THE ANGLO-AMERICAN INDENTURE –
COVENANT ENFORCEMENT AND BOND DEFAULTS -U.S. EXPERIENCE AND LESSONS FROM CANADA AND THE
U.K.
Prepared for the
American Bar Association
Section of Business Law
Spring Meeting
Vancouver, BC ♦ April 16-18, 2009
10:30 a.m. – 12:30 p.m.
Thursday, April 16, 2009
Presented by Committee on: Trust Indentures and Indenture Trustees and
Business Bankruptcy, Trust Indentures Subcommittee
CHIC_3952905.6
Moderator
Doneene Keemer Damon
Richards, Layton & Finger, P.A.
One Rodney Square, 920 N. King Street
Wilmington, DE 19801
Tel: (302) 651-7526 Fax: (302) 498-7526
Email: [email protected]
The Panel
Daniel R. Fisher
Wilmington Trust Company
One Rodney Square, 1100 N. Market Street
Wilmington, DE 19890
Tel: (302) 636-6463 Fax: (302) 636-4149
Email: [email protected]
Mark F. Hebbeln
Foley & Lardner LLP
321 North Clark, Suite 2800
Chicago, IL 60654-5313
Tel: (312) 832-4394 Fax: (312) 832-4700
Email: [email protected]
Harold L. Kaplan
Foley & Lardner LLP
321 North Clark, Suite 2800
Chicago, IL 60654-5313
Tel: (312) 832-4393 Fax: (312) 832-4700
Email: [email protected]
Brendan O’Neill
Goodmans, LLP
250 Yonge Street, Suite 2400
Toronto, Ontario M5B 2M6
Tel: (416) 849-6017 Fax: (416) 979-1234
Email: [email protected]
Program Chair
Harold L. Kaplan
Foley & Lardner LLP
321 North Clark, Suite 2800
Chicago, IL 60654-5313
Tel: (312) 832-4393 Fax: (312) 832-4700
Email: [email protected]
Program Co-Chair
Jay A. Carfagnini
Goodmans, LLP
250 Yonge Street, Suite 2400
Toronto, Ontario M5B 2M6
Tel: (416) 597-4107 Fax: (416) 979-1234
Email: [email protected]
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CHIC_3952905.6
THE ANGLO-AMERICAN INDENTURE – COVENANT ENFORCEMENT AND BOND
DEFAULTS -- U.S. EXPERIENCE AND LESSONS FROM CANADA AND THE U.K.
Harold L. Kaplan and Mark F. Hebbeln, Foley & Lardner LLP
U.S. EXPERIENCE AND TRENDS
I. INDENTURES AND INDENTURE COVENANTS
Publicly-issued corporate debt securities in the United States are generally issued
(and have been for over a century) pursuant to Indentures. The Indenture is the contract setting
forth the terms and conditions of the relationship between the issuer and the bondholders, and is
generally executed by the issuer with an Indenture Trustee, which serves as the representative of
the bondholders and the primary enforcer of the terms of the Securities and Indenture.
Indenture covenants are undertakings -- sometimes boilerplate, sometimes heavily
negotiated -- included in indentures for debt securities which are intended to give investors some
additional financial assurances or protections -- other than an issuer’s promise -- that the
principal of and interest on the securities will be paid when due and that the market value of the
securities will not artificially be undercut. Similar to, but usually less stringent than covenants
contained in bank loan agreements, indenture covenants are intended to protect investors by
limiting the issuer’s right to take specified steps that might impair its ability to pay. Typically, in
addition to requiring payment of principal and interest as scheduled, such covenants (i) require
certain reporting, corporate and financial actions of the issuer, and (ii) limit or condition the
ability of the issuer and any subsidiary guarantors to, for example, borrow money, grant liens on
assets, dispose of assets or make distributions to equityholders. For corporate (non-municipal)
debt of over $5 million which is generally governed by the Trust Indenture Act (TIA),1 certain of
these covenants are mandated by the TIA, while most other covenants are subject to negotiation.
In any case, the covenants attempt to address the myriad of transactions that may have the effect,
either directly or indirectly, of weakening the issuer’s economic ability to repay the debt or the
market value of the underlying securities.
II. THE ROLE OF THE INDENTURE TRUSTEE IN AN ACTIVIST WORLD
Modern indenture trustees have increasingly been called upon to balance
issuer/bondholder demands in interpreting and implementing the indenture, while serving as the
neutral conscience and enforcer of the fair interplay between today’s ever more aggressive
issuers and activist investors. This interplay is often complicated by such investors –
increasingly hedge funds with significant concentrations of debt -- (i) wanting to aggressively
read and enforce indenture covenants and (ii) holding different levels or tranches of such debt
and sometimes having multiple agendas (including sometimes aspiring to ultimate ownership or
control of the issuer).
1
15 U.S.C. Sections 77aaa through 77 bbbb.
3
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While the indenture trustee’s role expressed this way may seem to encompass and
raise serious ethical, or at least judgment, issues, it is important to remember and maintain that
the indenture trustee does not assume the generalized broad-based responsibilities of a common
law trustee, or “fiduciary”, but purely administers and implements contractual obligations under
the indenture. Having said that, the indenture trustee’s role under the indenture still can be
viewed as including facilitating a level playing field for all bondholders, while recognizing the
legitimate interests of (often including directions from) majority and minority holders. Whether
viewed as an ethical, contractual or just practical/self-protective mandate for the indenture
trustee, the indenture trustee has increasingly been confronted with ever more difficult issues of
balancing countervailing interests in doing what is right.2
This section obviously cannot consider all the situations or ramifications
confronting the modern indenture trustee, but will address by way of a big picture or thirty
thousand foot conceptual overview of fundamental principles: (i) some of the issues and
standards of care implicating the role of the indenture trustee; (ii) why indenture trustees are not
and should not be (or allow themselves to be) called or viewed as pure “fiduciaries”; and (iii)
how the indenture trustee may increasingly need as an initial matter to analyze the diverse
positions of its constituent bondholders in order to faithfully fulfill its role to “do right” in a
world of complicated debt offerings and capital structures, with investors often holding divergent
positions, tranches of debt and even agendas (such as sometimes the ambition to own or control
the issuer) and to deal with the conundrum of recognizing the legitimate interests of majority
holders, while still protecting and giving voice to minority holders who may feel disadvantaged
by a transaction or restructuring supported by the majority.
A. THE ROLE AND STANDARD OF CONDUCT EXPECTED OF THE
INDENTURE TRUSTEE.
1. Pre-Default/Post-Default Conduct.
It is hornbook law that, pre-default, the indenture trustee is expected to perform
the express ministerial functions prescribed in the four corners of the indenture document, and
post-default is to perform as would a “prudent man” (the phrasing used in the Trust Indenture
Act).3 The “prudent man” standard appears explicitly in most indentures4 and is read into all
2
Some of these issues are discussed in the authors’ recent article on issues confronting indenture trustees in
discriminatory exchange offers and consent solicitation by issuers, “Keeping a Level Playing Field: The Evolution
of Discriminatory Consent Solicitations and Exchange Offers”, ABA Trusts & Investments, March/April 2008.
3
See, e.g., Peak Partners, LP v. Republic Bank, 191 Fed. Appx. 118, 122 (3d Cir. 2006); Shawmut Bank v.
Kress Assocs., 33 F.3d 1477, 1491 (9th Cir. 1994); In re E.F. Hutton Southwest Properties II, Ltd., 953 F.2d 963,
972 (5th Cir. 1992) (heightened duties are not activated until a conflict arises where it is evident that the indenture
trustee may be sacrificing the interests of the beneficiaries in favor of its own financial position); Elliott Assocs. v. J.
Henry Schroder Bank & Trust Co., 838 F.2d 66, 71 (2d Cir. 1988) (“so long as the trustee fulfills its obligations
under the express terms of the indenture, it owes the debenture holders no additional, implicit pre-default duties or
obligations except to avoid conflicts of interest.”); Cruden v. Bank of New York, 1990 U.S. Dist. LEXIS 11564, at
*16 (S.D.N.Y. Sept. 4, 1990) (“The law in this Circuit therefore is clear concerning the pre-default duties of the
indenture trustee. The duty is purely contractual, and it is defined by the Trust Indenture Act and the terms of the
Indenture.”), aff’d in part, rev’d in part, 957 F.2d 961 (2d Cir. 1992); New York State Med. Care Facilities Fin.
Agency v. Bank of Tokyo Trust Co., 621 N.Y.S.2d 466, 467 (N.Y. Sup. Ct. 1994), aff’d, 629 N.Y.S.2d 3 (N.Y. App.
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TIA-governed corporate debt indentures, as required by TIA Section 315(c) (15 U.S.C. Section
77ooo(c)). As such, the indenture trustees’ standard of conduct is effectively contractuallymandated (often in accordance with statutory prescriptions) as opposed to arising whole cloth
from natural or common law.
This long-standing formulation is subject to the further limitation on trustee selfdealing or conflicts of interest5 and has been reiterated in the few recent cases dealing with the
standards of conduct expected of indenture trustees. For example, in the recent decision in Peak
Partners, LP v. Republic Bank, 191 Fed. Appx. 118, 122 (3d Cir. 2006), the Court, in holding
that allegedly premature payments of over $10 million alleged to have been made by the
indenture trustee to a secondary level of debt based on the reports it received, did not constitute
an “event of default” or cause harm, stated:
Unlike the ordinary trustee, who has historic common-law duties
imposed beyond those in the trust agreement, an indenture trustee
is more like a stakeholder whose duties and obligations are
Div. 1995); AMBAC Indem. Corp. v. Bankers Trust Co., 573 N.Y.S.2d 204, 206 (N.Y. Sup. Ct. 1991) (the duties of
an indenture trustee can be limited to those set forth in the indenture and, as a result, the trustee does not owe the
broad fiduciary duties of an ordinary trustee prior to an event of default, except that the trustee is at all times
obligated to avoid conflicts of interest with the beneficiaries). See also First Interstate Bank v. Pring, 969 F.2d 891,
900 (10th Cir. 1992) (an indenture trustee’s duties are strictly defined and limited to the terms of the indenture),
rev’d 511 U.S. 164 (1994); Lorenz v. CSX Corp., 1 F.3d 1406, 1416 (3d Cir. 1993) (the duties of an indenture
trustee, unlike those of a typical trustee, are defined exclusively by the terms of the indenture. The sole exception to
this rule is that the indenture trustee must avoid conflicts of interest with the debenture holders); Meckel v. Cont’l
Resources Co., 758 F.2d 811, 816 (2d Cir. 1985); Eldred v. Merchs. Nat’l Bank, 468 N.W.2d 221, 223 (Iowa 1991)
(an indenture trustee is more like a stakeholder whose duties and obligations are exclusively defined by the terms of
the indenture); Nat’l City Bank v. Coopers & Lybrand, 409 N.W.2d 862, 866 (Minn. App. 1987). Cf. Broad v.
Rockwell Int’l Corp., 642 F.2d 929 (5th Cir. 1981), cert. denied, 454 U.S. 965 (1981); Dabney v. Chase Nat’l Bank,
196 F.2d 668 (2d Cir. 1952), supplemented by, 201 F.2d 635 (2d Cir. 1953), cert. dismissed, 246 U.S. 863 (1953);
United States Trust Co. v. First Nat’l City Bank, 394 N.Y.S.2d 653 (N.Y. App. Div. 1977), aff’d, 382 N.E.2d 1355
(N.Y. 1978).
4
See, e.g., Section 7.01(a) of the Model Simplified Indenture published in The Business Lawyer, 38 Bus.
Law. 741 (1983), and Section 7.01(a) of the Revised Model Simplified Indenture published in The Business Lawyer,
55 Bus. Law. 1118 (2000).
5
The above standards of care may be enforced more stringently on the trustee if it is found that the trustee
engaged in self-dealing. Self-dealing encompasses any action of benefit to the indenture trustee financially or
otherwise in possible conflict with interests of holders. In re E.F. Hutton SW Props. II, Ltd., 953 F.2d 963, 972 (5th
Cir. 1992) (heightened duties are not activated until a conflict arises where it is evident that the indenture trustee
may be sacrificing the interests of the beneficiaries in favor of its own financial position); LNC Invs., Inc. v. First
Fid. Bank, 935 F. Supp. 1333, 1347 (S.D.N.Y. 1996) (fiduciary duties are not activated until it is clear that the
indenture trustee has a conflict of interests); AMBAC Indem. Corp. v. Bankers Trust Co., 573 N.Y.S.2d 204, 207
(N.Y. Sup. Ct. 1991) (the duties of an indenture trustee can be limited to those set forth in the indenture and, as a
result, the trustee does not owe the broad fiduciary duties of an ordinary trustee prior to an event of default, except
that the trustee is at all times obligated to avoid conflicts of interest with the beneficiaries). However, the possible
conflict must be plainly evident from the circumstances—a purely hypothetical conflict is not sufficient. In re E.F.
Hutton, 953 F.2d at 972. Moreover, the existence of a conflict may not be inferred simply from a relationship
between the issuer and the indenture trustee that is mutually beneficial (or even lucrative). Page Mill Asset Mgmt.
v. Credit Suisse First Boston Corp., Collateralized Mortgage Sec. Trust II, 2000 U.S. Dist. LEXIS 9077, at *5-6
(S.D.N.Y. June 27, 2000).
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exclusively defined by the terms of the indenture
agreement….New York common law imposes two duties on an
Indenture Trustee in addition to those specified in the Indenture:
(1) a duty to avoid conflicts of interest with the beneficiaries, and
(2) a duty to perform basic non-discretionary ministerial tasks….It
is only after an “event of default” occurs, as that term is defined in
the Indenture, that an Indenture Trustee's duty to noteholders
becomes more like that of a traditional trustee….In that case, the
Indenture Trustee must use the same degree of care and skill in
[its] exercise as a prudent man would exercise or use under the
circumstances in the conduct of his own affairs while exercising its
rights and powers under the Indenture….While not required to act
outside of its rights and powers under the Indenture, the trustee still
must, as prudence dictates, exercise those singularly conferred
prerogatives in order to secure the basic purpose of any trust
indenture, the repayment of the underlying obligation (internal
quotations and citations omitted).6
2. The Loewen Case – Pre-Default Ministerial Conduct .
In a decision dated June 25, 2008, in the Loewen case,7 the New York Court of
Appeals reinstated a negligence claim against an indenture trustee. Asserted on behalf of
upwards of $550 million of a total $750 million of holders of Loewen Notes, under three Note
issuances,8 the claim was made as a separate, standalone count, non-duplicative of contractual or
TIA claims, which had been released in the Loewen plan.
The Noteholders sought tens of millions of dollars in damages from the indenture
trustee, based on the claim that the trustee failed to deliver or cause to be delivered to a collateral
6
Accord U.S. Bank National Association v. United Airlines, 438 F.3d 720, 730 (7th Cir. 2006), in which
the Court held that the indenture trustee was bound by the terms of the indenture to make disbursements to United,
even though United was on the verge of bankruptcy; Semi-Tech Litigation Trust, LLC v. Bankers Trust Company,
353 F. Supp. 2d 460 (S.D.N.Y. 2005), in which the Court held that the “prudent person” duties of the trustee were
not triggered and damages were not caused under the terms of indenture merely as a consequence of the obligor's
submission of non-conforming compliance documentation; LNC Investments, Inc. v. National Westminster Bank,
308 F.3d 169 , 176 (2d Cir. 2002), in which the Court held that the trustee’s failure to make a prompt motion to lift
an automatic stay on airline equipment was not imprudent and that the question of prudence should be evaluated
based on what was reasonably known at the time; and Bluebird Partners v. First Fidelity Bank, et al., No. 601365/97
(Sup. Ct. N.Y. County Dec. 12, 2002), in which the Court instructed the jury that the appropriate inquiry in
determining prudence is whether the trustee made an informed, well-reasoned decision and whether prudence
dictated that a different course of action be followed.
7
For more details on issues raised in the Loewen case, see the following articles the author has written:
“Cases to Watch: Loewen,” ABA (American Bankers Association) Trust & Investments, September/October 2002
(pp. 11-12), “Trustee Indemnification as a Shield,” ABA (American Bankers Association) Trust & Investments,
March/April 2002 (pp. 13-15).
8
AG Capital Funding Partners, L.P. v. State Street Bank and Trust Co., 2008 NY Slip Op 5766, 2008 WL
2510628 (N.Y. Ct. of Appeals, June 25, 2008).
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trustee certain Additional Secured Indebtedness Registration Statements (ASIRS), the purpose of
which was to inform the collateral trustee of the new indenture trustee and that the Notes were to
share in the collateral pool. This asserted failure gave rise to the argument that the Notes were
not entitled to secured treatment or to share in the collateral pool. This exposure lead to a Planimposed compromise by the Noteholders in which they were forced to accept in excess of 10
percent – or perhaps $50 million to $75 million -- less than their total potential recovery if the
ASIRS had been filed.
The Court’s decision is perhaps the first appellate decision expressly holding that
prior to an event of default, an indenture trustee may not only owe noteholders contractual duties
under the indenture, but may also owe noteholders an independent, non-duplicative, nonpreempted duty to perform ministerial functions with due care (such as delivery and filing of
security interest documents), and that the failure to fulfill those obligations may subject the
trustee to stand-alone liability in tort, under a negligence standard, in addition to under any
contractual or other theory. In particular, the Court of Appeals specifically found:
“Based on the foregoing, we hold that an indenture trustee owes a
duty to perform its ministerial functions with due care, and if this
duty is breached the trustee will be subjected to tort liability.
However, contrary to plaintiffs’ arguments, the alleged breach of
such duty neither gives rise to fiduciary duties nor supports the
reinstatement of plaintiffs’ fourth and fifth causes of action [based
on claims of fiduciary duty].”
Not only does this decision raise the specter of possible ultimate trustee liability
in the Loewen situation -- where contractual, TIA and other indemnifiable claims other than
negligence had been released under the Plan -- but, it may also give indenture trustees additional
cause to consider the advisability (even where they may not have assumed primary responsibility
to do so) of monitoring and following-up protectively on assuring the filing of security interests
and other documents necessary to protect holders’ property interests.
B. THE INDENTURE TRUSTEE IS NOT A “FIDUCIARY” AND SHOULD NOT
FALL (OR BE PUSHED) INTO THE FIDUCIARY TRAP.
While indenture trustees have been called and still often are referred to as
“fiduciaries” with “fiduciary duties,” this characterization is probably a misnomer (and a
disservice to indenture trustees) that should not be countenanced or repeated by indenture
trustees, as it can only prejudice indenture trustees and mislead investors and other capital
market participants. In particular, while indenture trustees certainly have defined good faith
duties under the indenture, to the extent the “fiduciary” characterization is used or allowed to be
used, it may convey broader or more generalized (almost parental) duties of, for example, a
common law trustee, as opposed to the express contractual duties actually required of the
indenture trustee as a representative of (not replacement for) the bondholders, as discussed
above. Thus, using or allowing use of the “fiduciary” characterization may be read as the
indenture trustee agreeing to assume greater discretionary obligations than are prescribed or
allowed under the indenture.
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At common law, fiduciary duties generally attach to a common law trustee’s
decisions regarding the management of assets and the distribution of property to trust
beneficiaries.9 A common law trustee has a fiduciary obligation to protect and deal honestly
with its beneficiaries, including an obligation to provide information when it knows that its
failure to provide information might cause harm.10 This duty has been described as being the
“highest” duty11, “intense,”12 and “exacting,”13 as well as “demanding and inflexible.”14
Similarly, the Restatement (Third) of Trusts provides that “a trustee, in deciding whether and
how to exercise the powers of the trusteeship, is subject to and must act in accordance with the
fiduciary duties stated [in the Restatement].” Restatement (Third) of Trusts (2007), §86.
By contrast, indenture trustees’ duties are strictly limited to those set forth in the
indenture.
As the United States District Court for the Southern District of Texas recently
explained in Newby v. Enron Corp., “[B]ondholders/noteholders are a distinguishable type of
beneficiary . . . [because they] obtain their rights from a contract, known as an indenture, which
sets out a system of individual rights held separately by individual noteholders and of collective
rights held by the group of noteholders or their representative, i.e., the indenture trustee.”16 In
further illustration, the Court also noted that: “‘The term ‘trustee’ evokes strictly enforced
fiduciary duties. But an indenture trustee for a corporate bond has quite a different status and
serves different functions than, say, a trustee in a traditional default. Until the Event of Default
occurs, the trustee has virtually no obligations towards the bondholders . . . .’”17 Indeed, some
15
9
Tittle v. Enron Corp., 284 F. Supp. 2d 511, 544 (S.D. Tex. 2003).
10
Bouboulis v. Transp. Workers Union, Local 100, 2006 U.S. Dist. LEXIS 74238, at * 10-11 (S.D.N.Y.
11
Cundall v. U.S. Bank Nat’l Assoc., 882 N.E.2d 481, 490 (Ohio App. 2007).
12
Dabney v. Chase Nat’l Bank, 196 F.2d 668, 670 (2d Cir. 1952).
13
In re Schipper, 993 F.2d 513, 516 (7th Cir. 1991).
14
John Blair Comms. Profit Sharing Plan v. Telemundo Group, 26 F.3d 360, 367 (2d Cir. 1994)
2006).
15
See cases cited in footnote 1, supra; see also Peak Partners, LP v. Republic Bank, 191 Fed. Appx. 118,
122 (3d Cir. 2006) (“Unlike the ordinary trustee, who has historic common-law duties imposed beyond those in the
trust agreement, an indenture trustee is more like a stakeholder whose duties and obligations are exclusively
defined by the terms of the indenture agreement.”) (internal citations and quotations omitted); Bank of New York v.
Sunshine-Junior Stores, Inc. (In re Sunshine-Junior Stores, Inc.), 456 F.3d 1291, 1308-09 (11th Cir. 2006) (holding
that “[t]he scope of the indenture trustee’s duties and liabilities . . . is dictated by the express terms of the Trust
Indenture Agreement” and that “[t]he Indenture Trustee is . . . a creature created and governed by contract.”);
Raymond James & Assoc. v. Bank of New York Trust Company, N.A., 2008 U.S. Dist. LEXIS 4111, at *13 (M.D.
Fla. Jan. 18, 2008) (holding that “[u]nlike the ordinary trustee, who has historic common-law duties imposed beyond
those in the trust agreement, an indenture trustee is more like a stakeholder whose duties and obligations are
exclusively defined by the terms of the indenture agreement”) (citation omitted).
16
Newby v. Enron Corp. (In re Enron Corp. Sec., Derivative & “ERISA” Lit.), 2008 WL 744823, at *8
(S.D. Tex. Mar. 19, 2008).
17
Id. at *8, n.22 (quoting Marcel Kahan, Rethinking Corporate Bonds: The Trade-Off Between Individual
and Collective Rights, 77 N.Y.U. L. Rev. 1040, 1063-64 (Oct. 2002)).
