7th%20Annual%20Gas%20

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7th Annual Gas Power InstituteSeptember 4-5,
2008Managing Gap Risk Between Standard
FormTrading AgreementsCraig R. Enochs

• Craig R. Enochs
• cenochs_at_jw.com
• Jackson Walker L.L.P.
• 1401 McKinney, Suite 1900
• Houston, Texas 77010
• [phone] phone

2
Selected Sources of Gap Risk

• I. Issues Common to the NAESB, ISDA, EEI and CTA
• A. Notices
• B. Events of Default
• C. Setoff
• II. Other Agreement Differences
• A. Termination, Liquidation Settlement NAESB,
  ISDA and EEI
• B. Confirmation Procedures NAESB, ISDA and CTA
• C. Netting NAESB and ISDA
• D. Transfer and Assignment CTA and ISDA

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• I. Issues Common to the
• NAESB, ISDA, EEI and CTA

A. Notices B. Events of Default C. Setoff
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A. Notices

• 1. NAESB 9
• Methods Fax, mutually-accepted electronic
  means, overnight courier, first class mail or
  hand delivery
• General Rule deemed delivered when received on
  a Business Day
• If no proof of actual receipt, the following
  presumptions apply
• Fax deemed delivered when sending party
  receives fax machines confirmation of successful
  transmission. If after 500 p.m., deemed
  received the following Business Day
• Overnight Courier or Mail deemed delivered on
  following Business Day after sent, or earlier if
  confirmed by receiving party
• First Class Mail deemed delivered five (5)
  Business Days after mailing

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A. Notices

• 2. ISDA Master 12(a) Gas, Power and Coal
  Annexes
• Writing/Hand Delivery effective on date
  delivered
• Fax effective on date received by responsible
  recipient in legible form
• Proof of receipt is on sending party and cannot
  be proven through fax confirmation
• Certified or Registered Mail effective on date
  delivered (or delivery is attempted)
• Electronic Messaging System effective on date
  received
• Email (2002 ISDA) effective on date delivered

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A. Notices

• 2. ISDA Master 12(a) Gas, Power and Coal
  Annexes (cont.)
• If notice (i) not delivered on Local Business
  Day, or (ii) is delivered after close of
  business, notice deemed delivered on following
  Local Business Day
• Notices relating to Events of Default or
  Termination Events may not be sent by electronic
  messaging system (1992/2002), fax (1992) or email
  (2002 ISDA).

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A. Notices

• 3. EEI 10.7
• Fax or Hand Delivery
• If received during business hours on a Business
  Day, notice deemed effective at the close of
  business on such day
• If received after business hours, deemed
  effective at close of business on following
  Business Day
• Overnight Courier or U.S. Mail
• Deemed effective on the following Business Day
  after sent

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A. Notices

• 4. CTA 10.3
• Electronic means, fax or hand delivery
• If delivered during business hours on a Business
  Day, notice deemed received at close of business
  on such day
• If delivered after business hours, deemed
  received on close of business of following
  Business Day
• Overnight mail or courier
• Deemed received one (1) Business Day after sent

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A. Notices

• 5. Risk Analysis
• Operational Risk
• Various methods of notice permitted in trading
  contracts
• Ex ISDA contemplates electronic means,
  including email (2002 ISDA), but EEI does not
  contemplate electronic means unless otherwise
  elected by the parties
• Inconsistent notice provisions across trading
  agreements
• More likely that manner or method of notice may
  be insufficient

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A. Notices

• 5. Risk Analysis (cont.)
• Credit and Payment Risk
• Ineffective notice may create credit risk as to a
  defaulting counterparty
• Ex ISDA does not allow electronic means
  (1992/2002), fax (1992) or email (2002) notices
  with respect to Events of Default or Termination
  Events
• If notice is ineffective, Non-Defaulting Party
  cannot declare an Early Termination Date
• Parties should consider consistent notice
  provisions across trading contracts

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B. Events of Default

• 1. 2002 v. 2006 NAESB 10.2
• 2002 and 2006 NAESB each includes the following
  Events of Default
• Failure to pay
• Bankruptcy
• Default under Credit Support Obligations
• 2006 NAESB adds Additional Event of Default,
  which may be elected on Cover Sheet
• Indebtedness Cross Default party or Guarantor
  defaults on agreements relating to indebtedness
  for borrowed money
• Transactional Cross Default party or Guarantor
  defaults under a Specified Transaction.

