There have been a number of first instance decisions concerning the construction and effect of Section 2 (a) (iii) of the ISDA Master Agreement. The problem has been the conflicts between the various judgments, and in particular, with respect to the interpretation and effect of Section 2 (a) (iii). This has led to uncertainly as to how the Section is intended to operate. Further, general problems of interpretation have arisen with respect to the termination of Transactions and the calculation of loss, especially in the event of one party becoming subject to insolvency proceedings.

In Lomas and others v JFB Firth Rixson Inc and others [2012] EWCA Civ 419, the Court of Appeal wrestled with these authorities and resolved all the conflicts in interpretation and application. This has provided certainty and we set out below the seven main points to take away from the Court of Appeal decision.

  1. What is the effect of a bankruptcy Event of Default on the payment and debt obligations?

The obligation is suspended.

In the absence of an election for Automatic Early Termination, the Court of Appeal held that Section 2 (a) (i) suspends the payment obligation for as long as the Event of Default is continuing. The underlying debt obligation remains unaffected.

  1. Is the payment obligation extinguished by an Event of Default existing on the date for performance of that obligation?


The Non-Defaulting Party’s obligation to pay under Section 2 (a) (i) is not extinguished by an Event of Default existing and continuing on the date of performance. 

  1. Is the payment obligation extinguished on maturity of the Transactions?


The payment obligations are not extinguished on the maturity of the Transactions, i.e. the contractual end date of the ISDA Master Agreement. Indeed, it was noted that there is no provision providing for expiry by reason of effluction of time and no such term was capable of implication.

  1. Can a Non-Defaulting Party terminate after maturity of the Transactions?


It is possible for the Non-Defaulting Party to terminate the Master Agreement after maturity of the Transactions. By the same token, if Automatic Early Termination is applicable, this may occur after the maturity of the Transactions.

  1. In the case of insolvency, does the operation of Section 2 (a) (i) offend the anti-deprivation principle?


The anti-deprivation principle operates to invalidate a contract that has the effect of transferring a company’s property to another on insolvency (thus removing that property from the proceeds of the insolvency that would be available to the company’s creditors).

The Court of Appeal held that there was no suggestion that Section 2 (a) (iii) was formulated in such a manner as to avoid the effect of insolvency law. The commercial operation of Section 2 (a) (iii) had to be judged in relation to the entire life of the contract and not just at the point of insolvency.

Essentially, the Court of Appeal confirmed the basic principle that the courts will strive, as far as possible, to give effect to contractual terms that the parties have agreed  

  1. In the case of insolvency, does the operation of Section 2 (a) (i) offend the pari passu rule?


The pari passu rule is a general principle of English law that all unsecured creditors must be treated equally.

The Court of Appeal held that at the time of the insolvency, there was no debt due, as payment was subject to a condition precedent that there should be no continuing Event of Default.

Therefore, Section 2 (a) (iii) does not affect the pari passu rule because it prevents the relevant debt becoming payable with the result that there is no property capable of being distributed.

  1. What test should be applied to calculate the loss of bargain as a result of one party’s insolvency?

The Loss and Second Method for calculating the loss of bargain represents a departure from common law principles of calculating damages, so that it is assumed that the Transaction would have proceeded to its contractual conclusion on the basis that all condition were satisfied, no matter how improbable such an assumption would be in the real world.

This meant that the “nil” loss argument was rejected.

Therefore, if an Early Termination Date occurs automatically, i.e. by reason of the election of Automatic Early Termination, a party can not rely on Section 2 (a) (iii) to withhold payments it owes to the insolvent party.


The Court of Appeal has provided some welcome clarity to the termination of a master agreement following an event of default, especially in circumstances where one party is rendered insolvent and Automatic Early Termination is elected. It is presently unclear as to whether any of the issues will be appealed to the Supreme Court.

As to the future of Section 2, ISDA themselves were an intervener in the proceedings and the Court of Appeal accepted some of their submissions on the operation of Section 2. However, a debate remains within ISDA over the operation of Section 2 (a) (iii) and a revised section is still anticipated.

This revised section may address the issue of non-defaulting parties delaying termination of the Transactions on the occurrence of a continuing event of default. This can be seen in the revised Coal Annex, which, in the event of a continuing event of default, provides that if the event of default continues for 15 days without early termination, then the condition precedent to the obligations under Section 2 (a) (i) will no longer operate.

Finally, and with respect to the insolvency of a party, it should always be born in mind that the position may be different in other jurisdictions. For example, it should be remembered that in the Metavante decision in the United States Bankruptcy Court, it was held that a party’s right to rely on Section 2 (a) (iii) in order to withhold payment from a defaulting party whilst not closing out does not exist indefinitely, a different position to the judgment of the Court of Appeal.