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courts have rejected breach of fiduciary duty claims against indenture trustees as non-actionable,
allowing only claims for breach of the indenture to proceed.18
Indenture trustees and their counsel may only encourage greater exposure to
themselves to a higher, more unlimited standard of conduct (and discretion) than contemplated in
the indenture if they refer to themselves or allow themselves to be referred to as pure
“fiduciaries.” In so doing, they may be viewed as “leading with their chin” in implicitly
assuming or accepting the “self-inflicted wound” of a higher, more discretionary common law
trustee standard of care than the representative/prudent person role contemplated in the indenture
for indenture trustees. They should, therefore, probably refrain from ever using the word
“fiduciary” to describe the indenture trustee role, not only because of the possible expanded
exposure it invites, but also because it is misleading and contrary to the contractually-dictated
standard of care legally expected of indenture trustees.
C. THE MODERN CHALLENGE TO INDENTURE TRUSTEES: ANALYZING
THE POSITION OF AND DEALING WITH CONSTITUENCIES SO AS TO
PROMOTE AN EVEN PLAYING FIELD.
Thus, the role of the indenture trustee is not to be a common law fiduciary or to
super-impose its ethical or generalized judgment over its conduct towards or involving issuers
and bondholders, but rather to administer its obligations under the indenture, and to act as a
“prudent man” would upon default. While these contractual standards may not on their face
confront the indenture trustee with pure ethical choices, they do often force the indenture trustee
to make judgment calls in unclear situations, often considering the proper interpretation of the
indenture and balancing the interests of bondholders generally against maintenance of a fair,
even playing field for all holders. These issues have been presented in technicolor to the modern
indenture trustee as it has had to deal with ever more complex capital structures and more activist
investors who may insist on expansive reading of indentures; or have multiple and disparate
interests and agendas.19
18
See, e.g., Orix Real Estate Capital Mkts., LLC v. Superior Bank, FSB, 127 F. Supp. 2d 981, 984-985
(N.D. Ill. 2000).
19
While we cannot here examine the full range of scenarios that may arise, as a general proposition and
initial matter, in meeting its duties, the indenture trustee will generally need not only to identify the constituencies it
represents, but in doing so may also have to scratch below the surface to determine which exact interests particular
bondholders are attempting to vindicate and advance. Thus, the trustee may need to ask and address questions such
as the following: Does the indenture trustee have a duty to the issuer, all bondholders, majority bondholders, or
minority holders? Does the trustee have a duty to preserve a fair or level playing field between all the holders, and
how can the trustee determine the legitimate (as opposed to ulterior) interests and agenda of disparate constituencies,
including different holders within the class it represents?
In determining where particular investors may be coming from, it may be increasingly crucial to determine
whether unfairness in a transaction is contemplated and what positions holders may individually be seeking to
protect. In doing so, questions like the following can arise and may need to be addressed to give the trustee the
analytical tools to act prudently and assure a fair or level playing field for all its bondholders:
How much did the activist investor actually pay for its securities position so as to determine its break-even
or profit point absolutely and in contrast to other holders?
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III. RECENT, MORE AGGRESSIVE ENFORCEMENT OF INDENTURE COVENANTS:
THE NO-ACTION CLAUSE IN AN ACTIVIST WORLD
A. REPRESENTATIVE COVENANT INTERPRETATION AND
ENFORCEMENT ACTIONS
Recently a trend implicating investors and indenture trustees seems to have
emerged, involving the more proactive reading, interpretation and enforcement of indenture
covenants -- all under the more aggressive eye or overview of today’s modern fund investors.
The motivation for this more aggressive approach from the investor/hedge fund perspective
seems to be everything from (1) securing consent fees in exchange for waivers; to (2)
renegotiating financial terms of the securities like interest rates or maturities; to (3) accelerating
debt to attempt to accelerate and/or optimize recovery; to (4) using covenants to block issuer
transactions which might undermine or prejudice the bondholders’ position. This section will
look at (1) the contractual and conceptual bases underlying indenture interpretation and such
aggressive remedial action, and some representative cases and (2) the often-ignored question of
who -- the trustee and/or the securityholders -- has the authority to pursue or enforce covenant
interpretations or violations.
Among the earliest and most pronounced examples of this trend which burgeoned
in the last two years is the push by some investor to move aggressively (and insist that trustees
move aggressively) in pursuing seeming or arguable defaults relating to the failure of issuers to
timely file and transmit annual and quarterly reports with the S.E.C. pursuant to an indenture
reporting covenant and Section 314(a) of the TIA.20 The explosion of Delayed SEC Filing
Does the investor have conflicting tranches or positions, e.g., debt at different obligor entities or non pari
passu levels?
Is the investor merely seeking to optimize its recovery on certain bonds, or does the investor aim to gain
control of the issuer?
Finally, reflecting a new phenomenon -- has the investor hedged its position by, for example, also shorting
its position in the security, and how does this affect its goals, including perhaps putting its interests at odds with
other holders?* (This issue recently presented itself in the Delphi Corporation chapter 11 proceedings in the
Bankruptcy Court for the Southern District of New York. There, Delphi sought and obtained an order from the
Bankruptcy Court authorizing Delphi to conduct discovery under Bankruptcy Rule 2004 concerning allegations that
certain investors, including potentially certain entities that funded Delphi’s chapter 11 plan, had engaged in
“inappropriate conduct” by trading in or shorting of one or more of Delphi’s outstanding securities.)
While the answer to such questions might be difficult to uncover and the indenture trustee cannot be held
responsible for uncovering the full scope and accuracy of such information, such inquiries are becoming an
increasingly relevant initial analytical exercise for indenture trustees, if they are to sort out the actions they are to
take or are directed to take by disparate security holders.
20
See “Reading Indentures Strictly: The Rise of Delayed SEC Filing Defaults and Aggressive
Bondsecurityholders,” Trust & Investments, January/February 2007. In that article we discussed, among other
things, the September 2006 decision by the New York State Supreme Court in Bank of New York v. BearingPoint
which interpreted an indenture provision requiring the issuer to file with the trustee, within 15 days of filing the
same with the S.E.C., copies of its annual and other periodic reports pursuant to Section 13 or 15(d) of the Exchange
Act, to also require that the issuer timely file the annual and periodic reports with the S.E.C. Bank of New York v.
BearingPoint, Inc., 824 N.Y.S.2d 752 (N.Y.S. Sup. Ct.) (Sept. 18, 2006). In a June 2007 decision, however, a
federal district court for the Southern District of Texas held that a similar indenture provision required the issuer to
furnish a copy of its annual and period reports to the trustee only after such reports had actually been filed with the
S.E.C. (Cyberonics v. Wells Fargo Bank National Association.) See also Landry’s Restaurants, Inc. v. Post
10
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default claims has been followed and accompanied by other Covenant Compliance challenges.
Other covenants which have been the focus of significant recent controversy and proactive
enforcement actions include:
•
Change of Control Provisions—generally permitting securityholders to redeem their
bonds at 101% of or some other premium over the principal amount in instances where
the issuer is the subject of a leveraged buyout or some other scenario leading to a defined
change in ownership.
•
Negative Covenants on Debt, Liens, Lien Releases, Equal and Ratable Clauses—
generally limiting issuers from incurring new senior and/or secured debt which would
push the existing securities too far down the capital structure, or, in the case of new
secured debt, requiring equal and ratable sharing of the new collateral.
•
Mergers/Sales of Substantially All Assets—generally limiting the ability of issuers to
substantially merge or consolidate with another corporation or to convey all (or
substantially all) of their assets in one or more related transactions unless the surviving or
successor corporation assumes the debt obligation.
•
No-Call/Make-Whole/Prepayment Premiums—generally limiting redemptions or
requiring issuers to pay a premium for redeeming the securities before they are scheduled
to mature.
Recent Representative Covenant Enforcement Actions
Delayed SEC Filings/Breach of TIA §314(a) and Reporting Covenants
•
In Bank of New York v. Bearing Point, Inc., ((N.Y.S. Sup. Ct.), Sept. 18, 2006.)21 the
court interpreted an indenture provision requiring the issuer to file copies of its annual
and other periodic reports pursuant to Section 13 or 15(d) of the Exchange Act with the
trustee, within 15 days of filing the same with the S.E.C., to also require that the issuer
timely file the annual and periodic reports with the S.E.C. This any delay in filing with
the S.E.C. and transmittal to the trustee constitutes a default under the indenture.
•
In contrast, in Cyberonics v. Wells Fargo Bank National Association, ((S.D.TX), June 13,
2007)22 and Affiliated Computer Services, Inc. v. Wilmington Trust Co., ((N.D.TX), Feb.
12, 2008)23 both courts held similarly that indenture provisions similar to the one at
contention in Bearing Point required the issuers to furnish copies of their annual and
period reports to the trustees only after such reports had actually been filed with the
S.E.C.
Advisory Group, LLC, et al. (Case No. 07-cv-0406) (U.S. Dist. Ct. S.D. Tx.). United HealthGroup, Inc. v.
Wilmington Trust Co., (538 F. Supp. 2d 1108, 2008 WL 686755).
21
824 N.Y.S. 2d 752 2006 WL 2670143.
22
2007 WL 1729977.
23
2008 WL 37311.
11
CHIC_3952905.6
•
In Finisar Corp. v. U.S. Bank Trust Nat. Ass'n, ((N.D.Cal.), Aug. 25, 2008)24, the court
found that the issuer is not required to submit information to the trustee within 15 days of
SEC deadlines if the indenture does not explicitly direct the issuer to do so.
•
In UnitedHealth Group, Inc. v. Wilmington Trust Co., ((U.S. Dist. Ct. D. Minn.), March
10, 2008)25 the court adopted the Company’s narrow reading of the indenture provision
and TIA §314(a), and rejected the argument that delay in filing the Company’s 10-Q
breached an implied covenant of good faith and fair dealing under New York law: The
court concluded, “The Court finds, based on the Indenture’s plain meaning, that plaintiff
fulfilled its contractual duties when it provided defendant with copies of its SEC filings
within 15 days of their being filed with the Commission. Similarly, TIA Section 314
requires only that plaintiff provide the trustee with copies of SEC filings, establishing no
deadline whatsoever. Accordingly, plaintiff’s delay in filing its Form 10-Q does not
violate the Indenture’s terms. For these reasons, plaintiff has not defaulted on the Notes.”
Negative Pledge/Limitation on Liens/Equal and Ratable Clauses/ Limitation on Sale/Leaseback/
Release of Liens
•
In In re Solutia, Inc., et al. ((Bankr. S.D.N.Y.), May 1, 2007)26 the securityholders
challenged the unilateral “de-collateralization” of their securities. Specifically, in the
Solutia case, the bankruptcy court held that the clear and unambiguous provisions of an
indenture’s equal and ratable clause allowed the company to “de-collateralize” certain
notes—approximately ten weeks prior to filing for bankruptcy—by entering into a
replacement credit facility that was expressly structured to reduce the collateral pledged
to the lender so that the equal and ratable clause would no longer be triggered.27 Under
the terms of the indenture, if the company incurred secured debt that was secured by
collateral in excess of 15% of the company’s consolidated net tangible assets, then the
notes would be entitled to an equal and ratable security interest. The bankruptcy court
held that “the terms of the contractual relationship agreed to, and not broad concepts such
as equity, define the [company’s] obligations to its Noteholders[, and] . . . the [company]
did not breach any contractual duty to the Noteholders by entering into a new loan
agreement that deliberately de-securitized the Notes.”28
•
Realogy
In The Bank of New York Mellon et al. vs. Realogy Corp. ((Delaware Chancery Court)
Dec 18, 2008), the indenture trustee for one class of senior notes and a noteholder of the
same class of senior notes filed a complaint arguing that Realogy’s proposed tender note
offering would violate a previously signed credit agreement and thereby the indenture,
unless the company granted the senior noteholders equal and ratable liens. The proposed
24
Slip Copy, 2008 WL 3916050.
25
538 F. Supp. 2d 1108, 2008 WL 686755.
26
2007 WL 1302609.
27
2007 WL 1302609.
28
Id. at 9.
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CHIC_3952905.6
debt restructuring would elevate a subordinated class of noteholders over the senior
noteholders in priority. The court held in the noteholders favor and prohibited the
impending transaction.
Restrictions on Mergers/Sales of All or Substantially All Assets/Conveyance of Assets
•
In The Bank of New York v. Tyco International Group, the trustee, at the direction of the
holders of majority of the securities under two separate indentures, in June 2007 sought a
declaratory judgment to determine whether execution of certain supplemental indentures
which would implement a proposed separation of Tyco International Group and Tyco
International Ltd. into three independent, publicly traded companies, violated the
successor obligor clauses of the indentures governing some $5.6 billion in debt because
after the completion of the proposed separation, which would include the distribution of
the stock of two of the companies that represent approximately 53% of the value of the
businesses, the guarantor of the debt would no longer hold all or substantially all of the
assets of the company. In its decision the Court held that the transaction did not constitute
a sale of substantially all of Tyco’s assets which would violate the indenture and,
therefore, the trustee was obligated to execute the supplemental indentures required to
consummate the transaction.
•
In Wilmington Trust Company v. Tropicana Entertainment, LLC, ((Court of Chancery of
Delaware) Feb 29, 2008)29, the court rejected the argument made on behalf of the holders
by the trustee that Tropicana’s loss of its gaming license and the transfer of its rights to a
conservator constituted a transaction transferring substantially all its assets in violation of
the successor obligor provision of the indenture, but did constitute a prohibited Asset
Disposition.
Change of Control Provisions
•
In Law Debenture Trust Company of New York v. Petrohawk Energy Corp., et al. (Court
of Chancery of Delaware (decision issued August 1, 200730)), the indenture trustee for
$275 million 7 1/8% Senior Notes issued in 2004 by KCS Energy, acting at the direction
of a group of securityholders, alleged that a merger of KCS Energy and Petrohawk
Energy that was consummated in July 2006 triggered the change of control provision in
the indenture for the senior notes which obliged KCS to redeem the notes at 101% of
their face value. In an August 1, 2007 decision, the Delaware Chancery Court rejected
the trustee’s arguments, holding that with respect to the Majority Share provision the
indenture trustee and the securityholders had no standing to assert claims for the
companies’ failure to comply with a Certificate of Designation or federal securities
regulations because the complained of action was not taken under the indenture, and that
with respect to the Continuing Director provision the trustee’s arguments about the
technicalities of corporate law were unpersuasive and did not reflect a commercially
reasonable reading of the indenture.
29
2008 WL 5559161.
30
2007 WL 2248150 (Del. Ch.).
13
CHIC_3952905.6
•
In The Jean Coutu Group (PJC), Inc. v. Wells Fargo Bank,31 the issuer sought to compel
an unwilling trustee (over 79% of the securityholders had expressed to the company their
reservations regarding the proposed transaction) to execute a supplemental indenture
allowing a prospective purchaser to assume $850 million in notes as part of a sale
transaction with RiteAid, rather than requiring a change of control redemption; the
complaint also sought declaratory relief to rebuff securityholders who challenged the
transaction as constituting a change of control and as not constituting a sale of all or
substantially all assets. In March 2007 the company announced a settlement agreement
in which most holders agreed to sell their bonds back to the company for 7.9% over par,
and the company paid for some of the securityholders’ legal expenses.
Anti-Dilution Provisions
•
In Nash Finch Company v. Wells Fargo National Association ((MN St. Dist. Ct.) Dec 7,
2007)32. In September 2007, a group of fund investors sent a Notice of Default alleging
that the company violated the anti-dilution provisions of the indenture for the company’s
senior subordinated convertible notes due 2035 by failing to properly adjust the
conversion ratio for the Notes at the time the Company increased its regular quarterly
dividend from $0.135 per share to $0.18 per share in 2005. The company submitted to
the indenture trustee a supplemental indenture, which the company characterized as not
requiring consent by the holders, to clarify the anti-dilution provision and to make it
consistent with the offering memorandum for the notes. The indenture trustee then filed
a petition with the Minnesota state court seeking instruction regarding the supplemental
indenture. The company filed its own petition with the state court for an order construing
and interpreting the terms of the indenture. The court held against the investors’ position
finding that it would otherwise “afford an inequitable windfall where none was ever
intended.” The court instructed the trustee to endorse the supplemental indenture, and
“declare that Nash Finch has adjusted the Conversion Rate properly under the terms of
the Indenture; declare the Hedge Funds’ purported Notice of Default is invalid and
without effect; permanently enjoin and prohibit the Hedge Funds… from declaring an
Event of Default or seeking acceleration of the Notes on the basis of this dispute.”
No-Call/Make-Whole/Prepayment Provisions
•
In In re Calpine Corp. (district court opinion affirming bankruptcy court decision issued
January 9, 2007),33 the district court for the Southern District of New York upheld a
bankruptcy court order granting the Debtors’ motion to repay approximately $646.11
million in first lien notes, but which also “preserved all parties’ rights to litigate the
Trustee’s Make-Whole Premium Demand” in a separate adversary proceeding. Under
the terms of the indenture, redemption of the notes prior to October 1, 2009, required
payment of a Make-Whole Premium. While acknowledging that good business reasons
31
U.S. Dist. Ct. S.D.N.Y., Case No. 06-cv-14301-JGK.
32
MN St. Dist. Ct., Case No. 27-cv-07-19737.
33
356 B.R. 585 (S.D.N.Y.).
14
CHIC_3952905.6
supported the debtors’ repayment motion, the trustee objected to the bankruptcy court’s
order on the grounds that in failing to order the debtors to pay the Make-Whole Premium
or determining that the Make-Whole Premium was not due, the bankruptcy court
“violated the Noteholders’ contractual rights and impaired their claims outside of a
chapter 11 plan.” The trustee also argued that the issue for the court was not the debtors’
use of cash, but the treatment of the first lien securityholders’ claims. As of the date of
this writing, the trustee’s Make-Whole Premium demand remains pending in the
adversary proceeding; briefing on motions for summary judgment was completed at the
end of August. (First lien securityholders and second lien securityholders were active in
the Calpine case since before the company filed for bankruptcy, including, among other
things, notifying the collateral trustee in September 2005 of alleged violations of the
indenture’s restrictions on the use of proceeds from the sale of Designated Assets.)
B. THE TRUSTEE IN THE MIDDLE
Who can and should enforce both arguable and clear covenant breaches?
1. Defaults and Acceleration Under the Indenture
As mirrored in the ABA Model Simplified Indenture,34 corporate indentures
generally include the following provisions (appearing in more detail in Appendix A hereto) for
pursuing remedies with respect to Events of Default and enforcement of covenant provisions: the
trustee (who, upon default, is to act as a “prudent person”)35 by notice to the company, or the
securityholders of not less than 25% in principal amount of the securities by notice to the
company and the trustee, may accelerate the debt upon the occurrence and continuance of an
Event of Default defined in the indenture. Some defaults (such as non-payment of scheduled
principal or interest within the grace period or filing a bankruptcy) become Events of Default
automatically, while others (such as delayed S.E.C. filings and other covenant breaches) require
the giving by the trustee or holders of no less than 25% of the outstanding securities of a notice
of default and time to cure the default to the issuer. The indenture vests in the trustee the power
to pursue any other available remedies to collect payment of principal and interest on the
securities or to enforce the performance of any provision of the securities or the indenture, if an
Event of Default has occurred and is continuing. Nevertheless, the holders of a majority in
principal amount of the securities may direct the trustee as to the time, method and place of
conducting any proceeding for any remedy available to the trustee or in exercising any trust or
power conferred on the trustee. The trustee may refrain from following any direction that
conflicts with law or the indenture, is unduly prejudicial to the rights of other securityholders, or
would involve the trustee in liability or expense for which the trustee has not been satisfactorily
indemnified. Thus, there are several options, and there can be significant interplay between
34
The ABA Model Simplified Indenture was published in The Business Lawyer in 1983 (38 BUS. LAW. 741
(1983)). In 2000 the ABA published a proposed Revised Model Simplified Indenture (55 BUS. LAW. 1115 (2000)).
As of this date, the Revised Model Simplified Indenture has not found general acceptance. See footnotes 3 and 4
below for some of the more significant differences between the Model Simplified Indenture and the Revised Model
Simplified Indenture with respect to pursuing remedies under the indenture.
35
See section II hereof.
15
CHIC_3952905.6
trustees and securityholders as to who may or should declare a default or accelerate the principal
and interest of the securities. Twenty-five percent (25%) of the outstanding securityholders by
principal can do so; the trustee can do so, either unilaterally within its prudent-person discretion
or upon the direction (with appropriate indemnification) of the holders of a majority in principal
amount of the securities. As a practical matter, where available and where securityholders have
not acted in their own behalf, trustees often prefer to act with securityholder direction.
2. Remedial Lawsuits and the No-Action Clause.
While trustees clearly have the right to bring any indenture covenant enforcement
action, often securityholders wish to bring such lawsuits on their own behalf or on a more
aggressive timetable or based on perhaps a more aggressive reading of the indenture or situation
than the trustee is prepared to pursue. However, while not always appreciated by
securityholders, the right of securityholders to bring such suits may be contractually limited or
conditioned by the so-called No-Action Clause found in most indentures. The indenture’s
Limitation on Suits or No-Action Clause generally prohibits a securityholder from pursuing any
remedy under the indenture unless:
1. the holder gives notice to the trustee of a continuing Event of Default,
2. the holders of not less than 25% in principal amount of the securities make a written request
to the trustee to pursue the remedy,
3. such securityholder or securityholders offer to the trustee indemnity satisfactory to the trustee
against any loss, liability or expense,
4. the trustee does not comply with the request within 60 days after receipt of the request and
the offer of indemnity, and
5. during such 60-day period the holders of a majority in principal amount of the securities do
not give the trustee a direction inconsistent with the request.36
Indentures generally provide that no securityholder, however, may use the
indenture to prejudice the rights of another securityholder or to obtain a priority or preference
over another securityholder. Finally, the indenture generally identifies certain actions or rights
which are exempted from the operation of the no-action clause and which cannot be impaired or
affected without the consent of the securityholder, including (1) the right of a securityholder to
receive or to bring suit for enforcement of payment of any amount of principal or interest owed
such securityholder after such amount shall have become due, and (2) the right of any
securityholder to bring suit for the enforcement of the right to convert the security.37 Thus, while
36
The ABA Revised Model Simplified Indenture proposed shortening the period in which the trustee must
respond to a request for action by the securityholders to 15-30 days, while also permitting the trustee to deliver a
notice to the securityholders affirmatively declaring that the trustee will not comply with the securityholders’
request. The ABA Revised Model Simplified Indenture also deletes the provision requiring that the securityholders
offer indemnity to the trustee.
37
The commentary on the Revised Model Simplified Indenture also makes clear that the no-action clause
applies only to suits to enforce contract rights under the indenture, not to actions asserting rights arising under other
laws, including federal and state securities laws.
16
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securityholders may undertake suits to enforce payment of their scheduled amounts under
indentures, they are generally prohibited from undertaking suits that seek injunctive or payment
remedies on behalf of all the securityholders without first complying with the indenture’s noaction provision.
On the other hand, it is also generally accepted that trustees who do not wish to
bring an action in their own capacity or do not wish to impede a securityholder action can
accelerate and waive the requirements of indenture no-action clauses to allow securityholders to
proceed more directly and expeditiously in pursuing remedies.
Thus, activist fund investors, eager to stop transactions which they believe may
violate indenture covenants to their detriment (e.g., unfavorable new debt/lien issuances,
restructurings, mergers or sales) or to seize upon covenant violations as an opportunity to
increase yields, etc., may be well advised to—but often do not—first consider the no-action
clauses of the indentures for their securities and, if applicable, either bring suit with the trustee or
secure the trustee’s dispensation that it will not bring the suit, so the securityholder may. If the
no-action clause arguably applies, but has not been so addressed, the issuer company or even
another third party can attempt to delay and/or bring into question the validity of the
securityholder action based on non-compliance with the no-action clause. There is also a split of
authority whether the no-action clause limits the right of securityholders to be petitioning
creditors in an involuntary bankruptcy filing. See Grey v. Federated Group, 107 F.3d 730 (9th
Cir. 1997) (no-action clause controls securityholder petitioning creditor rights. Cf. Envirodyne
Indus. Inc., 174 B.R. 986, 997 (N.D. Ill. 1994) (holding that securityholders could be petitioning
creditors regardless of no-action clause).
Legal and Philosophical Underpinnings of the No-Action Clause. Courts have
recognized that no-action clauses are intended, among other things, (i) to ensure not only that
remedial actions undertaken to address defaults or covenant violations have sufficient support
from (and are not prejudicial to) the securityholders, but that the actions are undertaken on behalf
of and for the benefit of the entire class of securityholders, (ii) to allow the trustee to assess the
prudence and justifiability of the remedial action suggested, and (iii) to protect the issuer
company from being subjected to frivolous, abusive or otherwise inappropriate actions by a
single or several securityholders who may have a diversity of agendas in addition to those of the
other securityholders.38
38
The application of indenture no-action clauses may be further complicated and implicated in situations
where it is arguable whether a strict default requiring remedial action has even occurred. For example, in Ore Hill
Hub Fund Ltd., et al. v. Primus Telecommunications Group, Incorporated, et al. case (Case No. 07-cv-0647) (U.S.
Dist. Ct. S.D.N.Y.) securityholders of debt issued by the holding company sought to enjoin allegedly insolvent
holding company from transferring assets to allegedly insolvent parent for the purpose of allowing parent to make
scheduled debt payment on notes due February 15, 2007, for which holding company had no obligation, or,
alternatively, if the assets had already been transferred, to have such transfer set aside as a fraudulent transfer or
illegal dividend. The court denied the securityholders’ request for an injunction, and on February 15, 2007, the
$22.7 million outstanding principal amount of convertible subordinated debentures of the parent company was paid
17
CHIC_3952905.6
In light of these goals, both federal and state courts have generally construed noaction clauses strictly, but with a view to protecting bondholder interests.39 Some courts have
noted that the strict construction of no-action clauses is appropriate both because such clauses
represent restrictions on creditors’ common law rights and because a broad construction of noaction clauses that limited suits upon interest obligations would tend to undermine the
negotiability of corporate securities.40 The clause has also been strictly construed against
securityholders.41 In any event, the strictures of the no-action clause apply only to suits brought
to enforce contractual rights under the indenture or the securities, not to suits asserting rights
arising under other laws such as the federal securities laws.42 As the recent cases described
below illustrate, however, no-actions clauses, if addressed by securityholders and trustees, do not
need to be insurmountable barriers, including particularly for those securityholders seeking to
vindicate minority rights or to redress discriminatory exchange offers.
Recent No-Action Clause Cases.
Perhaps indicative of the spate of recent cases asserting indenture covenant
breaches, there are an increasing number of recent cases interpreting and applying no-action
clauses. Some, in invalidating securityholder actions, can be read as strictly requiring
compliance with the no-action clause. Certain other cases show the flexibility of courts in
finding no-action clauses either inapplicable or not dispositive in the particular situation, such as
where the securityholder is only trying to enforce its interest in payment or where the clause
would be impractical in operation. Each of these cases, however, evidences the delay and
confusion which can be imposed on a case if the no-action clause is ignored or not complied with
in cases where it is arguably operative.
•
Peak Partners, LP v. Republic Bank.43 In this 2006 case the Third Circuit Court of
Appeals held that the claims of an investor (who held only 1.4% of the issuance) for
negligence against a servicer, whose alleged erroneous monthly servicer certificates
failed to adequately reflect monthly servicing fees in the amount of approximately
39
For example, the absolute and unconditional right of a securityholder to sue for payment of
principal and interest when the same come due, which is one of the exceptions to the no-action clause required under
TIA Section 316(b), has been interpreted broadly against issuers to permit such suits even where the payment of
interest appeared to be contingent or conditional (Watts v. Missouri-Kansas-Texas R.R. Co., 383 F.2d 571 (5th Cir.
1967)) and where payments of principal and interest may have been contractually subordinated (UPIC & Co. v.
Kinder-Care Learning Ctrs., Inc., 793 F. Supp. 448, 455 (S.D.N.Y. 1992)). The courts in some of the earlier
decisions interpreting no-action clauses emphasized that actions to collect overdue principal and interest were
properly understood as actions under the notes or securities themselves rather than remedies under the indenture (see
UPIC & Co. v. Kinder-Care Learning Ctrs., Inc., 793 F. Supp. 448, 455 (S.D.N.Y. 1992); Watts v. MissouriKansas-Texas R.R. Co., 383 F.2d 571, 575 (5th Cir. 1967)).
40
Id. at 575, 578.
41
See Cruden v. Bank of New York, 957 F.2d 961 (2d Cir. 1992).
42
See McMahan & Co. v. Wherehouse Entertainment, Inc., 65 F.3d 1044 (2d Cir. 1995). See 55 BUSINESS
LAWYER 1115, 1190 (2000) Commentary on Revised Model Simplified Indenture § 6.03(2) (trustee generally not
authorized under indenture and pursuant to conflict rules to pursue securities fraud actions.)
43
2006 WL 2243040 (3rd Cir. 2006).
18
CHIC_3952905.6
$500,000, leading in turn to the indenture trustee making some $10 million of
overpayments of principal on certain mortgage-backed securities over the course of
nineteen (19) months, were barred by non-compliance with the indenture’s no-action
clause. The appeals court further held that the indenture’s no-action clause applied
equally to claims against issuer and non-issuer defendants.
•
ORIX Capital Markets v. GMAC Commercial Mortgage Corp.44 The California Court of
Appeals for the Second District held that an investor’s suit for breach of contract,
including the covenant of good faith and fair dealing, against the servicer was barred by
(i) not only the terms of an indenture no-action clause, but (ii) the terms of a loan pool
pooling and servicing agreement even though the pooling and servicing agreement did
not contain an explicit no-action clause.45 The appellate court found that ORIX, which
had purchased $20 million of certificates, was an intended third-party beneficiary also of
the loan pool pooling and servicing agreement. The court found that while the loan pool
pooling and servicing agreement “prescribe[d] a more limited number of covenants
inuring to the benefit of the investors,” the indenture, all of whose rights “inured to the
benefit of the investors,”46 contained an explicit and applicable no-action clause limiting
the investors’ rights to initiate suits. The court cited Feldbaum v. McCrory47:
‘The primary purpose of a no-action clause is . . . to protect issuers
from the expense involved in defending lawsuits that are either
frivolous or otherwise not in the economic interest of the
corporation and its creditors. In protecting the issuer such clauses
protect bondholders. They protect against the exercise of poor
judgment by a single bondholder or a small group of bondholders,
who might otherwise bring a suit against the issuer that most
bondholders would consider not to be in their collective economic
interest.’
44
2007 WL 137677 (Cal.App. 2 Dist. 2007).
45
The complex asset-backed securities transaction included, inter alia, (i) an owner trust agreement,
pursuant to which commercial lender Enterprise Mortgage Acceptance Company, LLC sold a pool of loans to a trust
formed for the purpose of acquiring the loan pool, (ii) a loan pool pooling and servicing agreement, pursuant to
which the owner trust transferred the pooled loans to a loan pool grantor trust in exchange for one class A loan pool
certificate representing all the beneficial ownership interests in the pooled loans, and one class X loan pool
certificate representing a specified portion of the interest payments on the loans, (iii) an indenture agreement,
pursuant to which the owner trust issued six classes of collateralized notes and transferred the class A loan pool
certificate, along with the right to receive distributions owed on it, to an indenture trustee, as collateral for the notes,
and (iv) a note pool pooling and servicing agreement, pursuant to which the notes were transferred to the trustee of a
note pool grantor trust and the trustee under the note grantor trust issued note pool certificates corresponding to each
class of notes. ORIX purchased note pool certificates in the secondary market.
46
The indenture stated “WHEREAS, all covenants and agreements made by the Issuer herein are for the
benefit and security of the Holders and the Indenture Trustee and their respective successors and assigns[.]”
47
(Del.Ch. June 2, 1992, Civ. A. Nos. 11866, 11920, 12006) 1992 WL 119095.
19
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Three other recent cases, however, have found that, where applicable, no-action
clauses are important and to be strictly applied, but are not necessarily insurmountable barriers to
suits by securityholders, depending upon the particular facts.
•
Great Plains Trust Company v. Union Pacific Railroad Company.48 The Eighth Circuit
Court of Appeals held in 2007 that a no-action clause did not trump the separate
indenture provision which gave to securityholders an absolute right to sue for overdue
payment of interest owed them individually on their bonds. In so doing, the appeals court
overturned the district court’s ruling that the indenture provision implementing Section
316(b) of the Trust Indenture Act, prohibiting certain purported restrictions on the rights
of securityholders, including the right to institute suit for enforcement of payment of any
unpaid amount of principal or interest, applied only when the principal amount of the
debentures was due.
•
Whitebox Convertible Arbitrage Partners, L.P. v. World Airways, Inc.49 The United
States District Court for the Northern District of Georgia, in ruling on a motion for
summary judgment (in 2006), held that an indenture’s no-action clause did not bar a suit
by two investors alleging that the issuer, following an unsuccessful exchange offer, was
attempting to conduct a preferential exchange offer with one set of securityholders
holding 50% of the subject securities and a wrongful redemption with the other
securityholders, thereby breaching the covenant of good faith and fair dealing.50 The
district court, while holding that no-action clauses are to be strictly construed, found that
they are not uniformly applicable in wrongful redemption/exchange offer suits. In
particular, the Court found that the issuer’s own actions made compliance with the noaction provision impossible and/or impractical by its attempt to consummate the
redemption in 29-days time, so that the indenture would be already discharged before the
expiration of the 60-day waiting period for a trustee response that the no-action clause
otherwise imposed on investors before commencing suit.
•
Cypress Associates, LLC v Sunnyside Cogeneration Associates Project.51 The Delaware
Court of Chancery held in 2006 that a no-action clause did not prohibit a suit by the
48
2007 WL 1855643 (C.A.8 (Mo.)) (8th Cir. 2007).
49
2006 WL 358270 (N.D.Ga. 2006).
50
While conducting a public exchange offer for its convertible senior subordinated debentures in 2003,
which required that 95% of existing securityholders tender their bonds in order for the offer to become effective, the
issuer simultaneously negotiated with a select group of holders of the convertible senior subordinated debentures to
consummate a private exchange offer. After the issuer announced the expiration of the public exchange offer
because an insufficient number of securityholders had tendered their bonds, the issuer then announced that it had
agreed to exchange $25,545,000 of convertible senior subordinated debentures held by the group of select
securityholders and that it would redeem the remaining debentures for cash. The plaintiff/investors claimed that
they were unilaterally and wrongfully designated for the redemption rather than the private exchange offer in
violation of the indenture provision that required that with respect to any partial redemption the securities to be
redeemed were to be selected by the trustee “by lot or pro rata or by such other method as the Trustee shall deem fair
and appropriate.”
51
2006 WL 668441 (Del.Ch. 2006).
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securityholder of some 74% of certain Series B revenue bonds seeking to prevent the
borrower under the indenture from entering into an amendment to a power purchase
agreement capping the price at which the borrower could sell its power, thereby
potentially diminishing or even eliminating annual payments on the Series B bonds,
which payments derived largely from any upside profits from the borrower’s sale of
power. Because Cypress was seeking “to vindicate its minority rights” rather than
advancing a claim that would “inure to [the benefit of] all Bondholders,” the court
concluded that it would be futile for Cypress to proceed under the no-action clause.
Given the fact that a majority of securityholders under all revenue bonds —although not
the 80% required under the indenture to amend any facility document—had given their
assent to the amendment, “it would be futile to expect that Cypress would attain the
support of a majority of the Bondholders . . . to press a claim that the Amendment was
not validly adopted.”52
*
*
*
*
*
*
*
*
Conclusion. As both issuers and more aggressive investors take a closer look at
indenture covenants in relation to situations to further or protect their own economic interests,
indenture trustees and their counsel, along with securityholders and their counsel, need to pay
particular attention to the terms of the indentures under which they act and to pay special
attention to and accommodate the limitations placed upon suits by securityholders. Otherwise,
non-compliance with No-Action Clauses can delay or block the ability of securityholders to
forestall unfavorable corporate transactions or expeditiously enforce remedial actions or
covenant defaults.
IV. RECENT CHALLENGES TO DISCRIMINATORY CONSENT SOLICITATIONS
AND EXCHANGE OFFERS -- KEEPING A LEVEL PLAYING FIELD.
Reflecting the recent trend of more aggressive reading, enforcement, and
(sometimes) manipulation of indentures,53 issuers and majority bondholders have increasingly
attempted to push the envelope, structuring consent solicitations and exchange offers to
maximize the value of those solicitations or offers to themselves—often to the seeming detriment
of minority or excluded bondholders—while still claiming to comply with their indentures. The
question increasingly arises whether these creative consent solicitations and exchange offers are
fair to minority/excluded bondholders, whether they comply with the underlying indentures or
applicable law, and what is the proper role of the indenture trustee.
52
The court further stated:
‘. . . [B]ondholders will be excused from compliance with a no-action provision where they allege specific
facts which if true establish that the trustee itself has breached its duty under the indenture or is incapable of
disinterestedly performing that duty.’
Id. at p. 7, quoting Feldbaum v. McCrory Corp., et al., 1992 WL 119095 (Del.Ch. June 2, 1992).
53
See “Aggressive Enforcement of Indenture Covenants: The No-Action Clause in an Activist World,”
ABA Trust & Investments, November/December 2007, and “Reading Indentures Strictly: The Rise of Delayed SEC
Filing Defaults and Aggressive Bondholders,” ABA Trust & Investments, January/February 2007.
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Such new and more aggressive consent solicitations and exchange offers can put
indenture trustees—who are generally also asked to execute supplemental indentures—in the
uncomfortable position of determining whether the transaction strictly complies with the
indenture at a time when the trustees face complaints from excluded minority bondholders who
feel unfairly disadvantaged by such consent solicitations or exchange offers. This dilemma is
exacerbated to the extent the trustee is at the same time being (i) directed by a majority of
holders to go forward, and (ii) assured by the issuer that the consent solicitation or exchange
offer complies with (or at least does not violate) the indenture and applicable law, and that,
therefore, the trustee has little or no option but to accept and implement the transaction and any
supplemental indentures. These transactions may raise for trustees, in the most fundamental
terms, the age-old question: Whom do trustees represent at any time -- the issuer, the majority
bondholders, or the minority bondholders (who may not even be at the table)?
This section will review some recent consent solicitations and exchange offers
that faced opposition from excluded bondholders on the grounds that they were unfairly or
unlawfully discriminatory, as well as basic structures and the relevant indenture provisions that
are typically at issue in such consent solicitations or exchange offers. The section will also
discuss the role of the indenture trustee in reviewing these consent solicitations and exchange
offers, pitfalls that indenture trustees should be aware of, and strategies for protecting
bondholder interests and indenture trustees in these situations.
A. SOLICITATION STRUCTURES AND RELEVANT MODEL INDENTURE
PROVISIONS
Through consent solicitations issuers typically seek majority bondholder approval
for amendments to the indenture or related transaction documents or waivers of certain defaults
or potential defaults. Such consents are usually secured with fees or other consideration going to
the consenting holders. Through exchange offers issuers typically seek to have bondholders
tender or exchange their bonds for new bonds or other consideration. These exchange offers may
be tied to obtaining consents from the tendering holders (i.e., those holders getting out of the
bonds) holding a majority in outstanding principal amount of the bonds to amend the indenture
for the bonds they are trading out of to, among other things, limit the covenants, allow for
structural subordination of the bonds to the new more senior debt, or waive actual or possible
defaults available to the remaining nontendering holders. While these so-called “exit consents”
may seem unfair to remaining minority holders, they have been found nonviolative of standard
indenture provisions and acceptable under Delaware law going back as far as 1986 in Katz v.
Oak Industries Inc.54 The relevant provisions of the ABA Revised Model Simplified Indenture,
including provisions relating to amendments to the indenture, direction of the trustee by a
majority of the holders, and the requirements of an officer’s certificate and opinion of counsel in
order to undertake any action under the indenture are included in Appendix B..
B. THE EXCLUSIVELY NEGOTIATED EXCHANGE OFFER
54
The plaintiff/investors also argued that the company breached its contractual duty of good faith and fair
dealing by manipulating the process by which certain debentureholders were chosen to participate in the private
exchange offer.
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A privately negotiated exchange offer not available to all holders can place
indenture trustees in a particular quandary between an issuer and its bondholders. Such exchange
offers (often accompanied by consent solicitations), which have become increasingly prevalent
as funds have acquired, either individually or jointly, majority positions in bonds, are not open to
the entire bondholder group, but instead are offered only to select or designated bondholders
whose consent and tender are needed. When an issuer extends such a preferential offer to some
bondholders over other bondholders (and thus presumably attempts to pay less for the consents
or exchanges than if all holders were offered the same deal), the excluded bondholders may
object and even seek to challenge the exchange offer as unfairly discriminatory. While the first
analytical step is to see whether the exclusive offer or solicitation strictly complies with the
indenture, excluded bondholders have increasingly also challenged discriminatory solicitations
as violating good-faith and fair-dealing requirements that they claim are implicit in the
indentures.
Case Study #1—World Airways
One month after announcing the expiration of an unsuccessful 2003 public
exchange offer because an insufficient number of holders had tendered their debentures, World
Airways announced that it had agreed to exchange $22,545,000 of 2004 convertible debentures
held by a group of select holders, while it would redeem the remaining 2004 convertible
debentures for cash (which redemption occurred on December 30, 2003). Only the select holders
received the company’s new convertible debentures due 2009 (representing a five-year extension
of the favorable 8 percent interest rate and a lower conversion price). In a lawsuit commenced in
May 2004, certain excluded investors in the 2004 convertible debentures claimed that they were
unilaterally and wrongfully designated for the redemption rather than the private exchange offer
in violation of, not only the duty of good faith and fair dealing, but also the indenture provision
(section 11.04) that required that with respect to any partial redemption the securities to be
redeemed were to be selected by the trustee “by lot or pro rata or by such other method as the
Trustee shall deem fair and appropriate.”55
In a decision issued in February 2006 denying the company’s motion for
summary judgment, the United States District Court for the Northern District of Georgia wrote
the following:
It appears that World Airways provided a special incentive to
certain bondholders in an effort to obtain their approval of a bond
exchange while not making the same offer to other bondholders.
… The fact that all bonds were redeemed immediately after the
Private Exchange was effected is meaningless once it is understood
that this full redemption took place after another, partial
redemption occurred. It is such manipulation that section 1104 [of
55
The plaintiff/investors also argued that the company breached its contractual duty of good faith and fair
dealing by manipulating the process by which certain debentureholders were chosen to participate in the private
exchange offer.
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the indenture] and the principles of good faith and fair dealing are
designed to avoid.56
The district court rejected the company’s contention that the private exchange
offer and the December 30 redemption could be considered in isolation from each other. The fact
that the company redeemed all the convertible debentures outstanding as of December 30, 2003,
i.e., those debentures outstanding after the private exchange offer had been effected, did not
change the fact that the company had engaged in disparate treatment of debentureholders in
violation of (1) the indenture provision requiring that securities called for redemption be selected
by lot or pro rata or by such other method as the trustee deems fair and appropriate and (2) the
principle of good faith and fair dealing. In August 2006, just before the case was scheduled to go
to trial, the parties reached a settlement, which included a full release of the company and
consideration of $400,000 cash paid to the plaintiff investors.
Case Study #257
In another situation in which the authors were involved, an issuer approached
several large holders (who constituted a majority of its unsecured bond issue) in an attempt to
reach an agreement whereby those holders, and those holders only, would exchange their bonds
for new bonds. The new bonds were to be second-lien bonds, which would give those chosen
holders a security interest in substantially all of the assets of the issuer, leaving substantially
impaired minority bondholders who were not allowed to participate. In addition, the deal
contemplated that the exchanging majority bondholders would execute exit consents to amend
the indenture governing the unsecured bonds to strip from the indenture most of the covenants
that would have protected the remaining minority bondholders. The exchange offer contemplated
that the indenture trustee and the issuer would execute a supplemental indenture to reflect the
stripping of the covenants from the indenture.
Finally, the exchange offer permitted all of the holders of the unsecured bonds of
the issuer’s parent company, which was a holding company, to also participate in the exchange
offer. Thus, the holders of the parent company’s bonds, which were structurally subordinated to
the issuer’s bonds, were to be able to leapfrog the minority holders of the issuer’s notes and gain
a secured priority position over them. The result was that the holders of the issuer’s notes that
were not permitted to participate in the exchange offer would have approximately $100 million
of new secured, second-lien notes placed ahead of them in the capital structure. Among other
things, this would likely reduce the value and rating of the bonds. At least one excluded
bondholder objected to the exchange offer on the grounds, among others, that it violated the
covenant of good faith and fair dealing implicit in every contract under New York law (the
indenture was governed by New York law). The bondholder further argued that the proposed
transaction would violate the section of the indenture that states that a holder may not use the
56
Whitebox Convertible Arbitrage Partners, L.P. v. World Airways, Inc., 2006 WL 358270 (N.D. Ga.
2006) at *3.
57
The names of the parties involved in this case study have been withheld.
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indenture to prejudice the rights of another holder or to obtain preference or priority over another
holder.
While this situation was ultimately resolved to the satisfaction of the issuer and
the objecting bondholder, the indenture trustee was again put in the middle, at least for a time.
The trustee was being asked by the issuer to sign a supplemental indenture based on exit
consents that the objecting bondholder essentially argued were obtained in violation of the duty
of good faith and fair dealing.
C. THE INDENTURE TRUSTEE’S ROLE, POTENTIAL DILEMMAS, AND
BEST PRACTICES
Most consent solicitations and exchange offers seem fairly uncontentious from an
indenture trustee’s perspective. The solicitation or offer is generally made to all holders and
either the requisite amount or percentage of bondholders consent or exchange, or they do not. If
they do not, the consent solicitation and exchange offer are unsuccessful, and the bond deal is
left generally unaffected. If they do consent, the indenture trustee’s role, if any, can be somewhat
ministerial, such as effecting a cancellation of tendered bonds or executing a noncontroversial or
consensual amendment to the indenture. But as the cases above demonstrate, this is not always
true. Creative issuers and their advisors can devise ways to minimize the cost or maximize the
value of a consent solicitation or exchange offer to the issuer by limiting its availability to the
bare minimum number of acceptances it needs to get its desired result. While such creativity is
not in and of itself always problematic, it can become an issue when it leads to disparate
treatment of bondholders. In these situations, a diligent indenture trustee will want to first
consider the role it should play in these consent solicitations and exchange offers and then
perform consistent with its duties under the indenture to protect itself and its bondholders.
2. Indenture Trustee’s Role
The first question an indenture trustee should ask itself in these situations is what
role it should play, if any. Is it a situation where the indenture trustee should bow to the will of
the majority either because there is no basis to object under the indenture or the transaction is fair
to holders generally? Or is it a situation where excluded minority holders are materially
disadvantaged and seem to need protection, particularly because they are not aware of the
proposed consent solicitation or exchange offer and its effect upon them, or because they are not
in a position to challenge it?
It is axiomatic that the indenture trustee’s duty is to enforce the terms of the
indenture. If the indenture explicitly prohibits the proposed action (or imposes pre-conditions or
documentary requirements such as certificates and opinions not adequately provided to the
trustee), then the indenture trustee’s role would seem to be relatively clear. But what if the
indenture does not contain a provision that explicitly or unambiguously forbids the proposed
transaction? If the indenture trustee comes to the conclusion that there is nothing it can or should
do to try to stop (or seek judicial approval for) the consent solicitation or exchange offer, it
should at the very least still consider sending a notice to all of the bondholders informing them of
the proposed transaction and its potential impact, any of their rights under the indenture, and
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referring them to sources (such as SEC filings) where they can find the terms of the proposed
transaction.
On the other hand, if the indenture trustee comes to the conclusion that the issuer
has not performed all the required steps under the indenture or it has not received requisite
consents or direction, or the proposed transaction violates the indenture in letter or spirit the
trustee will be called upon to insist on compliance. For example, some of the recent situations
have focused on the fact that many indentures, and the Revised Model Simplified Indenture,
contain provisions that arguably address discriminatory treatment of bondholders. The relevant
Revised Model Simplified Indenture provision states, “A Securityholder may not use this
Indenture to prejudice the rights of another Securityholder or to obtain a preference or priority
over another Securityholder [58 Bus. Law. 1115, 1138 (2000)].
While there is little or no reported case law interpreting it, this provision arguably
speaks to, and may be read to prohibit, certain actions by bondholders (not issuers or borrowers)
prejudicial to the interests of other bondholders.
3. Indenture Trustee Protective Measures and Best Practices
There are several tools at an indenture trustee’s disposal that can help it manage
situations such as those discussed above. Each situation is different, and different tools and
considerations should come into play in different situations. Some of those tools and
considerations are as follows:
Officers’ Certificate/Opinion of Counsel: Generally speaking, any
time an issuer asks an indenture trustee to take an action (for
example, executing a supplemental indenture), the indenture
trustee can insist that it be provided with an officers’ certificate
and an opinion of counsel. Those documents usually provide,
among other things, that the action to be taken by the indenture
trustee is authorized and permitted by the indenture. In many cases,
that is sufficient. But where the action to be taken by the indenture
trustee is questionable or is being challenged by a bondholder as
discriminatory or unfair, the indenture trustee can and should insist
that the officers’ certificate and, particularly, the opinion of
counsel, state not only that the action requested by the indenture
trustee does not violate the indenture or applicable law, but also
that the officers’ certificate and opinion of counsel specifically
state or opine that the alleged discrimination is not a bar, under the
indenture or applicable law, to the indenture trustee taking the
requested action. While the indenture trustee may experience
resistance to this suggestion from an issuer and its counsel, such
resistance can in and of itself tell the indenture trustee how
confident the issuer (and its counsel) is about its position.
Declaratory Judgment Action Commenced by Indenture Trustee:
Another option for an indenture trustee faced with a dispute
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between a bondholder and an issuer over the propriety of a consent
solicitation or exchange offer is to commence (or allow excluded
holders to commence) a declaratory judgment action in an
appropriate court. Such an action seeks a declaration concerning
the validity of the consent solicitation or exchange offer under the
indenture and applicable law. The court’s decision should give
guidance and protection to the indenture trustee and the indenture
trustee can be relatively certain that it will not incur liability to any
party by following the court’s directive. Of course, there are
possible downsides to instituting a declaratory judgment action.
For example, such an action could be expensive and timeconsuming and the issuer would be likely to put significant
pressure on the indenture trustee not to commence such a
proceeding, particularly if it delayed the proposed solicitation or
offer. But it is certainly a viable option for an indenture trustee put
in the middle of a colorable dispute between an issuer and one or
more of its bondholders.
Bondholder-Initiated Actions: Another litigation option is to
permit the complaining bondholder to institute its own action
against the issuer. While most indentures contain a “no-action
clause”58 that sets forth a series of steps a bondholder must take
before instituting its own action under an indenture against the
issuer (such as 25 percent in principal amount of the holders
requesting that the indenture trustee take the action and offering
the indenture trustee reasonable indemnity, the passage of 30 or 60
days, etc.), our experience has been that such issues that may be
viewed as a bar to a bondholder instituting its own action can
generally be resolved to the satisfaction of the holder and the
indenture trustee. For example, the trustee can agree earlier than 30
or 60 days that it will not commence the proposed action, so the
holder may, if it desires. The effect of a holder instituting an action
is much the same as if the indenture trustee had instituted the
action. In particular, it should give the indenture trustee significant
comfort that any action it takes in reliance on the court’s ruling
cannot be the basis for liability to the indenture trustee.
Early Notices and Other Communication with Issuer and
Bondholders: Perhaps the most important aspect of dealing with
situations such as those discussed above is early communication
among the parties and through notices to bondholders.
Communication with the issuer and bondholders—the earlier and
more often, the better—can sometimes lead to a resolution that is
58
See “Reading Indentures Strictly: The Rise of Delayed SEC Filing Defaults and Aggressive
Bondholders,” ABA Trust & Investments, January/February 2007.
27
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acceptable to all involved and at least trustee notices to
bondholders about the transaction and its implications minimize
the ability by any holder who received notice but did not object to
complain later. Conversely, a lack of communication can lead to
more conflict and expense.
*
*
*
*
*
*
*
*
Conclusion. Recently, issuers and holders seem to have become more creative and
aggressive in structuring consent solicitations and exchange offers so as to maximize the value to
the issuer or to majority holders, while leaving impaired or compromised minority holders.
While this may not per se be prohibited, it may become objectionable to minority holders if the
consent solicitation or exchange offer materially discriminates against them. This can put the
indenture trustee in the uncomfortable position of one party (the issuer or the majority holders)
insisting that the consent solicitation or exchange offer is perfectly legitimate and not violative of
the indenture or applicable law, and thus must go forward, and the other party (the minority
holders) insisting, perhaps with equal fervor, that the consent solicitation or exchange offer is
unfair and violative of their rights under the indenture and applicable law. While the indenture
trustee has little or no control over whether such an adversarial situation arises, it does have
independent duties under the indenture and some tools at its disposal (like those previously
mentioned) to effectively manage the situation, insist on indenture compliance, and minimize
any risk it may have.
V. LEAPFROGGING EXCHANGE OFFERS – CATAPULTING ONE TRANCHE OF
DEBT OVER ANOTHER
In an even more recent trend, several issuers have announced plans to buy peace
with dissident bondholders, avoid immediate defaults, or improve their balance sheets through
debt reduction by structuring debt exchanges that allow certain classes of existing bondholders to
leapfrog in priority over other classes.
Challenges have been mounted by potentially injured debt holders and trustees,
involving numerous claims, such as that the proposed leapfrogging breaches indenture
covenants, violates the implied duty of good faith and fair dealing, or constitutes a fraudulent
conveyance. An additional problem that indenture trustees may face is the possibility that the
class of bonds for which they are trustees is offered such a preferred leapfrogging exchange
offer, but not all of its bondholders tender, leaving the non-tendering bondholders arguably
prejudiced and the trustee with a much smaller and disadvantaged class of remaining
bondholders.
The following two cases are demonstrative of some of the issues or structures
faced in leapfrogging transactions:
Realogy -- A Recent Test Case Rejecting Leapfrogging
On November 13, 2008, Realogy Corporation, a provider of real estate and
relocation services, including such well-known brands as Century 21 and Coldwell Banker,
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announced the terms and conditions of a proposed debt refinancing in which it would convert
$1.1 billion in unsecured notes into $500 million in secured loans. The company invited eligible
holders of its three existing unsecured note issues to participate as lenders in new $500 million
second lien incremental term loans, which would be created under an accordion feature of its
existing credit agreement, which was secured by a second lien on substantially all of Realogy’s
assets.
The 12.375% Senior Subordinated Notes due 2015 (issued in the original
principal amount of $875 million) and which were contractually subordinated to the 10.50%
Senior Notes due 2015 (issued in the original principal amount of $1.7 billion) and the
11.00%/11.75% Senior Toggle Notes due 2014 (issued in the original principal amount of $582
million) were given the first opportunity to participate in the exchange, followed by the Senior
Noteholders, then, lastly, the Senior Toggle Noteholders. (The implicit principal value exchange
rate was approximately 36 cents on the dollar for the Senior Subordinated Notes, 50 cents on the
dollar for the Senior Notes and 47 cents on the dollar for the Senior Toggle Notes). Because the
exchange offer which would give exchanging Noteholders a secured position over non-tendering
notes was limited to a specific dollar amount -- $500 million in new secured loans -- it appeared
likely that the exchange offer would be fully subscribed before any Senior Toggle Noteholders
were entitled to exchange their Senior Toggle Notes. The offer was set to expire on December
11, 2008 (later extended to December 19, 2008).
On November 24, counsel for a majority of the Senior Toggle Noteholders sent
Realogy a letter demanding that Realogy terminate the exchange offer. The Noteholders alleged
in part that the proposed exchanges “are bad faith attempts to circumvent the Credit Agreement
and the Indentures, in particular the Senior Toggle Note Indenture… [and] do not provide the
company with fair value and constitute fraudulent conveyances.”59 The following day, Realogy
filed a statement with the Securities and Exchange Commission that rejected the charges
contained in the letter and affirmed the company’s commitment to complete the exchange offer.
On November 26, The Bank of New York Mellon, in its capacity as Indenture
Trustee for the Senior Toggle Notes, and High River Limited Partnership, a Senior Toggle
Noteholder, filed a complaint in Chancery Court of the State of Delaware. In the complaint, the
Trustee sought a declaratory judgment that consummation of the transaction without the granting
of liens to the Senior Toggle Notes would constitute a breach of the Senior Toggle Note
Indenture, and, in particular Section 4.12 of the Indenture, which in general terms restricts
Realogy’s right to grant additional liens on its property unless Realogy grants the Senior Toggle
Noteholders’ liens that are “equal and ratable” to liens on pari passu debt such as the Senior
Notes and senior liens ahead of liens granted to subordinated debt such as the Senior
Subordinated Notes. Realogy argued in response that Section 4.12 does not apply to “Permitted
Liens”, which includes liens granted under Realogy’s credit agreement, and that the liens being
granted to the Senior Subordinated Noteholders and Senior Noteholders in the exchange were, in
59
Realogy Corp., Current Report (Form 8-K) (Nov. 25, 2008).
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fact, “Permitted Liens” and, therefore, permitted under the Senior Toggle Notes indenture. Both
parties moved for summary judgment.60
In a decision dated December 18, 2008, the court observed that all of the
Trustee’s arguments boiled down to variants of the same proposition: that the proposed exchange
transaction violated Realogy’s Credit Agreement and, therefore, the liens to be granted to the
Senior Subordinated Noteholders were not “Permitted Liens” under the Indenture. The court
first noted that, under the Senior Toggle Notes indenture, to the extent that liens are created in
favor of indebtedness that is pari passu with the Senior Toggle Notes, the Senior Toggle Notes
must be granted equal and ratable liens. Further, to the extent that liens are created in favor of
indebtedness that is subordinated to the Senior Toggle Notes, the Senior Toggle Notes must be
granted liens senior to the liens supporting the subordinated indebtedness. Neither of those
restrictions would apply, however, if the new liens qualify as “Permitted Liens” under the Senior
Toggle Notes indenture. The definition of “Permitted Liens” under that indenture includes liens
created pursuant to the Credit Agreement.
The dispute in this case, thus, was whether the proposed exchange offer was
permitted by the Credit Agreement. After rejecting the Trustee’s argument that the new Credit
Agreement loans could not qualify as “Loans” under the Credit Agreement and, therefore, were
not permitted by the Credit Agreement, the Court accepted the Trustee’s argument that even if
the new Credit Agreement loans were “Loans” under the Credit Agreement, those “Loans”
would violate the negative covenants contained in Section 6.09 of the Credit Agreement insofar
as they did not constitute “Permitted Refinancing Indebtedness” under the Credit Agreement. In
fact, the Court concluded that “if Realogy wishes to engage in this proposed transaction, it would
need to obtain agreement from the required number of its bank lenders to amend or waive certain
provisions of the Credit Agreement.”
Following Realogy’s termination of the offer on December 19, 2008, Moody’s
lowered the company’s Corporate Family Rating to Caa3 from Caa2. On the other hand,
previously, when the offer was originally announced, Moody’s lowered the ratings on all of the
notes to C based on “Moody’s estimate of the likelihood of the Exchange Transaction closing
and the expected near term loss of the original principal amount.”61
Neff Corporation. In contrast to Realogy, Neff Corporation prevailed in its recent
court battle to complete a proposed exchange offer, although possible damage claims remain
outstanding today. Neff’s capital structure, which grew out of the acquisition of Neff by a
private equity firm, consisted of three primary tranches of debt each issued upon the acquisition
as of May 31, 2007 – first lien debt, second lien debt, and Neff’s 10% Senior Notes due 2015,
which were unsecured obligations of Neff. The tender offer was made to the Senior Noteholders
and, if accepted by the Senior Noteholders, would result in those Noteholders tendering their
notes at a discount to be included in the first lien Credit Agreement, in other words, being
60
In two additional counts in the complaint, High River alleged that, if consummated, the proposed
exchange offer would constitute a fraudulent conveyance on the part of Realogy. Those counts were not before the
Court at the time of its decision and, thus, the Court did not address them.
61
Moody Investors Service press release, dated November 17, 2008
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granted a lien position on Neff’s assets. The tendering Noteholders’ new liens would be
subordinate to the lien rights of the other holders of the first lien debt, but senior to the liens of
the holders of the second lien debt. The benefit to Neff of the tender offer was that Senior
Noteholders who participated in the tender offer would also agree to a reduction in the principal
amount of their debt up to 60% and be subject to the lower first lien interest rates, thereby
improving Neff’s balance sheet and decreasing its annual interest obligations.
On December 12, 2008, certain of the second lien lenders filed a complaint in
New York State Supreme Court to enjoin Neff’s offer to the Senior Noteholders on the grounds
that if the deal closed it would violate the terms of the (i) Intercreditor Agreement between the
holders of the first and second lien debt and (ii) Second Lien Credit Agreement, by elevating the
priority of the unsecured Senior Noteholders over the secured second lien lenders. The complaint
also contained a count for breach of contract, among other counts. Oral argument took place on
the December 15, 2008, the day the offer was scheduled to close. As of the date of the hearing
about 85% of the Senior Noteholders had already tendered into the offer. At oral argument, the
holders of the second lien debt argued, among other things, that the tender offer violated (i) the
Intercreditor Agreement, in that it would “adversely affect the perfection or priority” of their
liens and (ii) certain provisions of the Second Lien Credit Agreement, which, the holders of the
second lien debt argued, prohibited the granting of collateral to the Senior Noteholders.
In response, Neff argued that (i) the Intercreditor Agreement permitted Neff to
incur up to $467.5 million of debt under its First Lien Credit Agreement and that, even after the
tender offer, this threshold would not be crossed, (ii) the Second Lien Credit Agreement
permitted Neff to incur new debt so long as it was incurred in conformity with the First Lien
Credit Agreement and the Intercreditor Agreement, which it was, and (iii) in any event, this was
a situation in which, even if the second lien lenders were correct, they could be compensated by
money damages and, thus, issuance of a temporary restraining order was not appropriate.
The court ultimately ordered that the second lien lenders’ request for a temporary
restraining order be “withdrawn without prejudice to all of plaintiffs’ rights and remedies”,
(presumably it being decided that these circumstances did not justify a TRO). Neff announced
the closing of the deal the following day. The balance of the second lien lenders’ complaint
(other than the request for a temporary restraining order) is still in tact and the parties are still
litigating, among other things, the breach of contract count of the complaint.
Moreover, while the tendering Senior Noteholders may have enhanced their
position (albeit with reduced principal amount) in the lien/priority order, those Senior
Noteholders who did not tender find themselves in a much reduced and still unsecured class and
behind an additional approximately $100 million of Secured Debt.
Conclusion. Increasingly, trustees and bondholders may confront transactions
intended to prefer or leapfrog one level of debt over a more senior level of debt. In such case,
challenges may arise involving primary review of the indentures to determine if any convenants
are being breached and, alternatively, possible arguments that the transactions are not consistent
with good faith and fair dealing or would constitute fraudulent conveyances. These challenges
will often involve disputes centered upon alleged ambiguities or gaps in indentures intended to
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define and protect the rights of adversely affected bondholders and which indenture trustees are
authorized to enforce.
CANADIAN EXPERIENCE AND LESSONS FOR U.S. TRUSTEES
VI. BCE – BONDHOLDER “OPPRESSION REMEDIES” UNDER CANADIAN LAW
Reflecting a number of issues similar to ones previously discussed in the U.S.
context, this section will address the fascinating and ultimately unsuccessful bondholder
challenge to the BCE leveraged buy-out (LBO).
The largest LBO in Canadian -- and perhaps world -- history, which, while
recently litigated under and governed by Canadian law, may evidence not only the universal (at
least, North American) disposition of bondholders to attempt to forestall economically
prejudicial restructurings and transactions of material detriment to their market positions, but a
similar ultimate judicial hesitancy against the ultimate expansive reading of indentures or use of
other legal doctrines to block the corporate conduct of issuer-companies. The BCE LBO was
challenged in the context of Canadian law which provides even more potential ammunition for
bondholder objections to corporate activity based upon statutory prohibitions against oppressive
or unreasonable corporate transactions, in contrast to arguments of implied duties, good faith and
fair dealing under United States (particularly New York) contract law.
In BCE (involving the parent of Bell Canada), a leveraged buy-out (valued at
C$52 billion Canadian) was proposed in which BCE shareholders were to get a substantial
premium (estimated at 36 per cent) for their shares, financed in significant part by BCE and Bell
Canada incurring C$34 billion in loans secured by BCE/Bell Canada assets. While the
transaction on its face seemed very beneficial to shareholders, it arguably left C$5 billion of BCE
Noteholders exposed to a significantly impaired, less secure investment. In fact, the marketplace
discounted the Notes by 17 per cent to 20 per cent (approximately C$1 billion) in anticipation of
the LBO transaction and the rating agencies indicated that if the LBO transaction was
consummated, the Notes could go down as much as five rungs from AAA to below investment
grade. The contesting Noteholders -- predominantly some of the largest insurance companies in
Canada -- objected to the negative impact of the transaction, not only because of the market
value loss to them (perhaps C$250 to C$300 million out of C$1.4 billion in Notes they held), but
because if the Notes fell out of investment grade, most of the insurance companies would have to
immediately realize that loss and sell at the resulting substantial discount/loss because under the
regulatory scheme they were not allowed to hold non-investment grade bonds.
Canadian Court Orders
When BCE requested the Canadian Superior Court in Montreal to approve the
plan of arrangement necessary to effect the LBO, the Noteholders objected claiming:
•
that C$400,000 million of their Notes (which were part of two total issuances of C$2
billion) were covered by indentures that required the indenture trustees to first find the
transaction “in no wise prejudicial” to Noteholders
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•
that all the Notes exceeding C$5 billion (of which the objecting Noteholders had C$1.4
billion or 27.2 per cent) would experience “oppression” and be entitled to protective
“oppression remedies” under two unique sections of Canadian law.
In particular, §192 of the Canadian Business Corporation Act (“CBCA”) provides
that for an arrangement to get court approval it must be “found fair and reasonable,” while
Section 241 of the CBCA prohibits corporate action “that is oppressive or unfairly prejudicial or
that unfairly disregards the interests of any security holder, creditor, director or officer.”
Following a Superior Court decision approving the LBO arrangement transaction,
on May 21, 2008, the Canadian Court of Appeal, while also not accepting or considering the
arguable prohibitions of the transaction under the indenture terms, found against the LBO going
forward under the statutory “fair and reasonable” standard of Section 192 (which, being less
stringent, made it unnecessary to consider the “oppression” claim under Section 241).
Specifically, the Court of Appeal found that the BCE Board and the Superior Court considered
only the interests of shareholders and had not adequately considered the interests of
Debentureholders, who it was acknowledged would be economically prejudiced by the LBO
arrangement:
“The interests of the debentureholders, which are wider than their
contractual legal rights flowing from the Trust Indentures, should
have been considered by the Board . . . Since the trial judge did
not assess the issue . . . his erroneous approach could not lead to a
proper evaluation of the fairness and reasonableness of the Plan. . .
BCE never attempted to justify the fairness and reasonableness of
an arrangement that results in a significant adverse economic
impact on the debentureholders while at the same time it accords a
substantial premium to the shareholders. . . [T]he corporation has
the burden of demonstrating that the arrangement is, nonetheless,
fair and reasonable.”
The Court of Appeal, therefore, set aside the trial court (Superior Court) approval
of the LBO arrangement.
BCE then took an appeal of that decision to the Supreme Court of Canada, which
on June 20, 2008 overturned the Court of Appeal decision from the bench and authorized the
LBO arrangement transaction to go forward, promising a later reasoned decision.
In a peculiar twist of fate, the Supreme Court of Canada only issued its final
written opinion supporting the LBO on December 19, 2008 -- a week after the transaction was
abandoned because BCE could not, in the newly deteriorating economic environment, certify
that it would be solvent post-LBO, a central condition of the transaction
The Court, emphasizing, among other things, that BCE, having been put in play,
received three bids, all of which involved substantial leveraged secured financing and that such
financing was not expressly prohibited under the indenture, held that:
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“the Debentureholders did not establish [ as required for Section
241 oppression remedy] that they had a reasonable expectation that
the directors of BCE would protect their economic interests by
putting forth a plan of arrangement that would maintain the
investment grade trading value of their debentures”
As for the Section 192 fair and reasonable standard, the Court found that:
“Since only their economic interests were affected by the proposed
transaction, not their legal rights, and since they did not fall within
an exceptional situation where non-legal interests should be
considered under s. 192, the debentureholders did not constitute an
affected class under s. 192. The trial judge was thus correct in
concluding that they should not be permitted to veto almost 98
percent of the shareholders simply because the trading value of
their securities would be affected. Although not required, it
remained open to the trial judge to consider the debentureholders’
economic interests in his assessment of whether the arrangement
was fair and reasonable under s. 192, as he did.”
While the Supreme Court of Canada may have come out on the side of the LBO,
the credit crunch and economic downturn which arose and worsened during the delay
engendered by the litigation, conspired against it, resulting first in problems holding together the
lending commitment, and ultimately in the inability to deliver a solvency opinion, which was a
central financial condition for closing. By the time the Supreme Court of Canada issued its
formal written judgment approving the LBO, BCE on December 11, 2008 had already officially
announced that the buyers had terminated the LBO deal because the parties could not get a
required independent auditor solvency opinion. Thus, the delay caused by the Noteholders’
litigation arguably produced the results sought by the Noteholders that their legal arguments
could not.
Conclusion. While the story of the BCE LBO is interesting in its own right, and
highlights that timing and change of conditions often can trump strict legal analysis, it may also
exemplify and be a precursor of what may be an increasingly frequent type of transaction or debt
restructuring designed to prefer or catapult one level of debt over another.
Before the Supreme Court ruling, the Canadian Court of Appeal decision standing
alone could be read as suggesting intriguing possibilities by analogy, not only to Canadian
indenture trustees, but to U.S. indenture trustees and practitioners as to a possible route to an
expanded application of arguably analogous (although not as directly statutory) U.S. good faith
and fair dealing standards to particularly egregious and prejudicial transactions, depending on its
written decision. However, the Supreme Court of Canada seems to have brought those prospects
back to earth.
While today’s focus (both in the United States and Canada) may be shifting to
more unequivocal breaches of indentures such as payment defaults and bankruptcies as opposed
to those challenged in the covenant interpretation cases previously discussed, it can be assumed
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that bondholders will continue to use -- and ask indenture trustees to support -- a variety of
arguments at their and their indenture trustees’ disposal, whether contractual, statutory or
equitable, to attempt to block or be remunerated for particularly prejudicial transactions.
U.K EXPERIENCE AND LESSONS
VII. SIV CASES
One of the longest standing (but not definitively answered) conundrums facing
U.S. Trustees and their counsel has been whether to pay and how to treat scheduled interest or
principal payments on one series or set of bonds when there is no default nor acceleration of the
bonds, but at the same time the Trustee knows or believes that other series or sets of bonds for
which the Trustee serves likely will not be paid in full because of the financial condition of the
issuer. While U.S. Trustees have considered such situations and even deferred payments under
theories of anticipatory breach, adequate assurance of payment and application of the prudent
man standard, the U.K. Courts and Trustees have recently confronted these issues judicially in
the context of the liquidations of Structured Investment Vehicles (SIV’s).
In the last year or two, a number of Structured Investment Vehicles (SIVs),
subject to U.K. Trusteeship and law, have become increasingly under water, forcing U.K.
Trustees and any subsequently appointed U.K. receivers to decide who and when to pay
bondholders. Issues have most troublingly arisen during the pendency of or lead-up to an
insolvency event as to whether maturing loans should be fully paid ahead of other, later maturing
loans. Some U.K. Courts have found that the loan documents governing all classes of notes, read
strictly, allow the U.K. Trustee or receiver to make priority repayment on loans with the earliest
maturity dates paid first and in full. Other courts have interpreted loan documents to allow for
the payment of all loans regardless of order of maturity on a pari passu basis.
Cheyne Finance PLC. In Cheyne, the SIV went into receivership after it could no
longer obtain short term finance, but before an “Insolvency Event” as defined under its contract
occurred. The receivership initially asked the High Court to decide if the fund should give
priority to creditors with loans maturing in the near term or pay all senior noteholders pari passu.
The court in its first ruling in 2007 ruled in favor of the creditors with early maturing notes,
ordering the receiver to pay claims in the “pay as you go” manner.
The receivers then in a second action applied to the Court again, this time to
determine if in light of new developments, it should consider the fund’s assumed inability to pay
future obligations in full as an “Insolvency Event”. The language in the contract defined an
“Insolvency Event” based on section 123(1) of the Insolvency Act of 1986 as “the cash flow test
of whether a company is unable to pay its debts as they fall due,” however the contract did not
include section 123(2) of the Act, commonly known as the “balance sheet test.” The court not
finding any English precedent that defined the cash flow test with futurity, referred to a decision
from Australia, a country which does not use the balance sheet test for insolvency, to
demonstrate that the words “as they fall due” has been found to contain an element of futurity,
i.e., looking at future payment prospects. The court ordered that the receiver should consider the
fund’s inability to pay future obligations to determine if an “Insolvency Event” occurred, so the
debt should be paid pari pasu.
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Sigma Finance. After Lehman Brothers filed for bankruptcy in 2008, the already
diminishing value of Sigma Finance Corporation’s investments plummeted, and the investment
fund defaulted under its borrowing agreements. An administrative receiver was immediately
appointed to sort out Sigma’s $9 billion deficit. Most of Sigma’s secured loan notes were
guaranteed under a Security Trust Deed, that, upon an event of default, forced the trustee to enact
a 60 day “realization period” in which to deal with outstanding SIV liability. The trustee had to
decide whether to pay in full the amounts owed to the bondholders whose debts matured during
the realization period, and thereby, use up fund assets before paying other noteholders whose
debts matured later, or calculate the total value of short and long term liabilities and pay all of
the noteholders pari passu. The receiver appealed to the high court to clarify the trustee’s
payment obligations under the Deed. The court ruled that the clause in question directed the
trustee to pay noteholders when their loans matured, regardless of how much this payment
schedule prejudiced noteholders with different maturities. The Court of Appeals upheld the
lower court’s decision. In accepting this "pay as you go" rule, the court interpreted the
applicable clause in the Deed to mean "first in time" when paying off bondholders whose debts
became due, and reasoned that the drafters of the Deed could have included language found in
other parts of the Deed to indicate a pari passu distribution. On February 13, the Upper Chamber
of Parliament granted the bondholders leave to appeal the decision to the House of Lords.
Whistlejacket. By contrast, in the Whistlejacket case, the Court of Appeals found
the underlying loan agreements only dealt with how the money would be paid and not when the
money would be paid and did not address the priority of claims of noteholders within the same
class. In its May 22, 2008 decision, the court allowed the receiver to take the "usual discretion"
in considering the current and future amounts due to a particular class of noteholders, and to pay
off all of the noteholders pari passu.
Orion. When the Orion SIV defaulted on its notes, the junior and senior
noteholders demanded competing payment plans from the security trustee. The central issue
confronted by the Security Trustee was its obligation to follow the direction of the senior
noteholders contrary to the wishes of the junior noteholders as to time, manner and place of
liquidating the collateral. In making its 2008 ruling, the High Court had to consider, in addition
to English law, the laws of the State of New York which defined the terms of the trustee’s
appointment under the contract. Under New York law, a trustee must enforce the terms of a
security in a “commercially reasonably manner”. The High Court ruled that the senior creditors
could not dictate the exact manner in which the trustee sold Orion’s secured assets, but the
trustee needed to abide by the terms of the original loan documents that subordinated the junior
creditor’s right to repayment to the senior creditor’s, and act swiftly to compensate the senior
debt holders.
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Appendix A
Sample Standard Provisions Relating to Default/Direction/No-Action Clauses
The ABA Model Simplified Indenture, published in 1983, includes the following sample
provisions relating to Events of Default and remedies:
Section 6.02. Acceleration.
If an Event of Default occurs and is continuing, the Trustee by notice to the Company, or the
holders of at 25% in principal amount of the Securities by notice to the Company and the
Trustee, may declare the principal of and accrued interest on all Securities to be due and payable.
Upon such declaration the principal and interest shall be due and payable immediately. The
Holders of a majority in principal amount of the Securities by notice to the Trustee may rescind
an acceleration and its consequences if the recission would not conflict with any judgment or
decree and if all existing Events of Default have been cured or waived except nonpayment of
Principal or interest that has become due solely because of the acceleration.
Section 6.03. Other Remedies.
If an Event of Default occurs and is continuing, the Trustee may pursue any available remedy to
collect the payment of principal or interest on the Securities or to enforce the performance of any
provision of the Securities or this Indenture.
The Trustee may maintain a proceeding even if it does not possess any of the Securities or does
not produce any of them in the proceeding. A delay or omission by the Trustee or any
Securityholder in exercising any right or remedy accruing upon an Event of Default shall not
impair the right or remedy or constitute a waiver of or acquiescence in the Event of Default. All
remedies are cumulative to the extent permitted by law.
Section 6.04. Waiver of Past Defaults.
The Holders of a majority in principal amount of the Securities by notice to the Trustee may
waive an existing Default and its consequences except a Default in the payment of the principal
of or interest on any Security or a Default . . . .
Section 6.05
Control by Majority.
The Holders of a majority in principal amount of the Securities may direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee or exercising any
trust or power conferred on it. However, the Trustee may refuse to follow any direction that
conflicts with law or this Indenture, is unduly prejudicial to the rights of other Securityholders,
or would involve the Trustee in personal liability.
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Section 6.06. Limitation on Suits.
A Securityholder may pursue a remedy with respect to this Indenture or the Securities only if:
(1) the Holder gives to the Trustee notice of a continuing Event of Default;
(2) the Holders of at least 25% in Principal amount of the Securities make a request to the
Trustee to pursue the remedy;
(3) such Holder or Holders offer to the Trustee indemnity satisfactory to the Trustee against any
loss, liability or expense;
(4) the Trustee does not comply with the request within 60 days after receipt of the request and
the offer of indemnity; and
(5) during such 60-day period the Holders of a majority in principal amount of the Securities do
not give the Trustee a direction inconsistent with the request.
A Securityholder may not use this Indenture to prejudice the rights of another Securityholder or
to obtain a preference or priority over another Securityholder.
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Appendix B
RELEVANT CONSENT SOLICITATION PROVISIONS FROM THE ABA REVISED
MODEL SIMPLIFIED INDENTURE
Section 6.05
Control by Majority.
The Holders of a majority in Principal amount of the Securities may direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee or exercising any
trust or power conferred on the Trustee. However, the Trustee may refuse to follow any direction
that conflicts with law or this Indenture, is unduly prejudicial to the rights of other
Securityholders, or would involve the Trustee in personal liability or expense for which the
Trustee has not received a satisfactory indemnity.
Section 6.06
Limitation on Suits.
A Securityholder may not use this Indenture to prejudice the rights of another Securityholder or
to obtain a preference or priority over another Securityholder.
Section 9.02 Amendments—With Consent of Holders.
The Company and the Trustee may amend this Indenture or the Securities with the written
consent of the Holders of at least a majority in Principal amount of the Securities. However,
without the consent of each Securityholder affected, an amendment under this Section may not:
(1) reduce the amount of Securities whose Holders must consent to an amendment;
(2) reduce the interest on or change the time for payment of interest on any security:
(3) reduce the Principal of or change the fixed maturity of any Security;
(4) reduce the premium payable upon the redemption of any Security [or change the time at
which any security may or shall be redeemed];
(5) make any security payable in money other than that stated in the Security;
(6) make any change in Section 6.04, 6.07 or 9.02 (second sentence);
(7) make any change that adversely affects the right to convert any Security; or
(8) make any change in Article 11 that adversely affects the rights of any securityholder.
It shall not be necessary for the consent of the Holders under this Section to
approve the particular form of any proposed amendment, but it shall be sufficient if such consent
approves the substance thereof.
An amendment under this Section may not make any change that adversely
affects the rights under Article 11 of any Senior Debt unless it consents to the change.
Section 12.03 Certificate and Opinion as to Conditions Precedent.
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Upon a request or application by the Company to the Trustee to take any action under this
Indenture, the Company shall furnish to the Trustee:
(1) an Officers’ Certificate stating that, in the opinion of the signers, all conditions precedent, if
any, provided for in this Indenture relating to the proposed action have been complied with; and
(2) an Opinion of Counsel stating that, in the opinion of such counsel, all such conditions
precedent have been complied with.
Section 12.04 Statements Required in Certificates or Opinions.
Each certificate or opinion with respect to compliance with a condition or covenant provided for
in this Indenture shall include:
(1) a statement that each Person making such certificate or opinion has read such covenant or
condition;
(2) a brief statement as to the nature and scope of the examination or investigation upon which
statements or opinions contained in such certificate or opinion are based;
(3) a statement that, in the opinion of such Person, the Person has made such examination or
investigation as is necessary to enable such Person to express an informed opinion as to whether
or not such covenant or condition has been complied with; and
(4) a statement as to whether or not, in the opinion of such Person, such condition or covenant
has been complied with.
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Appended Cases
AG Capital Funding Partners, L.P. v State St. Bank & Trust Co., 11 N.Y.3d 146, 896 N.E.2d 61
(N.Y. 2008)
Bank of New York v. Tyco International, 545 F.Supp.2d 312 (S.D.N.Y. 2008)
The Bank of New York Mellon v. Realogy Corporation, 2008 WL 5259732 (December 18, 2008)
BCE Inc. v. 1976 Debentureholders, 2008 SCC 69
In the Matter of Cheyne Finance PLC (in Receivership), [2007] EWHC 2402_2 (Ch), High Court
(Chancery Division)
In the Matter of Cheyne Finance PLC (in Receivership), [2007] EWHC 2402 (Ch), High Court
(Chancery Division)
In the Matter of Whistlejacket Capital Limited (in Receivership), [2008] EWHC 463 (Ch), High
Court (Chancery Division)
In the Matter of Sigma Finance Corporation (in Administrative Receivership), [2008] EWHC
2997 (Ch), High Court (Chancery Division)
In the Matter of Sigma Finance Corporation (in Administrative Receivership), [2008] EWCA
Civ 1303, Court of Appeal (Civil Division)
The Bank of New York v. Montana Board of Investments, [2008] EWHC 1594 (Ch), High Court
(Chancery Division)
Concord Trust v. Law Debenture Trust Corp., [2005] UKHL 27, United Kingdom House of
Lords
Law Debenture Trust v. Concord Trust, [2007] EWHC 2255 (Ch), High Court (Chancery
Division)
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HAROLD L. KAPLAN
Harold L. Kaplan is a partner with Foley & Lardner LLP. He,
among other things, is the leader of the firm's Corporate
Trust and Bondholders Rights Team and is a member of the
firm's Bankruptcy & Business Reorganizations Practice. Over
the last two decades, Mr. Kaplan has represented financial
institutions, debtors, trustees under the Bankruptcy Code
and the Securities Investors Protection Act, foreign
liquidators in ancillary proceedings, creditors committees,
and other creditor groups, including representing indenture
trustees and bondholder interests.
PARTNER
[email protected]
321 NORTH CLARK STREET SUITE 2800
CHICAGO, IL 60654-5313
(312) 832-4393
90 PARK AVENUE
NEW YORK, NY 10016-1314
In addition to more traditional areas of practice, he has
extensive experience in claims trading and regulated
industry matters, including railroad, airline and other
transportation reorganizations; utility industry matters;
securities industry and broker-dealer matters; insurance and
bank insolvencies; telecommunications, gaming, oil and gas
and mining proceedings; and health care industry matters,
including health care finance, reorganizations, insolvencies,
and other proceedings.
Mr. Kaplan was named one of 12 outstanding bankruptcy
lawyers in the country in 2005, 2004 and 2003, and one of
13 in 2001, by Turnarounds & Workouts magazine. He is
recognized as one of Chambers USA's 2006, 2007 and 2008
"Leaders in their Field" for bankruptcy. *
Mr. Kaplan has authored numerous articles and spoken on
transactional, bondholder/corporate trust, health care and
bankruptcy topics. He is a member of the American
Bankruptcy Institute, where he is a contributing editor to the
ABI Journal’s "Intensive Care" column on health care related
issues. He has been a presenter at numerous conferences on
corporate reorganization, distressed debt, distressed real
estate, health care financing and bond default, and chairs
the Annual Corporate Reorganizations Conference held in
Chicago. He is a past chair of the Chicago Bar Association
Bankruptcy and Reorganization Committee; chair of the
American Bar Association Health Care-Related and Not-forProfit Bankruptcy Issues Subcommittee; vice-chair of the
American Bar Association Committee on Trust Indentures
©2009 Foley & Lardner LLP • Attorney Advertisement • Prior results do not guarantee a similar outcome • 321 North Clark Street, Chicago, IL 60654 • 312.832.4500
and Indenture Trustees (including chairing its default
subcommittee), as well as serving on several related
committees, including the advisory drafting group of the
Subcommittee on Revision of the Model Simplified
Indenture. He is also a member of the editorial board of the
American Bankers Association Trust and Investments
magazine, and was a member of the editorial board of
Network News, a publication for corporate trustees. He
recently served as an original member of the Cornerstone
Council, an advisory group that makes recommendations to
the Turnaround Management Association (TMA)
Management Committee on the uses of Cornerstone 15
funds for academic research.
Mr. Kaplan received his law degree from the University of
Chicago Law School (J.D. 1975). He is a graduate of the
University of Wisconsin (M.A. 1975, B.A. 1972).
Mr. Kaplan is admitted to practice in Illinois and New York
and has appeared in courts and cases throughout the United
States.
Previous and Current Representative Major
Bond/Indenture Trustee/Creditor Cases:
ASARCO, Bally Total Fitness, Kimball Hill, Remy
International, UAL Corp., Northwest Airlines Corp., FLYi,
Inc., Mirant Corp., Loral Orion, USGen New England, Atlas
Air, Tower Automotive, WHX Corp., Kaiser Aluminum,
Conseco, Petro-Geo, HealthSouth, Magellan Health Services,
NCS Healthcare, AHERF, Home Products International, Inc.,
Fleming, Kmart, Redback Networks, USN Communications,
Favorite Brands, Southern Mineral, United Companies
Financial, ContiFinancial, Sunterra, Crown Vantage, Kitty
Hawk, Safety-Kleen, Reliant Building Products, WheelingPittsburgh, Metal Management, Armstrong World Industries,
Outboard Marine, Loewen Group, Globe Manufacturing,
Pacific Gas & Electric, AMRESCO, Goss Holdings,
Thermadyne Holdings, Jacobson Stores, Farmland
Industries, Hunt International Resources, Sunshine Mining,
Eastern Air Lines, Telemundo, Bally’s Grand, Wedtech,
Manville Forest Products, Venture Stores, Rock Island
Railroad, Milwaukee Road, and WPPSS.
©2009 Foley & Lardner LLP
2
Recent publications and speaking engagements from 2006
to present (partial list):
•
•
•
•
•
•
•
•
•
•
©2009 Foley & Lardner LLP
“Tranche Warfare: Leapfrogging Debt Through
Exchange Offers,” co-authored with Mark F. Hebbeln,
Corporate Trust Section, ABA (American Bankers
Association) Trust & Investments, March/April 2009.
"BCE Post-Mortem," co-authored with Mark F.
Hebbeln, Network News column, ABA (American
Bankers Association) Trust &
Investments, January/February 2009.
"BCE: Bondholder ‘Oppression Remedies’ Under
Canadian Law," co-authored with Mark F. Hebbeln,
Network News column, ABA (American Bankers
Association) Trust & Investments,
November/December 2008.
"Covenants Count: Current CaseLaw," co-authored
with Mark F. Hebbeln, Network News column, ABA
(American Bankers Association) Trust & Investments,
September/October 2008.
"News Brief: Loewen Decision on Trustee Pre-Default
Ministerial Conduct," co-authored with Mark F.
Hebbeln, Network News column, ABA (American
Bankers Association) Trust & Investments,
September/October 2008.
"Trusting Trust Accounts -- Comparative Safeguards
of Customer Accounts," Corporate Trust section, ABA
(American Bankers Association) Trust & Investments,
September/October 2008.
"Doing Well by Doing Right: The Ethical-Legal
Challenge of the Indenture Trustee in an Activist
World," co-authored with Mark F. Hebbeln, Corporate
Trust section, ABA (American Bankers Association)
Trust & Investments, July-August 2008.
"Keeping a Level Playing Field: The Evolution of
Discriminatory Consent Solicitations and Exchange
Offers," co-authored with Mark F. Hebbeln,
Corporate Trust section, ABA (American Bankers
Association) Trust & Investments, March/April 2008.
"The Evolving Standards For the Appointment of a
Patient Care Ombudsman: Section 333 in
"Operation"," co-authored with Samuel R. Maizel, ABI
(American Bankruptcy Institute) Journal, Intensive Care,
March 2008.
"Recent Developments Possibly Putting Investor
Privacy and Purchased Debt Claims at Risk," co-
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©2009 Foley & Lardner LLP
authored with Daniel Northrop, Network News
column, ABA (American Bankers Association) Trust &
Investments, January/February 2008.
"Aggressive Enforcement of Indenture Covenants:
The No-Action Clause in an Activist World," coauthored with Mark F. Hebbeln and Daniel Northrop,
Corporate Trust section, ABA (American Bankers
Association) Trust & Investments,
November/December 2007.
"Indenture Trustee Role and Obligation in
Settlements Affecting Bondholder Rights: The
Kenton County Bonds/Delta Air Lines Case," coauthored with Daniel Northrop, Network News
column, ABA (American Bankers Association) Trust &
Investments, November/December 2007.
"Recoupment in Health Care Bankruptcies: A
Shrinking Issue?," co-authored with Timothy R.
Casey, ABI (American Bankruptcy Institute) Journal,
Intensive Care, October 2007.
"Grand Old Trustee Standard of Care Cases Draw to
a Close Bluebird, Semi-Tech, Holmes Harbor," coauthored with Daniel Northrop, Network News
column, ABA (American Bankers Association) Trust &
Investments, September/October 2007.
"Indenture Trustee Fees and Expenses in Bankruptcy
- A Strategic Consideration Update," co-authored
with Mark F. Hebbeln and Daniel Northrop,
Corporate Trust section, ABA (American Bankers
Association) Trust & Investments, May/June 2007.
"Update on Trustee Litigation in the United Airlines
Case: Lease Recharacterization," co-authored with
Mark F. Hebbeln and Daniel Northrop, Network
News column, ABA (American Bankers Association)
Trust & Investments, May/June 2007 (Part 2 of 2).
"Update on Trustee Litigation in the United Airlines
Case: Lease Recharacterization," co-authored with
Mark F. Hebbeln and Daniel Northrop, Network
News column, ABA (American Bankers Association)
Trust & Investments, March/April 2007 (Part 1 of 2).