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B. Events of Default

• 1. 2002 v. 2006 NAESB 10.2 (cont.)
• Risk Analysis
• Additional Events of Default in 2006 NAESB
  mitigate credit and commercial risks by looking
  to performance of obligations outside the NAESB
• 2006 NAESB closes some gap risk by moving the
  2002 NAESB closer to the EEI and ISDA

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B. Events of Default

• 2. 1992 v. 2002 ISDA 5(a)-(b)
• 2002 ISDA modifies cure periods
• Failure to pay or deliver 5(a)(i)
• One (1) Local Business Day instead of three (3)
  Local Business Days
• Default Under Specified Transaction
  5(a)(v)(2)
• One (1) Local Business Day instead of three (3)
  Local Business Days
• Bankruptcy 5(a)(vii)(1)(B)
• Fifteen (15) days instead of thirty (30) days
• Risk Analysis shorter cure periods mitigate
  credit risk

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B. Events of Default

• 2. 1992 v. 2002 ISDA (cont.)
• Breach of Agreement 5(a)(ii)
• 2002 ISDA expands Breach of Agreement
• Event of Default if a party disaffirms,
  disclaims, repudiates or rejectsor challenges
  the validity of the ISDA
• With respect to the 2002 language, the 30-day
  cure period in 5(a)(ii) does not apply
• Risk Analysis allows swifter action when a
  counterparty clearly indicates it will not honor
  its ISDA obligations

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B. Events of Default

• 2. 1992 v. 2002 ISDA (cont.)
• Default Under Specified Transaction 5(a)(v)
• 2002 ISDA expands on events which constitute a
  default, including
• Default under credit support arrangement relating
  to a Specified Transaction
• Challenging the validity of a Specified
  Transaction
• Specified Transaction includes catch-all
  clause to capture future derivatives products not
  otherwise stated
• Risk Analysis
• Avoids the risk that certain actions may not
  properly trigger the Event of Default
• Avoids the risk that certain derivatives may be
  inadvertently excluded from the laundry list of
  Specified Transactions

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B. Events of Default

• 2. 1992 v. 2002 ISDA (cont.)
• Cross Default 5(a)(vi)
• 2002 ISDA To determine whether a party has
  exceeded Threshold Amount, party may look to both
  (i) principal of accelerated obligations, and
  (ii) unpaid amounts
• 1992 ISDA Party cannot combine accelerated
  obligations and unpaid amounts to determine
  Threshold Amount
• Risk Analysis 2002 ISDA makes Cross Default
  much more sensitive and useful in situations
  where a counterparty commits multiple defaults,
  but some defaults are difficult to ascertain

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B. Events of Default

• 2. 1992 v. 2002 ISDA (cont.)
• Merger Without Assumption 5(a)(viii)
• 2002 ISDA expands to include reorganization,
  reincorporation and reconstitution
• Risk Analysis Mitigates credit risk by
  diminishing the ambiguity of what corporate
  action triggers this Event of Default

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B. Events of Default

• 2. 1992 v. 2002 ISDA (cont.)
• Credit Support Default 5(a)(iii)
• 2002 ISDA expands to include circumstances when a
  security interest granted under a Credit Support
  Document fails to be in full force and effect
• Risk Analysis Mitigates credit risk by
  expanding Event of Default upon failure under
  either (i) Credit Support Document, or (ii)
  security interest granted under such document.

