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.

Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Reed Smith (Worldwide)
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Reed Smith (Worldwide)
Related Articles
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions