DEFINITION of 'Termination Clause '
A section of a swap contract that describes what will happen if the contract is ended early or defaulted on. The termination clause can make the counterparty who is responsible for the default or termination event pay damages to the other counterparty. The agreement value method, formula method or indemnification method can be used to calculate these damages, called "termination payments". When a swap is terminated early, both parties will cease making the agreed-upon payments.
BREAKING DOWN 'Termination Clause '
Counterparties using the International Swaps and Derivatives Association's master swap agreement can take advantage of the termination clause that is already written into that agreement. Possible termination events include legal or regulatory changes that prevent one or both parties from fulfilling the contract terms ("illegality"), the placement of a withholding tax on the transaction ("tax event" or "tax event upon merger"), or a reduction in one counterparty's creditworthiness ("credit event"). Failure to pay or a declaration of bankruptcy by either party are examples of default events.