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B. Events of Default

• 3. NAESB v. ISDA Gas Annex
• Common Events of Default NAESB 10.2 ISDA
  5(a)
• Failure to pay when due
• Breach of credit obligations
• Insolvency and bankruptcy-related events
• Events of Default in ISDA not found in NAESB
• Breach of Agreement (other than failure to pay)
• Misrepresentations
• Default under Specified Transaction
• Similar to Transactional Cross Default election
  in 2006 NAESB
• Cross Default
• Similar to Indebtedness Cross Default election in
  2006 NAESB
• Merger Without Assumption

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B. Events of Default

• 3. NAESB v. ISDA Gas Annex (cont.)
• Termination Events in ISDA not found in NAESB
• Illegality
• Force Majeure Event (2002)
• Tax Event and Tax Event Upon Merger
• Credit Event Upon Merger
• Additional Termination Event

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B. Events of Default

• 4. EEI v. ISDA Power Annex
• Common Events of Default EEI 5.1 and ISDA
  5(a)
• Failure to pay when due
• False or misleading representations
• Breach of Agreement (other than failure to pay)
• Insolvency and bankruptcy-related events
• Breach of credit obligations
• Merger without assumption
• Cross Default

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B. Events of Default

• 4. EEI v. ISDA Power Annex (cont.)
• Events of Default and Termination Events in ISDA
  not found in EEI
• Default under Specified Transaction
• Illegality
• Force Majeure Event (2002 ISDA)
• Tax Event and Tax Event Upon Merger
• Credit Event Upon Merger
• Additional Termination Event

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B. Events of Default

• 5. CTA v. ISDA Coal Annex
• Common Events of Default CTA 8.1 ISDA 5(a)
• Failure to Pay
• Breach of Agreement (other than failing to
  pay/deliver)
• CTA Cure Period of ten (10) Business Days, but
  potential extension of up to sixty (60) days
• ISDA Thirty (30)/Fifteen (15) Business Days
  (1992/2002)
• Credit Support Default
• Misrepresentation
• Cross Default
• Bankruptcy
• ISDA triggering events more broad (e.g., passing
  resolutions for winding up or appointment of
  receiver)
• Failure by Seller to provide reasonable
  assurances as to future coal shipments after
  non-conforming shipments are delivered
• CTA 8.1(e) Coal Annex, Appendix 1, 13

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B. Events of Default

• 5. CTA v. ISDA Coal Annex (cont.)
• Event of Default in CTA not found in ISDA
  Material Adverse Change
• Parties elect MAC definition on Cover Sheet
• Credit Rating Trigger (as set by Parties)
• Event that has a material adverse effect on
  operations, financial condition or business of a
  Party as a whole
• Even if MAC occurs, it is not an Event of Default
  if Defaulting Party establishes and maintains
  Performance Assurance for the duration of the MAC
• Risk Analysis
• MAC provision mitigates credit risk by entitling
  a Party to either (i) receive Performance
  Assurance, or (ii) declare Event of Default when
  the other Party shows signs of financial distress
  that may not fit cleanly in another Event of
  Default

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B. Events of Default

• 5. CTA v. ISDA Coal Annex (cont.)
• Events of Default/Termination Events in ISDA not
  found in CTA
• Default Under Specified Transaction
• Merger Without Assumption
• Illegality
• Force Majeure Event (2002)
• Tax Event/Tax Event Upon Merger
• Credit Event Upon Merger

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B. Events of Default

• 6. Automatic Early Termination under ISDA
• How it works
• Upon occurrence of certain bankruptcy events, an
  Early Termination Date is deemed to occur
• Parties do not follow Early Termination Date
  notice procedures
• Not in standard NAESB, EEI or CTA
• May be useful in jurisdictions without U.S.
  Bankruptcy Code safe harbor provisions
• Between U.S. counterparties, often not elected
• Avoids risk of termination without Non-Defaulting
  Partys knowledge
• Allows for cure and/or negotiation of better
  terms
• Avoids risk of unwanted Settlement Payments by
  Non-Defaulting Party

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B. Events of Default

• 7. Risk Analysis Events of Default
• Events of Default mitigate credit and payment
  risks with respect to the Defaulting Party
• More ways to terminate under ISDA than under
  NAESB, EEI or CTA, but all may not be necessary
  for every transaction
• Risks of underlying transaction help determine
  which Events of Default make sense
• Short-Term v. Long-Term
• Index Price v. Fixed Price
• Automatic Early Termination May be beneficial
  under certain circumstances
• May create operational and credit risk if elected
  in some but not all contracts with a counterparty

