A Practical Analysis of the ISDA Master Agreement

The previous article provided a roadmap for understanding GCC netting regulations in the UAE, KSA and Qatar and how credit risk can be managed across onshore and offshore jurisdictions.

This sequel follows with a practical analysis of the specific contractual provisions that can be invoked under the ISDA master agreement and how these provisions interact with netting regulations. In particular, we cover the enforceability of force majeure, credit support default and cross-default when dealing with counterparties based in the Gulf.

Overview

Under the ISDA master agreement, there are two distinct mechanisms in which close-out netting can be exercised: events of default which arise from a party’s own failure and termination events which result from circumstances beyond either party’s control. 

Set out below are a series of points to bear in mind to handle termination/events of default when dealing with counterparties in the Gulf.

Termination Events

Force Majeure

In the ISDA master agreement, force majeure is defined as an act beyond the control of a party resulting in prevention, impossibility or impracticability. The party cannot claim a force majeure event before taking reasonable efforts to overcome the event but this does not require incurring a loss other than material or incidental expenses.

With the current geopolitical tensions across the GCC and the closure of key trade routes, parties will undoubtedly look to invoke force majeure to terminate contractual arrangements in order to receive a consolidated net payment under the ISDA master agreement. When doing so, parties seeking to terminate should consider the following:

1. Has the waiting period elapsed? 

A breach due to force majeure is deferred until the end of the waiting period which is defined as eight (8) local business days following the occurrence of that event or circumstance.

2. Is the event truly beyond a party’s control?

Even where there is a trade route closure, courts will scrutinise whether the party took reasonable steps to mitigate risk such as sourcing through alternative routes. A party cannot claim impossibility or impracability purely because performance has become costlier such as payment of war risk charges.

3. Has the event affected the specific office through which the party performs?

ISDA’s drafting of force majeure is office-specific and looks to whether the particular office though which the party entered into the transaction is prevented from performing. This is relevant for global multinationals with regional hubs in the GCC. A disruption affecting the Dubai office may not excuse performance if the transaction could have been settled through an alternative office.

4. Does the confirmation contain its own disruption callbacks?

ISDA requires that parties fully exhaust contractual remedies such as disruption fallbacks before force majeure is invoked. 

5. What does the governing law say about force majeaure?

Excluding free zones which are based on English law, onshore courts based in the UAE, KSA and Qatar apply their own body of jurisprudence that may supplement or override contractual terms. It is imperative that parties understand how local courts interpret the doctrines of impossibility and impracticability as this may impose additional hurdles when dealing with onshore parties.

Events of Default 

Credit Support Default

A precarious scenario would be triggering a credit support default due to failure of the credit support provider to perform under the guarantee. Here, the danger lies in a diligent counterparty who continues to make payments and comply with its obligations facing this precarious situation due to suspected or actual breach from the credit support provider. This carries particular weight when dealing with GCC counterparties given the prevalence of parent company guarantees and share pledges as credit support mechanisms. 

An additional risk arises when considering the distinction between the contractual and statutory positions in respect of invoking a credit support default. The contractual position under the ISDA master agreement grants the non-defaulting party the right to terminate all outstanding transactions and demand a single net payment for failure to comply with collateral obligations, however both the UAE and KSA Netting Regulations only protect the enforceability of collateral that has already been posted. The practical consequence of this distinction is that the creditor must rely on contractual remedies in cases of credit support default as the netting regulations only extend protection to security that is fully registered and perfected according to local law. Even when the counterparty relies on the contractual position, these contractual remedies are not guaranteed as they depend on the counterparty holding sufficient assets to satisfy the close-out amount.

In times of distress, parties are advised to engage in a review exercise in respect of all collateral documentation to ensure security is properly perfected under local law to avail of statutory protection and maximise close-out netting gains. The UAE Netting Law explicitly prevents recharacterisation of title transfer collateral arrangements through Article 15, providing statutory certainty that a transfer of assets by way of collateral will be treated as outright ownership rather than a security interest. This protection is also extended by free zone jurisdictions most notably in the DIFC, ADGM and QFC. 

Cross-Default 

A cross-default provision entitles the non-defaulting party to invoke close-out netting if the other party defaults under another agreement provided a specified threshold is met. In times of distress where a counterparty may be struggling under multiple obligations, this provision allows creditors to act before the liquidity crunch goes beyond reach.

This is of particular significance for corporate and family conglomerates in the Gulf holding multiple subsidiaries spanning a broad range of sectors. If a subsidiary defaults on a loan, the creditor’s netting arrangement with another subsidiary falling under the same group must exceed both the threshold amount and meet specified indebtedness requirements to trigger an event of default.

There is a further complication on whether the local netting regulations will uphold contractual netting arrangements if the cross-default subsequently results in bankruptcy of the counterparty. This is expressly protected by the UAE and KSA Netting Regulations which preserve the priority of netting arrangements during bankruptcy proceedings provided the counterparty in KSA is CMA/SAMA regulated and the arrangement itself is a qualified financial contract. Conversely, in Qatar where no netting law exists, the bankruptcy trustee may challenge termination as a preferential transaction or simply ignore it. 

Given that corporate groups in the GCC tend to have complex ownership structures and cross-guarantees, parties should map out which affiliates are covered by this provision and the specific thresholds that give rise to an event of default.

For companies based in the GCC facing liquidity pressure, engaging early with your counterparty by seeking waivers or amendments is a prudent approach to circumvent an event of default. A bank loan that is cured within a grace period does not usually trigger cross-default.

Conclusion

Ultimately, while the ISDA master agreement offers a sophisticated contractual toolkit for managing counterparty failure, its effectiveness depends on the legal environment in which it is enforced. Market participants based in the Gulf must understand how the model agreement works in context with the broader GCC laws that come into play when enforcing close-out netting in onshore jurisdictions.