counterparty default – the legal issues · manufactured payments (income). act of insolvency –...

Counterparty default – the legal issues

Habib Motani

9 July 2012

Presentation for ICMA

Overview

Context and general legal issues Who is your counterparty? Events of Default under the 2000 and 2011

versions of the Global Master Repurchase Agreement (GMRA)

Comparison with other standard agreements: 2000 and 2010 versions of the Global Master

Securities Lending Agreement (GMSLA) 1992 and 2002 versions of the ISDA Master

Agreement (ISDA) Potential relevance of capital and/or exchange

controls Process for terminating upon an Event of

Default Practical lessons

9 July 2012 2 Counterparty default – the legal issues

Who is your counterparty?

Essential to know exactly which legal entity you are dealing with What did firms mean when they said they

had exposure to “Lehman”? Has an Event of Default occurred in

relation to your counterparty? Is an Event of Default in relation to a group

company of your counterparty relevant? – Collateral or Credit Support Provider – Guarantor – Specified Entity


What events could lead to an Event of Default under the 2000 GMRA?

Failure to pay purchase price/repurchase price

Failure to pay sums due on mini close out.

Optional (specify in Annex 1), failure to deliver

securities on purchase date / repurchase date (see also

mini close-out below).

Failure to comply with margin provisions.

Failure to pay manufactured payments

(income).

Act of Insolvency

Incorrect or untrue representations.

Admission of inability to perform or intention not to

perform (disclaiming contract).

Suspension or expulsion from securities exchange,

suspension from dealing by a govt agency or appt of

trustee by regulator.

Any other breach not remedied for 30 days after

notice of breach.

Not Events of Default, but also consider: a) mini-close

out provisions and b) termination of affected

transactions for tax event .

Also, bear in mind parties may have negotiated

modifications / additional events in Annex I or a

Confirmation.


Changes to the list of Events of Default in the 2011 GMRA


Failure to pay purchase price/repurchase price

Failure to pay sums due on mini close out.

Optional (specify in Annex 1), failure to deliver

securities on purchase date / repurchase date within the standard settlement

time (see also mini close-out below).

Failure to comply with margin provisions.

Failure to pay manufactured payments

(income).

Act of Insolvency – expanded in 2011 GMRA, more in line with definition of Bankruptcy in

the ISDA Master Agreement.

Incorrect or untrue representations.

Admission of inability to perform or intention not to perform (disclaiming

contract).

In default, suspension or expulsion from securities exchange, suspension/prohibition from dealing by a Competent Authority or

appt of trustee by regulator , in each case on grounds of failure to meet reqts re financial

resources / credit rating.

Any other breach not remedied for 30 days after

notice of breach.

Not Events of Default, but also consider: a) mini-close

out provisions and b) termination of affected

transactions for tax event .

Also, bear in mind parties may have negotiated

modifications / additional events in Annex I or a

Confirmation.

Comparison with GMSLA and ISDA (1)

2000 GMRA

2011 GMRA

2000 GMSLA

2010 GMSLA

1992 ISDA

2002 ISDA

Failure to pay Y – failure to pay purchase price or repurchase price

Y – failure to pay purchase price or repurchase price

N - but see specific EoDs below

N - but see specific EoDs below

Y – general failure to pay/deliver EoD


Failure to deliver N – but see specific EoDs below

N – but see specific EoDs below





Failure to deliver or redeliver repoed/lent securities

Option^ Option^ N^ N^ N/A* N/A*

Failure to pay sums due on mini close-out

Y Y Y Y N/A* N/A*

Failure to comply with margin / collateral provisions

Y Y Y – except failure to deliver equivalent collateral^

Y – except failure to deliver equivalent collateral^

Y – credit support default EoD

Y – credit support default EoD

Failure to pay income Y Y Y Y N/A*

N/A*


*Note the general failure to pay/deliver Event of Default in the 1992 ISDA and 2002 ISDA ^Note, however, the mini close-out provisions


