Termination Events - ISDA Provision

2002 ISDA Master Agreement

A Jolly Contrarian owner’s manual™

The JC’s Nutshell summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack.

ISDA Text: 5(b)

5(b) Termination Events. The occurrence at any time with respect to a party or, if applicable, any Credit Support Provider of such party or any Specified Entity of such party of any event specified below constitutes (subject to Section 5(c)) an Illegality if the event is specified in clause (i) below, a Force Majeure Event if the event is specified in clause (ii) below, a Tax Event if the event is specified in clause (iii) below, a Tax Event Upon Merger if the event is specified in clause (iv) below, and, if specified to be applicable, a Credit Event Upon Merger if the event is specified pursuant to clause 5(b)(v) below:
5(b)(i) Illegality. After giving effect to any applicable provision, disruption fallback or remedy specified in, or pursuant to, the relevant Confirmation or elsewhere in this Agreement, due to an event or circumstance (other than any action taken by a party or, if applicable, any Credit Support Provider of such party) occurring after a Transaction is entered into, it becomes unlawful under any applicable law (including without limitation the laws of any country in which payment, delivery or compliance is required by either party or any Credit Support Provider, as the case may be), on any day, or it would be unlawful if the relevant payment, delivery or compliance were required on that day (in each case, other than as a result of a breach by the party of Section 4(b)):―
5(b)(i)(1) for the Office through which such party (which will be the Affected Party) makes and receives payments or deliveries with respect to such Transaction to perform any absolute or contingent obligation to make a payment or delivery in respect of such Transaction, to receive a payment or delivery in respect of such Transaction or to comply with any other material provision of this Agreement relating to such Transaction; or
5(b)(i)(2) for such party or any Credit Support Provider of such party (which will be the Affected Party) to perform any absolute or contingent obligation to make a payment or delivery which such party or Credit Support Provider has under any Credit Support Document relating to such Transaction, to receive a payment or delivery under such Credit Support Document or to comply with any other material provision of such Credit Support Document;
5(b)(ii) Force Majeure Event. After giving effect to any applicable provision, disruption fallback or remedy specified in, or pursuant to, the relevant Confirmation or elsewhere in this Agreement, by reason of force majeure or act of state occurring after a Transaction is entered into, on any day:―
5(b)(ii)(1) the Office through which such party (which will be the Affected Party) makes and receives payments or deliveries with respect to such Transaction is prevented from performing any absolute or contingent obligation to make a payment or delivery in respect of such Transaction, from receiving a payment or delivery in respect of such Transaction or from complying with any other material provision of this Agreement relating to such Transaction (or would be so prevented if such payment, delivery or compliance were required on that day), or it becomes impossible or impracticable for such Office so to perform, receive or comply (or it would be impossible or impracticable for such Office so to perform, receive or comply if such payment, delivery or compliance were required on that day); or
5(b)(ii)(2) such party or any Credit Support Provider of such party (which will be the Affected Party) is prevented from performing any absolute or contingent obligation to make a payment or delivery which such party or Credit Support Provider has under any Credit Support Document relating to such Transaction, from receiving a payment or delivery under such Credit Support Document or from complying with any other material provision of such Credit Support Document (or would be so prevented if such payment, delivery or compliance were required on that day), or it becomes impossible or impracticable for such party or Credit Support Provider so to perform, receive or comply (or it would be impossible or impracticable for such party or Credit Support Provider so to perform, receive or comply if such payment, delivery or compliance were required on that day),
so long as the force majeure or act of state is beyond the control of such Office, such party or such Credit Support Provider, as appropriate, and such Office, party or Credit Support Provider could not, after using all reasonable efforts (which will not require such party or Credit Support Provider to incur a loss, other than immaterial, incidental expenses), overcome such prevention, impossibility or impracticability;
5(b)(iii) Tax Event. Due to
(1) any action taken by a taxing authority, or brought in a court of competent jurisdiction, after a Transaction is entered into (regardless of whether such action is taken or brought with respect to a party to this Agreement) or
(2) a Change in Tax Law,
the party (which will be the Affected Party) will, or there is a substantial likelihood that it will, on the next succeeding Scheduled Settlement Date
(A) be required to pay to the other party an additional amount in respect of an Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 9(h)) or
(B) receive a payment from which an amount is required to be deducted or withheld for or on account of a Tax (except in respect of interest under Section 9(h)) and no additional amount is required to be paid in respect of such Tax under Section 2(d)(i)(4) (other than by reason of Section 2(d)(i)(4)(A) or (B));
The line breaks are for comprehension and do not appear in the original
5(b)(iv) Tax Event Upon Merger. The party (the “Burdened Party”) on the next succeeding Scheduled Settlement Date will either (1) be required to pay an additional amount in respect of an Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 9(h)) or (2) receive a payment from which an amount has been deducted or withheld for or on account of any Tax in respect of which the other party is not required to pay an additional amount (other than by reason of Section 2(d)(i)(4)(A) or (B)), in either case as a result of a party consolidating or amalgamating with, or merging with or into, or transferring all or substantially all its assets (or any substantial part of the assets comprising the business conducted by it as of the date of this Master Agreement) to, or reorganising, reincorporating or reconstituting into or as, another entity (which will be the Affected Party) where such action does not constitute a Merger Without Assumption;
5(b)(v) Credit Event Upon Merger. If “Credit Event Upon Merger” is specified in the Schedule as applying to the party, a Designated Event (as defined below) occurs with respect to such party, any Credit Support Provider of such party or any applicable Specified Entity of such party (in each case, “X”) and such Designated Event does not constitute a Merger Without Assumption, and the creditworthiness of X or, if applicable, the successor, surviving or transferee entity of X, after taking into account any applicable Credit Support Document, is materially weaker immediately after the occurrence of such Designated Event than that of X immediately prior to the occurrence of such Designated Event (and, in any such event, such party or its successor, surviving or transferee entity, as appropriate, will be the Affected Party).
A “Designated Event” with respect to X means that:―
(1) X consolidates or amalgamates with, or merges with or into, or transfers all or substantially all its assets (or any substantial part of the assets comprising the business conducted by X as of the date of this ISDA Master Agreement) to, or reorganises, reincorporates or reconstitutes into or as, another entity;
(2) any person, related group of persons or entity acquires directly or indirectly the beneficial ownership of (A) equity securities having the power to elect a majority of the board of directors (or its equivalent) of X or (B) any other ownership interest enabling it to exercise control of X; or
(3) X effects any substantial change in its capital structure by means of the issuance, incurrence or guarantee of debt or the issuance of (A) preferred stock or other securities convertible into or exchangeable for debt or preferred stock or (B) in the case of entities other than corporations, any other form of ownership interest; or
5(b)(vi) Additional Termination Event. If any “Additional Termination Event” is specified in the Schedule or any Confirmation as applying, the occurrence of such event (and, in such event, the Affected Party or Affected Parties will be as specified for such Additional Termination Event in the Schedule or such Confirmation).

