ISDA Section 2(a)(iii) Condition Precedent: Payment Suspension, Lomas & 2014 Sunset Amendment

Buried inside sixty words of Section 2(a)(iii) of the 1992 and 2002 ISDA Master Agreements sits one of the most fiercely litigated clauses in financial history. Designed to prevent a solvent counterparty from wiring cash into a black-hole bankruptcy estate ("throwing good money after bad"), Section 2(a)(iii) makes every scheduled swap payment and delivery subject to the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing.

How Unamended Section 2(a)(iii) Created "Perpetual Limbo" After Lehman’s 2008 Bankruptcy#

When Lehman Brothers Holdings Inc. and Lehman Brothers International (Europe) filed for insolvency in September 2008, hundreds of out-of-the-money counterparties—corporates, municipalities, and funds that owed net millions to Lehman on interest-rate swaps—made a startling tactical discovery inside the 2002 ISDA Master Agreement architecture:

1. Under Section 6(a), electing Early Termination upon an Event of Default is a right, not an obligation, of the Non-Defaulting Party (unless Automatic Early Termination [AET] was switched on in the Schedule!).
2. Had those out-of-the-money counterparties designated an Early Termination Date, Section 6(e) two-way close-out netting ("Full Two-Way Payment") would have forced them to pay Lehman’s estate the full positive Close-Out Amount immediately!
3. Instead, they refused to terminate and invoked Section 2(a)(iii)—withholding every quarterly fixed-rate swap payment indefinitely while Lehman remained in permanent bankruptcy!

Transatlantic Judicial Split: U.S. Metavante Ruling vs English Court of Appeal Lomas v Firth Rixson#

Lehman’s U.S. Chapter 11 debtors and UK PwC administrators sued in New York and London, producing diametrically opposite precedents across the two governing laws of global OTC swaps:

• *United States (In re Lehman Brothers Holdings Inc. / Metavante, Bankr. S.D.N.Y. 2009): Judge James Peck ruled that under the U.S. Bankruptcy Code (11 U.S.C. §§ 365(e)(1) & 560), although swap safe harbors protect prompt liquidation/termination* of swaps, sitting on an un-terminated swap indefinitely while refusing to pay violates the automatic stay and ipso facto prohibition! Metavante was given a brief "reasonable window" to terminate and pay—or else perform its ongoing swap payments with statutory default interest!
• *England & Wales (Lomas v JFB Firth Rixson Inc., [2012] EWCA Civ 419): The English Court of Appeal enforced the literal freedom-of-contract wording of Section 2(a)(iii)! It held that (a) payment obligations are suspended* (not extinguished once-and-for-all), (b) no implied term forces a Non-Defaulting Party to designate Early Termination within a "reasonable time," and (c) suspended obligations simply fall away if still unpayable at final trade maturity!

Regulatory Backlash & the June 2014 ISDA Section 2(a)(iii) Time-Limit Amendment#

Prudential supervisors—including the UK Prudential Regulation Authority, UK HM Treasury, and BCBS / BIS—warned that indefinite Section 2(a)(iii) payment suspension trapped billions of liquid value away from failing G-SIB estates like Bank of America or BNP Paribas and undermined orderly resolution, threatening to deny regulatory close-out netting capital relief on unamended contracts.

In June 2014, ISDA published the Amendment to the ISDA Master Agreement in respect of Section 2(a)(iii) introducing a contractual "Condition End Date": the defaulting party (or its insolvency administrator) may serve formal notice triggering a negotiated sunset window (typically 90 or 180 calendar days)—by the end of which the Non-Defaulting Party MUST either designate an Early Termination Date or resume paying suspended amounts (with accrued interest)!

Interaction With Credit Support Annexes and Resolution Stay Protocols#

Notice too that under Paragraph 4(a) of the 1995 English Law CSA and Paragraph 4(a) of the 1994 NY Law CSA, delivery of collateral is also subject to conditions precedent! Modern 2016 Variation Margin CSAs and BRRD / U.S. QFC Resolution Stay Protocols tightly bound suspension windows to 24–48 hours during resolution bail-ins.

Drafting Best Practices in Institutional Schedule Negotiations#

Legal and credit teams benchmark Condition End Date elections (90 days dealer-to-dealer vs 180 days institutional buy-side) across the ISDA-2002-CSA Standard and the 2002 ISDA Master Agreement, CSA & SIMM topic hub.