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 Tuesday 03 February 2015

Additional Termination Event versus Additional Event of Default: does it matter what you call it?


During a course of the negotiation of an ISDA Master Agreement you may be asked by your counterparty to define an event which could close out all Transactions under an Agreement as an “Additional Termination Event” (ATE) or “Additional Event of Default” (AEoD).  

Introduction

In broad terms an Event of Default is one where one party is to blame while a Termination Event may simply be suffered by or happen to a party or it could be to blame for it.  A Termination Event may be outside a party’s control.

Section 5 of the ISDA Master Agreement contains the Agreement’s standard Events of Default and Termination Events.  

Section 5(b)(vi) of the 2002 ISDA Master Agreement was added so that parties may state Additional Termination Events in Part 1(g) of the Schedule or any Confirmation and any Affected Party or Affected Parties for them. 

There is no equivalent Section for Additional Events of Default but these can normally be added in Part 5 of the Schedule.

It is assumed that where an Additional Termination Event happens, all Transactions will be Affected Transactions and the Non-affected Party can terminate them all.  Many Additional Termination Events are credit related (e.g. ratings downgrade events, net asset value decline events, change of ownership) and therefore impact the entire contractual relationship between the parties and not just a particular group of Transactions. So they all need to be terminated.

It is relatively common for people to focus on Section 6(e) of the Agreement (Payments on Early Termination) and note that if there is an Event of Default or a Termination Event with one Affected Party then the payment calculations are made in the same way (i.e. by the party not at fault).  Because of this people often think that there is no real impact if an event is described as an Additional Event of Default or Additional Termination Event. 

However, there are consequences which should be carefully considered including the following:

Notification requirements

Under Section 6(b)(i) of the 2002 Agreement, where a Termination Event (which is not Force Majeure Event) occurs, the Affected Party will promptly upon becoming aware of it, notify the other party of it and its nature and each Affected Transaction and any other information the Non-affected Party may require.  

There is no such notice requirement for Events of Default. 

Failure of the Affected Party to provide such notice when it is aware of the ATE could lead to an Event of Default (either (1) Misrepresentation of the Absence of Certain Events representation in Section 3(b) if the Affected Party continues entering into Transactions or (2) Breach of Agreement (Section 5(b)(ii)(i)) if the notice failure is not rectified within 30 days of notice of the failure).

Early Termination Payment Timings 

Early termination payments including the relevant interest payable for Events of Default are payable on the day that the Early Termination Date notice becomes effective.  

Early termination payments including the relevant interest payable for Termination Events (where there is one Affected Party) are payable two Local Business Days after the day that the Early Termination Date notice becomes effective.  

Condition Precedent

Section 2(a)(iii) of the Agreement allows an innocent party to stop making payments and deliveries made in the normal course of business if (1) an Event of Default or Potential Event of Default occurs and is continuing with respect to one of the parties or (2) an Early Termination Date is declared whether because of an Event of Default or a Termination Event or (3) any other condition precedent in the Agreement is not fulfilled. 

Therefore it is possible to defer payments under Section 2(a)(iii) if a potential Additional Event of Default occurs (i.e. an event which could lead to a full blown Additional Event of Default if it develops).  However it is not possible to stop payments if a potential Additional Termination Event occurs.  It would only be possible to rely on Section 2(a)(iii) for an ATE once an Early Termination Date has been designated.

Interest payments in default situations 

Where an Early Termination Amount is late in being paid interest will accrue on it in the Termination Currency from and including the Early Termination Date to but excluding the date it is actually paid.  Interest will be charged at the Applicable Close-out Rate which is defined in this context as follows:-

(1) The Default Rate (i.e. 1% over the payer’s cost of funds) if the Early Termination Amount is owed by the Defaulting Party; 

(2) the Non-default Rate (i.e. an interbank overnight deposit rate offered to the Non-defaulting Party by a major bank selected in good faith by them); and

(3) the Applicable Deferral Rate (i.e. the arithmetic mean of the payee’s cost of funds and the interbank overnight deposit rate offered by a major bank chosen in good faith by the payer) in all other cases.  This would include Early Termination Amounts related to Additional Termination Events.

So as you can see, whether an additional event is defined as a Termination Event or Event of Default has implications for a number of provisions within the ISDA Master Agreement. You should therefore consider this broader picture when making your choice of terminology.

Posted by Abigail Harding


Tagged: ISDA negotiation ISDA OTC derivatives

Category: ISDA negotiation


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