ISDA Derivatives and Communicating Notice
In the current environment, various types of derivatives—swaps, options, forwards, among others—are coming under intense pressure. Values of reference assets and rates fluctuate wildly, often on an intra-day basis. At the same time, market values have declined for all types of collateral and assets, resulting in margin and collateral calls being made. As parties grapple with operational challenges and liquidity squeezes in the face of the COVID-19 pandemic, defaults are inevitable. It is critical in these circumstances for non-defaulting parties to ensure they do not inadvertently waive or otherwise prejudice their rights.
One of the ways parties can get tripped up is in delivery of notice. This may seem like a trivial issue in the days of ubiquitous e-mail and other electronic communications, but it is not—ISDA contracts have specific provisions governing the methods of providing notice. The need to focus on these notice provisions is of particular importance now with the myriad of workplace disruptions being experienced. Occurrences like office closures (including offices designated for receipt of notice), slower response times, and employees working remotely are now commonplace and present additional complications. Below is a brief discussion of the law on notice provisions and some suggestions for best practices in the current pandemic environment.
Default and Termination Notice Provisions in the ISDA Master Agreement
In a default situation, the effectiveness of notices delivered by the non-defaulting party is key in determining if and when a default has occurred and when an early termination of a derivative transaction has been declared. Defaults such as failure to make a payment or delivery, or failure to post additional margin, occur only upon expiry of the relevant cure period following effective notice by the non-defaulting party. Similarly, declaration of termination of a transaction under an ISDA contract is effective only when notice of the early termination date is effectively delivered in accordance with the terms of the agreement.
Section 12(a) in the ISDA Master Agreement sets forth the methods for notice. Under the original 1987 version of the agreement, notice can be provided in one of the following manners: (i) in writing and delivered in person, (ii) sent by certified or registered mail (airmail, if overseas) or the equivalent (with return receipt requested), (iii) by overnight courtier, or (iv) by telex (with answerback received).
Subsequent iterations of the ISDA Master Agreement expanded upon these permitted methods. For example, the 1992 ISDA Master Agreement also allows parties to provide notice—other than notice of Events of Default and Termination Events under Section 5 or Early Termination under Section 6—by facsimile or “electronic messaging system.” The 2002 ISDA Master Agreement includes, for the first time, e-mail as a permitted method of providing notice.
The standard provisions may be modified, supplemented, and/or overridden by the Schedule to the Master Agreement or by the confirmation for a particular transaction. In some instances, parties have included provisions in the ISDA Schedule or confirmation to permit notice of defaults and/or terminations via e-mail. In the majority of derivatives contracts, however, Section 12(a) of the ISDA Master Agreement remains unchanged.
New York Law Governing Contractual Notice Provisions
New York law is chosen by the parties to govern many ISDA agreements. The general rule in New York, articulated in Rockland Exposition Inc. v. Alliance of Automotive Service Providers of New Jersey, is that strict compliance with contractual notice provisions is not necessary if the recipient received actual notice and was not otherwise prejudiced by the deviation.
But the rule expressed in Rockland is not absolute, and New York courts have sometimes held, outside the ISDA context, that strict compliance with the form of notice provided for in the contract is required.
What Happens If Notice Does Not Strictly Comply with the ISDA Provisions?
In circumstances where notice cannot be provided in strict compliance with the governing ISDA Agreement—if a counterparty’s office is closed and not accepting mail, a counterparty is unresponsive, etc.—there are several arguments that notice, if actually received by the non-defaulting party, is nonetheless effective.
The first argument is that under Rockland, strict compliance is not required as long as notice is actually received and the recipient was not otherwise prejudiced. But even if notice in strict accordance with the contractual provision were to be considered a condition precedent, the doctrine of “prevention” may excuse a party’s failure to perform when the failure was caused by another party’s conduct that frustrated or prevented the occurrence of the condition.
In that case—MBIA v. Coöperatieve Centrale Raiffeisen–Boerenleenbank B.A. (“Rabobank”), et. al.—one of the parties, Rabobank, argued there was no breach because its New York branch failed to provide Rabobank’s London branch (which served as counterparty on the ISDA swap agreement and was the entity required to provide notice to plaintiff) with notice that certain reference obligations were being sold. The Court denied the parties’ cross motions for summary judgment, finding in relevant part that Rabobank’s liability under the swap agreement was “not automatically precluded by the New York branch’s failure to send notice to the London branch.”
Finally, the implied covenant of good faith and fair dealing requires a party to “refrain from conduct which would prevent or hinder the occurrence of [a] condition.”
Best Practices For Providing Notice
Disruptions in traditional modes of communication can wreak havoc on attempts to provide notice to a counterparty. In order to avoid inadvertent waiver or otherwise prejudicing their rights, parties to ISDA Agreements should take the following steps when preparing and delivering notices of default or termination:
Read the master agreement notice provisions closely along with any modifications in the ISDA Schedule, any Credit Support Annex, and transaction confirmations;
Determine what kind of notice needs to be provided;
If the contract does not allow it, do not rely on e-mail or other methods used in the past, even with the same counterparty, just because they have not been challenged before;
If you can, comply strictly with the contract and use more than one permissible means of providing notice;
Keep careful records of the facts relating to all the notices—or attempts to provide notice—you send out; and
If your counterparty makes it impossible to provide notice in strict compliance with the contract, do your best to use other methods and preserve any evidence that actual notice was received.
Finally, with respect to new ISDA contracts, new transactions under existing agreements, or amendments to existing contracts, parties should consider adding e-mail as a permissible notice delivery method for all purposes, including in connection with defaults and terminations.