Speaker, "Recent Developments in Corporate Trust-Litigation and Defaults," The Fiduciary and
Investment Risk Management Association, Inc.
Corporate Trust Senior Managers Forum, February
27, 2007 (Ponte Vedra Beach, Florida).
"Reading Indentures Strictly: The Rise of Delayed
SEC Filing Defaults and Aggressive Bondholders," co-
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authored with Daniel Northrop, Corporate Trust
section, ABA (American Bankers Association) Trust &
Investments, January/February 2007.
"Putting New Bankruptcy Code Information-Sharing
Provisions Into Practice: Creditors' Committee
Protocols," co-authored with Daniel Northrop,
Corporate Trust section, ABA (American Bankers
Association) Trust & Investments,
November/December 2006.
"Update on NOL Trading Orders and Trading Wall
Orders," co-authored with Daniel Northrop, Network
News column, ABA (American Bankers Association)
Trust & Investments, November/December 2006.
Co-Chair of Conference, Renaissance American
Management, Inc. & Beard Group, Ninth Annual
Conference on Corporate Reorganizations, June 2223, 2006 (Chicago, Illinois).
"Hospitals Face New Financial Threat of Charity Care
Legislation," co-authored with Linda S. Moroney, ABI
(American Bankruptcy Institute) Journal, Intensive Care,
June 2006.
"Denial of Antitrust Claims Against United EETC
Trustees," co-authored with Mark F. Hebbeln and
Daniel Northrop, Network News column, ABA
(American Bankers Association) Trust & Investments,
January/February 2006.
Speaker, "Recent Developments in Corporate Trust-Litigation and Defaults," The Fiduciary and
Investment Risk Management Association, Inc.
Corporate Trust Senior Managers Forum, January
19, 2006 (Ponte Vedra Beach, Florida).
"BAPCPA: Health Care Lenders Beware?," ABI
(American Bankruptcy Institute) Journal,
December/January 2006.
Publications and speaking engagements before 2006 are
available upon request.
Recent honors (partial list):
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©2009 Foley & Lardner LLP
Chair of Gardner Carton & Douglas (2004-2006); CoChair of Corporate Restructuring Group (19992007).
Named to List of 12 Outstanding Bankruptcy
Lawyers for 2005, Turnarounds & Workouts, December
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©2009 Foley & Lardner LLP
15, 2005
Named to List of 12 Outstanding Bankruptcy
Lawyers for 2004, Turnarounds & Workouts, December
15, 2004
Named to List of 12 Outstanding Bankruptcy
Lawyers for 2003, Turnarounds & Workouts, December
15, 2003
Named to List of 13 Outstanding Bankruptcy
Lawyers for 2001, Turnarounds & Workouts, December
15, 2001
ABI (American Bankruptcy Institute) Journal,
Contributing Editor, "Intensive Care" Column (2004present)
American Bar Association Healthcare-Related and
Not-for-Profit Bankruptcy Issues Working Group,
Chair (2000-present)
American Bar Association Health Care-Related
Insolvency Working Group, Vice-Chair (1998 -2000)
American Bar Association Committee on Trust
Indentures and Indenture Trustees, Vice Chair
(2006-present) and former Membership Chair
American Bar Association Subcommittee on Revision
of the Model Simplified Indenture, Advisory Drafting
Group Member (Revised Model Simplified Indenture
Published in 2000)
American Bankers Association, Trust & Investments,
Editorial Board (2000-present)
American Bankers Association Network News,
Editorial Board (1998-1999)
Chicago Bar Association, Bankruptcy &
Reorganization Committee, Chair (2002-2003)
Chicago Bar Association, Bankruptcy &
Reorganization Committee, Vice Chair (2001-2002)
Chicago Bar Association, Bankruptcy &
Reorganization Committee, Educational Chair (20002001)
Chicago Bar Association, Large Law Firm
Committee, Co-Chair (2005-present)
Annual Renaissance American Management, Inc. &
Beard Group Corporate Reorganization Conference
(Chicago), Chair (1998-present)
Annual Renaissance American Management, Inc. &
Beard Group Healthcare Restructuring/Transactions
Conference (Chicago), Chair and Sponsor (2000present)
6
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Faculty, Cannon Banking Institute (1999)
Turnaround Management Association, Cornerstone
Council 15 Member (2004-2008)
*The Illinois Supreme Court does not recognize certifications
of specialties in the practice of law and no award or
recognition is a requirement to practice law in Illinois.
©2009 Foley & Lardner LLP
7
Jay A. Carfagnini
[email protected]
416.597.4107
Profile
Jay A. Carfagnini is a partner and heads the Corporate Restructuring Group at Goodmans. His practice focuses on
banking and financing law, corporate reorganizations, bankruptcy and insolvency law. He has a particular expertise in
cross-border and international transactions, particularly in the interplay of Canadian restructuring proceedings with U.S.
Chapter 11 proceedings and U.K. administration proceedings. Jay has been an active participant and advisor in most of the
major restructurings in Canada in the past several years, including Nortel Networks, InterTAN Canada/Circuit City,
AbitibiBowater, Tower Automotive, Quebecor World, Calpine Canada, MuscleTech, American Color Graphics, Hoop
Canada, Inc., Laidlaw Inc., JTI-Macdonald Inc., Air Canada, Beloit Corporation, Harnischfeger Industries Inc., Exodus
Communications Group, Call-Net Enterprises Inc., Mosaic Group Inc., Kaiser Aluminum Group, American ECO Corp.,
Fleming Group/Core-Mark Int’l, Amtelecom Group, International Wallcoverings Ltd., Canadian Commercial Bank, MedChem Medical Supplies Services Group, Olympia & York Developments Limited, Dylex Limited, Atkins Nutritional
(Canada), Krispy Kreme (Canada), T. Eaton Co. Ltd., the Tee Comm Electronics and AlphaStar digital home TV Group
and the Sammi Atlas Steel Group.
Jay has been consistently identified as a leading practitioner of insolvency and restructuring law by several international
legal publications including the Lexpert/American Lawyer Media Guide to the Leading 500 Lawyers in Canada, The Canadian
Legal Lexpert Directory, Lexpert Magazine’s Leading US/Canada Cross-Border Litigation Lawyers in Canada and the Leading
US/Canada Cross-Border Corporate Lawyers in Canada for insolvency and corporate restructuring, Chambers Global Guide to
the World’s Leading Lawyers, Euromoney’s Guide to the World’s Leading Insolvency and Restructuring Lawyers, IFLR 1000, PLC
Which Lawyer?, PLC Restructuring and Insolvency Handbook and Best Lawyers in Canada. Jay is also recognized as one of the
“Most Highly Regarded Individuals – Global” for insolvency and restructuring by Law Business Research’s An International
Who’s Who of Business Lawyers from 2005 to 2008 and by Euromoney’s Best of the Best as one of the best in his field of
insolvency and restructuring in 2006 and 2008.
Jay is a member of the Ontario and Alberta bars, the International Bar Association, the Law Society of Upper Canada, the
Canadian Bar Association, the American Bar Association, the Turnaround Management Association, the International
Insolvency Institute, the Insolvency Institute of Canada and INSOL International.
Education
University of Western Ontario, LL.B.
Doneene Keemer Damon
Director
[email protected]
Direct: 302-651-7526
Fax: 302-498-7526
One Rodney Square
920 North King Street
Wilmington, DE 19801
Phone: 302-651-7700
DONEENE KEEMER DAMON is a Director in the Business Department of Richards, Layton & Finger, P.A. . Her
practice focuses primarily on formation and operational issues relating to the use of Delaware common
law and statutory trusts in various financing structures. Ms. Damon’s practice includes formation and
operational issues relating to Delaware statutory trusts in all types of commercial and business transactions,
including securitizations, structured finance, investment funds, real estate financings, CDOs, leveraged
leases, mutual funds, and trust preferred securities transactions. Ms. Damon’s practice also includes the
representation of banks and trust companies in connection with their trust and agency services in various
commercial transactions.
A frequent lecturer on the advantages of using Delaware statutory trusts in financing transactions and CDO
transactions, Ms. Damon co-authored chapter 9, “The Role of the Trustee in Leasing Transactions,” in the PLI
Equipment Leasing – Leveraged Leasing and “Advantages and Uses of Delaware Statutory Trusts and Limited
Liability Companies as Bankruptcy Remote Entities,” published by Bloomberg.
Ms. Damon is a member of the Delaware, Washington, DC, and American Bar Associations . She is Chair
of the American Bar Association Committee on Trust Indentures and Indenture Trustees, and Co-Chair of
the American Bar Associations’ Committee on Corporate Director Diversity. Ms. Damon is also a member of
the ABA’s Banking Law Committee, Securitization and Structured Finance Committee, UCC Committee and
Committee on Partnerships and Unincorporated Business Organizations. Ms. Damon is a participant in the
American Securitization Forum’s Outside Counsel Subforum and Communication and Education Committee.
A committed advocate for diversity in both the legal profession and the larger community, Ms. Damon is
chair of the firm’s Diversity Committee and the firm’s representative on the U.S. Law Firm Group Committee
on Racial and Ethnic Diversity. She is a member of the American Bar Association’s Diversity Committee and
the Multicultural Judges and Lawyers Section of the Delaware State Bar Association. Extending her outreach
into the community, Ms. Damon serves on the boards of the Lawyers’ Committee for Civil Rights Under Law,
Christiana Care Health System and Health Services, Meals on Wheels Delaware, Inc., Wilmington Friends
School, the Delaware Lawyer, and the Delaware Art Museum.
Ms. Damon has been recognized by the International Women’s Review Board for Excellence in Law
and Continental Who’s Who for her legal skills. She is the recipient of the YWCA 2009 Trailblazer Award
for recognizing her outstanding contributions to her profession as she has broken new ground for the
advancement of women and minorities.
She received a JD, cum laude, from Temple University School of Law and a BS, cum laude, from
St. Joseph’s University.
n n n
www.rlf.com
Daniel R. Fisher
Senior Vice President / Division Manager
Wilmington Trust FSB
Dan is a Senior Vice President and Division Manager for the Global Finance Division of
Wilmington Trust’s Corporate Capital Markets Services Department in both New York
and Wilmington, Delaware. Dan is responsible for developing and managing the
company’s global and domestic bond debt, global and domestic, bankruptcy/insolvency
and reorganization trust and agency products and services, loan administration services,
project finance, equipment finance and emerging markets products and services. He has
a broad background in the corporate trust industry with over twenty-four years of
experience, serving in various capacities from sales, account administration and product
management to senior management.
Prior to joining Wilmington Trust, Dan was the SVP/Corporate Trust Manager of Law
Debenture Trust Company of New York where he established their US trust business in
2002. During his career, Dan has also held various positions in corporate trust
departments for institutions such as U.S. Bank, The Chase Manhattan Bank and Morgan
Guaranty Trust Company of New York.
Dan is a frequent speaker at the American Banker Association’s annual Capital Markets
Conference and he is the co-author of the article “The Cross-Border Trustee: From
Behind the Scenes to Center Stage” for the bankruptcy trade journal Insol World.
Dan graduated cum laude from Villanova University with a B.A. and he received his J.D.
from Seton Hall University Law School. He is a member of the New Jersey State Bar
Association.
- Public -
MARK F. HEBBELN
Mark F. Hebbeln is a partner with Foley & Lardner LLP,
and is a member of the firm's Bankruptcy & Business
Reorganizations Practice. He concentrates his practice in
corporate restructuring, which includes the
representation of indenture trustees, creditors'
committees, securitization trustees, assignees for the
benefit of creditors, and individual creditors in insolvency
proceedings in state and federal courts.
PARTNER
[email protected]
321 NORTH CLARK STREET SUITE 2800
CHICAGO, IL 60654-5313
(312) 832-4394
Mr. Hebbeln has represented indenture trustees and
bondholder interests in national bankruptcy cases
including Remy International, Bally, ASARCO, United Air
Lines, Inc., Atlas Air, Mirant Corporation, Kaiser
Aluminum, Pacific Gas and Electric Company, Jacobson
Stores, and International Utility Structures, Inc. He has
also represented indenture trustee and bondholder
interests in health care reorganizations, insolvencies and
other proceedings. He has extensive experience in
representing securitization trustees in insolvency and
bankruptcy proceedings and in representing official
creditors' committees in chapter 11 proceedings.
Mr. Hebbeln has written extensively on bankruptcy and
insolvency, including articles on indenture trustee and
bondholder interests, break-up fees and the automatic
stay. He has also presented at several conferences,
including the 2002 American Bar Association meeting
held in conjunction with the National Conference of
Bankruptcy Judges, the 2003 Corporate Reorganizations
Conference and the 2005 American Bankers Association
Capital Markets Conference. Turnarounds & Workouts
recognized him as one of 12 outstanding young
restructuring lawyers in the nation in 2005 and as one of
14 outstanding young restructuring lawyers in the nation
in 2006. He was named a Rising Star in the field of
bankruptcy in Illinois Super Lawyers 2008 – Rising Stars
Edition.*
Mr. Hebbeln received his J.D. from Emory University
©2009 Foley & Lardner LLP • Attorney Advertisement • Prior results do not guarantee a similar outcome • 321 North Clark Street, Chicago, IL 60654 • 312.832.4500
School of Law (1997), where he was an articles editor for
the Bankruptcy Developments Journal. He received his
bachelor's degree, cum laude, in economics and politics
from Wake Forest University (B.A., 1993), where he was
admitted to the Pi Sigma Alpha (political science) and
Omicron Delta Epsilon (economics) national honor
societies.
Mr. Hebbeln is admitted to practice in Illinois and
Georgia. He is a member of the American Bar
Association, the American Bankruptcy Institute, and the
Chicago Bar Association.
Previous and Current Representative Major
Bond/Indenture Trustee/Creditor Cases:
ASARCO, Bally Total Fitness, Kimball Hill, Remy
International, UAL Corp., Northwest Airlines Corp., FLYi,
Inc., Mirant Corp., Atlas Air, Kaiser Aluminum, Conseco,
Petro-Geo, HealthSouth, Magellan Health Services, NCS
Healthcare, Home Products International, Inc., Redback
Networks, United Companies Financial, Globe
Manufacturing, Pacific Gas & Electric, Jacobson Stores.
Publications:
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©2009 Foley & Lardner LLP
“Tranche Warfare: Leapfrogging Debt Through
Exchange Offers,” co-authored with Harold L.
Kaplan, Corporate Trust Section, ABA (American
Bankers Association) Trust & Investments, March/April
2009
"BCE Post-Mortem," co-authored with Harold L.
Kaplan, Network News column, ABA (American
Bankers Association) Trust &
Investments, January/February 2009.
"BCE: Bondholder "Oppression Remedies" Under
Canadian Law," co-authored with Harold L.
Kaplan, Network News column, ABA (American
Bankers Association) Trust & Investments,
November/December 2008.
"Covenants Count: Current CaseLaw," includes
News Brief: "Loewen Decision on Trustee PreDefault Ministerial Conduct," co-authored with
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©2009 Foley & Lardner LLP
Harold L. Kaplan, Network News column, ABA
(American Bankers Association) Trust & Investments,
September/October 2008.
"Trusting Trust Accounts -- Comparative
Safeguards of Customer Accounts," Corporate
Trust section, ABA (American Bankers Association)
Trust & Investments, September/October 2008.
"Doing Well by Doing Right: The Ethical-Legal
Challenge of the Indenture Trustee in an Activist
World," co-authored with Harold L. Kaplan,
Corporate Trust section, ABA (American Bankers
Association) Trust & Investments, July/August
2008.
"Keeping a Level Playing Field: The Evolution of
Discriminatory Consent Solicitations and
Exchange Offers," co-authored with Harold L.
Kaplan, Corporate Trust section, ABA (American
Bankers Association) Trust & Investments,
March/April 2008.
"Aggressive Enforcement of Indenture Covenants:
The No-Action Clause in an Activist World," coauthored with Harold L. Kaplan and Daniel
Northrop, Corporate Trust section, ABA (American
Bankers Association) Trust & Investments,
November/December 2007.
"Indenture Trustee Fees and Expenses in
Bankruptcy - A Strategic Consideration Update,"
co-authored with Harold L. Kaplan and Daniel
Northrop, Corporate Trust section, ABA (American
Bankers Association) Trust & Investments, May/June
2007.
"Update on Trustee Litigation in the United
Airlines Case: Lease Recharacterization," coauthored with Harold L. Kaplan and Daniel
Northrop, Network News column, ABA (American
Bankers Association) Trust & Investments, May/June
2007 (part 2 of 2).
"Update on Trustee Litigation in the United
Airlines Case: Lease Recharacterization," coauthored with Harold L. Kaplan and Daniel
Northrop, Network News column, ABA (American
Bankers Association) Trust & Investments,
March/April 2007 (Part I of 2).
"Denial of Antitrust Claims Against United EETC
3
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©2009 Foley & Lardner LLP
Trustees," co-authored with Harold L. Kaplan and
Daniel Northrop, Network News column, ABA
(American Bankers Association) Trust & Investments,
January/February 2006.
"The Impact of New Bankruptcy Legislation on
Indenture Trustees," co-authored with Harold L.
Kaplan and Daniel Northrop, Corporate Trust
section, ABA (American Bankers Association) Trust &
Investments, July/August 2005.
"Indenture Trustees and Lease
Recharacterization," co-authored with Tracy L.
Treger and Harold L. Kaplan, Corporate Trust
section, ABA (American Bankers Association) Trust &
Investments, March/April 2005.
"Is ‘Lease’ a Financing Agreement in Disguise?
Rights of Both Sides Hinge on the Answer," The
Journal of Corporate Renewal, July 2004 (with
Tracy L. Treger).
"Indenture Trustee Fees and Expenses in
Bankruptcy: Theory and Practice," co-authored
with Harold L. Kaplan, Corporate Trust section,
ABA (American Bankers Association) Trust &
Investments, May/June 2004.
Contributing Author, 2002, Wiley Law Update.
"MSRB Proposes Rules for Communicating with
Beneficial Owners," co-authored with Harold L.
Kaplan, ABA (American Bankers Association) Trust &
Investments, May/June 2001.
"Saga Continues in Eastern Case," co-authored
with Harold L. Kaplan, ABA (American Bankers
Association) Trust & Investments, May/June 2001
"Prepetition Waivers of the Automatic Stay in
Bankruptcy: The Economic Case for
Nonenforcement," 115 Banking L.J. 126, February
1998.
"The Economic Case for Judicial Deference to
Break-Up Fee Agreements in Bankruptcy," 13
Bankr. Dev. J. 475, Spring 1997.
*The Illinois Supreme Court does not recognize
certifications of specialties in the practice of law
and no award or recognition is a requirement to
practice law in Illinois.
4
Brendan O’Neill
[email protected]
416.849.6017
Profile
Brendan O'Neill is a partner in the Corporate Restructuring Group at Goodmans. He practices in the areas of
bankruptcy, insolvency and reorganization law. Brendan has experience in out-of-court restructurings and workouts,
cross-border and transnational insolvencies and restructurings, U.S. Chapter 11 reorganizations, bankruptcy-based
acquisitions, bankruptcy-based litigation (in particular, indenture-based disputes and litigation) and near-insolvency
investing scenarios. Brendan has represented debtors, secured and unsecured lenders and creditors, official and unofficial
creditors’ committees, bondholders, shareholders and investors focused on distressed situations.
Brendan joined the group from the Bankruptcy and Corporate Reorganization Department of Paul, Weiss, Rifkind,
Wharton & Garrison LLP in New York. While at Paul Weiss, Brendan participated in many of the recent, major U.S.
Chapter 11 cases, including representing key creditors in the Adelphia and DIRECT TV cases and the Official Committee
of Unsecured Creditors in the Chapter 11 cases of Armstrong Industries, Inc., United Pan-Europe Communications,
IMPSAT Fiber Networks, Inc., United-Australia Pacific and Navigator Gas Transport PLC.
Since joining Goodmans, Brendan has been involved in the Stelco restructuring, the firm’s representation of Calpine
Canada in its CCAA proceedings and the firm’s representation of the Pan-Canadian Investors Committee in the ABCP
restructuring.
Brendan has lectured and written on various cross-border insolvency matters, including new Chapter 15 of the U.S.
Bankruptcy Code in particular.
Education
Queens University, B.A. (Hons.)
University of Toronto, L.L.B.
Professional Affiliations
Canadian Bar Association
Ontario Bar Association, Insolvency Section
INSOL International
American Bankruptcy Institute
Turnaround Management Association
Year of Call
Ontario
New York
AG Capital Funding Partners, L.P. v State St. Bank & Trust Co. (2008 NY Slip Op 05766) Page 1 of 10
AG Capital Funding Partners, L.P. v State St. Bank & Trust Co.
2008 NY Slip Op 05766 [11 NY3d 146]
June 25, 2008
Jones, J.
Court of Appeals
Published by New York State Law Reporting Bureau pursuant to Judiciary Law
§ 431.
As corrected through Wednesday, October 22, 2008
[*1]
AG Capital Funding Partners, L.P., et al., Appellants,
v
State Street Bank and Trust Company, Respondent. (And Other Actions.)
Argued May 28, 2008; decided June 25, 2008
AG Capital Funding Partners, L.P. v State St. Bank & Trust Co., 40 AD3d 392,
modified.
{**11 NY3d at 150} OPINION OF THE COURT
Jones, J.
In this appeal arising out of the issuance of a series of debt securities by nonparties
Loewen Group International, Inc. and Loewen Group, Inc. (collectively Loewen), the
question before us is whether plaintiffs have viable claims against defendant State Street
Bank and Trust Company (State Street) for breach of contract, violation of the federal Trust
Indenture Act of 1939 (see 15 USC § 77aaa et seq.), breach of fiduciary duty and negligence
based on its alleged failure to deliver debt transaction registration statements arguably
required to secure the debt. We conclude that plaintiffs' contract and Trust Indenture Act
claims are barred by a release previously executed by plaintiffs as part of a bankruptcy
settlement with Loewen and that no fiduciary duties exist. However, because negligence
claims are not barred by the release, and because there is an issue of fact as to whether State
Street owed and violated a duty of care to plaintiffs, we reinstate the cause of action for
http://www.courts.state.ny.us/REPORTER/3dseries/2008/2008_05766.htm
3/10/2009
AG Capital Funding Partners, L.P. v State St. Bank & Trust Co. (2008 NY Slip Op 05766) Page 2 of 10
negligence brought by plaintiffs against State Street.
[*2]Facts[FN1]
In May 1996, Loewen and collateral trustee Bankers Trust entered into a Collateral
Trust Agreement (CTA). As relevant here, the CTA permitted holders of future debt
offerings to{**11 NY3d at 151} acquire secured-creditor status with respect to the same
pool of collateral. Specifically, the CTA provided that future
"trustees or like representatives acting on behalf of Holders of any proposed
Additional Secured Indebtedness . . . may become Secured Party Representatives
under this Collateral Trust Agreement and be entitled to the benefits of the
security interests in the Collateral as set out herein and in the other Collateral
Documents. To become a Secured Party Representative hereunder each such
representative or Holder must deliver to the Trustee, for acceptance and
registration in the Secured Indebtedness Register, an Additional Secured
Indebtedness Registration Statement" (emphasis added).
