Can a Determining Party Unilaterally Revise a Close out Calculation after It Has Been Issued?

Concept

The question of whether a Determining Party may unilaterally revise a close-out calculation strikes at the heart of financial market integrity. The architecture of the ISDA Master Agreement is engineered to provide certainty and finality in moments of maximum stress, such as the termination of a portfolio of derivatives following a default. Within this system, the close-out calculation is the terminal procedure designed to produce a single, definitive net payment obligation. Its primary function is to crystallize the economic value of the terminated transactions at a specific moment, thereby preventing open-ended risk exposure.

The system is predicated on the principle that once this value is determined and communicated, it forms the basis of a binding legal obligation. Any capacity for unilateral revision would dismantle this finality, introducing a fatal instability into the protocol. It would transform a mechanism designed for dispute resolution into a source of perpetual dispute.

The prohibition against unilateral revision is a core feature of this systemic design. The process grants the Determining Party, typically the non-defaulting party, a significant degree of authority in performing the calculation. This authority is balanced by a strict set of duties. Under the 2002 ISDA Master Agreement, the Determining Party must act in good faith and use commercially reasonable procedures to produce a commercially reasonable result.

This standard is not a mere procedural guideline; it is an objective, enforceable benchmark. The calculation, once issued, is a definitive statement of account based on market conditions at a precise point in time. Allowing a party to amend this statement based on subsequent market movements or a reconsideration of its own inputs would grant it an option it did not bargain for, effectively allowing it to re-price the terminated portfolio at the other party’s expense. This would undermine the entire economic purpose of the close-out netting mechanism, which is to provide a clean and final termination of the parties’ mutual obligations.

The close-out calculation under an ISDA Master Agreement represents a definitive and binding determination of value, engineered for finality to ensure market stability.

Therefore, the system architecture treats the initial calculation as a singular, dispositive act. It is a snapshot of value. The framework does acknowledge that errors can occur. A distinction exists between correcting a demonstrable mathematical or clerical error and performing a wholesale redetermination of the close-out amount.

The former involves the rectification of a mistake to ensure the calculation reflects the originally intended inputs and methodology. The latter, a redetermination, implies a new assessment, potentially using different inputs or assumptions, which is precisely what the principle of finality is designed to prevent. The courts have reinforced this view, scrutinizing any attempt to submit a revised calculation with deep skepticism, particularly when it appears to be a reaction to a disappointing initial result or an attempt to improve one’s position after the fact. The system’s integrity demands that the Determining Party gets one opportunity to perform its duty correctly. Any subsequent adjustments are subject to judicial review and must be justified as corrections of manifest error, not as opportunistic second attempts.

The Role of Finality in Market Architecture

In over-the-counter derivatives markets, certainty is the bedrock of liquidity and risk transfer. The ISDA Master Agreement functions as the operating system for this market, and the close-out mechanism is its critical fail-safe protocol. Finality within this context means that upon the occurrence of a specified event (a default or termination event), there is a clear, predictable, and legally robust process for ending the contractual relationship.

The issuance of a close-out calculation is the culmination of this process. It is the point at which all outstanding obligations are collapsed into a single net present value.

A system that permitted a party to unilaterally withdraw and resubmit its calculation would lack this essential finality. It would create a state of perpetual uncertainty. The recipient of the calculation would be unable to rely on it for its own risk management, accounting, or liquidity planning. This uncertainty would have a cascading effect, impairing the firm’s ability to manage its other market positions and meet its obligations to other counterparties.

The entire chain of modern finance, which relies on the dependable valuation of assets and liabilities, would be weakened. The principle of finality is therefore a structural necessity, ensuring that the close-out process extinguishes risk rather than amplifying it.

What Constitutes a Binding Calculation?

A close-out calculation becomes binding upon its effective delivery and communication to the other party. The ISDA framework does not prescribe a specific form for this communication, but it must be clear, unequivocal, and provide sufficient detail to show how the amount was determined. The delivery of this notice triggers a legal obligation.

The calculated amount becomes a debt due and payable. This is the point of no return for the Determining Party in terms of its methodology and substantive inputs.

The binding nature of the calculation is reinforced by the legal framework surrounding it. Should the recipient dispute the calculation, its recourse is not to ignore the notice but to challenge it through the dispute resolution mechanisms specified in the agreement, which may ultimately lead to litigation. In court, the burden would be on the Determining Party to demonstrate that its original calculation complied with the contractual standard of using “commercially reasonable procedures to produce a commercially reasonable result.” An attempt by the Determining Party to submit a “revised” calculation during this process would be viewed as an admission that its original calculation was flawed.

The court’s focus would remain on the validity of the initial determination, not on the merits of a subsequent, revised one. The system is designed to assess the correctness of the action taken at the time it was taken, preserving the temporal logic of the close-out.

