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Section 2(a)(iii) of the ISDA Master Agreement: It Applies as Drafted to an English Counterparty the Subject of an English Administration

December 2010
David Barwise, Ingrid York

In Lomas and others (Administrators of Lehman Brothers International (Europe) v JRB Firth Rixson, Inc and others and The International Swaps and Derivatives Association Inc. (as Intervenor) [2010] EWHC 3372 (Ch), the High Court considered for the first time the operation of Section 2(a)(iii) of the 1992 ISDA Master Agreement (the "1992 Agreement") and the 2002 ISDA Master Agreement (the "2002 Agreement" and, together with the 1992 Agreement, the "Agreement") in the context of formal insolvency proceedings in England and Wales.

As a reminder, Section 2(a)(iii) of the Agreement provides that: "(iii) Each obligation of each party under Section 2(a)(i) [the obligation to make payment or delivery under the Agreement] is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing, (2) the condition precedent that no Early Termination Date in respect of the relevant transaction has occurred or been effectively designated and (3) each other applicable condition precedent specified in this Agreement."

The key findings of the High Court were that:

Section 2(a)(iii) of the Agreement suspends a payment obligation.Section 2(a)(iii) of the Agreement does not extinguish a payment obligation.
Such suspended payment obligation lapses on the normal expiry date of the swap transaction.
Section 2(a)(iii) of the Agreement does not necessarily offend the anti-deprivation principle. However, the anti-deprivation principle could be infringed if Section 2(a)(iii) is invoked in circumstances where the Defaulting Party has no outstanding (unperformed) obligations or in circumstances where the Non-defaulting Party asserts that Section 2(a)(iii) operates on a gross, rather than a net, basis.
Section 2(a)(iii) of the Agreement, invoked upon a Bankruptcy Event of Default, is not a penalty.
A Non-defaulting Party can decide in its own interests as to whether, or when, to designate an Early Termination Date.
The loss of a right to receive a contingent payment caused by a Bankruptcy Event of Default is not a forfeiture from which an English court will grant relief.

These findings are discussed in more detail in the attached Insight. Click here to download.

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