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C. Setoff

• 1. 2002 v. 2006 NAESB 10.3.2
• Elected on Cover Sheet of both 2002 and 2006
  NAESB
• 2002 NAESB Other Agreement Setoff
• If Other Agreement Setoffs apply, bilateral
  setoff is the only option
• Non-Defaulting Party sets off Net Settlement
  Amount against
• Margin or collateral held by Non-Defaulting Party
• Any amounts payable by the Defaulting Party to
  the Non-Defaulting Party under any other
  agreement

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C. Setoff

• 1. 2002 v. 2006 NAESB 10.3.2 (cont.)
• 2006 NAESB Other Agreement Setoffs 2 Options
• Bilateral Setoff Same as setoff in 2002 NAESB
• Triangular Setoff Same as setoff in 2002 NAESB,
  plus
• Setoff Net Settlement Amount owed to
  Non-Defaulting Party against amount(s) owed by
  Non-Defaulting Party or Affiliates to Defaulting
  Party
• Setoff Net Settlement Amount owed to Defaulting
  Party against amount(s) owed by Defaulting Party
  to Non-Defaulting Party or Affiliates
• Setoff Net Settlement Amount owed to Defaulting
  Party against amount(s) owed by Defaulting Party
  or Affiliates to Non-Defaulting Party

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C. Setoff

• 2. 1992 v. 2002 ISDA
• 1992 ISDA No setoff provision
• 2002 ISDA Setoff provision in 6(f)
• Non-defaulting Party may setoff Early Termination
  Amount against any other amounts owed between the
  parties

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C. Setoff

• 3. NAESB v. ISDA Gas Annex
• NAESB 10.3.2 Election on Cover Sheet
• Other Agreement Setoffs Apply
• 2002 NAESB Bilateral
• 2006 NAESB Bilateral or Triangular, as elected
  by the parties
• Other Agreement Setoffs Do Not Apply
• Setoff limited to amounts owed under the NAESB.
• ISDA Gas Annex
• 2002 ISDA 6(f) Setoff provision
• Setoff amounts owed between the parties arising
  under ISDA or any other agreement
• No cross-Affiliate setoff

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C. Setoff

• 4. EEI v. ISDA Power Annex
• EEI 5.6 Setoff options elected on Cover Sheet
• Option A Non-Defaulting Party sets off
  obligations owed by Defaulting Party to
  Non-Defaulting Party under any agreements between
  the Parties
• Options B Non-Defaulting Party sets off
  obligations owed by Defaulting Party (or its
  Affiliates) to the Non-Defaulting Party (or its
  Affiliates) under any agreements between the
  Parties and/or their Affiliates
• ISDA Power Annex
• 2002 ISDA Setoff provision in 6(f)
• Setoff amounts owed between the parties arising
  under ISDA or any other agreement
• No cross-Affiliate setoff

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C. Setoff

• 5. CTA v. ISDA Coal Annex
• CTA 8.3
• Upon an Event of Default, Non-Defaulting Party
  sets off amounts owed between the Parties under
  the CTA
• ISDA
• 2002 Setoff provision 6(f)
• Setoff amounts owed between the parties arising
  under ISDA or any other agreement
• No cross-Affiliate setoff

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C. Setoff

• 6. Risk Analysis Risks Mitigated by Setoff
• Commercial Risks
• Immediately extinguishes payment obligations
• Reduces involvement in bankruptcy proceedings
• Credit Risks
• Amounts owed by Defaulting Party are immediately
  setoff
• Cash Flow Risk
• No waiting for payments from Defaulting Party
• Enterprise-wide risks among Affiliates
• Manages risk of having to pay Termination
  Payments across trading contracts and Affiliates

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• II. Other Agreement Differences
• Potentially Creating Gap Risk

• A. Termination, Liquidation Settlement (NAESB,
  ISDA and EEI)
• B. Confirmation Procedures (NAESB, ISDA and CTA)
• C. Netting (NAESB and ISDA)
• D. Transfer and Assignment (CTA and ISDA)

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A. Termination, Liquidation Settlement

