Interpretation of Section 2(a)(iii) of the ISDA Master Agreement is proving to be a topical issue in these recessionary times, both here and across the pond. James Curtis explains that a recent comment from Flaux J on the interpretation of Section 2(a)(iii) under English law may raise some eyebrows.

Section 2(a)(iii) provides that a party’s payment or delivery obligation is subject to the condition precedent that no Event of Default or Potential Event of Default (each as defined in the Master Agreement) has occurred and is continuing for its counterparty.

The Marine Trade S.A. v. (1) Pioneer Freight Futures Co Ltd BVI and (2) Armada (Singapore) PTE Ltd [2009] EWHC 2656 (Comm) case concerned a dispute between two companies, Marine Trade S.A. (Marine) and Pioneer Freight Futures S.A. (Pioneer). Marine and Pioneer had entered into a series of forward freight agreements. The agreements were cash-settled contracts for differences, the “difference” being between a rate agreed between the parties and a rate published by the Baltic Exchange. The agreements incorporated the terms of the 1992 ISDA Master


For the January 2009 contract month, Marine owed around US$12 million to Pioneer and Pioneer owed around US$7 million to Marine. These sums were payable on 6 February 2009. Pioneer conceded during the trial that, from 6 February 2009 until the trial date, an Event of Default (as defined in the Master Agreement) had affected Pioneer. Before conceding this, Pioneer had argued that, even if an Event of Default was affecting it on 6 February 2009, it stopped affecting it later.  

One of the questions that arose was if, after 6 February 2009, the Event of Default had ceased to affect Pioneer, would Marine then have become obliged to pay the US$12 million which it did not have to pay on 6 February 2009 because of the effect of Section 2(a)(iii)?

In fact the court did not need to decide the point. However, as the parties had fully argued it in court, Flaux J addressed the issue. He said: “If the party seeking payment of a Settlement Sum for a Contract Month cannot comply with the conditions precedent, then it is clear from the terms of the contract … that no obligation to pay the Settlement Sum comes into existence. There is nothing in the wording of the provisions of the contract to suggest that, if the condition precedent is fulfilled at some later date, some obligation to pay then springs up.”  

This seems surprising. If it is correct, it is relevant for a Potential Event of Default which the affected party can “cure” without any action by the other party. For example, assume that Party 1 is in breach of a trivial obligation under the Master Agreement. The counterparty, Party 2, as it may under Section 2(a)(iii), refuses to pay on the due date. According to Flaux J’s interpretation, Party 1 will have lost its right to payment. The right will only “come back into existence” on close out of the Agreement (which of course may never happen). At this point the unpaid amount will be taken into account under the “Unpaid Amounts” definition (which includes amounts that would have been payable if Section 2(a)(iii) had not applied).

One might think that the words “has occurred and is continuing” in Section 2(a)(iii) imply that, once the Event of Default or Potential Event of Default is no longer continuing, the other party’s obligation revives. However, Flaux J considered that “is continuing” referred to the position on the day the obligation to pay accrued (i.e. 6 February 2009).

Flaux J’s comments were obiter, which means that they have no binding authority under English law and are therefore non-appellable. Nonetheless, there may be an appeal against the first instance decision. Perhaps if the case proceeds to appeal, the Court of Appeal will see fit to comment further on Flaux J’s obiter, but important, observation.

In the current economic environment of counterparty defaults and insolvencies, it is unsurprising that parties are turning to Section 2(a)(iii). Flaux J’s comments come in the wake of the New York Bankruptcy Court’s decision the Lehman Brothers Special Financing Inc. and Metavante Corporation case. Here the court looked at whether, following the bankruptcy of Lehman Brothers Special Financing, the US Bankruptcy Code permitted Metavante to rely on Section 2(a)(iii) to avoid making payments. The court held that it did not. Instead, under New York law, a party faced with a bankrupt counterparty has two choices:

  1. Keep the contract in place and continue to make scheduled payments.
  2. Terminate the contract within a reasonable time of the counterparty’s default.