UK: Interpretation Of Section 2(a)(iii) Of The ISDA Master Agreement

Last Updated: 3 April 2011
Article by Edward Davis and Sue Millar

In Lomas and Others v JFB Firth Rixson, Inc and Others [2010] EWHC 3372 (Ch), the High Court considered the meaning and effect of Section 2(a)(iii) of the ISDA Master Agreement (1992 and 2002 versions), which provides that the payment obligations of the parties are subject to the condition precedent that no event of default is continuing with respect to the other party.

The joint administrators ("the Administrators") of Lehman Brothers International Europe ("LBIE") applied for directions as to the true construction and effect of five interest rate swap agreements pursuant to which LBIE was the floating rate payer. Each swap incorporated the terms of either the 1992 or the 2002 version of the ISDA Master Agreement.


The Respondents, LBIE's fixed rate paying counterparties, relied on Section 2(a)(iii) of the Master Agreement as the basis for a refusal to make payments which would otherwise have fallen due to LBIE. Section 2(a)(iii) provides that a party's payment obligations are subject (amongst other things) to the condition precedent that there is no continuing Event of Default with respect to the other party. One such Event of Default is the "Bankruptcy" of the counterparty, which includes the appointment of an administrator. Accordingly, as at 15 September 2008, there was an Event of Default in respect of LBIE. The Respondents argued that because of this Event of Default they did not have any obligation to make any further fixed rate payments to LBIE (LBIE would otherwise have been very substantially in the money under all five swaps).

The Administrators challenged the counterparties' interpretation of the Master Agreement under four headings:

1 The Respondents' interpretation was, they said, commercially absurd and/or unreasonable and must therefore yield to implied terms to the contrary. They advanced three alternatives:

  1. that the non-defaulting party's payment obligation was only suspended for a "reasonable period", to allow it to decide whether to designate an Early Termination Date ("ETD");
  2. that Section 2(a)(iii) suspended the non-defaulting party's payment obligations until the end of the term of the transaction, at which point it was obliged to designate an ETD; and/or
  3. the non-defaulting party had a discretion whether or not to designate an ETD and had to do so in a manner which was not arbitrary, capricious or unreasonable.

2 The Master Agreement offended the "anti-deprivation principle", because the adverse effects on LBIE and its creditors were triggered by the onset of LBIE's administration.

3 The counterparties' interpretation gave rise to a penalty.

4 Their interpretation constituted a forfeiture, against which the Court should grant relief.

The Court rejected the arguments on penalty and forfeiture very swiftly, and so most of the judgment, and hence this article, focuses on the Administrators' arguments as to implied terms and the anti-deprivation principle.

Once and for all or suspension?

The Judge dealt first with an issue about whether or not Section 2(a)(iii) had a "once and for all" effect (i.e. that if an Event of Default was continuing on a particular date for payment by the non-defaulting party, then that payment obligation never arose); or whether the effect of Section 2(a)(iii) was only to suspend the coming into effect of the payment obligation until the default was cured. It was accepted that in relation to the 2002 Master Agreement the "once and for all" submission could not be maintained because Section 9(h)(i)(3)(A) of that agreement expressly contemplated that an amount might become payable to the satisfaction of the Section 2(a)(iii) condition precedent after a payment date. Nonetheless, some of the Respondents submitted that, under both the 1992 and 2002 versions, an amount could not become payable by reason of the satisfaction of a condition precedent after the swap had run its term. The Judge found that although the once and for all approach had the undoubted merit of simplicity and certainty because the payer did not need to make a provision against the risk of the obligation falling due in the future, he came to the conclusion on balance that the suspensory construction was to be preferred. The main reason for this was that the "once and for all" construction would produce a pointlessly draconian outcome (the permanent extinction of a right to a payment), in the event of a minor and momentary default, or even a Potential Event of Default.

