marine trade v pioneer client briefing

7/31/2019 Marine Trade v Pioneer Client Briefing

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Marine Trade v Pioneer| 04 December 20091

Section 2(a)(iii) of the ISDA MasterAgreement: does it suspend or extinguishobligations?

4 December 2009

Marine Trade SA v Pioneer Freight Futures Co Ltd BVI [2009]

EWHC 2656 (Comm)

The High Court has considered the scope and effect of s2(a)(iii) of

the ISDA Master Agreement in circumstances outside formalinsolvency proceedings. While the courts conclusions on theenforceability of s2(a)(iii) as an effective condition precedent to

payment are unremarkable, the judge has made some rathersurprising statements as to the effect of s2(a)(iii) when an Eventof Default has been remedied.

The facts

Marine Trade SA (Marine Trade) and Pioneer Freight FuturesCo Ltd (Pioneer) entered into 14 Forward Freight Agreement(FFAs) which were subject to an agreement on the terms of the

1992 ISDA Master Agreement (the ISDA Master Agreement),as supplemented by Clause 9 of the 2007 Terms of the ForwardFreight Agreement Brokers Association (the FFABA Terms).

The FFAs were each cash settled contracts for differences and,for each month, a Settlement Sum was calculated for each FFAby reference to the Baltic Exchange Indices.

The aggregate gross Settlement Sums for the FFAs for January2009 resulted in USD 7 million payable to Marine Trade and USD12 million payable to Pioneer. Ordinarily, the Settlement Sumswere subject to payment netting under s2(c) of the ISDA Master

Agreement. The net payment for January 2009 after the operationof payment netting was approximately USD 5 million, payable byMarine Trade.

Marine Trade claimed that, at the end of January 2009, Pioneerwas unable to pay its debts as they fell due and was consequently

subject to a Bankruptcy Event of Default under s5(a)(vii)(2) of theISDA Master Agreement. It relied on s2(a)(iii) of the ISDA MasterAgreement to withhold payment of the USD 12 million, and

claimed USD 7 million (the gross amount due without operation ofpayment netting) from Pioneer. Meanwhile Pioneer invoicedMarine Trade for the net payment of USD 5 million.

Neither party made any payment on the payment date of 6February 2009 and Pioneer served a notice on Marine Trade of a

Each obligation of

each party under Section

2(a)(i) is subject to

(1) the condition

precedent that no Event

of Default or Potential

Event of Default with

respect to the other

party has occurred and

is continuing [].

Section 2(a)(iii) ISDA

Master Agreement


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Marine Trade v Pioneer | 04 December 20092

Failure to Pay Event of Default under s5(a)(i) of the ISDA MasterAgreement.

Marine Trade sought an injunction to prevent Pioneer from

serving an Early Termination Notice under s6 of the ISDA MasterAgreement. The injunction was refused and Marine Trade then

paid the net amount of USD 5 million under protest but served itsown notice on Pioneer under s5(a)(i) for a Failure to Pay USD 7million.

In the High Court proceedings Marine Trade sought payment ofUSD 7 million from Pioneer and repayment of the USD 5 million

which it paid under protest. Pursuant to a consent order, Pioneerundertook not to send any further notices of Event of Default orEarly Termination Notices prior to the decision at first instance.

Prior to the High Court hearing, in May 2009, Marine Tradebecame unable to pay its debts as they fell due, which constituted

an Event of Default under s5(a)(vii)(2) of the ISDA MasterAgreement.

The relevant contractual provisions

Section 2(a)(iii) of the ISDA Master Agreement provides asfollows:

Each obligation of each party under Section 2(a)(i) is subjectto (1) the condition precedent that no Event of Default orPotential Event of Default with respect to the other party hasoccurred and is continuing [].

Section 2(c) of the ISDA Master Agreement provides for payment

netting in the following terms:

If on any date amounts would otherwise be payable:

(i) in the same currency; and

(ii) in respect of the same Transaction,

by each party to the other, then, on such date, each partysobligation to make payment of any such amount will beautomatically satisfied and discharged and, if the aggregateamount that would otherwise have been payable by one party

exceeds the aggregate amount that would otherwise havebeen payable by the other party, replaced by an obligationupon the party by whom the larger aggregate amount would

have been payable to pay to the other party the excess of thelarger aggregate amount over the smaller aggregate amount.