Strategy

The strategic considerations surrounding the revision of a close-out calculation are complex, pivoting on the critical distinction between correcting an error and opportunistically redetermining an outcome. For a Determining Party, the strategy begins long before any calculation is issued. It lies in establishing and documenting a robust, transparent, and defensible procedure for arriving at the close-out amount. The governing standard under the 2002 ISDA Master Agreement is one of objective commercial reasonableness.

This imposes a significantly higher burden than the more subjective “rationality” standard associated with the 1992 Agreement. A successful strategy requires building a process that can withstand judicial scrutiny, proving that the methods used were not merely plausible, but were objectively fair and aligned with market practice at the time of termination.

Once a calculation is issued, the strategic landscape shifts dramatically. If the Determining Party discovers a potential mistake, it faces a critical decision. The primary strategic goal is to preserve the integrity of the close-out process while rectifying a genuine error. Attempting a unilateral “revision” is a high-risk maneuver that is likely to be challenged and viewed unfavorably by a court.

A more sound strategy involves transparency. This may include notifying the counterparty of the discovered error, providing a detailed explanation of its nature and impact, and proposing a corrected calculation. This approach frames the action as a good-faith effort to comply with the contractual obligation to produce an accurate result, rather than an attempt to manipulate the outcome. It shifts the focus from a unilateral act to a bilateral discussion, which, even if contentious, is more likely to be seen as commercially reasonable.

A Determining Party’s strategy must be built on the foundation of objective commercial reasonableness, as a unilateral revision risks being invalidated by courts in favor of the original calculation’s finality.

The counterparty’s strategy upon receiving a revised calculation is more straightforward ▴ to scrutinize it intensely. The recipient should immediately question the basis for the revision. Is it a correction of a clear, mechanical error (e.g. a data entry mistake, a currency conversion flaw)? Or does it represent a change in methodology, the introduction of new market data that was available but not used previously, or an adjustment to a discretionary input?

The latter category suggests a redetermination, not a correction. The strategic response is to reject the revised calculation and hold the Determining Party to its original statement, asserting the principle of finality. This forces the Determining Party to justify not one, but two different calculations, a position of significant legal vulnerability. The case of Lehman Brothers Special Financing v. National Power Corporation serves as a powerful illustration, where a party’s attempt to revise its calculation years later was a central point of contention and ultimately unsuccessful.

Comparing the 1992 and 2002 ISDA Standards

The evolution from the 1992 ISDA Master Agreement to the 2002 version marks a pivotal shift in the strategic obligations of the Determining Party. Understanding this change is fundamental to grasping the strategic constraints on revising a calculation. The two frameworks establish different standards for how the final close-out amount is to be determined, which has profound implications for any subsequent attempt to alter it.

What Is the Process for Correcting a Manifest Error?

While a unilateral redetermination is impermissible, the system does allow for the correction of a “manifest error.” This term refers to a mistake that is obvious and indisputable on the face of the calculation. It is a narrow exception to the rule of finality. The process for correcting such an error is not explicitly defined in the ISDA Master Agreement and must be navigated with extreme care.

1. Identification and Documentation The party that identifies the error must immediately document its findings. This includes specifying the exact nature of the mistake (e.g. incorrect data input, flawed formula application, miscalculation of interest) and quantifying its impact on the final close-out amount. The documentation should prove that the error is clerical or mathematical, not judgmental.
2. Prompt Notification The discovering party must promptly notify its counterparty. The notification should be transparent, providing all the documentation related to the error and a clear explanation of how the corrected calculation was derived. Delaying notification can be interpreted as strategic behavior, undermining the claim of a good-faith correction.
3. Providing a Corrected Statement Alongside the notification, a corrected statement of account should be provided. This statement should be identical to the original in all respects except for the specific correction of the manifest error. All other inputs, assumptions, and methodologies must remain unchanged.
4. Seeking Agreement The correcting party should seek the counterparty’s agreement to the revised figure. If the error is genuinely manifest, the counterparty is likely to agree. If the counterparty disputes whether the issue was a manifest error or a change in judgment, the matter may proceed to formal dispute resolution. In that forum, the focus will be on the narrow question of whether the original calculation contained a clear mistake, not on which calculation is “better.”

Execution

The execution of a close-out calculation is a high-stakes, time-sensitive procedure that demands operational precision and a deep understanding of the governing legal standards. A Determining Party’s actions are governed by the strict mandate of the 2002 ISDA Master Agreement ▴ to act in good faith and deploy commercially reasonable procedures to achieve a commercially reasonable result. This is an operational directive. It requires the construction of a repeatable, auditable, and defensible process for valuing a terminated derivatives portfolio.

The prohibition on unilateral revision means that this process must be executed correctly the first time. There is no opportunity for a second attempt based on a change of heart or strategy.

Operationally, this translates into a series of non-negotiable steps. The Determining Party must first establish a precise “as of” valuation date and time, typically the early termination date. All market data, replacement transaction quotes, and other inputs must be anchored to this specific point in time. The methodology for valuation must be selected and applied consistently across the entire portfolio.

