Corporate Treasury Archives - BR Derivatives Report

Andrew P. Cross and David E. Kronenberg —

Background:

The governing agreements for a wide range of transactions, from the most basic financing arrangements to the most complex derivatives trading relationships, frequently include a “cross-default” event of default. This type of a default is triggered under one agreement when a party defaults in respect of indebtedness incurred under another agreement (i.e., “other indebtedness”)—hence the name, “cross-default.”

A cross-default provision often includes a monetary threshold that must be exceeded before a default will occur. For example, an event of default will occur if a payment is missed and either the amount of the missed payment, alone or in combination with the principal amount of the other indebtedness, exceeds a specific level.

Cross-Default under the 2002 ISDA Master Agreement:

Section 5(a)(vi) of the published form of 2002 ISDA Master Agreement is the cross-default event of default that is most common to derivatives trading relationships. Counterparties to master trading agreements that do not contain a cross-default event of default often incorporate a provision into those agreements that mirrors Section 5(a)(vi) of the ISDA Master Agreement.

An event of default will occur under Section 5(a)(vi) of the ISDA Master Agreement when a counterparty—or its credit support provider (e.g., a guarantor of any obligations under the ISDA Master Agreement) or any identified party (typically, an affiliate)—defaults under an agreement or instrument relating to “Specified Indebtedness,” which the ISDA Master Agreement defines as “any obligation in respect of borrowed money.” Section 5(a)(vi) provides for two different default scenarios: the first scenario applies to any default while the second scenario applies only to a payment default.

Andrew P. Cross —

Managing a company’s cash and financial assets equates to managing a company’s risks. This is axiomatic. Derivatives—and related contractual arrangements—have been widely used for risk management purposes in the financial markets for many years. This is common knowledge.

Nevertheless, in our experience, there is a wide range of familiarity and expertise among corporate treasury teams (broadly defined to include the in-house attorneys who support such teams) when it comes to the use of derivatives for risk management purposes, in general, and legal issues related to their use, in particular.

At one end of the spectrum is the extremely sophisticated corporate treasury team supported by one or more dedicated in-house attorneys with deep experience negotiating derivatives trading documentation. This scenario, while ideal, is not very common, even among some of the largest companies.

At the other end of the spectrum is a solo corporate treasurer or chief financial officer using derivatives for the first time and working without the support of a dedicated attorney (in-house or otherwise). This scenario, while less than ideal, is also more common.