2000 GMRA

2011 GMRA

2000 GMSLA

2010 GMSLA

1992 ISDA

2002 ISDA

Insolvency Y Y Y Y Y – bankruptcy EoD

Y – bankruptcy EoD

Reps untrue/incorrect Y Y Y Y Y – misrepresentation EoD

Y – misrepresentation EoD

Disclaiming contract Y Y Y Y Y – repudiation of agreement EoD

Y – repudiation of agreement EoD

Suspension from exchange/dealing

Y Y Y Y N N

Other breach not remedied in specified time period

Y Y Y Y Y – breach of agreement EoD

Y – breach of agreement EoD

Default under specified transaction

N N N N Y Y

Cross-default N N N N Y Y



2000 GMRA

2011 GMRA

2000 GMSLA

2010 GMSLA

1992 ISDA

2002 ISDA

Merger without assumption

N N N N Y Y

Illegality N* N* N N N – but Termination Event

N – but Termination Event

Force majeure N* N* N N N N – but Termination Event

Tax event N – but may be able to terminate*

N – but may be able to terminate*

N N N – but Termination Event

Y – but Termination Event

Tax event upon merger N N N N N – but Termination Event

Y – but Termination Event

Credit event upon merger N N N N N – but Termination Event

N – but Termination Event

Optional termination N N Y Y N N

Additional events If agreed If agreed If agreed If agreed If agreed If agreed


* Note that a party may be able to terminate an affected transaction for a tax event or change in fiscal or regulatory regime which have a material adverse effect on that party in the context of that transaction.

What might happen on a Eurozone exit? Planning scenario


A single state announces immediate exit from the Eurozone but not the EU

Creates a replacement currency

New currency law redenominates some existing euro obligations

Imposes capital and exchange controls (possibly border controls)

Declares bank holiday to give more time to effect exit and redenomination

Eurozone exit – general legal issues


Redenomination Capital and exchange controls

Frustration and illegality Insolvency

Suspension and termination

rights

Potential relevance of capital and/or exchange controls - overview


In the context of a potential Euro exit, capital and/or exchange controls could be imposed: before the exit, to prevent capital flight; simultaneously with the exit, to support the redenominated

currency; or without there being an exit.

Legal issues: IMF Articles of Agreement:

– Unenforceability of “exchange contracts” Treaty on the Functioning of the EU General Agreement on Trade in Services Bilateral Investment Treaties

Disruption, uncertainty – whether imposed with IMF approval or not

Even if imposed without IMF approval: Still potentially very disruptive The period between the imposition of the controls and the date

when, in any individual contract case, they are found not to be enforceable, could be long and be one of considerable uncertainty in relation to the contract itself and what the parties ought to be doing pursuant to it

Potential relevance of capital and/or exchange controls – practical issues


You will have to form views quickly on the scope of the capital/exchange controls ring-fence and what payments and deliveries can and cannot be made (your view might differ from that taken by your counterparties)

Impact on incoming or outgoing payments or deliveries If your counterparty fails to make a payment or delivery

when due as a result of the controls: Can you terminate? Is it an Event of Default or any other event

which gives you the right to close-out (e.g. an Illegality Termination Event under an ISDA)?

Are you still under an obligation to pay/deliver (e.g. under the GMRA, have you switched on the optional condition precedent, similar to section 2(a)(iii) ISDA and, even if you have, are you confident there’s an Event of Default?)

Consequences of getting it wrong Market disruption Settlement disruption Impact on valuations and margin Impact on account structures Possibility of criminal offence in the departing state?

Failure to pay

What if counterparty makes payment in the new currency, not euro?

Have the obligations been redenominated? Jurisdiction Governing law Currency of payment provisions Place of payment

Contractual currency provisions of contract: GMRA paragraph 7(a) – payee may at its option accept tender

in any other currency, provided payee could purchase the relevant amount in the contractual currency with that payment

GMSLA – no equivalent provision ISDA section 8(a) – similar to GMRA position, but not optional

Grace periods? Do other provisions (e.g. Illegality/Force Majeure)

apply instead of the relevant failure to pay Event of Default?

What is the rest of the market doing?


Act of Insolvency - GMRA


2000 GMRA compared with the 2011 GMRA:

Presenter

Presentation Notes

The GMRA is now much more in line with the 2002 ISDA. Less in line with GMSLA.