In the late 1990s, in an effort to raise capital, Loewen issued a series of debt securities.
[FN2] Three of the debt securities, the pass-through asset trust securities (PATS), issued in
September 1997, and the Series 6 and 7 Notes (Notes), issued in May 1998, are relevant
here. Under the indenture for each transaction, Loewen engaged State Street to serve as
indenture trustee and administer the debt issue. Plaintiffs—various insurance companies,
mutual funds and investment funds—are holders of the PATS and Notes, which were valued
at approximately $750 million when issued. For each transaction, Loewen and State Street
executed an additional secured indebtedness registration statement (ASIRS) as set forth in
the CTA. Each ASIRS, incorporating by reference the CTA between Loewen and Bankers
Trust, provided:
"By executing and delivering this Additional Secured Indebtedness Registration
Statement and, upon the acceptance and recordation hereof by the Trustee in
[*3]accordance with Section 2.3 of the Collateral Trust Agreement, State
Street . . . as trustee under the indenture . . . hereby agrees on behalf of itself and
the Holders it represents to be bound by all the terms and provisions of the
[CTA] applicable to a{**11 NY3d at 152} Holder and a Secured Party
Representative" (emphasis added).[FN3]
It is undisputed that no ASIRS for the PATS or the Notes was ever delivered to or
received by Bankers Trust.
http://www.courts.state.ny.us/REPORTER/3dseries/2008/2008_05766.htm
3/10/2009
AG Capital Funding Partners, L.P. v State St. Bank & Trust Co. (2008 NY Slip Op 05766) Page 3 of 10
In June 1999, Loewen filed for chapter 11 bankruptcy protection. Because no ASIRS
was delivered for the subject debt securities, uncertainty arose as to whether the holders of
those instruments had secured-creditor status. In the bankruptcy proceeding, plaintiffs
approved Loewen's fourth reorganization plan and settled their claims against Loewen by
accepting a discounted value for the Notes and PATS. Plaintiffs also agreed to "release"
State Street in accordance with Loewen's reorganization plan, which provided that
"each holder of a CTA Note Claim, each Indenture Trustee and each Principal
CTA Creditor will be deemed to forever release, waive and discharge [State
Street] . . . from any claims, demands, rights, causes of action[ ] or liabilities that,
if enforced against [State Street], entitle [State Street] to an Allowed Claim for
indemnification from [Loewen]."
The indentures for the subject transactions required that Loewen
"shall indemnify [State Street] for, and hold it harmless against, any loss or
liability incurred by it arising out of or in connection with the administration of
this trust and its rights or duties hereunder, including the costs and expenses of
defending itself against any claim or liability in connection with the exercise or
performance of any of its powers or duties hereunder. . . . [Loewen] need not
reimburse any expense or indemnify against any loss or liability to the extent
incurred by [State Street] through its{**11 NY3d at 153} negligence, bad faith or
willful misconduct" (emphasis added).
Thus, State Street was not indemnified by Loewen, and therefore not released by
plaintiffs, as to any claim based on its negligence.
Procedural History
In 2002, plaintiffs commenced this action against State Street, alleging six causes of
action: (1) breach of the PATS ASIRS and the Notes ASIRS, (2) breach of the PATS
indenture and the Notes indenture, (3) violation of the federal Trust Indenture Act, (4)
breach of fiduciary duty as an indenture trustee, (5) breach of fiduciary duty as a secured
party representative and (6) negligence. In sum, plaintiffs alleged that State Street's failure to
deliver the ASIRS to Bankers Trust for registration as required under the CTA and the
ASIRS caused plaintiffs to settle their claims in Loewen's bankruptcy for "tens of millions of
dollars" less than if State Street had delivered the ASIRS. In its answer, State Street denied
the complaint's allegations and asserted various affirmative defenses, including release. State
Street further countered that the subject notes were secured, whether or not they were
http://www.courts.state.ny.us/REPORTER/3dseries/2008/2008_05766.htm
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AG Capital Funding Partners, L.P. v State St. Bank & Trust Co. (2008 NY Slip Op 05766) Page 4 of 10
registered.[FN4] In January 2005, State Street moved for summary judgment dismissing
the complaint, and plaintiffs moved for partial summary judgment on their contract claims
(i.e., breach of the ASIRS and breach of the indentures), as well as their breach of fiduciary
duty as indenture trustee and negligence [*4]claims. Plaintiffs also sought an award of
damages.{**11 NY3d at 154}
In July 2005, Supreme Court (1) granted State Street's motion to the extent of
dismissing plaintiffs' claims for breach of contract and violation of the Trust Indenture Act,
(2) granted plaintiffs' motion to the extent of granting them summary judgment as to liability
on their breach of fiduciary duty as indenture trustee and negligence claims and (3)
otherwise denied the motions. Specifically, the court held that the release plaintiffs executed
as part of the Loewen bankruptcy settlement barred their contract and violation of the Trust
Indenture Act claims, but did not affect their breach of fiduciary duty and negligence claims.
Further, the court, relying on the Appellate Division's 2004 decision dismissing State
Street's third-party claims, held that plaintiffs were entitled to summary judgment as to
liability on their breach of fiduciary duty as indenture trustee and negligence claims.
However, in our November 2005 decision reversing the dismissal of the third-party
negligence and contribution claims, we noted that the Appellate Division's comments on the
merits of the main claim were "premature and beyond the scope of the appeal" (5 NY3d at
590 n 3).
After our November 2005 decision, State Street moved to vacate certain portions of
Supreme Court's July 2005 decision and to renew its summary judgment motion as to the
remaining claims, arguing that this Court rejected the Appellate Division's conclusion that
plaintiffs could predicate tort claims on State Street's failure to perform ministerial tasks. In
May 2006, Supreme Court (1) vacated so much of its prior order that granted plaintiffs
summary judgment on the breach of fiduciary duty as indenture trustee and negligence
claims, (2) granted State Street's motion to renew and (3) upon renewal, denied State Street's
motion for summary judgment dismissing plaintiffs' breach of fiduciary duty (as indenture
trustee and secured party representative) claims and their negligence claim. The parties
appealed from Supreme Court's July 2005 and May 2006 orders to the extent they were
aggrieved.
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The Appellate Division dismissed plaintiffs' claims for breach of contract and violation
of the Trust Indenture Act, explaining that because these claims were not predicated upon
State Street's negligence, bad faith or willful misconduct, they are clearly barred by the
release (40 AD3d 392, 393-394 [1st Dept 2007]). The court further concluded that the
remaining claims for breach of fiduciary duty and negligence "should have been dismissed
since they are essentially duplicative of the claims for{**11 NY3d at 155} breach of
contract" (id. at 394). The court stated that, "[n]otwithstanding the wording of" such claims,
"it is apparent that plaintiffs have not alleged the breach of an extracontractual duty
redressable in tort" (id.). We granted plaintiffs leave to appeal and now modify and reinstate
the negligence claim against State Street.
Discussion
Plaintiffs argue that the Appellate Division decision immunizes State Street's failure to
perform its most basic and fundamental obligations as an indenture trustee. Specifically,
plaintiffs contend that: (1) Loewen's indemnification obligations to State Street, [*5]
consistent with the Trust Indenture Act, did not relieve State Street from any claims or
liability resulting from its own misconduct or failure to perform its express contractual
obligations; as such, the release has no effect on plaintiffs' breach of contract claims; and (2)
prior to the issuer's default, State Street owed plaintiffs an extracontractual duty to perform
basic, nondiscretionary ministerial tasks (e.g., delivery of the ASIRS) and that breach of
such duty supports a tort claim against State Street. State Street counters that (1) plaintiffs'
breach of contract and Trust Indenture Act claims are barred by the release; (2) plaintiffs
have not alleged the breach of an extracontractual duty redressable in tort; and (3) in any
event, plaintiffs' tort claims are duplicative of the breach of contract claims.
Under the plain terms of the release, its scope is based on the terms of the
indemnification provision set forth in each indenture. In short, the indentures provide that
Loewen shall indemnify State Street for and hold it harmless against all claims except those
based on State Street's negligence, bad faith or willful misconduct.[FN5] As plaintiffs' breach
of contract and Trust Indenture Act claims against State Street are not based on State Street's
negligence, bad faith or willful misconduct, these claims fall under the category of "Allowed
Claim for indemnification" and are barred pursuant to the release. Therefore, the Appellate
Division properly concluded that, based on the release, State Street is entitled to summary
judgment dismissing plaintiffs' first three claims.{**11 NY3d at 156}
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We turn next to plaintiffs' contention that State Street may be held liable in tort for its
failure to perform the basic, nondiscretionary ministerial function of delivering the ASIRS
(prior to the event of default) and that, accordingly, plaintiffs' fourth and fifth claims,
sounding in breach of fiduciary duty as an indenture trustee and as a secured party
representative, respectively, should be reinstated.
The Trust Indenture Act of 1939, which is applicable "to notes, bonds, debentures, and
other evidences of indebtedness, whether or not secured, and to all certificates representing
such an interest" (5 Hazen, Securities Regulation § 19.2, at 261 [5th ed]), was enacted
because "previous abuses by indenture trustees had adversely affected the national public
interest and the interest of investors in notes, bonds [and] debentures, 15 U.S.C. § 77bbb (a),
and Congress sought to address this national problem in a uniform way, S.Rep. No. 248,
76th Cong., 1st Sess. 3 (1939)" (Bluebird Partners, L.P. v First Fid. Bank, N.A. N.J., 85 F3d
970, 974 [2d Cir 1996] [internal quotation marks omitted]). In short, "[t]he Act is designed
to vindicate a federal policy of [*6]protecting investors" (id. [internal quotation marks and
emphasis omitted]). As relevant here, the Act states that an indenture "shall automatically be
deemed (unless it is expressly provided therein that any such provision is excluded) to
provide that, prior to default . . . the indenture trustee shall not be liable except for the
performance of such duties as are specifically set out in such indenture" (15 USC § 77ooo
[a] [1] [emphasis added]).
New York state and federal case law are consistent with section 77ooo (a) (1) of the
Act. In Hazzard v Chase Natl. Bank of City of N.Y., Supreme Court, New York County
explained that
"[t]he corporate trustee has very little in common with the ordinary trustee . . . .
The trustee under a corporate indenture . . . has his [or her] rights and duties
defined, not by the fiduciary relationship, but exclusively by the terms of the
agreement. His [or her] status is more that of a stakeholder than one of a
trustee" (159 Misc 57, 83-84 [1936], affd without op 257 App Div 950 [1st Dept
1939], affd without op 282 NY 652 [1940], cert denied 311 US 708 [1940]; see
Elliott Assoc. v J. Henry Schroder Bank & Trust Co., 838 F2d 66, 71 [2d Cir
1988] [holding that as long as trustee fulfills obligations under the express terms
of indenture, no pre-default duties owed to{**11 NY3d at 157} debt holders
except to avoid conflicts of interest]; Meckel v Continental Resources Co., 758
F2d 811, 816 [2d Cir 1985] [same as Hazzard]; Craig v Bank of N.Y., 2002 WL
1543893, 2002 US Dist LEXIS 12721 [SD NY 2002]; Magten Asset Mgt. Corp. v
Bank of N.Y., 15 Misc 3d 1132[A], 2007 NY Slip Op 50951[U] [Sup Ct, NY
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AG Capital Funding Partners, L.P. v State St. Bank & Trust Co. (2008 NY Slip Op 05766) Page 7 of 10
County 2007] [same as Hazzard]; AMBAC Indem. Corp. v Bankers Trust Co.,
151 Misc 2d 334, 338-339 [Sup Ct, NY County 1991] [same as Hazzard and
Elliott Assoc.]).
We further note that a number of courts have held that prior to default, indenture
trustees owe note holders an extracontractual duty to perform basic, nondiscretionary,
ministerial functions redressable in tort if such duty is breached (see LNC Inv., Inc. v First
Fid. Bank, N.A., 935 F Supp 1333, 1347 [SD NY 1996];[FN6] Philip v L.F. Rothschild &
Co., 1999 WL 771354, *1, 1999 US Dist LEXIS 14967, *3-4 [SD NY 1999]; Dresner Co.
Profit Sharing Plan v First Fid. Bank, N.A., N.J., 1996 WL 694345, *4, 1996 US Dist
LEXIS 17913, *12-13 [SD NY 1996]; Williams v Continental Stock Transfer & Trust Co., 1
F Supp 2d 836, 840 [ND Ill 1998]). These decisions are consistent with section 77ooo (a) (1)
of the Trust [*7]Indenture Act, Elliott Assoc. and Hazzard.
Based on the foregoing, we hold that an indenture trustee owes a duty to perform its
ministerial functions with due care, and if this duty is breached the trustee will be subjected
to tort liability. However, contrary to plaintiffs' arguments, the alleged breach of such duty
neither gives rise to fiduciary duties nor supports the reinstatement of plaintiffs' fourth and
fifth causes of action.
[2] Plaintiffs' fourth cause of action alleging that State Street had a fiduciary duty as an
"Indenture Trustee" is not viable. First, they cannot point to any provision in the indentures
that places fiduciary obligations on State Street prior to an event of{**11 NY3d at 158}
default.[FN7] Second, as will be made clear below, fiduciary obligations are wholly different
from the performance of ministerial functions with due care. Finally, mere allegations that a
fiduciary duty exists, with nothing more, are insufficient to withstand summary judgment.
Plaintiffs' fifth cause of action alleging that State Street had a fiduciary duty as a
"Secured Party Representative" is not viable under the general principles governing
fiduciary relationships. "A fiduciary relationship 'exists between two persons when one of
them is under a duty to act for or to give advice for the benefit of another upon matters
within the scope of the relation' " (EBC I, Inc. v Goldman, Sachs & Co., 5 NY3d 11, 19
[2005], quoting Restatement [Second] of Torts § 874, Comment a). Determining whether a
fiduciary relationship exists necessarily involves a fact-specific inquiry (see id.). "[E]ssential
elements of a fiduciary relation are . . . 'reliance, . . . de facto control and dominance'
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AG Capital Funding Partners, L.P. v State St. Bank & Trust Co. (2008 NY Slip Op 05766) Page 8 of 10
" (Northeast Gen. Corp. v Wellington Adv., 82 NY2d 158, 173 [1993, Hancock, J.,
dissenting] [citations omitted]). Stated differently, "[a] fiduciary relation exists when
confidence is reposed on one side and there is resulting superiority and influence on the
other" (id.).
Here, State Street never became a secured party representative, as defined by the CTA,
in the first instance. Accordingly, State Street never undertook "a duty to act for or to give
advice for the benefit of another" in that capacity.
Finally, we conclude that the Appellate Division erred in dismissing plaintiffs'
negligence claim as duplicative of plaintiffs' breach of the ASIRS (contract) claim. At the
outset, we reiterate that the release executed by plaintiffs only applied to claims for which
Loewen [*8]would have to indemnify State Street under the respective indentures, which
specifically exclude acts of negligence from Loewen's indemnification obligations.
Therefore, the release does not shield State Street from its own acts of negligence.
Here, it is undisputed that State Street and Loewen executed the ASIRS, that the
ASIRS called for State Street to deliver{**11 NY3d at 159} same to Bankers Trust and that
State Street failed to deliver the ASIRS or ensure that the ASIRS were delivered to Bankers
Trust. Accordingly, there are issues of fact as to whether State Street, separate and apart
from its contractual duty under the ASIRS, undertook and breached a duty of care,
"connected with and dependent upon the [ASIRS]" (Clark-Fitzpatrick, Inc. v Long Is. R.R.
Co., 70 NY2d 382, 389 [1987] [citation omitted]), to act in accordance with the ASIRS and
the CTA registration requirements to protect plaintiffs' security rights in the CTA collateral
and whether plaintiffs sustained significant losses as a result of this alleged breach. These
questions should be resolved at trial.
State Street's reliance on various representations and opinions of Loewen's counsel
(Thelen) stating that the PATS and the Notes were, or would be, entitled to secured status is
misplaced and, in any event, does not alter our holding on plaintiffs' negligence claim.
Because State Street did not advise Thelen that it had failed to deliver the ASIRS as it
agreed to do, State Street cannot, in good faith, rely upon Thelen's representations.
Accordingly, the order of the Appellate Division should be modified, without costs, by
remitting to Supreme Court for further proceedings in accordance with this opinion and, as
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so modified, affirmed.
Chief Judge Kaye and Judges Graffeo, Read, Smith and Pigott concur; Judge Ciparick
taking no part.
Order modified, etc.
Footnotes
Footnote 1: The facts concerning the transactions at issue are largely set forth in a prior
decision of this Court (see AG Capital Funding Partners, L.P. v State St. Bank & Trust Co.,
5 NY3d 582 [2005] [In a related third-party action commenced by State Street, the Court
reinstated its claims for negligence and contribution]). We restate and augment the facts
only to the extent necessary to resolve the instant appeal (which concerns the main action).
Footnote 2: The document setting the terms and conditions of a debt issuance is a corporate
indenture (see Black's Law Dictionary 784 [8th ed 2004]).
Footnote 3: UBS Warburg LLC (UBS) was lead underwriter in the PATS transaction, and
its counsel, Skadden, Arps, Slate, Meagher & Flom LLP, hosted and ran the closing.
Salomon Smith Barney, Inc. (Salomon) was lead underwriter in the Notes transaction, and
its counsel, Davis Polk & Wardwell, hosted and ran the closing. Thelen Reid & Priest LLP
(Thelen) represented Loewen and drafted the ASIRS for both transactions. Our prior
decision provides a detailed exposition of the foregoing (see AG Capital, 5 NY3d at 588589). State Street alleges that after the respective closings, Thelen made numerous
representations through, among other things, the issuance of opinion letters to Bankers
Trust, that the subject debt was fully secured and ranked equally with the other secured debt
previously issued by Loewen.
Footnote 4: In 2003, State Street commenced a third-party action asserting claims for
common-law indemnification, contribution and unjust enrichment against third-party
defendants Salomon, UBS and Thelen, and negligent misrepresentation and attorney
malpractice against Thelen. State Street alleged that if it is liable to plaintiffs in the main
action, the third-party defendants should ultimately be held liable to it because they assumed
State Street's delivery obligation and breached that duty by failing to deliver the ASIRS. The
third-party defendants moved to dismiss the third-party complaint under CPLR 3211 (a) (7).
Supreme Court dismissed the unjust enrichment, indemnification, attorney malpractice and
negligent misrepresentation claims. However, the court let State Street's negligence and
contribution claims go forward. In August 2004, the Appellate Division granted third-party
defendants' motions in their entirety and dismissed State Street's third-party complaint,
holding that "State Street assumed the contractual obligation to deliver to Bankers Trust a
registration statement for any additional secured indebtedness" (10 AD3d 293, 294 [2004]).
We reinstated the contribution and negligence claims (5 NY3d 582 [2005]). In so holding,
we "express[ed] no opinion on the merits of the underlying claims against State Street" (id.
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at 590).
Footnote 5: This provision is consistent with the Trust Indenture Act, which states: a
corporate indenture "shall not contain any provisions relieving the indenture trustee from
liability for its own negligent action, its own negligent failure to act, or its own willful
misconduct" (15 USC § 77ooo [d]).
Footnote 6: In support of its holding in LNC Inv., the Southern District cited New York State
Med. Care Facilities Fin. Agency v Bank of Tokyo Trust Co. (163 Misc 2d 551 [Sup Ct, NY
County 1994], affd on different grounds 216 AD2d 126 [1st Dept 1995], lv dismissed 87
NY2d 892 [1995]). In that case, as here, the ministerial task defendant trustee was required
to perform was set forth in an agreement executed by the debt issuer and the indenture
trustee. Put differently, the duty to perform the required ministerial task clearly arose under
the terms of the agreement.
Footnote 7: This is consistent with the Trust Indenture Act, which distinguishes between an
indenture trustee's pre- and post-default duties. Thus, while an indenture trustee, prior to
default, is liable for obligations specifically set forth in the indenture, once the issuer
defaults, the trustee "shall exercise . . . such of the rights and powers vested in it by such
indenture, and . . . use the same degree of care and skill in their exercise, as a prudent
[person] would exercise or use under the circumstances in the conduct of his [or her] own
affairs" (15 USC § 77ooo [c]).
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IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
THE BANK OF NEW YORK MELLON,
solely in its capacity as Trustee under the
Indenture pursuant to which the 11.00%/
11.75% Senior Toggle Notes Due 2014
were issued, and HIGH RIVER LIMITED
PARTNERSHIP,
Plaintiffs,
v.
REALOGY CORPORATION,
Defendant.
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C.A. No. 4200-VCL
MEMORANDUM OPINION
Submitted: December 15, 2008
Decided: December 18, 2008
Stephen E. Jenkins, Esquire, Richard I.G. Jones, Esquire, Andrew D. Cordo,
Esquire, ASHBY & GEDDES, P.A., Wilmington, Delaware; Sigmund S. WissnerGross, Esquire, May Orenstein, Esquire, BROWN RUDNICK LLP, New York,
New York; James Gadsden, Esquire, CARTER LEDYARD & MILBURN LLP,
New York, New York, Attorneys for the Bank of New York Mellon, solely in its
capacity as Trustee under the Indenture pursuant to which 11.00%/11.75% Senior
Toggle Notes Due 2014 were issued.
Thomas J. Allingham II, Esquire, Paul J. Lockwood, Esquire, SKADDEN ARPS
SLATE MEAGHER & FLOM LLP, Wilmington, Delaware; George A.
Zimmerman, Esquire, Lauren E. Aguiar, Esquire, SKADDEN ARPS SLATE
MEAGHER & FLOM LLP, New York, New York, Attorneys for Realogy
Corporation.
LAMB, Vice Chancellor.
All of a corporation’s unsecured indebtedness is trading at a deep discount to
face value. The corporate borrower proposes to take advantage of the substantial
arbitrage opportunity presented by offering to refinance a large amount of the
unsecured indebtedness with a substantially smaller amount of a senior secured
term loan. The corporation means to do this by offering holders of the unsecured
indebtedness the opportunity to exchange notes for a participation in a new term
loan facility secured by a second lien on its assets. If successful, this gambit will
reduce both current cash interest payments and future principal obligations.
Holders of a class of unsecured notes that permit the corporation to make
interest payments either in kind or in cash (the “Toggle Notes”) object to the terms
of the exchange offer because it discriminates against them in favor of holders of
other classes of unsecured notes that pay interest in cash. These holders have
enlisted the trustee under the indenture governing the Toggle Notes to sue the
corporation for a declaration to the effect that the proposed transaction would
violate the terms of that indenture.
The trustee and the corporate issuer have both moved for summary
judgment. Both argue that the relevant contracts unambiguously support their
interpretation. Both urge the court to enter a declaratory judgment in their favor.