The question then arose of how long a suspended payment obligation remains in suspense (i.e. until the expiry of the term of the transaction, or indefinitely?). The Court concluded that the payment obligation remained in suspense only until the expiry of the term of the transaction, essentially because it was wholly inconsistent with any reasonable understanding of the Master Agreement to argue that payment obligations arising under a transaction could give rise to indefinite contingent liabilities, in the event that an Event of Default may be cured long after the expiry of the transaction.

Implied terms

The Court then considered the three alternative constructions advanced by the Administrators, as outlined above. The essence of the Administrators' complaint was that, in the events that had happened, the construction proposed by the Respondents gave them a windfall rather than protection from, or compensation for, the consequences of LBIE's default. The Court was not persuaded by any of the Administrators' submissions on construction:

  1. The argument that the suspension of the non-defaulting parties' payment obligation was only for a reasonable time could not be implied into the terms of the Master Agreement. In the event of a Bankruptcy Event of Default the non-defaulting party would have to buy a replacement hedge in the market and then prove for the Settlement Amount against the defaulting party in its liquidation or administration, from which it may receive a modest, or no, dividend. Accordingly, it was not possible to treat the early termination election as always being a sufficient remedy for the non-defaulting party. It was not therefore surprising to find that the Master Agreement contains provision whereby the non-defaulting party may say that, for as long as the default means that the secure hedge for which it had contracted is absent, no further payment will be made under the swap.
  2. The alleged implied term that the condition precedent in Section 2(a)(iii) falls away at the end of the term of the transaction, at which point the non-defaulting party had to designate an ETD, was also found to be at variance with the plain language with the Master Agreement.
  3. Finally, in relation to the Administrators' arguments about the unreasonable exercise of a discretion, the Court said that it did "not begin to understand how the Respondents' choice not to elect for Early Termination in relation to the swaps . . . can possibly be categorised as dishonest, in bad faith or exercised otherwise than for the purpose for which it was conferred".


The Court found that Section 2(a)(iii) did not contravene the anti-deprivation rule because the nature of LBIE's rights did not change on 15 September 2008 when it went into administration. Where the asset of an insolvent company is a chose in action representing the quid pro quo for something already done, sold or delivered before insolvency, then the Court will be slow to permit the insertion of a flaw in that asset triggered by the insolvency process. On the other hand, where the right in question consists of the quid pro quo for services yet to be rendered, or something still to be supplied by the insolvent company in an ongoing contract, then the Court will readily permit the insertion of such a flaw. The contingent rights to future net payments, as at 15 September 2008, enjoyed by LBIE were the quid pro quo not merely for services previously rendered to the swap counterparties, but also for the ongoing provision of an interest rate hedge. LBIE's insolvency was sufficient to undermine the basis of that ongoing relationship with its counterparties.

Practical implications

ISDA has stated that it is in the process of preparing a form of amendment to Section 2(a)(iii) in response to some of the issues raised by this case. In particular, ISDA has said that the finding by the Court that payments that had been suspended under Section 2(a)(iii) may be extinguished after the last day for payment under the transaction is surprising and at odds with the market's expectations. The decision may well be subject to appeal.

Although the Court found that Section 2(a)(iii) did not contravene the anti-deprivation principle, it made it clear that this decision was based on the fact that the swaps in question were interest rate swaps which constituted an ongoing relationship between the parties in which their rights to receive contingent net payments accrued from time to time as the quid pro quo for the provision of a continuing service. It is perfectly possible that a different analysis might be appropriate for other transactions under an ISDA Master Agreement. Moreover, it was conceded in this case that Section 2(a)(iii) operated on a net rather than a gross basis (i.e. the non-defaulting party must take into account its own payments when enforcing the defaulting party's payment obligation). If it had been concluded that Section 2(a)(iii) operated so as to increase LBIE's obligation on any future payment date from a net amount to a gross amount, that might well have offended the anti-deprivation principle because it would have imposed a greater financial obligation on LBIE by reason of its insolvency than would otherwise have been imposed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

This article was originally written for Stephenson Harwood's quarterly publication, Finance Litigation Legal Eye. If you would like to receive this publication, please contact Stephenson Harwood.

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.

In association with
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.