Template:Failure to pay procedure

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 {{{{{1}}}|Failure to Pay or Deliver}} under Section {{{{{1}}}|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 {{{{{1}}}|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 “{{{{{1}}}|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 {{{{{1}}}|Early Termination Date}} and determined pursuant to Section 6(e)”.

So, you will need:

• A failure: A {{{{{1}}}|Failure to Pay or Deliver}}, on day T. This is an {{{{{1}}}|Event of Default}} under Section {{{{{1}}}|5(a)(i)}}. You must have:

(i) a Failure by the {{{{{1}}}|Defaulting Party}} to make a payment or delivery when due;

(ii) a notice by the {{{{{1}}}|Non-Defaulting Party}} under Section {{{{{1}}}|6(a)}} to the {{{{{1}}}|Defaulting Party}} that the failure has happened and designating an Early Termination Date, no more than twenty days in the future.

• Notice of failure: The {{{{{1}}}|Non-defaulting Party}} must give notice of the {{{{{1}}}|Failure to Pay or Deliver}} (which since it is not due until the close of business on a given day, Q.E.D., can be validly given only after close of business on the due date for payment or delivery) and, by dint of Section {{{{{1}}}|12(a)}} ({{{{{1}}}|Notices}}), will only be deemed effective on the following {{{{{1}}}|Local Business Day}}: ie T+1. Note also: you cannot send a close-out notice by email, electronic messaging system, or (if you have a 1992 ISDA, at any rate), by fax. The proper form is to have it hand-delivered by someone prepared to swear an affidavit as to when and where they delivered it to the Defaulting Party.
• Grace Period: Once the notice is effective, the {{{{{1}}}|Defaulting Party}} has a window (the grace period) in which it can remedy the failure to pay or deliver.

(i) The standard grace periods are set out in Section {{{{{1}}}|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 {{{{{1}}}|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 {{{{{1}}}|LBD}}s, for example.

(ii) So: once you have a clear, notified {{{{{1}}}|Failure to Pay or Deliver}}, you have to wait at least one and possibly three or more {{{{{1}}}|Local Business Day}}s before doing anything about it. Therefore you are on tenterhooks until the close of business T+2 {{{{{1}}}|LBD}}s (standard 2002 ISDA), or T+4 LBDs (standard 1992 ISDA).

(iii) At the expiry of this grace period, you finally have a fully operational {{{{{1}}}|Event of Default}}. Now Section {{{{{1}}}|6(a)}} gives you the right, by not more than 20 days’ notice to designate an {{{{{1}}}|Early Termination Date}} for all outstanding Transactions. So, at some point in the next twenty days.

(iv) For this we go to Section {{{{{1}}}|6(e)}}, noting as we fly over it, that Section {{{{{1}}}|6(c)}} reminds us for the avoidance of doubt that even if the {{{{{1}}}|Event of Default}} which triggers the {{{{{1}}}|Early Termination Date}} evaporates in the meantime — these things happen, okay? — yon {{{{{1}}}|Defaulting Party}}’s goose is still irretrievably cooked.

• Determining Close-out Amounts: There is a bit of a chicken-and-egg situation here as you must now ascertain termination values for the {{{{{1}}}|Terminated Transaction}}s as of the Early Termination Date, and you can’t really work out their mark-to-market values for that date at any time before then, unless you are able to see into the future and everything. Anyway, that’s a conundrum for your trading people (and in-house metaphysicians) to deal with and it need not trouble we eagles of the law. For our purposes, the trading and risk people need to come up with Close-out Amounts for all outstanding {{{{{1}}}|Transaction}}s. Once they have done that you are ready for your Section {{{{{1}}}|6(e)}} notice.
• {{{{{1}}}|Early Termination Amount}}: Your inhouse metaphysicians having calculated your Close-out Amounts, you must assemble all the values into an {{{{{1}}}|Early Termination Amount}}.