Template:Isda 2(a)(iii) summ: Difference between revisions

{{drop|I|n the language}} of financial obligations, one’s rights to future payments under a contract are an asset. You own them and, all other things being equal, can therefore ''deal'' with them — that is, sell or raise money against them — the same way you can sell or mortgage a house, car, a portfolio of equities, or some [[Bitcoin|decentralised cryptographic tokens representing abstract capital]]. ''[Really? — Ed.]''

“Assets” have a few “[[ontological]]” properties, one of which is ''continuity'', in time and space. Assets might rust, depreciate, go out of fashion or stop working properly but they are nevertheless, existentially, still ''there'', at least until you do sell them. They therefore have some value to you, however parlous the state of your affairs might otherwise be.  

This makes accounting for assets possible, albeit difficult. Should the fates line up for you such that someone is drawing up a closing account of your earthly financial existence — should you become ''[[Insolvency|bankrupt]]'', heaven forfend — your assets can reliability be popped onto the “plus” side of the ledger. The difficulty subsists in working out what they are worth, but at least they are there.

Section {{{{{1}}}|2(a)(iii)}} has exactly that effect on a {{{{{1}}}|Defaulting Party}}’s claims under an ISDA. Just when it goes insolvent or fails materially to perform, its “asset” represented by the {{{{{1}}}|Transaction}}, perhaps temporarily, vanishes. It makes the ISDA a “[[flawed asset]]” because allows a {{{{{1}}}|Non-defaulting Party}} to indefinitely suspend its performance of its obligations under a {{{{{1}}}|Transaction}} without terminating the {{{{{1}}}|Transaction}} if its counterparty defaults. Should the {{{{{1}}}|Defaulting Party}} cure the default, the {{{{{1}}}|Transaction}} resumes and the {{{{{1}}}|Non-defaulting Party}} must resume all its obligations, including the suspended ones. But for so long as the default is not cured, the {{{{{1}}}|Non-defaulting Party}} does not have to do anything but keeps the option to terminate (thereby crystallising the loss at any time.

{{drop|I|n the United}} States, there is a provision in the [[Bankruptcy Code]] rendering unenforceable any term in a contract that provides for its termination or modification solely because of a provision in such contract or lease that is triggered by insolvency proceedings. These are known by Americans as “[[ipso facto]]” clauses, because the simple ''fact'' of bankruptcy “in itself” triggers the clause. If Section {{{{{1}}}|2(a)(iii)}} is an ipso facto clause, then it would not be enforceable.

Whether Section 2(a)(iii) is indeed an [[ipso facto clause]] is a subject of vigorous but tiresome debate. For our purposes, the fact that people don’t easily agree about it is all you need to know: this makes a silly contractual provision even more cavalier.  

In the UK, there is no statutory equivalent of America’s [[ipso facto rule]], but hundreds of years ago resourceful common law judges “discovered” an “anti‑deprivation” rule that, in the honeyed words of Sir William Page Wood V.C., in Whitmore v Mason (1861) 2J&H 204:

{{drop|W|hat is the}} actual point of this odd condition precedent anyway? Why not just close out and be done with it? Why would any party ever want to ''not'' close out a {{{{{1}}}|Defaulting Party}}?  

 

The “[[The bilaterality, or not, of the ISDA|bilaterality]]” of most derivatives arrangements means that either party may, net, be “[[out of the money]]” — that is, across all outstanding transactions, it would have to ''pay'' a net sum of money if all transactions were terminated. This is a notional debt that only becomes “due” as such if you designate an {{{{{1}}}|Early Termination Date}} under the Master Agreement. So an [[out-of-the-money]] {{{{{1}}}|Non-defaulting Party}} has a good reason therefore ''not'' to close out the ISDA. Why should it have to pay out just because a {{{{{1}}}|Defaulting Party}} has failed to perform its end of the bargain? On the other hand, if it forebears from terminating against a bankrupt counterparty the {{{{{1}}}|Non-defaulting Party}} doesn’t want to have to continue stoically paying good money away to a bankrupt counterparty who isn’t reciprocating.