• 1. 2002 v. 2006 NAESB 10.3 Terminating
  Transactions
• 2002 and 2006 NAESB Upon designation of Early
  Termination Date, all transactions must be
  terminated and liquidated, except for Excluded
  Transactions
• 2002 NAESB Excluded Transactions
• May not be terminated and liquidated under law
  and
• Commercially impracticable to terminate in the
  reasonable opinion of Non-Defaulting Party
• 2006 NAESB Excluded Transactions
• May not be terminated or liquidated under law
• NOTE does not include commercially
  impracticable transactions

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A. Termination, Liquidation Settlement

• 1. 2002 v. 2006 NAESB 10.3 Terminating
  Transactions (cont.)
• Risk Analysis
• Practical Risk Inability to Liquidate
  Transactions
• A Non-Defaulting Party under the 2006 NAESB may
  not be able to terminate and liquidate certain
  transactions as of the Early Termination Date if
  they are commercially impracticable
• Example Gas purchases at illiquid Delivery
  Points

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A. Termination, Liquidation Settlement

• 2. 1992 v. 2002 ISDA 6 Calculation and
  Payment of Amounts Upon Termination
• 1992 ISDA 6(e)
• Market Quotation or Loss calculation method
• One-way or two-way payment (First or Second
  method)
• 2002 ISDA 6(d)-(e)
• Close-out Amount Hybrid of Market Quotation and
  Loss
• Calculation of gains, losses and costs incurred
  in replacing or realizing the economic equivalent
  of terminated transactions.
• Determining Party may use internal valuations of
  its losses and costs, but also must use
  third-party quotations or market data in valuing
  transactions

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A. Termination, Liquidation Settlement

• 2. 1992 v. 2002 ISDA 6 Calculation and
  Payment of Amounts Upon Termination (cont.)
• Risk Analysis
• Close-out Amount mitigates risk of subjective
  valuations under Loss calculation method
• Close-out Amount more flexible than Market
  Quotation because a party may look to internal
  data and estimated losses
• Close-out Amount is more subjective than Market
  Quotation and more objective than Loss

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A. Termination, Liquidation Settlement

• 3. NAESB v. ISDA Gas Annex Calculation and
  Payments of Amounts Owed Upon Termination
• NAESB 10.3.1
• Non-Defaulting Party determines
• Amount owed by each party for Gas delivered and
  received on or before the Termination Date
• All other applicable charges related to such
  deliveries and receipts for which payment has not
  yet been made
• If Additional Termination Damages apply
• Liquidation and acceleration of Terminated
  Transactions at Market Value
• If Market Value greater than Contract Value,
  difference due to Buyer
• If Market Value less than Contract Value,
  difference due to Seller
• Default two-way payment

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A. Termination, Liquidation Settlement

• 3. NAESB v. ISDA Gas Annex Calculation and
  Payment of Amounts Owed Upon Termination (cont.)
• ISDA 6(e) Market Quotation and Loss
• Market Quotation
• Value of Terminated Transactions based on
  quotations from Reference-Market Makers plus any
  Unpaid Amounts owed to Non-Defaulting Party
  minus
• Unpaid Amounts owed to the Defaulting Party
• Loss
• Non-Defaulting Partys total losses and costs
  resulting from early termination and liquidation,
  including loss of bargain, costs of funding, and
  costs of terminating, liquidating or
  reestablishing any hedge
• ISDA 6(e) First and Second Method
• One-way v. two-way payment

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A. Termination, Liquidation Settlement

• 4. EEI v. ISDA Power Annex Calculation and
  Payment of Amounts Owed Upon Termination
• EEI
• 5.2 Non-Defaulting Party calculates
  Settlement Amount for each Terminated Transaction
  in a commercially reasonable manner
• 5.3 Settlement Amounts netted into Termination
  Payment, payable either to or from the
  Non-Defaulting Party
• Default two-way payment unless changed by parties
• ISDA
• 6(e) Market Quotation or Loss, as elected by
  parties
• ISDA 6(e) First or Second Method, as elected
  by the parties (one-way or two-way payment)

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A. Termination, Liquidation Settlement

