Australia: English court upholds ISDA's interpretation of ISDA Master Agreement

Key Points:

The Lomas decision confirms the understanding of the OTC derivatives industry and realigns the Australian and English law position on the operation of Section 2(a)(iii) of the ISDA Master Agreement.

The recent decision of the UK Court of Appeal in Lomas and others v JFB Firth Rixson, Inc and others [2012] EWCA Civ 419 confirms that, under English law, Section 2(a)(iii) of the ISDA Master Agreement operates to protect a non-defaulting party in the case of a counterparty's default (or potential default) by suspending its payment obligations until the trigger events are cured by the defaulting counterparty. The suspension can be indefinite – it does not expire on the final payment date of the swap transaction.

The decision confirms the understanding of the over-the-counter (OTC) derivatives industry and realigns the Australian and English law position in relation to the operation of Section 2(a)(iii) of the ISDA Master Agreement.

The proposal by the International Swaps and Derivatives Association, Inc. (ISDA) in April 2011 to introduce a time limit on how long a non-defaulting party is entitled to suspend its obligations under Section 2(a)(iii) is likely to continue to be the subject of further interest, particularly in light of recent pressure from the UK Treasury and the general concern of regulators to impose a time limit to provide certainty for administrators and creditors of defaulting parties.

In Australia, the customary amendment to provide that Section 2(a)(iii)(1) ceases to apply once the defaulting party no longer has any further obligations to perform will likely still be made, to ensure that the suspension does not indefinitely deprive the defaulting party and its creditors of the benefit of an "in-the-money" position where the defaulting party has satisfied all of its obligations, notwithstanding the occurrence of an Event of Default or Potential Event of Default.


Section 2(a)(iii) of the ISDA Master Agreement is considered one of the principal pillars upon which the Master Agreement is based. Under Section 2(a)(iii)(1), where an Event of Default or Potential Event of Default occurs with respect to a party to a transaction, the other party can rely on this provision to refrain from making any further payments or deliveries under the ISDA Master Agreement, thereby protecting its position and not exposing itself to further loss.

Over the last decade and particularly in the aftermath of the GFC, the enforceability and operation of Section 2(a)(iii) has been tested in various jurisdictions, after several cases were heard involving defaulting parties (or their administrators) suing out-of-the-money non-defaulting parties for suspending payments instead of terminating and closing-out outstanding positions. The divergent approaches of UK, US and Australian courts to the interpretation of Section 2(a)(iii) and its enforceability in the context of the applicable insolvency laws had created uncertainty in the OTC derivatives market over its operation. The courts have struggled to reach a consistent view on a number of issues in relation to Section 2(a)(iii), including its suspensive effect.

Debate on the suspensive effect

The courts have considered two key issues in relation to the suspensive effect of Section 2(a)(iii):

  1. Does Section 2(a)(iii) operate only to suspend the obligations of the non-defaulting party for as long as the event of default is continuing, or does it extinguish obligations entirely?
  2. If the effect of Section (2)(a)(iii) is to suspend obligations, does the suspension continue for a potentially indefinite period of time (particularly in the case of an administration or insolvency)?

The recent UK Court of Appeal decision brings some welcome clarity to these issues. We have summarised below some of the leading cases affected by the decision and their differing interpretations.

Australian approach

The Australian decision, SIMMS and Another (in their capacity as liquidators of Enron Australia Finance Pty Ltd (in liq)) v TXU Electricity Ltd [2003] NSWSC 1169 (Enron v TXU) is the leading authority in Australia in relation to the suspensive effect of Section 2(a)(iii).

Enron and TXU were party to a large number of electricity swaps. Upon Enron's liquidation, TXU relied on Section 2(a)(iii), to cease making payments to Enron without terminating the swaps. Enron's liquidator sought leave of the court to compel TXU to designate an early termination date.

The court refused to rewrite the agreement, essentially confirming that under the ISDA Master Agreement, a non-defaulting party has the right to choose not to designate an early termination date and rely instead on Section 2(a)(iii) to avoid having to make payments. Justice Austin went further to state in obiter that "a payment obligation [under Section 2(a)(iii)] will spring up under a pre-existing trade once the relevant condition is satisfied, and in that sense it might be said... that the payment obligation is "suspended" while the condition remains unfulfilled".

The market considered this case to confirm the non-defaulting party's right to withhold (potentially indefinitely) payments under Section 2(a)(iii) and the enforceability of that right against a liquidator.

US approach

In the US, debate has focused on the enforceability of Section 2(a)(iii) in the context of the US Bankruptcy Code.

In re Lehman Brothers Holdings, Inc., Case No. 08-13555 et seq. (JMP) (jointly administered), Metavante Corporation (Metavante) and Lehman Brothers Special Financing (LBSF), entered into interest rate swap transactions. Under the agreement, Metavante was the fixed rate payer and LBSF was the floating rate payer. LBSF filed for bankruptcy protection under Chapter 11 of the US Bankruptcy Code. Rather than designate an early termination, Metavante relied on Section 2(a)(iii) to withhold payment on the outstanding transactions, as an early termination would have required a multi-million dollar payment to LBSF.

The court held that the non-defaulting party must decide whether or not to terminate the contract, and that the decision must be made within a reasonable time, effectively limiting the section's enforceability. The court reasoned that to indefinitely suspend payment obligations under the section amounted to a modification of the parties' contractual rights, and was therefore in contravention of the US Bankruptcy Code.