This may involve seeking quotes from third-party dealers, using internal pricing models, or consulting market data services. Crucially, every step, every piece of data, and every decision must be documented. This documentation is the primary evidence that the procedure was commercially reasonable. Should the calculation be challenged, this audit trail will be the centerpiece of the legal defense.

Executing a close-out calculation is a definitive operational act where the absence of a revision mechanism demands flawless, documented, and objectively reasonable procedures from the outset.

The concept of “commercial reasonableness” is not abstract; it is tested against concrete market practices. A procedure would be deemed unreasonable if, for example, the Determining Party only sought quotes from affiliated entities, ignored readily available and more favorable market data, or used internal models that were inconsistent with industry standards. The result would be deemed unreasonable if it deviated significantly from the economic reality of replacing the terminated transactions at the time of close-out. The execution phase is therefore a rigorous exercise in valuation, documentation, and adherence to an objective standard, all performed under the unyielding pressure of finality.

A Procedural Playbook for the Determining Party

To ensure compliance and defensibility, a Determining Party should follow a structured operational playbook. This playbook provides a clear sequence of actions designed to meet the requirements of the ISDA Master Agreement.

• Step 1 Secure The Portfolio Upon the designation of an Early Termination Date, immediately identify all transactions governed by the relevant ISDA Master Agreement. Freeze the portfolio and confirm all trade details, including notional amounts, payment dates, and other key economic terms.
• Step 2 Establish The Valuation Framework Define the specific valuation methodology to be used. This decision should be guided by the nature of the transactions and the availability of market data. The framework must be applied consistently across all transactions. For example, deciding to use a mid-market valuation approach for all interest rate swaps.
• Step 3 Gather Market Data Collect all necessary inputs “as of” the Early Termination Date. This includes obtaining quotes for replacement transactions from a reasonable number of independent, creditworthy dealers, gathering relevant market data (e.g. yield curves, volatility surfaces), and documenting all sources. It is critical to demonstrate that the data gathering was comprehensive and unbiased.
• Step 4 Calculate The Close Out Amount Perform the calculation based on the established framework and gathered data. The calculation should determine the “gains or losses, and costs” associated with replacing the economic equivalent of the terminated portfolio. This includes accounting for both realized and unrealized amounts, as well as any unpaid amounts due.
• Step 5 Conduct Internal Verification Before issuing the notice, a separate individual or team should verify the calculation. This review should check for mathematical accuracy, correct application of the valuation framework, and complete documentation. This step is a critical control to prevent manifest errors.
• Step 6 Issue The Close Out Notice Prepare and deliver a formal notice to the counterparty. The notice must state the final Close-out Amount, the Early Termination Date, and provide details of the calculation in a manner that allows the counterparty to understand how the figure was derived. This act makes the calculation binding.

How Is a Close out Amount Quantified?

The quantification of the Close-out Amount is a detailed financial exercise. The goal is to compute a single number that represents the net economic value of the terminated portfolio. The table below provides a simplified, hypothetical example of such a calculation for a small portfolio of two trades.

In this example, the Determining Party aggregates the costs and gains across the portfolio. The replacement cost for the swap is a positive value (a loss for the Determining Party), while the gain on the FX forward is a negative value (a gain for the Determining Party). These are netted against each other, and then any other outstanding amounts and direct costs are included to arrive at the final, single Close-out Amount. This entire process, including the dealer quotes and cost documentation, must be preserved as evidence of a commercially reasonable procedure.

What Happens If the Calculation Is Challenged?

If the receiving party challenges the Close-out Amount, the dispute resolution process outlined in the ISDA Master Agreement is triggered. The Determining Party cannot simply issue a new number. Instead, it must defend its original calculation. The process typically involves a period of negotiation between the parties.

If negotiations fail, the dispute may escalate to mediation or litigation. In court, a judge will not create a “new” correct calculation. The court’s role is to assess whether the Determining Party’s original calculation met the contractual standard. If the court finds that the procedure or the result was not commercially reasonable, it may declare the calculation void and rule on the damages based on evidence presented by both sides.

This underscores the immense pressure to execute the initial calculation flawlessly. The entire system is designed to scrutinize that single, binding act.

Reflection

The rigidity of the close-out calculation process reflects a foundational principle of market architecture ▴ in moments of crisis, clarity and finality are paramount. The inability of a Determining Party to unilaterally revise its calculation is a deliberate design choice, a structural safeguard that forces discipline and objectivity. This prompts a deeper consideration of your own operational frameworks. How are your internal valuation and risk management procedures designed to perform under pressure?

Do they produce outcomes that are not only internally consistent but also externally defensible against a standard of objective, commercial reasonableness? The knowledge that there is no opportunity for revision should inform the design of the process itself, embedding verification, documentation, and unbiased judgment at every step. Ultimately, mastering the market is not about having the freedom to act, but about building systems that produce the correct, definitive action when it matters most.