Related agreements and comparisons

Click here for the text of Section 5(b) in the 1992 ISDA
Click to compare this section in the 1992 ISDA and 2002 ISDA.

Resources and Navigation

This provision in the 1992

Resources Wikitext | Nutshell wikitext | 1992 ISDA wikitext | 2002 vs 1992 Showdown | 2006 ISDA Definitions | 2008 ISDA | JC’s ISDA code project
Navigation Preamble | 1(a) (b) (c) | 2(a) (b) (c) (d) | 3(a) (b) (c) (d) (e) (f) (g) | 4(a) (b) (c) (d) (e) | 55(a) Events of Default: 5(a)(i) Failure to Pay or Deliver 5(a)(ii) Breach of Agreement 5(a)(iii) Credit Support Default 5(a)(iv) Misrepresentation 5(a)(v) Default Under Specified Transaction 5(a)(vi) Cross Default 5(a)(vii) Bankruptcy 5(a)(viii) Merger Without Assumption 5(b) Termination Events: 5(b)(i) Illegality 5(b)(ii) Force Majeure Event 5(b)(iii) Tax Event 5(b)(iv) Tax Event Upon Merger 5(b)(v) Credit Event Upon Merger 5(b)(vi) Additional Termination Event (c) (d) (e) | 6(a) (b) (c) (d) (e) (f) | 7 | 8(a) (b) (c) (d) | 9(a) (b) (c) (d) (e) (f) (g) (h) | 10 | 11 | 12(a) (b) | 13(a) (b) (c) (d) | 14 |

Index: Click to expand:

Overview

Renumbering due to new Force Majeure Event

Since the 2002 ISDA includes a Force Majeure Event, using language that was already agreed and widely inserted into the 1992 ISDA Schedule before its publication. Because this was entered as Section 5(b)(ii) — I mean, honestly, could they have not made it Section 5(b)(vi), so all the other clause references could stay the same? You have no idea what conceptual problems this has created for the poor JC trying to efficiently organise this website.

