Template:M gen 1992 ISDA 8

Section 8(a)

One could have stopped after the first sentence, but it is a rare ISDA ninja that can help himself babbling. ISDA ninjas would make terrible used-car salespeople.

Why the ISDA Master Agreement feels the need to contemplate the discharge of obligations in one currency by payment of an amount in another — non-compliance with the clear terms of the contract in other words — we can only guess. The payer’s ability to plow this obverse furrow still depends on the payee’s good humour: the payee is not obliged to indulge the payer, but may, by converting the tendered amount into the Contractual Currency.

If there is a shortfall, the payer must pay it immediately — fair, since the payer is craving the recipient’s indulgence in the first place and is really courting a Failure to Pay or Deliver by his cavalier behaviour.

If there is an excess, the recipient must return it promptly — also fair, seeing as she didn’t ask to be paid in Brazilian Real, and had to go to all the trouble of converting it and faffing around at the FX counter at that little shop in the arcade near Liverpool Street.

Section 8(b)

Enforcing judgments in far-flung places

It is a fact of life that when enforcing a cross-border contract, you may find yourself journeying to foreign climes in a bid to prise assets and payments out of a foreign counterparty. Places like Italy. With the best will in the world, and the firmest written intentions that the agreement be governed by English law and justiciable exclusively by her majesty’s courts, that may still mean engaging with, and obtaining judgments from foreign court systems, if that is where your counterparty and its financial resources are located. Those courts may be obliged to award their judgments, about your judgment, in their local currency. That exposes you to FX risk. This clause requires the parties to true up — immediately, should the windfall accrue to the Defaulting Party, only promptly if it accrues to the innocent one — by reference to a fairly determined “rate of exchange”.

Nerd’s point: This obligation is, strictly speaking, an indemnity obligation, in the true sense of that concept, in that is a payment that becomes due by reference to an externality that was not caused by breach of contract (even though originally it might have arisen out of one). So that’s nice.

Rate of exchange

Abvout that “rate of exchange” — in the 1992 ISDA defined on the spot; in the 2002 ISDA promoted to the big league and featuring in the main Definitions section. Allow the JC a pet moan. Goddamn “definitions”.

You could scarcely ask for a less necessary definition. In their hearts, you sense ISDA’s crack drafting squad™ knew this, for they couldn’t find it in themselves to even capitalise it. In the 1992 ISDA, rate of exchange didn’t even make the Definitions section, but was half-heartedly tacked onto the end of a clause halfway through the Contractual Currency section. It made it into the 2002 ISDA’s Definitions Section only because it somehow wangled its unecessary way into the new Set-off clause (Section 6(f) of the 2002 ISDA).

But if two guiding principles of defining terms are (i) don’t, for terms you only use once or twice, and (ii) don’t, if the meaning of the thing you are considering defining is patently obvious — then “rate of exchange” comprehensively fails the main criteria of a good definition.

The JC’s general view is, all other things being equal, to ease comprehension, eschew definitions.

Also, could they not have used “exchange rate”, instead of rate of exchange?

Section 8(c)

So who even knew the things in Section 8(a) and 8(b) were indemnities?

They are, in the strict literal sense of an indemnity: a contractual promise to pay a sum of money (the difference between the amount paid in the Non-Contractual Currency and the actual amount owed in the Contractual Currency) in circumstances not (strictly) amounting to a breach; they are not in the popular (but misconceived) conception of an indemnity as some kind of all-conquering smart bomb.

Now, we must hush, if we want to get home at a reasonable hour, because the Indemnity is one of the JC’s pet subjects. Get him started and that’s the evening gone.

Section 8(d)

So if your clottish counterparty can’t follow simple instructions and sends you Lire rather than Pesetas, and thereby fails to cover your loss, as long as you can prove what the exchange rate was at the time you would have exchanged it into the Contractual Currency, you can recover a loss, even if you didn’t.

Now this, to me, seems a little controversial. What if the exchange rate dropped through the floor, then recovered, and the Non-Affected Party held his nerve. Can he then cherry-pick?