Academic journal article Washington International Law Journal

Australian Insolvency Law and the 1992 Isda Master Agreement-Catalyst, Reaction, and Solution

Academic journal article Washington International Law Journal

Australian Insolvency Law and the 1992 Isda Master Agreement-Catalyst, Reaction, and Solution

Article excerpt


In December 2003, the Supreme Court of New South Wales, Australia, decided a case involving the rights of an insolvent party under an electricity swap contract.1 The court held in that case, Enron Australia Finance Pty Ltd v. TXU Electricity Ltd, that it did not have authority under Australian insolvency law2 to alter the terms of the swap contract to force the non-insolvent party, TXU Electricity ('TXU"), to pay the net amount owed in the event that TXU chose to terminate the agreement.' The New South Wales Court of Appeal affirmed the lower court's decision in full.4

Under the court's interpretation of Australian corporate insolvency law,5 the International Swap and Derivative Association's ("ISDA") 1992 Master Agreement ("Master Agreement")6 effectively allows TXU to walk away from the contract,7 despite the fact that the parties elected a provision that disallows them to walk away from their obligation.8 The outcome of the case exposed terms in the Master Agreement that interact to operate contrary to the plain meaning.9 The risk of loss that TXU assumed under the Master Agreement was transferred to the creditors of Enron Australia in liquidation, depriving them of the value from the Master Agreement and relieving TXU of any potential payment obligation.10 In order to reduce the potential for systemic collapse, give effect to the Master Agreement's terms as written, and remain consistent with the ISDA's underlying policy goals, there must be some mechanism to provide for the Master Agreement's termination."

Those involved in derivatives markets in which courts can determine the enforceability of contractual provisions under insolvency and bankruptcy laws 12 have noticed the Enron Australia decision.13 This case is significant because end users of varying sophistication enter into derivative contracts both for hedging and investing purposes.14 Additionally, there is a growing concern regarding the obligations of private entities that draft model transactional documents.15 The Master Agreement's subversive operation is also inconsistent with the accounting and disclosure of swap and derivative transactions.16

While reactions have been varied,17 the case highlighted a potentially unanticipated outcome under the ISDA Master Agreement; one that leaves an aftertaste of inequity. In the interests of maintaining market stability and the transparency of risk allocation among parties to swap contracts governed by the Master Agreement, the ISDA should amend the agreement to allow for its timely termination in the event of one party's liquidation. The ISDA has an interest, and perhaps even an obligation, to ensure that the default outcome under the Master Agreement is clear from the express language and terms, and to protect the derivative instrument as an asset in a defaulting party's liquidation.

This Comment argues that the ISDA has assumed a role of responsibility for the stability of the over-the-counter ("OTC") derivatives market. It is likewise in the interest of this privately regulated multinational industry to maintain market stability through the clear operation of the terms of the Master Agreement. The ISDA thus has both an obligation to amend, and interest in amending, the model documentation to provide for clear operation of the model agreements. Part II provides background to the ISDA and select provisions of the 1992 Master Agreement. Part III briefly explains a debtor's contractual rights under Australian insolvency law. Part IV examines the Enron Australia opinion and the inequitable risk transfer under the Master Agreement from the non-defaulting party to the defaulting party's creditors. Part V examines the potential effects of, and issues raised by, this decision in comparison with the underlying purpose of the ISDA Master Agreement. Part VI argues that derivative market participants should be made aware of the operation of the Master Agreement in the event of the insolvency of an in-the-money party in order to contract around the outcome demonstrated in Enron Australia. …

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