Clause-by-clause

5(b)(i): Illegality: Quite a lot of formal change to the definition of Illegality; not clear how much of it makes all that much practical difference. The 2002 ISDA requires you to give effect to remedies or fallbacks in the Confirmation that might take you out of Illegality before evoking this provision — which ought to go without saying. It also carves out Illegalities caused by the action of either party, which also seems a bit fussy, and throws in some including-without-limitation stuff which, definitely is a bit fussy. Lastly, the 2002 ISDA clarifies that the party suffering the Illegality is the Affected Party, and that an Illegality applies to the non-receipt of payments just as much as to their non-payment. Again, all this ought to have been true the 1992 ISDA — no doubt there is some whacky litigation that said otherwise — so this is mainly in the service of avoiding doubt.
5(b)(ii): Force Majeure Event: There is no Force Majeure in the 1992 ISDA, though parties would habitually negotiate one in, and by the time the 2002 ISDA was published it was in fairly standardised. For those who didn’t negotiate it in there was also the ISDA Illegality/Force Majeure Protocol (see here) which they could sign — upon payment of the suitable fee is ISDA — to adopt/incorporate the relevant parts.
5(b)(iii): Tax Event: Other than the renumbering, no real change in the definition of Tax Event from the 1992 ISDA. Note, unhelpfully, the sub-paragraph reference in the 1992 ISDA is (1) and (2) and in the 2002 ISDA is (A) and (B). Otherwise, pretty much the same.
5(b)(iv): Tax Event Upon Merger: Note the missing “indemnifiable” from the fifth line of the 2002 ISDA version and the expanded description of “merger events” towards the end of the clause. And the renumbering as a result of the Force Majeure Event clause in the 2002 ISDA.
5(b)(v): Credit Event Upon Merger: The 2002 ISDA introduced the concept of the “Designated Event”, which was an attempt to define more forensically the sorts of corporate events that should be covered by CEUM. They are notoriously difficult to pin down. Even before the 2002 ISDA was published, it was common to upgrade the 1992 ISDA formulation to something resembling the glorious concoction that became Section 5(b)(v) of the 2002 ISDA. The 1992 wording is a bit lame. On the other hand, you could count the number of times an ISDA Master Agreement is closed out purely on account of Credit Event Upon Merger on the fingers of one hand, even if you had lost all the fingers on that hand to an industrial accident. So — yeah.
5(b)(vi): Additional Termination Events: Other than the numbering discrepancy and a daring change of a “shall” to a “will”, Section 5(b)(vi) of the 2002 ISDA is the same as Section 5(b)(v) of the 1992 ISDA. That said, ATEs are likely to be the most haggled-over part of your ISDA Master Agreement.

Summary

Section 5(b)(i) Illegality

An Illegality is a Section 5(b) Termination Event — being one of those irritating vicissitudes of life that are no-one’s fault but which mean things cannot go on, and not a Section 5(a) Event of Default, being those perfidious actions of one or other Party which bring matters to an end which, but for that behaviour, ought really to have been avoided.

Note also the impact of Illegality and Force Majeure on a party’s obligations to perform through another branch under Section 5(e), which in turn folds into the spectacular optional representation a party may make under 10(a) to state the blindingly obvious, namely that the law as to corporate legal personality is as is commonly understood by first-year law students. Who knows — maybe it is different in emerging markets and former Communist states?

For the silent great majority of swap entities for whom it is not, the curious proposition arises: what is the legal, and contractual, consequence of electing not to state the blindingly obvious? Does that mean it is deemed not to be true?

If the rules change, that is beyond your control, so it can’t be helped and hence Illegality is a Termination Event not an Event of Default. The 2002 ISDA develops the language of the 1992 ISDA to cater to insomniacs and paranoiacs but does not really add a great deal of substance.

An Illegality may only be triggered after exhausting the fallbacks and remedies specified in the ISDA Master Agreement.

Note the effect of section 6(b)(iv)(2) in the 2002 ISDA is to impose a Waiting Period of three Local Business Days before one can terminate for Illegality. There is no such waiting period in the 1992 ISDA.

