Counterparty Default - The Legal Issues - Habib Motani

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
Counterparty default the legal issues 9 July 2012
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
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What events could lead to an Event of Default under the 2000 GMRA?
Failure to pay purchase price/repurchase price Optional (specify in Annex 1), failure to deliver securities on purchase date / repurchase date (see also mini close-out below). Failure to pay sums due on mini close out.
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.
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Changes to the list of Events of Default in the 2011 GMRA

Failure to pay purchase price/repurchase price 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 pay sums due on mini close out.
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.
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Comparison with GMSLA and ISDA (1)

2000 GMRA
Failure to pay Y failure to pay purchase price or repurchase price N but see specific EoDs below Option^
2011 GMRA
Y failure to pay purchase price or repurchase price N but see specific EoDs below Option^
2000 GMSLA
N - but see specific EoDs below
2010 GMSLA
N - but see specific EoDs below
1992 ISDA
Y general failure to pay/deliver EoD
2002 ISDA
Y general failure to pay/deliver EoD
Failure to deliver
N but see specific EoDs below N^
N but see specific EoDs below N^
Y general failure to pay/deliver EoD N/A*
Y general failure to pay/deliver EoD N/A*
Failure to deliver or redeliver repoed/lent securities Failure to pay sums due on mini close-out Failure to comply with margin / collateral provisions
Y Y
Y Y
Y Y except failure to deliver equivalent collateral^ Y
Y Y except failure to deliver equivalent collateral^ Y
N/A* Y credit support default EoD
N/A* Y credit support default EoD
Failure to pay income
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
Insolvency Y
2011 GMRA
Y
2000 GMSLA
Y
2010 GMSLA
Y
1992 ISDA
Y bankruptcy EoD Y misrepresen tation EoD Y repudiation of agreement EoD N Y breach of agreement EoD Y Y
2002 ISDA
Y bankruptcy EoD Y misrepresen tation EoD Y repudiation of agreement EoD N Y breach of agreement EoD Y Y
Reps untrue/incorrect
Disclaiming contract
Suspension from exchange/dealing Other breach not remedied in specified time period
Y Y
Y Y
Y Y
Y Y
Default under specified transaction Cross-default
N N
N N
N N
N N
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2000 GMRA
Merger without assumption Illegality N N*
2011 GMRA
N N*
2000 GMSLA
N N
2010 GMSLA
N N
1992 ISDA
Y N but Termination Event N
2002 ISDA
Y N but Termination Event N but Termination Event Y but Termination Event Y but Termination Event N but Termination Event N If agreed
Force majeure
N*
N*
Tax event
N but may be able to terminate* N
N but may be able to terminate* N
N but Termination Event N but Termination Event N but Termination Event N If agreed
Tax event upon merger
Credit event upon merger
Optional termination Additional events
N If agreed
N If agreed
Y If agreed
Y 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.
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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
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Eurozone exit general legal issues
Redenomination
Capital and exchange controls
Frustration and illegality
Insolvency
Suspension and termination rights
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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
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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 theres 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?
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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?
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Act of Insolvency - GMRA

2000 GMRA compared with the 2011 GMRA:
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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 Partys 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);
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Bankruptcy - ISDA
1992 ISDA compared with 2002 ISDA:
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Process for terminating upon an Event of Default - overview

So, youre 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
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Process for terminating upon an Event of Default - comparison

Under the 2000 GMRA and the 2000 and 2010 GMSLA:
Default notice (unless AET) Event of Default and acceleration
Event
Under the 2011 GMRA and the 1992 and 2002 ISDA:
Event = Event of Default Early termination notice (unless AET switched on)
Acceleration
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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
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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?
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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?
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Questions?
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Speaker
Habib Motani habib.motani@cliffordchance.com +44 (0)207006 1718
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www.cliffordchance.com
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

Habib Motani 9 July 2012

Presentation for ICMA

Who is your counterparty?