Act of Insolvency - GMSLA


2000 GMSLA and 2010 GMSLA: Act of Insolvency means in relation to either Party:

a) its making a general assignment for the benefit of, or entering into a reorganisation, arrangement, or composition with creditors; or

b) its stating in writing that it is unable to pay its debts as they become due; or c) its seeking, consenting to or acquiescing in the appointment of any trustee,

administrator, receiver or liquidator or analogous officer of it or any material part of its property; or

d) the presentation or filing of a petition in respect of it (other than by the other Party to this Agreement in respect of any obligation under this Agreement) in any court or before any agency alleging or for the bankruptcy, winding-up or insolvency of such Party (or any analogous proceeding) or seeking any reorganisation, arrangement, composition, re-adjustment, administration, liquidation, dissolution or similar relief under any present or future statute, law or regulation, such petition not having been stayed or dismissed within 30 days of its filing (except in the case of a petition for winding-up or any analogous proceeding in respect of which no such 30 day period shall apply); or

e) the appointment of a receiver, administrator, liquidator or trustee or analogous officer of such Party over all or any material part of such Party’s property; or

f) the convening of any meeting of its creditors for the purpose of considering a voluntary arrangement as referred to in Section 3 of the Insolvency Act 1986 (or any analogous proceeding);

Presenter

Presentation Notes

The GMSLA definition of Act of Insolvency is in line with the 2000 GMRA (but not the 2011 GMRA or 2002 ISDA, which are broader in many respects – and in respect of which the period for dismissing petitions is 15 days, not the much lengthier 30 days as is the case under the GMSLA)

Bankruptcy - ISDA


1992 ISDA compared with 2002 ISDA:

Process for terminating upon an Event of Default - overview


So, you’re confident your counterparty has defaulted and you want to terminate…

Act quickly, both in: serving the relevant notice (i.e. the Default

Notice or Early Termination Notice) (unless certain of AET); and

obtaining quotes. Follow internal procedures and the

requirements of the legal documentation Try to act as an organisation – know what

other desks are doing e.g. re obtaining quotes

Process for terminating upon an Event of Default - comparison


Event

Default notice

(unless AET)

Event of Default and acceleration

Event = Event of Default

Early termination

notice (unless AET switched

on)

Acceleration

Under the 2000 GMRA and the 2000 and 2010 GMSLA:

Under the 2011 GMRA and the 1992 and 2002 ISDA:

Automatic early termination


Presentation of a petition for winding up or any analogous proceeding or the appointment of a liquidator or analogous officer*

2000 GMRA and 2000 GMSLA standard position is that this event would lead to

automatic Event of Default and early termination 2010 GMSLA

as for 2000 GMSLA, but parties to elect if they want AET to apply to a party

2011 GMRA and 1992 and 2002 ISDA parties to elect if they want AET to apply to a

party if AET applies, this event would lead to

automatic early termination Experiences of AET in Lehman If there is any ambiguity and you want to terminate,

serve the notice

*Note, a broader list is used in the 1992 and 2002 ISDA

Practical Lessons (1)

Lesson 1: Be Prepared Conduct fire drills Have “disaster manuals” ready including

precedent default notices / early termination notices

Be able to locate agreements Check agreements

– All signed? – Address for notices? – Prepare summary of main provisions relevant

to default and termination e.g. does Automatic Early Termination apply?

Names and contact details of key staff – Who is contactable over the weekend?


Practical Lessons (2)

Lesson 2: be aware of timing issues Act quickly and be proactive Co-ordinate across your organisation Keep records Be prepared to justify your decisions and actions

Lesson 3: delayed information and reactions are costly Prepare – as when an Event of Default occurs you

will need information and have to make decisions quickly

– What transactions do you have with the defaulting party?

– What is the exposure? – Has an Event of Default occurred? Is it an analogous

event? No standard terminology across documents – Is it an automatic event of default? Is that helpful?


Questions?


Speaker

Habib Motani [email protected] +44 (0)207006 1718


mailto:[email protected]

Clifford Chance, 10 Upper Bank Street, London, E14 5JJ © Clifford Chance LLP 2012 Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC323571 Registered office: 10 Upper Bank Street, London, E14 5JJ We use the word 'partner' to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications

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Counterparty default – the legal issues

counterparty default – the legal issues · manufactured payments (income). act of insolvency –...

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