Section 2(a)(iii) of every standard International Swaps and Derivatives Association (ISDA) Master Agreement provides in relevant part that a non-defaulting party does not have to perform so long as any event of default or potential event of default is continuing with respect to its counterparty. The exact extent of the protection provided by this provision has been the subject of trans-Atlantic controversy in the past few years as U.S. court decisions coming out of the Lehman insolvency have thrown doubt on its efficacy while some English decisions have expanded its impact to make it even more favorable to non-defaulting parties than the market had generally believed to be the case. A judgment handed down by the English Court of Appeals on April 3 dealing with four related cases has now settled the position for English law ISDA masters on the basis that the traditional market view of the provision was essentially correct all along – Section 2(a)(iii) suspends rather than extinguishes performance by the non-defaulting party and the suspension can be indefinite. The decision, however, also adds the important clarification that suspended obligations must always be taken into account in determining the amount due between the parties in connection with a close-out of transactions under the relevant master agreement.
For parties to New York law ISDA master agreements, the most useful parts of the decision in Lomas and others v JFB Firth Rixson, Inc. and others will be the reasoning used by the court to conclude that 1) there is nothing in the master agreement or relevant law that causes the protection of the clause to a non-defaulting party to expire after “a reasonable time”, and 2) the provision does not violate the anti-depravation and pari passu principles of English insolvency law. That reasoning is likely to be cited extensively in any future case in the U.S. that involves the same issues addressed by Judge Peck’s decision in the swap dispute between Metavante Corporation and Lehman Brothers Special Financing.
A copy of the English Court of Appeals judgment can be found here.