Most companies come to derivatives because a lender requires a hedge. A floating-rate term loan or construction loan often obligates the borrower to swap or cap its SOFR exposure, and the bank making the loan offers the swap too. The hedge is documented on an ISDA form that looks standard and mostly is, but the Schedule, the credit support terms, and the way the swap ties into the loan documents decide what the company owes if rates move, the loan is repaid early, or the relationship ends badly. We represent corporate end users, borrowers, funds, and project companies in documenting hedges and in disputes with dealers and counterparties.
The ISDA Documentation
The ISDA Master Agreement, in its 1992 or 2002 form, is a printed standard that parties do not edit. All negotiation happens in the Schedule, which selects and modifies the Master Agreement's provisions, and in the Confirmation for each trade. Key Schedule points include the Events of Default and Termination Events, cross-default thresholds and whether they reach the company's loan facilities, Additional Termination Events tied to the credit agreement, and the close-out method. Collateral terms go in a Credit Support Annex. Many borrower hedges are instead secured by the loan collateral on a pari passu basis, which avoids posting cash margin but makes the hedge-related terms in the credit agreement and intercreditor arrangements critical.
Hedging Borrower Exposure
Interest rate swaps convert floating-rate debt to fixed. Interest rate caps limit the floating rate in exchange for an upfront premium and are common in commercial real estate loans. Cross-currency swaps and FX forwards hedge borrowings or revenues in another currency. The hedge has to match the debt it covers. Mismatches in notional amortization, reset dates, rate floors, or day count conventions leave the company with residual exposure, and a prepayment or refinancing of the loan leaves the swap in place unless it is terminated, which can mean a large breakage payment if rates have fallen. We review the economics against the loan terms, negotiate dealer pricing and amendments, and plan in advance how the hedge will unwind.
Dodd-Frank Title VII Compliance
Title VII of the Dodd-Frank Act brought swaps under regulation by the CFTC, with security-based swaps under the SEC. Standardized interest rate swaps are subject to a clearing mandate, but non-financial end users hedging commercial risk can elect the end-user exception under Section 2(h)(7) of the Commodity Exchange Act, with the election usually reported by the dealer and board committee approval required for SEC filers. A party must be an eligible contract participant to enter an uncleared swap, which creates a recurring problem in loan deals: a guarantor that is not an ECP cannot guarantee the swap obligations, so credit agreements and guaranties include excluded swap obligation and keepwell provisions. Dealers handle most reporting, but end users keep recordkeeping duties.
Terminations And Close-Out Disputes
Derivatives disputes cluster around the moment a relationship ends. A party declares an Event of Default or Termination Event, designates an Early Termination Date, and calculates a close-out payment under Market Quotation or Loss in the 1992 form or Close-out Amount in the 2002 form. The other side challenges the trigger, the timing, or the number. Courts in New York and England, where most ISDA disputes are decided, have addressed when a non-defaulting party may suspend payments under Section 2(a)(iii), what standard of reasonableness applies to close-out valuations, and how Bankruptcy Code safe harbors protect termination rights. We bring and defend these claims, working with valuation consultants to rebuild the calculation from market data.
Hedging Mistakes To Avoid
Companies most often get hurt by terms they never focused on. A low cross-default threshold can let a dealer terminate the swap when the company has a minor dispute with an unrelated lender. An Additional Termination Event tied to the loan can end the hedge at a bad moment if the loan is refinanced with a different bank. A Credit Support Annex with a zero threshold can force cash posting during a rate swing exactly when liquidity is tight. Borrowers also sign hedges without seeing the dealer's markup embedded in the fixed rate. We read the Schedule against the credit agreement, ask for pricing transparency, and explain what each termination right means in dollars before the company signs.