By an amendment in Clause 9 of the FFABA Terms, limb (ii) ofs2(c) above was amended so that a net amount would be

determined in respect of all amounts payable on the same date inthe same currency in respect of two or more Transactions.

The High Court judgment

Where Pioneer is

affected by an Event of

Default, as a

consequence of

s2(a)(iii), Marine Trade

has no obligation to

make payment to Pioneer

at all.Marine Trade v

Pioneer, per Flaux J at

paragraph 22


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The effect of s2(a)(iii) on payments falling due from the Non-Defaulting Party after an Event of Default

Pioneer conceded that in January 2009 it was unable to pay itsdebts as they fell due and that an Event of Default had therefore

occurred under s5(a)(vii)(2). Consequently, as a result of s2(a)(iii),Marine Trade had no obligation to pay Pioneer on February 6.This conclusion was not disputed by Pioneer and was accepted

by the judge without any lengthy consideration.

The effect of remedying the Event of Default on the

suspended payment

Although Pioneer conceded this point, it initially argued that it

subsequently became able to pay its debts. It therefore claimed

that Marine Trades obligation to pay the USD 12 million thatwould otherwise have been due on 6 February was no longer

suspended and so became payable at that time.

Pioneer later conceded that it hadbeen affected by the Event of

Default at all material times and so the issue strictly did not arise.However, as the point had been argued in full, the judgeexpressed his views on it. Flaux J stated that, in his opinion,

s2(a)(iii) is a one time provision for the assessment of whether asum is owed. If the party due to receive an amount has notsatisfied the condition precedent then no obligation to pay comesinto existence. Even if the Event of Default is remedied at a laterdate, no amount will ever become payable. S2(a)(iii) thereforeoperates to extinguish rather than suspend the obligations if thecondition precedent is not satisfied on the due date. This view iscontrary to commentators on the ISDA Master Agreement (seeFirth, Derivatives: Law and Practice, paras 11-012 to 11-013 and

Henderson on Derivatives, para 18.3)

Flaux J found that there was no provision in the ISDA Master

Agreement to suggest that if the condition precedent is fulfilled atsome time later then the obligation to pay springs up. While it istrue that there is no such express provision, the difficultly with his

interpretation is that it leads to an extremely uncommercial result.

For example, if an administrative error causes there to be a deminimis underpayment, the party would lose the benefit of allpayments and deliveries that would otherwise be due to it beforethe error has been corrected. Similarly, if a bankruptcy petition is

filed against a party by a vexatious litigant that party will lose thebenefit of all payments and deliveries it should have received inthe time it takes to dismiss the petition.

Flaux Js conclusion would also lead to the paradoxical situationthat if A is owed an amount by B but A is, on the due date, subjectto an Event of Default which is subsequently cured, the amountdue to A would never become payable while the ISDA Master

Agreement subsists, but on an early termination of the Agreementit would be an Unpaid Amount (since this term includes theamounts that became payable (or that would have becomepayable but for s2(a)(iii)) [] prior to such Early Termination

If the party seeking

payment cannot comply

with the conditions

precedent, then it is

clear from the terms of

the contract that no

obligation to pay 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.Marine

Trade v Pioneer, per

Flaux J at paragraph 61


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Date). It would, therefore, be taken into account in the EarlyTermination Amount.

Flaux Js view also seems to be contrary to the interpretation of

the Supreme Court of New South Wales in Enron Australia v TXUElectricity [2003] NSWSC 1169 (affirmed (2005) N.S.W.C.A.). In

this case, it was suggested that a payment obligation will springup once the relevant condition (in s2(a)(iii)) is satisfied and in thatsense it might be saidthat the payment obligation is

suspended while the condition remains unfulfilled, and thatamounts accrue notwithstanding that the condition is unfulfilled(at paragraph 12).

Interpreting s2(a)(iii)

Flaux J has taken a literal approach to interpreting s2(a)(iii) as aone time test. However, the condition precedent that no Event of

Default or Potential Event of Default has occurred and iscontinuing could be construed as meaning that an obligationdoes not fall due for performance while an Event of Default or

Potential Event of Default is continuing. As Lord Diplock stated inThe Antaios1

, if detailed semantic and syntactical analysis ofwords in a commercial contract is going to lead to a conclusion

that flouts business commonsense, it must be made to yield tobusiness commonsense. The adverse consequences that resultfrom a literal interpretation of s2(a)(iii) would suggest that the

obligation should be regarded as only suspended while the Eventof Default or Potential Event of Default is continuing and notdestroyed by it.

