The winter of 2013-14 offered up a perfect storm of natural gas price spikes and threats to electric reliability. Expect more of the same.
The unclear language governing termination rights is subject to interpretation and extraordinary financial risk.
Failing to perform or defaulting under other contracts;
b) Exceeding credit or trading limits set out in confirmation or agreements;
c) Debt downgrades;
d) Other material adverse changes in financial condition; and
e) Substantial changes in market prices which materially and adversely impact ability to perform.
Also in section 27, the WSPP lists acceptable forms of adequate assistance:
a) posting of a letter of credit;
b) cash prepayment;
c) posting of other acceptable collateral or security by the second party;
d) a guarantee agreement executed by a creditworthy entity; and
e) some other mutually agreeable method of satisfying the first party.
All five reasons for requesting adequate assurance are triggered by the financial viability of the second party and are independent of the financial situation of the company requesting adequate assurance (first party). Tellingly, the WSPPA also states that although the first party may require the second party to provide a form of adequate assurance, the form is at the second party’s option.
Further, section 27 of the WSPPA outlines the behavior and principles to be followed when requesting and accepting adequate assurances. The first sentence of the section states, “Should a party’s creditworthiness, financial responsibility, or performance viability become unsatisfactory to the other party in such other party’s reasonably exercised discretion … [the dissatisfied party can request adequate assurances].” It goes on to state that the first party may require the second party to provide [adequate assurance], at the second party’s option “(but subject to the first party’s acceptance based upon reasonably exercised judgment.” Clear-ly, an assumption of reasonableness runs throughout the agreement).
The WSPPA provides guidance with respect to events permitting requests for assurances and also the form of adequate assurance. However, in allowing “some other mutually agreeable method of satisfying the first party” as a form of adequate assurance, it widens the definition of form and makes the provision more ambiguous.
MPPSA: More Blurry Fine Print
Section 5.1 of the MPPSA, “event of default,” states that an “event of default shall mean, with respect to a party (a ‘defaulting party’), the occurrence of any of the following ... (e) the failure of such party to satisfy the creditworthiness/collateral requirements agreed to pursuant to article eight [of the cover sheet].” Article 8 provides for the nomination of amounts and forms of collateral, but it gives little guidance to the rules governing the request and acceptance of adequate assurances in ensuring contract performance.
ISDA Agreement: Where’s the Guidance?
In section 5(a)(iii) of the 2002 ISDA Master Agreement, “credit support default” is listed as an event of default, but little guidance is offered other than stating that any credit support document must be complied with, current and valid. Nevertheless, the user’s guide to the ISDA 2002 Master Agreement does provide further guidance. Chapter 5 of the user’s guide on the “adequate assurances provision” states that under certain circumstances, parties to the 2002 [ISDA] agreement may wish to consider the incorporation of an adequate assurances provision. It further states that “under an adequate assurances provision, when reasonable grounds for insecurity of performance are