The 2002 ISDA adds a Force Majeure termination event — Illegality is, of course, a sub-species of force majeure, so it is then obliged to artfully explain what happens when you have a Force Majeure that is also an Illegality. Section 5(c) (Hierarchy of Events) deals with this, providing that (i) Illegality trumps Force Majeure and (ii) Illegality and Force Majeure both trump the Failure to Pay and Breach of Agreement Events of Default. Given that Illegality is no longer subject to the “two Affected Parties” delay on termination (as it was in the 1992 ISDA), this is significant.

Since the 1992 ISDA is still in widespread use, especially in the New World, and Americans are not entirely blind to what goes on beyond their shores, they have seen the sense of the Force Majeure concept and often reverse engineer an equivalent Force Majeure provision into their 1992s via the Schedule (I know, I know: why not just use the 2002 ISDA?) If yours is like that, then all this hierarchy chat may be useful to you.

Section 5(b)(ii) Force Majeure (2002 only)

For the last word on force majeure, the JC’s ultimate force majeure clause is where it’s at. Breaking what must be a habit of a lifetime, somehow ISDA’s crack drafting squad™ managed to refrain from going crazy-ape bonkers with a definition of force majeure and instead, didn’t define it at all. In the 1992 ISDA they didn’t even include the concept.

Interlude: if you are in a hurry you can avoid this next bit.

I don’t know this, but I am going to hazard the confident hypothesis that what happened here was this:

ISDA’s crack drafting squad™, having convened its full counsel of war, fought so bloodily over the issue, over so long a period, that the great marble concourse on Mount Olympus was awash with the blood of slain legal eagles, littered with severed limbs, wings, discarded weapons, arcane references to regional variations of tidal waves, horse droppings from Valkyries etc., that there was barely a soul standing, and the only thing that prevented total final wipe-out was someone going, “ALL RIGHT, GOD DAMN IT. WE WON’T DEFINE WHAT WE MEAN BY FORCE MAJEURE AT ALL.”

There was then this quiet, eerie calm, when remaining combatants suddenly stopped; even those mortally wounded on the floor looked up, beatifically; a golden light bathed the whole atrium, choirs of angels sang and the chairperson said, “right, well that seems like a sensible, practical solution. What next then?”

“We thought we should rewrite the 2002 ISDA Equity Derivatives Definitions in machine code, your worship.”

“Excellent idea! Let’s stop faffing around with this force majeure nonsense and do that then!”

Ok back to normal.

Force Majeure in the 1992 ISDA

We may have said this before but, just because there isn’t a Force Majeure proper in the preprinted 1992 doesn’t mean people don’t borrow the concept from the 2002 — which has been around for, you know, 21 years now — and put it in anyway. One thing we can’t fathom is what possessed ISDA’s crack drafting squad™ to put it in at Section 5(b)(ii), rather than Section 5(b)(iv) just before the Additional Termination Event section, because for absolute shizzle anyone familiar with one version of the ISDA Master Agreement is going to get confused as hell if they start misunderstanding clause references in the other.

Act of state

Note the reference to “act of state”. Now a state, rather like a corporation, is a juridical being — a fiction of the law — with no res extensa as such. It exists on the rarefied non-material plane of jurisprudence. There are, thus, only a certain number of things that, without the agency of one if its employees, a state can do, and these involve enacting and repealing laws, promulgating and withdrawing regulations, signing treaties, entering contracts and, where is has waived its sovereign immunity, litigating their meaning.

Thus, a force majeure taking the shape of an act of state is, we humbly submit, a change in law which makes it impossible for one side or the other to perform its obligations. Compare, therefore, with Illegality.

Section 5(b)(ii)/(iii) Tax Event

Basically the gist is this: if the rules change after the Trade Date such that you have to gross up an Indemnifiable Tax would weren’t expecting to when you priced the trade, you have a right to get out of the trade, rather than having to ship the gross up for the remainder of the Transaction.

That said, this paragraph is a bastard to understand. Have a gander at the JC’s nutshell version (premium only, sorry) and you’ll see it is not such a bastard after all, then.