The 2002 ISDA Master Agreement, which contains the samecondition precedent, is clearer as to the effect of s2(a)(iii). This

provides, in s9(h)(i)(3)(A), that interest will accrue on amountswithheld under s2(a)(iii) and that such interest will be paid aftersuch [withheld] amount becomes payable. This clearly

contemplates that the suspended amounts may become payableat a later date. Although the 2002 ISDA Master Agreement strictlycannot be used as a guide to interpreting the 1992 Agreement, it

would be odd if the identical provisions in s2(a)(iii) of eachagreement resulted in different conclusions.

Is payment netting under s2(c) available after an Event ofDefault?

The judgment also considers whether payment netting unders2(c) is available where a payment has been affected by s2(a)(iii).The judge held that, since nothing was due from Marine Trade on

6 February due to 2(a)(iii), s2(c) could not operate as it requiresamounts to be payable, which as a matter of ordinary languagemeans now due and owing for immediate payment.

1 Antaios Sompania Naviera SA v Salen Rederierna AB (The Antaios) [1984]

A.C. 191

If detailed semantic

and syntactical analysis

of words in a commercial

contract is going to

lead to a conclusion

that flouts business

commonsense, it must be

made to yield to

business commonsense.

Per Lord Diplock,Antaios Sompania Naviera

SA v Salen Rederierna AB

(The Antaios)

Quite apart from the

ordinary meaning of

language, when the

agreement is considered

as a whole, the word

payable in s2(c)

clearly means that there

is a current enforceable

obligation to pay.

Marine Trade v Pioneer,

per Flaux J at paragraph

22


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Can s2(a)(iii) apply to a late payment?

At the date of the hearing, Pioneer had not paid the USD 7 millionclaimed by Marine Trade. It argued that, to the extent that this

gross amount had been due on 6 February 2009 rather than thenet amount, as Marine Trade itself was subject to a Bankruptcy

Event of Default in May 2009, Pioneer could rely on s2(a)(iii) towithhold this payment. The judge did not agree. S2(a)(iii) is testedwhen the obligation falls due; if at this date there is no Event of

Default then the obligation falls due for performance at that timeand is not subsequently destroyed or suspended by an Event ofDefault by the payee. To entertain Pioneers construction would

allow the party with the obligation to take advantage of its ownfailure to perform in the interim.

Conclusion

On one hand this ruling is a helpful in confirming that:

1. s2(a)(iii) results in no payments being due from a non-

defaulting party where the counterparty is subject to an Eventof Default;

2. such withheld payments will not be subject to payment netting

under s2(c); and3. the condition precedent in s2(a)(iii) is tested at the time the

payment obligation falls due, so that a subsequent Event ofDefault by the payee does not excuse payment.

On the other hand, the judges conclusion that s2(a)(iii) is a onetime test and therefore prevents the obligation from ever arisingrather than simply suspending it is unhelpful and, if followed,leads to an extremely uncommercial result.

Finally, it is worth noting, that although Pioneer and Marine Tradewere both subject to a Bankruptcy Event of Default, neither party

was subject to formal insolvency proceedings and so there wasno question of s2(a)(iii) falling foul of the anti-deprivation rule asmost recently considered in Perpetual Trustee & Belmont Park

Investments v BNY Corporate Trustee Services[2009] EWCA Civ11602

. On this point, s2(a)(iii) remains untested in the English

courts.

2 Please refer to our client briefing of 10 November 2009 for a summary of the

Court of Appeal decision in this case.


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Contact

For further information on

issues raised by this caseplease contact:

Simon Firth

Partner, London

Telephone(+44) 020 7456 3764

[email protected]

Suza nna Brunton

Managing Associate, London

Telephone(+44) 020 7456 5382

[email protected]

or your usual Linklaters LLPcontact.

linklaters.com

Authors: Suzanna Brunton

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advice. Should you have any questions on issues reported here or on other areas of law, please contact

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