Limiting the enforceability of Section 2(a)(iii) set a concerning precedent for market participants that local bankruptcy laws could simply override a commercial agreement governed by the ISDA Master Agreement.

UK approach: Marine Trade

In Marine Trade SA v Pioneer Freight Futures Co Ltd BVI [2009] EWHC 2656 (Comm), Marine Trade and Pioneer had entered into forward freight agreements, which incorporated 1992 ISDA Master Agreements. Pioneer was subject to a Bankruptcy Event of Default. Marine Trade relied on Section 2(a)(iii) to withhold a "Settlement Sum" of USD $12 million. Pioneer initially argued that it subsequently cured the Event of Default and therefore claimed that the money became payable.
In an obiter statement, the court suggested that even if the defaulting party ceased to be in default, there was nothing in the ISDA Master Agreement to suggest that the non-defaulting party's obligation to pay would be automatically revived. The court's view was that Section 2(a)(iii) operated as a "one time" provision in assessing whether a sum is owed. That is, if the conditions precedent are not fulfilled on the due date for the relevant payment obligation, the payment obligation never becomes due.

The "once and for all test" is widely regarded as uncommercial. For instance, if mere administrative error triggers an Event of Default or Potential Event of Default, the defaulting party would lose the benefit of all payments that would otherwise have been due to it in the time it takes to rectify these problems.

UK approach: Lomas (2010)

In Lomas and others (together the Joint Administrators of Lehman Brothers International (Europe) (in administration)) v JFB Firth Rixson, Inc. and others and ISDA as an intervenor (2010), four out-of-the-money counterparties declined to terminate their interest rate swap transactions with Lehman Brothers International Europe following the latter's administration, instead relying on Section 2(a)(iii) to suspend payments. Lehman's administrators sought direction from the court as to the correct interpretation of the section.
The court affirmed the reasoning in Marine Trade, that a non-defaulting party can suspend payments under the relevant transaction while there is an Event of Default.

ISDA, which was granted leave to intervene in the case, further maintained that the effect of a continuing default on a particular payment date is only to suspend the payment obligation until the default is cured and the condition precedent is satisfied. This argument departed from the "once and for all" test in Marine Trade in that the payment obligation could, in theory, remain indefinitely notwithstanding that the payment date had fallen due.

Although the court agreed with ISDA that a payment obligation is suspended until the Event of Default is cured, it found that this was only the case up until the expiry of the term of the transaction at which point, if the Event of Default has not been cured, the payment obligation is extinguished and the non-defaulting party is permanently released from its obligation to pay the defaulting party. This aspect of the decision did not align with the market's expectations, and a plain reading of the provision, that the suspension under Section 2(a)(iii) should last indefinitely.

An end to the uncertainty? – the UK Court of Appeal Lomas decision

Lomas was appealed in the UK Court of Appeal (CA) in December 2011. The appeal was joined with the appeals of three other cases that considered related issues. Judgment was handed down on 3 April 2012.

The UK CA dismissed the Lomas appeal and upheld the UK High Court's Lomas decision in relation to the suspensive effect of Section 2(a)(iii). However, it disagreed with the UK High Court on the question of the duration of the payment suspension. The UK CA held that payment suspension under Section 2(a)(iii) can be indefinite regardless of the original termination date of the related swap transaction. That is, the suspension of payment obligations continues in force until the Event of Default is cured or the non-defaulting party elects to terminate. If it is cured, the non-defaulting party's payment obligation would spring up to the extent the relevant swap transaction is not terminated. If it is never cured, there continues to be no obligation on the non-defaulting party to make payment.

The UK CA's decision realigns the English law position in relation to the suspensive effect of Section 2(a)(iii) with the position in Enron v TXU. However whether the decision effectively puts to rest the uncertainty associated with this provision is likely to be a hot topic for further debate, particularly amongst regulators in the UK and Australia.

Where to from here?

In response to concerns raised by the UK High Court cases and the UK Treasury, ISDA released a consultation paper in April 2011 which, among other things, proposed various amendments to Section 2(a)(iii) including:

  • clarification that the obligations of a non-defaulting party affected by Section 2(a)(iii) are suspended rather than extinguished and that the duration of the suspension can be indefinite;
  • clarification that the defaulting party's obligations under the suspension are netted against payments due by the non-defaulting party; and
  • the introduction of a time period for suspension of obligations between 90 and 180 days.

It will be interesting to observe whether as a result of the UK CA's decision ISDA will be under increased pressure to further refine Section 2(a)(iii) along the lines of the proposals set out above, to provide certainty that transactions will be terminated within a reasonable period in cases where a defaulting party goes into administration or files for bankruptcy.

The position in Australia

Since the decision in Enron v TXU, OTC counterparties in Australia have traditionally included an amendment to Section 2(a)(iii)(1) providing that Section 2(a)(iii)(1) ceases to apply once the defaulting party no longer has any further obligations to perform.

Until a position is reached by the industry in relation to specifying a time limit on the operation of Section 2(a)(iii), this amendment is likely to continue to be adopted by parties to ISDA Master Agreements where the governing law is Australian law, to ensure that the suspension does not indefinitely deprive the defaulting party and its creditors of the benefit of an "in-the- money" position where the defaulting party has satisfied all of its obligations, notwithstanding the occurrence of an Event of Default or Potential Event of Default.

You might also be interested in...

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.