7 March 2023
We’re programmed to hate them, but lawyers get paid to deal with them, maybe they even love them. What am I talking about? Problems sitting in a deep dark place in documents which can cause issues when circumstances arise and prevent or delay any action.
Why call them cockroaches? Well, I learned this nickname from a colleague at the ISDA AGM in Prague when he compared 2(a)(iii) of the ISDA Master Agreement to a cockroach. This standard clause came to fame during the Lehman’s Crisis when insolvency practitioners found that transactions could be left open indefinitely by the out-of-the-money, non-defaulting counterparty, who could avoid crystallising any loss by simply refusing to pay and not terminate their transactions. Bank regulators demanded some limit to this frustrating set of circumstances caused by this small clause that prevented a resolution to the situation.
My colleague made this analogy between clause 2(a)(iii) and a cockroach because we were in Prague, home to Czech author Kafka. In his novella The Metamorphosis, Kafka describes how an ordinary young man wakes up one day as a huge cockroach and cannot move because he is upside down on his bed. What does his family do now? How do they live their normal lives around this puzzling inconvenience? No, they did not call in the lawyers, but I’m sure you catch the drift…
There are many standard clauses in agreements which, if not amended, are waiting for the right circumstances to turn them into an enormous impediment to the exercise of what would seem to be normal commercial life, and those are the standard clauses.
I remember in my very early days working in derivatives when a trader asked me if the “standard clauses could be amended” and I naively said “yes”. Well, they can, but not in the body of the standard agreement, but in the schedule. Often the standard wording needs to be amended in order to obtain netting in a certain jurisdiction, or in respect of a certain type of counterparty. Now, another cockroach may appear either by that clause not being amended in the schedule or by the absence of such amendment. Time to either jump up on a chair in the kitchen or take steps to remove them.
The next type of cockroach is easy to identify. In my early days in derivatives, I negotiated clauses in a schedule and gradually learned that there is an enormous difference between something drafted with a series of “ors” or a series of “ands”. You look at a downgrade clause and you find “and, and, and” and you are stuck. Shriek! Another cockroach!
Find where they live of course… You need to go into those dark places in the back of the cupboard under the sink… It is the same with agreements. But the real problem is that you are not aware of how many agreements have the same clause. If you wait for the circumstances to arise in which those clauses become a cockroach you are in serious trouble. During that terrible weekend before Lehman’s went bust I would estimate that easily thousands of lawyers spent all the hours possible to sift through the agreements and establish the presence or not of various cockroaches.
They may in fact be coming from outside your kitchen, maybe from the neighbours upstairs. Agreements can be amended not only in the schedule, but in confirmations or in other agreements and this has become far more complicated over time rather than being simplified. Things are changed all over the place in new definitions, regulations, protocols, IM docs… This is a complexity that lawyers love, but businesses do not exist to make lawyers happy.
‘Digitisation of documents’ is not a panacea, but if carried out thoughtfully it can provide the solution to the first and second problems of how to deal with cockroaches. Digitisation can help identify clauses in all their diversity, including those “ands” and “ors”, wherever they may be. There are limits of course, as some clauses are outside your documentation – you cannot always force your neighbour to be of assistance. And then the real problem arises – some cockroaches are invisible, they have an “and” where you need an ”or”. The search for cockroaches needs to be thorough enough that when you discover what a particularly unwelcome species looks like you can seek them out and ignore the welcome ones.
At Likezero we do not like to think of ourselves as cockroach hunters, but someone has to do it! As my colleague said, clauses can have their cockroach moment where they are metamorphosed from something ordinary into a huge inconvenience. Likezero can help you deal with the known cockroaches and help you identify possible future ones.