August 27, 2014

Section 2(a)(iii) – The Clock is Ticking… | ISDA Master Agreement

The clock is ticking: Proposed amendment to section 2(a)(iii) of the ISDA Master Agreement (1992 and 2002).

The clock is ticking: Proposed amendment to section 2(a)(iii) of the ISDA Master Agreement (1992 and 2002).

Background to section 2(a)(iii)

The ISDA Master Agreement has always been understood to provide that following your counterparty’s default, you do not have to perform any payment or delivery obligations until that default is cured (e.g. the Defaulting Party makes payment to remedy a failure to pay under section 5(a)(i)). In particular, section 2(a)(iii) states that a party’s payment or delivery obligations under a transaction are subject to the condition precedent that no Event of Default or Potential Event of Default has occurred and is continuing with respect to the other party. This allows a Non-defaulting Party to withhold payments and/or deliveries under the Master Agreement that are due to a Defaulting Party.

Controversy and Challenge

Section 2(a)(iii) was challenged in a series of cases[1] following the financial crisis as it leaves a defaulting party’s creditors unable to claim any outstanding amounts owed to it, unless the default is cured.

  • Lehman Brothers International (Europe) on insolvency had a number of interest rate swaps which were in the money, with the counterparties refusing to terminate their transactions. The counterparties were relying on section 2(a)(iii) to withhold payments that were due to be made to LBIE. LBIE’s administrators sought to challenge the enforceability of the provision to force the counterparties[2] to pay the amounts owed.

    • Reasons for challenge to obtain a court ruling to answer the following questions:

      • Does the clause operate only to suspend the obligations of the Non-defaulting Party whilst the Event of Default is continuing, or is the payment and/or delivery obligation extinguished?

      • If the clause only suspends the Non-defaulting Party’s obligations, should this be allowed for an indefinite amount of time?

      • Is the clause contrary to English insolvency rules and/or potentially public policy?

Proposed ISDA Amendment to the 1992 and 2002 ISDA Master Agreement

The regulators are keen to encourage both parties to make payments on termination to reduce systemic risk. Additionally, in an insolvency situation, the provision may be contrary to insolvency provisions in certain jurisdictions. In June 2014, ISDA published a proposed amendment to allay the industry’s concerns and create more certainty.

In summary, the proposed ISDA Amendment would:

  • Enable parties to include a time limit on a Non-defaulting Party’s right to withhold payments under section 2(a)(iii) and therefore preventing the Defaulting Party being left continually in a disadvantaged position.

  • It would be achieved through a ‘Condition End Date’ where the parties stipulate the agreed time limit.

The ISDA Amendment and Explanatory memorandum can be found here.


[1] Marine Trade S.A. v Pioneer Freight Futures Co Ltd & another [2009] EWHC 2656 (Comm), re Lehman Brothers Holdings, Inc., Case No. 08-13555 et seq. (JMP)(jointly administered) (‘Metavante’)

[2] Lomas and others (together the Joint Administrators of Lehman Brothers International (Europe) (in

administration)) v JFB Firth Rixson, Inc. and others and ISDA as intervenor (2010)

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