What Are the Key Differences in Force Majeure Treatment between the 1992 and 2002 ISDA Masters?

Concept

The fundamental architectural divergence in force majeure treatment between the 1992 and 2002 ISDA Master Agreements is a direct reflection of an evolution in market participants’ approach to systemic risk. The 1992 Agreement operates on an implicit framework, lacking a standardized, codified force majeure provision. This absence presumed that such catastrophic, non-credit-related disruptions were either too remote to warrant specific inclusion or best handled through bespoke negotiation, often falling under the doctrine of impossibility or frustration of purpose, which varied significantly by jurisdiction. Consequently, parties using the 1992 architecture were required to either custom-draft their own force majeure clauses into the Schedule or adhere to protocols developed later, creating a fragmented and unpredictable landscape for managing truly exceptional events.

The 2002 ISDA Master Agreement corrected this structural omission by embedding a dedicated force majeure clause directly into its operational mechanics as a Termination Event. This was a deliberate engineering choice, born from the market’s experience with events that strained the global financial system. The inclusion of Section 5(b)(ii) introduced a standardized, universally understood protocol for addressing events beyond a party’s control that render performance impossible or impracticable.

It created a clear, albeit narrow, pathway for deferring and ultimately terminating obligations without immediately triggering a default. This shift represents a move from a reactive, negotiated approach to a proactive, systematized one, acknowledging that operational impossibility is a distinct category of risk that requires its own specific, pre-defined resolution architecture.

The 1992 ISDA Master Agreement contains no native force majeure clause, while the 2002 version integrates it as a specific Termination Event.

This architectural change is significant. The 1992 Agreement’s silence on the matter meant that in the face of an event like a natural disaster or a government-mandated shutdown, parties were left to argue the nuances of common law doctrines, a process fraught with legal uncertainty and high transaction costs. The 2002 Agreement, by contrast, provides a defined procedure.

It acknowledges that an inability to perform due to an external, insurmountable event is a different class of failure than a refusal or inability to pay due to financial distress. This distinction is at the core of the 2002 framework’s design, providing a mechanism that prevents a non-credit-related disruption from automatically cascading into a full-blown Event of Default, with all the systemic consequences that entails.

Strategy

The strategic implications of the differing force majeure treatments are profound, directly impacting counterparty risk assessment, operational readiness, and the legal certainty of derivatives portfolios. Operating under the 1992 ISDA framework necessitates a strategy of proactive gap-filling. Without a built-in force majeure clause, a firm’s primary strategy is one of customized negotiation. This involves drafting a specific force majeure provision into the Schedule to the Master Agreement.

This approach, while flexible, introduces significant basis risk, as bespoke clauses can vary widely between counterparties, making portfolio-level risk aggregation a complex and manual process. An alternative strategy for parties committed to the 1992 framework is adherence to the ISDA Illegality/Force Majeure Protocol, which effectively patches the 2002 Agreement’s force majeure provision into the older document. This creates a degree of standardization but requires an affirmative step and may not cover all legacy agreements.

The 2002 ISDA Strategic Framework

The 2002 ISDA Agreement shifts the strategy from customization to the management of a standardized process. The inclusion of Force Majeure as a Termination Event under Section 5(b)(ii) provides a clear, albeit prescriptive, strategic pathway. The core of this strategy revolves around the “Waiting Period.” Upon the occurrence of a force majeure event, performance obligations are not immediately terminated; they are deferred for a period of eight Local Business Days. This built-in pause is a critical strategic tool.

It allows time for the disruption to potentially resolve itself without forcing the premature termination of transactions. It provides a buffer, preventing a temporary operational disruption (e.g. a data center outage due to a hurricane) from triggering a permanent and potentially costly close-out.

The 2002 ISDA’s introduction of a “Waiting Period” provides a strategic pause to assess whether a disruptive event is temporary or requires termination.

Furthermore, the 2002 Agreement establishes a clear hierarchy of events. An event that could be classified as both a Force Majeure and a Failure to Pay will be treated as a Force Majeure, preventing the non-performing party from being immediately classified as a defaulter. This is a crucial strategic distinction that quarantines operational failures from credit failures, thereby preventing the immediate triggering of cross-default provisions across other agreements.

