What is the ISDA® Set-off Provision?

The standard set-off provision can be found in clause 6(f) of the 2002 ISDA® Master Agreement. Set-off is used in the final settlement of accounts and it extinguishes the mutual debts owed between the parties in exchange for a new, net amount which will be due and payable between the parties. A set-off provision is important as it gives a Non-Defaulting Party the ability to set off amounts which it owes the Defaulting Party, against amounts which the Defaulting Party owes it. Without such a right, a Non-Defaulting Party’s credit risk may be increased, as it may have to pay over a Close Out Amount or Early Termination Amount under the ISDA®, where the Defaulting Party may still owe amounts to the Non-Defaulting Party (and be unlikely to be able to pay them) under another agreement. The set-off provision in the ISDA® states that where there has been an Event of Default or a Termination Event, where there is one Affected Party and all transactions under the ISDA® are terminating; then the Termination Amount which is calculated can, at the option of the Non-Defaulting Party, be reduced by setting off against any other amount (owed between the contracting parties) – which is payable, whether or not those amounts arose under the ISDA®, or whether or not those amounts are matured or contingent. The point to note is that the set-off right is a right, which only the Non-Defaulting Party can invoke. The set-off provision requires mutuality. There must be an amount owing from Payer to Payee and from Payee to Payer. Set-off raises issues that may be subject to differing treatment in different jurisdictions. If one is triggering any Event of Default or Termination Event which is not a bankruptcy Event of Default, then the parties will be subject to the common law rules of set-off and the contractual terms agreed in the ISDA®. Common law requires that the parties must establish mutuality (i.e. Payer owes something to Payee, and Payee owes something to Payer). If one is triggering the bankruptcy Event of Default, then the parties will be subject to the insolvency laws of the party who is bankrupt. In South Africa, Section 35(B) of the Insolvency Act stipulates that parties can only set-off amounts owing under Master Agreements (including ISDA®, GMRA, GMSLA and Bond Exchange Agreements). Bespoke, non-standard agreements like a loan or a credit facility would not form part of this definition of a Master Agreement and are therefore not subject to rights of set-off.