On June 19, 2014, ISDA published an amendment to Section 2(a)(iii) of the ISDA® Master Agreement (ISDA Master) that may be used by parties to an ISDA Master to address the controversial open-ended payment-withholding option during the continuation of a counterparty default under that section. This issue was heavily litigated in both the US and the UK in the wake of the financial crisis. Most notably, in the US, this provision was the subject of the Metavante decision in the Lehman Brothers bankruptcy case. The amendment gives parties the opportunity to integrate a time limit on this provision into their ISDA Master Agreements.

Section 2(a)(iii) of the ISDA Master gives a non-defaulting counterparty the right to withhold payment under the transactions entered into under the agreement for as long as a counterparty Event of Default (EOD) or Potential Event of Default (PEOD) persists. This provision essentially provides an open-ended option on the agreement for the non-defaulting party for the duration of the EOD/PEOD. Certain non-defaulting counterparties have held debtor counterparties in limbo under this provision while awaiting the transaction to move in their favor.

In Metavante, the SDNY Bankruptcy Court (Lehman court) ruled that the provision operated as a prohibited ipso facto clause because it deprived the debtor of its rights (to payments under the contract) as a result of its bankruptcy filing, which is a default under Section 5(a) of the ISDA Master (see Legal Update, Lehman Court Ruling in Metavante Matter Expected to Complicate Withholding Payments Under Derivatives Contracts and Article, The Bankruptcy Court Ruling in the Lehman Metavante Matter). The corollary UK cases reached the opposite result under UK insolvency law, creating a transatlantic disparity with respect to the interpretation of this provision (see Legal Update, Section 2(a)(iii) ISDA Master Agreement: Court of Appeal judgment on four appeals: Appeal 1: Lomas v JFB Firth Rixson and Appeal 2: LBSF v Carlton: section 2(a)(iii) does not contravene anti-deprivation or pari passu rule).

The Lehman court ruled the provision was unenforceable in a US bankruptcy proceeding, holding that the non-defaulting party must elect to terminate the transaction(s) under the ISDA Master or resume making payments under the transaction(s) "promptly" or could be deemed to have waived the right to terminate. The court did not provide any parameters or further guidance on this point. The ISDA 2(a)(iii) amendment provides the parties to an ISDA Master with the opportunity to clarify this time frame, potentially avoiding costly litigation.

The amendment includes two attachments, one for each of the 1992 ISDA Master and the 2002 ISDA Master. The parties select the relevant attachment based on which ISDA Master they have entered into - they function the same. Each attachment is composed of two provisions:

Clause (i) of the new section allows the defaulting party, by notice to the non-defaulting party, to invoke clause (iii) of the new section, which eliminates on the Condition End Date the condition precedent of Section 2(a)(iii) to payment under Section 2(a)(i) of the ISDA Master that no counterparty EOD has occurred and is continuing. The Condition End Date occurs an agreed number of days, as negotiated by the parties (for example, 90 days), after the notice is given by the defaulting party to the non-defaulting party. On the Condition End Date, if the EOD for which notice was given under clause (i) of the new section is still continuing, then the non-defaulting party has a choice between:

ISDA notes that Paragraph 4(a)(1) of the ISDA Credit Support Annex may also need to be amended to become subject to the Condition End Date, as payment and delivery of collateral is also suspended by the operation of Section 2(a)(iii) of the ISDA Master.

The amendment also includes provisions to address the occurrence of another EOD after a Condition End Date notice under the new section has already been given by the defaulting party. Provisions are also included for the occurrence of a Potential Event of Default under the ISDA Master.

ISDA issued an accompanying explanatory memorandum on the amendment.

For more information on the ISDA Master, including Section 2(a)(iii), as well as related Section 2(a)(i), and early termination under the ISDA Master, see the following Practical Law resources:

ISDA Documents: Overview (US).

The ISDA Master Agreement: Checklist of Action Points upon Counterparty Failure to Perform.

The ISDA Master Agreement: Early Termination.

Comparison of 1992 and 2002 ISDA Master Agreements.