tax Event}}s, {{isdaprov|Credit Event Upon Merger}}s, {{isdaprov|Illegality}} and so on), and in many cases relate to some only and not all of the {{isdaprov|Transaction}}s under the {{isdama}}. 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 {{isdaprov|Additional Termination Event}}s. | Not to be, although easily, confused with {{isdaprov|Termination Events}} under the {{isdama}}. These are (in the main) kinder and gentler than {{isdaprov|Events of Default}}, arise from factors outside the parties control ({{isdaprov|Force Majeure}}, {{isdaprov|Tax Event}}s, {{isdaprov|Credit Event Upon Merger}}s, {{isdaprov|Illegality}} and so on), and in many cases relate to some only and not all of the {{isdaprov|Transaction}}s under the {{isdama}}. 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 {{isdaprov|Additional Termination Event}}s. | ||
{{sa}} | {{sa}} | ||