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Early termination amount under ISDA is not a penalty

BNP Paribas v Wockhardt EU Operations Swiss AG [2009] EWHC 3116 (Comm)

The Commercial Court judgment by Christopher Clarke J in the case of BNP Paribas v Wockhardt EU Operations Swiss AG, held that there was no realistic prospect of the defendant establishing that Early Termination provisions in the 2002 ISDA Master Agreement (Master Agreement) were penal in character and its defence in this respect was struck out.

In this summary judgment application, the defendant contended that it had an arguable case that the provisions relating to an Early Termination Amount (ETA) in an ISDA Master Agreement were unenforceable by reason of the doctrine relating to penalties.

The parties had entered into a Master Agreement. This case concerns three foreign exchange target redemption forward transactions entered into under the umbrella of the Master Agreement. Each transaction involved the sale by BNP to Wockhardt of at least euro 400,000 per month in exchange for US dollars at a fixed rate.

Wockhardt failed to pay in respect of two dollar payments, culminating in BNP terminating the transactions under the Master Agreement and providing a statement of calculations showing the ETA payable by Wockhardt. The ETA comprised the amounts of the earlier non-payments (Unpaid Amounts), default interest, and a Close-out Amount. This Close-out Amount was designed to compensate BNP in respect of other outstanding transactions with Wockhardt which were also terminated.

ISDA Master

The ISDA Master Agreement provides that, on early termination of derivative transactions, an ETA will be payable by one party to the other. Following an Event of Default, the ETA will be calculated by the Non-defaulting Party; Section 6(e) of the Master Agreement sets out the methodology for doing so. The Master Agreement seeks to forestall any argument that the ETA constitutes a penalty, by recording at Section 6(e)(v), that the parties agree that the Section 6(e) amount is a reasonable pre-estimate of loss, payable for the loss of bargain and the loss of protection against future risks, and not a penalty.


A penalty has been described as where a “single lump sum is made payable by way of compensation on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage” (per Lord Dunedin in Dunlop Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79.

The defendant, Wockhardt, argued that the ETA provisions do not provide for a genuine pre-estimate of loss but for the payment of the same amount on the occurrence of any one of a number of possible breaches which may give rise to widely different consequences. In particular, the defendant argued that the effect is a penalty because the full ETA is payable irrespective of whether:

  • the defaulting party has one open transaction or many open transactions;
  • the default occurs early or late in the life of the transaction; and/or
    the default is small or large on one transaction or on many transactions;
  • and, further, the amount of the ETA cannot be predicted at the time of entering into the transactions as it depends upon market fluctuations in currency and interest rates.

Christopher Clarke J stated that, in order to determine whether the clause is deemed a penalty, it is necessary to consider what was actually due to BNP following termination as a result of Wockhardt’s breach. As the Unpaid Amounts were already payable before termination, they did not comprise a penalty.

As for the Close-out Amount, the critical question was whether or not the non-payment of any amount on delivery (such as Wockhardt’s failure to pay for the euros) amounts to a breach of condition by virtue of which BNP is entitled to treat itself discharged from its ongoing primary obligations under the Master Agreement. Christopher Clarke J decided that it did, given that the parties had spelt out the right for the non-defaulting party to terminate for non-payment and the method of calculation.

It did not matter that the parties had not used the words “condition” or “repudiatory breach”, as these were just legal shorthand expressions: “When the parties have expressed those consequences for themselves they have no need of the shorthand”. The close-out calculation did not represent a windfall but a crystallisation of the benefit or burden of unperformed future obligations. On that basis, it could not be construed as penal, particularly given that BNP was required to act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result.

Although an extravagant amount payable upon breach of condition can still be a penalty, in this case the amount was not extravagant. The calculation would not necessarily result in amounts becoming payable by the defaulter to the non-defaulter; they could be payable in either direction. The amount payable as an ETA (and thus the total value of the performance remaining) would change throughout the life of the agreement in line with market fluctuations. There could be nothing penal in a provision which requires the acceleration in the event of breach of an amount which, without breach, would become due later.

Christopher Clarke J was also robustly supportive of the ISDA scheme whereby the Confirmations, Master Agreement, Schedule and Credit Support documentation are construed as constituting one single contract (hence breach in relation to one transaction can cause all other transactions to be terminated): “there is nothing artificial about the agreement of the parties….their agreement prescribes the substance of the legal relations into which they have freely chosen to enter.”

The defendant, Wockhardt, had no realistic prospect of establishing that the Early Termination provisions were penal in character, and those parts of its defence were struck out.

Mahmood Lone, Senior Associate, Litigation Banking Finance and Regulatory Group, comments: Given the prevalence and importance of the ISDA Master Agreement in the financial industry, it is always reassuring when the courts endorse the mechanisms that have been designed to come into play when there has been a breach. This judgment reaffirms that the English courts appreciate the role of the ISDA Master Agreement in the international financial markets, and will seek to deal with issues relating to its validity expeditiously and in a way that respects party autonomy.

In this case, Wockhardt sought to challenge: (i) the single agreement provision in the ISDA Master Agreement which was alleged to be “artificial”, and (ii) the Early Termination and Close-out provisions as penalties. The court resoundingly rejected both propositions. Both these aspects are of critical importance to the operation of the ISDA Master Agreement. In particular, the effect of the single agreement provision – the User’s Guide to the 2002 Master Agreement describes Section 1(c) as “a fundamental provision that is the basis for close-out netting” – is to create a single net amount payable by one party to another on the termination of the relationship between the parties. This is particularly significant if one of the parties becomes insolvent. In that situation, a solvent counterparty could otherwise be obliged to make payment of sums it owes to the insolvent party, while it would be left with a claim in an insolvency for sums which it is owed.

Issues also arose in this case as to whether the Close-out Amount (as part of the ETA) was “commercially reasonable”, as required by the definition in the Master Agreement. BNP submitted witness evidence from an assistant trader explaining how the Close-out Amount was calculated. Although Christopher Clark J did not decide the point, he indicated that it appeared to him that BNP had established that it was commercially reasonable. This serves as a useful reminder that, when determining and calculating amounts payable on termination of the Master Agreement, parties should keep good records of the processes and steps involved in reaching determinations and calculations (including any quotations and valuations) and should act in good faith using commercially reasonable procedures.

Finally, it is interesting to note that the judgment indicates that Wockhardt has issued an application to amend its defence to include allegations of misrepresentation and breach of duty. Allegations of this nature are increasingly being made in the context of Master Agreements.

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey, or tel +44 (0)20 3088 3710.