• 5. NAESB, EEI and ISDA Risk Analysis
• Inherent operational risks in various calculation
  methods
• NAESB method and Market Quotation are
  substantively similar, while EEI requires
  calculation in a commercially reasonable manner
• Use of market quotes may not accurately reflect
  actual or anticipated value of transactions
• Subjective nature of Loss calculation
• Inconsistent Payment Risks to Defaulting Party
• NAESB and EEI are two-way payment
• Potential exposure if one-way payment elected in
  ISDA

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B. Confirmation Procedures

• 1. NAESB v. ISDA Gas Annex
• NAESB 1.2 Procedure elected on Cover Sheet
• Oral Transaction Procedure
• Transaction is binding when parties orally agree
  upon terms
• Failure to send Transaction Confirmation does not
  affect performance obligations
• Written Transaction Procedure
• Parties must exchange non-conflicting Transaction
  Confirmation before parties legally obligated to
  perform

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B. Confirmation Procedures

• 1. NAESB v. ISDA Gas Annex (cont.)
• ISDA 9(e)(ii)
• Parties legally bound from the moment they agree
  on commercial terms
• Confirm Transaction terms by sending written
  Confirmations
• No other specific terms or procedures in form
  ISDA

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B. Confirmation Procedures

• 2. CTA v. ISDA Coal Annex
• CTA 1.1
• Parties are bound when terms agreed upon (whether
  oral or written)
• Buyer shall provide Confirmation with commercial
  terms
• If Seller disputes terms, Parties use
  commercially reasonable efforts to resolve the
  dispute within ten (10) Business Days
• If dispute cannot be resolved, Parties may seek
  any other remedy under the CTA
• ISDA 9.2(e)(ii)
• Parties legally bound from the moment they agree
  on commercial terms, and confirm by sending
  written Confirmations

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B. Confirmation Procedures

• 3. NAESB, CTA and ISDA Risk Analysis
• Confirmation procedures should conform to risk in
  underlying transactions
• Short-term v. Long-term
• Risk of disagreement regarding future performance
  obligations
• Operational Risk in Confirming Transactions
• Buyer confirms in CTA, Seller confirms in NAESB
  and ISDA does not specify
• Inconsistent Dispute Resolution Procedures
• NAESB and CTA v. ISDA

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C. Netting

• 1. NAESB v. ISDA Gas Annex
• NAESB 7.7
• All payments due and owing (or past due and
  owing) netted into single amount
• The party owing the greater amount shall make a
  single payment to the other party
• Not limited to amounts owed under a single
  transaction
• ISDA 2(c)
• Netting generally limited to amounts due (i) on
  the same date (ii) in the same currency and
  (iii) in respect of the same Transaction.
• Can be modified by the parties in the Schedule
• Risk Analysis
• Inconsistent netting provisions across multiple
  agreements may create cash flow and operational
  risks
• Cross-Transactional Netting NAESB v. ISDA

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D. Transfer and Assignment

• 1. CTA v. ISDA Coal Annex
• General Rule No transfer or assignment without
  prior written consent of other party (CTA 10.1
  ISDA 7)
• CTA Consent cannot be unreasonably withheld or
  delayed
• ISDA No reasonableness requirement
• Exceptions in CTA
• Financing or financial arrangements
• Affiliate at least as creditworthy as assignor
• Person succeeding to all or substantially all of
  Partys assets (merger, reorganization, or
  otherwise)

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D. Transfer and Assignment

• 1. CTA v. ISDA Coal Annex (cont.)
• Exceptions in ISDA
• Transfers of rights to receive Termination
  Payments from Defaulting Party
• Consolidation, merger or transfer of all assets
• Risk Analysis
• CTA provides more flexibility
• ISDA may make transfers more difficult, time
  consuming and expensive

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• Conclusion

• Differences exist between trading agreements
• May be difficult to make all agreements
  consistent
• Identify priority issues
• Scope
• Research paper
• Craig R. Enochs
• cenochs_at_jw.com
• Jackson Walker L.L.P.
• 1401 McKinney, Suite 1900
• Houston, Texas 77010
• [phone] phone