However, if the event also constitutes a more severe Event of Default, such as Bankruptcy, the Event of Default takes precedence. This hierarchy provides a sophisticated, risk-sensitive framework for classifying and responding to disruptions.

Comparative Strategic Approaches

The table below outlines the strategic differences in managing force majeure risk under the two agreements.

Execution

The execution of force majeure provisions under the 2002 ISDA Master Agreement is a precise, multi-step process that demands rigorous operational discipline. Unlike the ambiguous legal landscape of the 1992 Agreement, the 2002 version provides a clear playbook, transforming a potential legal crisis into a managed, procedural event. The execution process begins with the identification of a potential Force Majeure Event, defined as an event of “force majeure or act of state” that makes performance impossible or impracticable. This is a high bar; it requires that the event is beyond the party’s control and could not be overcome with “all reasonable efforts” without incurring significant loss.

Operational Playbook for a Force Majeure Event

Once an Affected Party identifies such an event, a specific sequence of actions is triggered. The operational integrity of the firm depends on adhering to this sequence precisely.

1. Initial Assessment The first step is a rapid, fact-based assessment. Is the inability to perform directly caused by an external event? Have all other applicable remedies or fallbacks in the confirmation or definitions been exhausted? The provision cannot be invoked until these other avenues are explored.
2. Prompt Notification Section 6(b)(i) of the 2002 Agreement requires each party to “promptly upon becoming aware of it, use all reasonable efforts to notify the other party” of the Force Majeure Event. This notice should specify the nature of the event. While the Waiting Period begins from the occurrence of the event itself, not the notice, failure to notify promptly can create significant relationship and legal friction.
3. The Waiting Period This is the core of the execution process. For a Force Majeure Event, an eight Local Business Day Waiting Period commences. During this period, payment and delivery obligations under the affected transactions are deferred. This is a critical suspension of performance that prevents an immediate default. Operations teams must track this period meticulously.
4. Termination If the event is continuing after the Waiting Period expires, either party has the right to terminate the affected transactions by giving notice. This notice must specify an Early Termination Date that is not earlier than the second Local Business Day after the notice is effective and not later than 20 days after.
5. Close-Out Calculation Upon termination due to a Force Majeure Event, the Close-Out Amount is calculated. A crucial execution detail is that, for a Force Majeure termination, the calculation must use mid-market quotations and must not consider the creditworthiness of the Determining Party. This “no-fault” valuation approach reflects the fact that the termination was caused by an external event, not the credit deterioration of a counterparty.

Hierarchy of Events in Execution

The execution of a force majeure claim is deeply intertwined with the hierarchy of events defined in Section 5(c). This hierarchy acts as a traffic-control system for classifying disruptions. Understanding this is critical for any trading desk or legal team.

What Is the Practical Difference in Grace Periods?

A related point of execution is the difference in grace periods for a simple failure to pay, which highlights the different philosophies of the two agreements. The 1992 form provides a three-business-day grace period for a failure to pay. The 2002 form shortens this to one business day. This change, combined with the introduction of the force majeure clause, shows a move towards a system that is less tolerant of simple payment errors but more structured and accommodating of genuine, externally caused operational failures.

Reflection

How Does This Evolution Impact Your Risk Framework?

The transition from the 1992 Agreement’s silence on force majeure to the 2002 Agreement’s explicit, procedural approach is more than a simple contractual update. It represents a fundamental shift in the financial market’s operating system for handling exogenous shocks. It compels us to ask not just which agreement our counterparties are on, but how our own internal systems for risk identification, operational response, and legal escalation are architected. Does our framework treat all failures to perform as monolithic events, or does it have the sophistication to distinguish between a credit failure and an operational impossibility?

The 2002 ISDA provides a standardized module for this, but the ultimate effectiveness of that module depends on the quality of the internal operating system into which it is integrated. The knowledge of these differences is a component of a larger system of intelligence required to maintain a decisive edge in today’s markets.