In the context of cleared swaps, you typically add a third limb, which is along the lines of:

(3) required to make a deduction from a payment under an Associated LCH Transaction where no corresponding gross up amount is required under the corresponding Transaction Payment under this Agreement.
Section 5(b)(iii)/(iv) Tax Event Upon Merger

This is you can imagine, a red letter day for ISDA’s crack drafting squad™ who quite outdid itself in the complicated permutations for how to terminate an ISDA Master Agreement should there be a Tax Event or a Tax Event Upon Merger. Things kick off in Section 6(b)(ii) and it really just gets better from there.

So, Tax Event Upon Merger considers the scenario where the coming together of two entites — we assume they hail from different jurisdictions or at least have different practical tax residences — has an unfortunate effect on the tax status of payments due by the merged entity under an existing Transaction.

It introduces a new and unique concept — the “Burdened Party”, being the one who gets slugged with the tax — and who may or may not be the “Affected Party” — in this case the one subject to the merger.

Section 5(b)(iv)/(v) Credit Event Upon Merger

Known among the cognoscenti as “CEUM”, the same way Tax Event Upon Merger is a “TEUM”. No idea how you pronounce it, but since ISDA ninjas communicate only in long, appended, multicoloured emails and never actually speak to each other, it doesn’t matter.

Pay attention to the interplay between this section and Section 7(a) (Transfer). You should not need to amend Section 7(a) (for example to require equivalence of credit quality of any transferee entity etc., because that is managed by CEUM.

Note also the interrelationship between CEUM and a Ratings Downgrade Additional Termination Event, should there be one. One can be forgiven for feeling a little ambivalent about CEUM because it is either caught by Ratings Downgrade or, if there is no requirement for a general Ratings Downgrade, insisting on CEUM seems a bit arbitrary (i.e. why do you care about a downgrade as a result of a merger, but not any other ratings downgrade?)

Section 5(b)(v)/(vi) Additional Termination Events

Additional Termination Events are the other termination events your Credit department has dreamt up for this specific counterparty, that didn’t occur to the framers of the ISDA Master Agreement — or, at any rate, weren’t sufficiently universal to warrant being included in the ISDA Master Agreement for all. While the standard Termination Events tend to be “non-fault” events which justify termination of the relationship on economic grounds, but not on terms necessarily punitive to the Affected Party, Additional Termination Events are more “credit-y”, more susceptible of moral outrage, and as such more closely resemble Events of Default than Termination Events.

Common ones include:

There is a — well, contrarian — school of thought that Additional Termination Events better serve the interests of the Ancient Guild of Contract Negotiators and the Worshipful Company of Credit Officers than they do the shareholders of the institutions for whom these artisans practise their craft, for in these days of zero-threshold CSAs, the real credit protections in the ISDA Master Agreement are the standard Events of Default (especially Failure to Pay or Deliver and Bankruptcy).

It’s a fair bet no-one in the organisation will have kept a record of how often you pulled NAV trigger. It may well be never.

“Ahh”, your credit officer will say, “but it gets the counterparty to the negotiating table”.

Hmmm.

Premium content

Here the free bit runs out. Subscribers click 👉 here. New readers sign up 👉 here and, for ½ a weekly 🍺 go full ninja about all these juicy topics 👇
  • The JC’s famous Nutshell summary of this clause
  • Events of Default vs. Termination Events showdown: why is there a difference between Events of Default and Termination Events, what is the difference, how will it affect me in practice, tell me more about this odd netherworld of Additional Termination Events, and is there a good way of describing both, or must I really stick with “an Event of Default or a Termination Event, as the case may be”?
  • A looooong essay about the genealogy of Termination Events and Events of Defaults, why they are different, what they do, which ones matter, which ones are regrettable and the curious incident of the flawed asset clause in the night-time.
  • Section 5(e): the head office and the branch
  • Legal personality: the nature of head offices, branches and affiliates, and so on: a handy guide for when you can’t bring yourself to explain to the head of credit again why you don’t need a contract between two branches of the same entity.
  • How the hierarchy works between Illegalities, Force Majeure and Events of Default, should they all descend on your Counterparty at once, in the shape of the same event
  • Deferral of payments and deliveries during the Waiting Period
  • Waiting Periods generally

Template:Isda Tax Event premium

  • “Burdened” Party? Is that different from an Affected Party?
  • The unbearable vagueness of “materially weaker”
  • The perennial hedge fund complaint: come on, guys: I am never going to merge.

Template:Isda Additional Termination Events premium

See also

Template:Isda 5(b) sa

References