In the end, the issue boils down to whether or not the proposed lien securing the
new term loan is a “Permitted Lien” within the meaning of the Toggle Note
1
indenture. That question, in turn, depends on whether the proposed borrowing
satisfies the definition of Permitted Refinancing Indebtedness found in the bank
credit agreement incorporated by reference into that indenture. Applying New
York law of contract interpretation, the court concludes that it does not. Therefore,
a declaratory judgment will issue in favor of the trustee.
I.
A.
The Parties
Plaintiff The Bank of New York Mellon (the “Trustee”) is a New York
banking corporation and the indenture trustee for the 11.00%/11.75% Senior
Toggle Notes due 2014 (the “Senior Toggle Notes”) issued by Realogy.
Plaintiff High River Limited Partnership is a Delaware limited partnership
with its principal place of business in New York City. High River is controlled by
investor Carl Icahn, and purports to be a beneficial owner of an unspecified
quantity of Senior Toggle Notes.
Defendant Realogy Corporation is a Delaware corporation with its principal
place of business in Parsippany, New Jersey. Realogy is a provider of real estate
and relocation services, and includes such well-known brands as Century 21,
Coldwell Banker, and Sotheby’s International Realty. Realogy is the issuer of the
Senior Toggle Notes.
2
B.
Facts
Realogy is one of the four companies that resulted from the break-up of
Cendant Corporation in 2006. Realogy was a publicly traded corporation from the
time it was spun-off by Cendant in 2006 until it was taken private by an affiliate of
Apollo Management, L.P. (collectively with its affiliates, “Apollo”) in April 2007,
during the height of the private equity boom.
In order to provide the large amount of debt financing necessary to complete
Apollo’s acquisition of Realogy, Realogy issued a number of debt instruments.
Senior-most in its capital structure is a senior secured facility consisting of a
$3.17 billion term loan facility (“Term B Loans”) and a $750 million revolving
loan and letter of credit facility, both pursuant to the Credit Agreement dated as of
April 10, 2007 (the “Credit Agreement”), among, inter alia, Realogy, JPMorgan
Chase Bank, N.A. (“JPM”) as administrative agent for the lenders, and the various
lenders to whom JPM syndicated the loans (the “Lenders”). The Credit Agreement
obligations are secured by a first lien on substantially all of the assets of Realogy.
In addition to the Term B and revolving loan facilities, the Credit Agreement also
provides for an “accordion” feature which allows Realogy to issue up to
$650 million in additional term loans (the “Other Term Loans”).1 These Other
1
Unlike the Term B and revolving loans, which the syndicated lenders are committed to fund
under the Credit Agreement, the Other Term Loans place no obligations to fund on the
syndicated lenders. Instead, the Credit Agreement anticipates soliciting new lenders to
participate in the Other Term Loans.
3
Term Loans may be issued on either the same terms as the Term B Loans under the
Credit Agreement or on such other alternative terms as JPM should deem
satisfactory.
Concurrently with and in addition to the Credit Agreement indebtedness,
Realogy issued several classes of notes. Senior among these note issues are the
$1.7 billion principal value of 10.50% Senior Notes due 2014 (the “Senior Cash
Notes”) and the $582 million2 principal value of the aforementioned Senior Toggle
Notes (collectively the “Senior Notes”). The Senior Cash Notes require cash
payment of interest on a semi-annual basis. The Senior Toggle Notes allow the
semi-annual interest payments to be paid-in-kind (“PIK”) with additional Senior
Toggle Notes, effectively allowing Realogy the flexibility to capitalize a portion of
its interest expenses if it so chooses. The Senior Notes rank pari passu to the
Credit Agreement indebtedness but are unsecured. Realogy also issued
$875 million principal value of 12.375% Senior Subordinated Notes due 2015 (the
“Senior Subordinated Notes”), which are subordinated in right of payment to the
Senior Notes and the Credit Agreement indebtedness. Like the Senior Cash Notes,
the Senior Subordinated Notes require semi-annual cash payment of interest and
are unsecured. Both the Credit Agreement and the trust indentures governing the
2
Realogy initially issued $550 million of Senior Toggle Notes, but elected to capitalize its
October 2008 interest payment. Realogy Corp., Current Report (Form 8-K) (Dec. 2, 2008) .
4
various notes contain negative covenants regarding the use of funds for the early
redemption or refinancing of indebtedness.
Like the rest of the residential real estate industry, Realogy has fallen on
hard times since the closing of its LBO. As evidence of the market’s evaluation of
Realogy’s diminished prospects to pay back its debt, the Senior Cash Notes
presently trade at just below 18 cents on the dollar, the Senior Toggle Notes at
approximately 13 cents on the dollar, and the Senior Subordinated Notes at just
below 12 cents on the dollar. All of the notes are presently rated C by the various
debt rating agencies.
On November 13, 2008, Realogy issued a press release announcing the
terms and conditions of a proposed debt refinancing. According to the terms of the
offer (as finally amended), eligible noteholders3 are invited to participate as lenders
under a new $500 million term lending facility. The term lending facility would
consist of Term C and Term D Loans under the Other Term Loans accordion
feature of the Credit Agreement, and would be secured by a second lien on
substantially all of the assets of Realogy. Instead of funding these term loans with
cash, the participating noteholders would fund their obligations under the new term
loans with the delivery of existing notes, with priority given to commitments
3
Because of the nature of the refinancing indebtedness, participants must be eligible qualified
institutional buyers pursuant to Rule 144A under the Securities Act of 1933.
5
funded with certain classes of notes. In order of priority, for each $100,000 in term
loan commitment, holders of:
(1)
Senior Subordinated Notes would be required to deliver $277,477.484
in principal value of Senior Subordinated Notes, up to an aggregate
value of all term loan commitments funded by Senior Subordinated
Notes of $125 million;
(2)
Senior Cash Notes would be required to deliver $198,709.685 in
principal value of Senior Cash Notes, up to an aggregate value of all
term loan commitments funded by Senior Cash Notes equal to the
difference between $500 million and the aggregate value of term loan
commitments accepted from holders of the Senior Subordinated
Notes;
(3)
Senior Toggle Notes would be required to deliver $212,030.086 in
principal value of Senior Toggle Notes, up to an aggregate value of
the lesser of (a) $175 million and (b) the difference between
$500 million and the aggregate value of term loan commitments
4
Implying a principal value exchange rate of approximately 36 cents on the dollar.
Implying a principal value exchange rate of approximately 50 cents on the dollar.
6
Implying a principal value exchange rate of approximately 47 cents on the dollar.
5
6
accepted from holders of the Senior Subordinated Notes and Senior
Cash Notes combined.7
Thus, the new term loans would be pari passu to the existing indebtedness under
the Credit Agreement as well as the Senior Notes. Unlike the Senior Notes
however, the new term loans would be secured debt. This security would give the
holders of the new term loans an effectively higher priority in any potential
bankruptcy proceeding than any of the Senior Notes or the Senior Subordinated
Notes.
The invitations to participate will expire, unless extended by Realogy, at
midnight New York City time on December 19, 2008.8 Realogy expects the
transaction to close on December 23, 2008.9
On November 24, 2008, counsel for the majority of the Senior Toggle
Noteholders demanded in writing that Realogy confirm that it would terminate the
7
See Realogy Corp., Current Report (Form 8-K), at 2 (Dec. 8, 2008); Realogy Confidential
Information Memorandum for Up To $500,000,000 Second Lien Incremental Term Loans.
While Senior Subordinated Notes and Senior Cash Notes are invited to make commitments for
Term C Loans, the Senior Toggle Notes are instead invited to make commitments for Term D
Loans. Unlike the Term C Loans, Term D Loans have a PIK feature that preserves Realogy’s
ability to capitalize interest under the Senior Toggle Notes. It is anticipated that commitments
funded by the Senior Subordinated Notes and the Senior Cash Notes will exhaust the
$500 million maximum commitment. Thus, although the Toggle Noteholders are nominally
invited to participate in the transaction, it is possible that no commitments funded by Senior
Toggle Notes will be accepted by Realogy. The plaintiff also notes that Apollo owns
approximately $69 million in Senior Subordinated Notes, and has indicated its intention to
participate in the exchange to the maximum extent possible.
8
See Realogy Corp., Current Report (Form 8-K), at 2 (Dec. 8, 2008).
9
Id.
7
proposed exchange transaction, citing inter alia, allegations of certain covenant
breaches of the indenture governing the Senior Toggle Notes (the “Indenture”).10
Realogy replied on November 25, 2008 that it intended to proceed with the
transaction. Later that day, Realogy filed a Current Report with the Securities and
Exchange Commission (the “SEC”) confirming that intention and its rejection of
the noteholders’ position.11
On November 26, 2008, the Trustee similarly demanded that Realogy cure
certain alleged anticipated failures to comply with the terms of the Indenture and
that Realogy immediately terminate the proposed exchange transaction. Included
in the Trustee’s grounds for this demand was the claim that the exchange
transaction would constitute a breach of Section 4.12 of the Indenture.
C.
Procedural History
The Trustee and High River filed the complaint against Realogy in this court
on November 26, 2008. Counts I and II, brought by the Trustee, seek declaratory
judgment that consummation of the transaction without the granting of certain liens
to the Senior Toggle Notes would constitute a breach of Section 4.12 of the
Indenture. Counts III and IV, brought by High River, involve allegations that the
10
Realogy Corp., Indenture for 11.00%/11.75% Senior Toggle Notes due 2014 (Form S-4, Ex.
4.5) (Dec. 18, 2007).
11
Realogy Corp., Current Report (Form 8-K) (Nov. 25, 2008).
8
exchange transaction if consummated would constitute a fraudulent transfer on the
part of Realogy, and are not presently before the court.
On December 1, 2008, the plaintiffs filed a motion to expedite. During a
telephonic conference that afternoon, the parties informed the court that the
plaintiffs’ motion to expedite was unopposed and proposed that cross-motions for
summary judgment on Counts I and II be heard in an expedited manner. The
parties also agreed to stay Counts III and IV.12 Realogy timely filed its answer to
Counts I and II of the complaint on December 8, 2008. The parties submitted
opening briefs on their cross-motions for summary judgment on December 9, 2008
and answering briefs on December 14, 2008. A hearing was held on December 15,
2008.
II.
The legal standard for cross-motions for summary judgment is well settled.
To prevail, each moving party must show that there is “no genuine issue as to any
material fact” and that each party is “entitled to judgment as a matter of law.”13
Where the parties have filed cross-motions for summary judgment and neither
party has argued that there is an issue of material fact, the motions are deemed to
12
Because High River lacks standing on Counts I and II, it has not appeared via counsel with
respect to the present cross-motions for summary judgment.
13
Ct. Ch. R. 56(c); see also Acro Extrusion Corp. v. Cunningham, 810 A.2d 345, 347 (Del.
2002); Williams v. Geier, 671 A.2d 1368, 1375 (Del. 1996).
9
be a stipulation for a decision based on the submitted record.14 However, even
when presented with cross-motions for summary judgment, a court must deny
summary judgment if a material factual dispute exists.15
In deciding a motion for summary judgment, the court must view the facts in
the light most favorable to the nonmoving party.16 The moving party bears the
burden of demonstrating that there is no material question of fact.17 “A party
opposing summary judgment, however, may not merely deny the factual
allegations adduced by the movant.”18 “If the movant puts in the record facts
which, if undenied, entitle him to summary judgment, the burden shifts to the
defending party to dispute the facts by affidavit or proof of similar weight.”19
Summary judgment will not be granted when the record reasonably indicates that a
material fact is in dispute or “if it seems desirable to inquire more thoroughly into
the facts in order to clarify the application of law to the circumstances.”20
14
Ct. Ch. R. 56(h).
Fasciana v. Elec. Data Sys. Corp., 829 A.2d 160, 166-67 (Del. Ch. 2003) (citing Empire of
Am. Relocation Servs., Inc. v. Commercial Credit Co., 551 A.2d 433, 435 (Del. 1988)).
16
Tanzer v. Int’l Gen. Indus., Inc., 402 A.2d 382, 385 (Del. Ch. 1979) (citing Judah v. Delaware
Trust Co., 378 A.2d 624, 632 (Del. 1977)).
17
Id.
18
Tanzer, 402 A.2d at 385.
19
Id.
20
Ebersole v. Lowengrub, 180 A.2d 467, 470 (Del. 1962).
15
10
III.
The Trustee makes a number of arguments as to why the proposed exchange
transaction violates the Indenture. All of the Trustee’s arguments, however, boil
down to variants of the same proposition: the proposed transaction violates the
Credit Agreement. Section 4.12 of the Indenture restricts Realogy’s right to grant
or suffer the existence of liens.21 To the extent that liens are created in favor of
indebtedness which is pari passu to the Senior Toggle Notes, the Senior Toggle
Notes must be granted equal and ratable liens. To the extent that liens are created
in favor of indebtedness which is subordinated to the Senior Toggle Notes, the
Senior Toggle Notes must be granted liens senior to the liens supporting the
subordinated indebtedness. Neither of these restrictions apply, however, if the
created liens qualify as Permitted Liens under the Indenture. The definition of
21
Section 4.12 of the Indenture reads:
The Issuer shall not, and shall not permit any of the Restricted Subsidiaries to, directly or
indirectly, create, Incur or suffer to exist any Lien on any asset or property of the Issuer
or such Restricted Subsidiary securing Indebtedness unless the Notes or, in respect of
Liens on any asset or property of a Restricted Subsidiary, any Note Guarantee of such
Restricted Subsidiary, are equally and ratably secured with (or on a senior basis to, in the
case of obligations subordinated in right of payment to the Notes or the Note Guarantees,
as the case may be) the obligations so secured until such time as such obligations are no
longer secured by a Lien. The preceding sentence shall not require the Issuer or any
Restricted Subsidiary to secure the Notes if the Lien consists of a Permitted Lien. Any
Lien that is granted to secure the Notes or such Note Guarantee under this Section 4.12
shall be automatically released and discharged at the same time as the release of the Lien
that gave rise to the obligation to secure the Notes or such Note Guarantee under Section
4.12.
11
Permitted Liens in the Indenture, under subsection (6)(B), includes liens created
pursuant to the Credit Agreement.22 This much is undisputed between the parties.
The dispute here is whether or not the proposed exchange transaction is
permitted by the Credit Agreement. If it is not, the Trustee argues, it cannot be
incurred “under the Credit Agreement.”23 If it cannot be incurred “under the Credit
Agreement,” it cannot be a Permitted Lien.24 If it is not a Permitted Lien, then
failing to provide the appropriate equal and ratable or senior liens to the Senior
Toggle Notes is a breach of Section 4.12. The Trustee asserts that the proposed
exchange transaction is not permitted under the Credit Agreement, and therefore
22
The definition of Permitted Lien under the Indenture reads, in pertinent part:
“Permitted Lien” means, with respect to any Person:
(6)
(B) Liens securing an aggregate principal amount of Senior Pari Passu
Indebtedness not to exceed the aggregate amount of Senior Pari Passu
Indebtedness permitted to be Incurred pursuant to clauses (1) and (24) of Section
4.09(b).
Section 4.09 of the Indenture reads, in pertinent part:
(a)
(1) The Issuer shall not, and shall not permit any of the Restricted Subsidiaries to,
directly or indirectly, Incur any Indebtedness (including Acquired Indebtedness)
or issue any shares of Disqualified Stock . . . .
(b)
The limitations set forth in Section 4.09(a) hereof shall not apply to:
(1)
the Incurrence by the Issuer or the Restricted Subsidiaries of Indebtedness
under the Credit Agreement and the issuance and creation of letters of
credit and bankers’ acceptances thereunder (with letters of credit and
bankers’ acceptances being deemed to have a principal amount equal to
the face amount thereof) up to an aggregate principal amount of $3,250.0
million at any one time outstanding, less all principal repayments of
Indebtedness Incurred under this clause (1) with the Net Proceeds of Asset
Sales utilized in accordance with Section 4.10(b)(1)(a) that permanently
reduces the commitments thereunder . . . .
23
Indenture § 4.09(b)(1).
24
See Indenture § 1.01, at 27; Indenture § 4.09(b)(1). This assumes, as both parties agree, that
none of the other exceptions under the definition of Permitted Liens in the Indenture could be
applied to the transaction.
12
the transaction, if consummated, would result in a breach of Section 4.12 of the
Indenture. Realogy counters that in fact the transaction is permitted under the
Credit Agreement, and therefore the liens securing the Second Lien Term Loans
constitute Permitted Liens under the Indenture. As a result, Realogy argues, no
breach of Section 4.12 of the Indenture will occur. Because the Credit Agreement
is simply a contract between Realogy, the Lenders, and JPM as administrative
agent, this is simply an exercise in contract interpretation.25
Both the Credit Agreement and the Indenture are to be construed under New
York law, pursuant to choice of law provisions contained in each document.26
“Under New York law, as in Delaware, the construction and interpretation of an
unambiguous written contract is an issue of law within the province of the court.”27
“Included in this initial interpretation is the threshold question of whether the terms
of the contract are ambiguous.”28 “Contractual language whose meaning is
otherwise plain is not ambiguous merely because the parties urge different
25
Cf. Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d 1039, 1049 (2d Cir. 1982)
(stating that under New York law, “[i]nterpretation of indenture provisions is a matter of basic
contract law”).
26
See Credit Agreement § 10.07; Indenture § 12.08.
27
Law Debenture Trust Co. v. Petrohawk Energy Corp., 2007 WL 2248150, at *5 (Del. Ch.),
aff’d mem., 947 A.2d 1121 (Del. 2008); see also K. Bell & Assocs., Inc. v. Lloyd’s Underwriters,
97 F.3d 632, 637 (2d Cir. 1996).
28
Alexander & Alexander Servs. v. These Certain Underwriters at Lloyd’s, London, 136 F.3d 82,
86 (2d Cir. 1998).
13
interpretations in the litigation.”29 “Contract language is unambiguous if it has ‘a
definite and precise meaning, unattended by danger of misconception in the
purport of the [contract] itself, and concerning which there is no reasonable basis
for a difference of opinion.’”30 “Where the [contract’s] language is free from
ambiguity, its meaning may be determined as a matter of law on the basis of the
writing alone without resort to extrinsic evidence.”31 Thus, summary judgment is
an appropriate process for the enforcement of unambiguous contracts because there
are no material disputes of fact for the court to resolve.32
“In interpreting contract language, New York contract law instructs courts
ordinarily to give the words and phrases employed their plain and commonlyaccepted meanings.”33
The parties’ rights under an unambiguous contract should be
fathomed from the terms expressed in the instrument itself rather than
from extrinsic evidence as to terms that were not expressed or judicial
views as to what terms might be preferable. In its efforts to preserve
the parties’ rights and the status quo, the court must be careful not to
alter the terms of the agreement. The parties having agreed upon their
own terms and conditions, “the courts cannot change them and must
not permit them to be violated or disregarded.”34
29
First Lincoln Holdings, Inc. v. Equitable Life Assurance Society, 164 F. Supp. 2d 383, 393
(S.D.N.Y. 2001) (citing U.S. Trust Co. of New York v. Jenner, 168 F.3d 630, 632 (2d Cir. 1999)).
30
Metro. Life Ins. Co. v. RJR Nabisco, Inc., 906 F.2d 884, 889 (2d Cir. 1990) (quoting Breed v.
Ins. Co. of N. Am., 413 N.Y.S.2d 352, 355 (App. Div. 1978)).
31
Master-Built Constr. Co. v. Thorne, 802 N.Y.S.2d 713, 714 (App. Div. 2005).
32
See Reardon v. Exch. Furniture Store, 188 A. 704, 707 (Del. 1936)).
33
Petrohawk, 2007 WL 2248150, at *6.
34
RJR Nabisco, Inc., 906 F.2d at 889 (some internal citations and quotations omitted) (quoting
Whiteside v. North American Accident Ins. Co., 93 N.E. 948, 950 (N.Y, 1911)).
14
The parties agree that the Credit Agreement is unambiguous, although they
disagree in certain key aspects as to its meaning. The Trustee, to whom the burden
of proving that the proposed transaction is not permitted under the Credit
Agreement falls,35 essentially advances two arguments.36 First, the Trustee asserts,
because the proposed Second Lien Term Loans are to be funded with tendered
notes and not with cash, the Second Lien Term Loans cannot qualify as Loans
under the Credit Agreement. Second, even if the Second Lien Term Loans are
Loans under the Credit Agreement, those Loans would violate the negative
covenants contained in Section 6.09 of the Credit Agreement. Each of these
positions will be taken in turn.
IV.
The Trustee urges that the Second Lien Term Loans cannot be Loans under
the Credit Agreement because they are not funded in cash. In support of its
position, the Trustee makes two basic arguments: (1) the plain meaning of “loan”
does not encompass non-cash funded transactions; (2) non-cash funded loans are in
any event not permitted by the terms of the Credit Agreement.
35
Cf. In re Loral space * Commc’ns Inc. Consol. Litig., 2008 WL 4293781, at *35 (Del. Ch.)
(“Indentures are to be read strictly and to the extent they do not expressly restrict the rights of
the issuer, the issuer is left with the freedom to act, subject only to the boundaries of other
positive law.”).
36
See Pls.’ Opening Br. § II; Pls.’ Answering Br. § I.
15
A.
Does “Loan” Necessarily Imply Cash Funding?
Realogy purports that the new Second Lien Term Loans will be created as
Other Term Loans pursuant to Section 2.20 of the Credit Agreement.37 “Other
Term Loans” is defined in Section 2.20 as “term loans with pricing and/or
amortization terms different from the Term B Loans.” The Trustee argues that the
plain meaning of the word “loans” does not permit for the funding of borrowings
other than in cash. Thus, because the borrowings will not be funded with cash,
they cannot be Other Term Loans, and therefore cannot be authorized under
Section 2.20.
The court finds this argument uncompelling. The fundamental feature of a
loan is the advancement of some valuable property in exchange for a promise to
repay that advancement.38 Generally the repayment is required to be in cash, even
if the initial value given is not. There are many commercial examples of loans
37
Section 2.20 of the Credit Agreement reads, in pertinent part:
(a) The Borrower may, by written notice to the Administrative Agent from time to time,
request Incremental Term Loan Commitments . . . , in an amount not to exceed the
Incremental Amount from one or more Incremental Term Lenders . . . (which may
include any existing Lender) willing to provide such Incremental Term Loans . . ., in
their own discretion . . . . Such notice shall set forth . . . (iv) in the case of Incremental
Term Loan Commitments, whether such Incremental Term Loan Commitments are to be
Term Loan Commitments or commitments to make term loans with pricing and/or
amortization terms different from the Term B Loans (“Other Term Loans”).
38
See In re Renshaw, 222 F.3d 82, 88 (2d Cir. 2000) (interpreting the term loan “according to its
settled meaning under the common law”). Renshaw states, “[t]o constitute a loan there must be
(i) a contract, whereby (ii) one party transfers a defined quantity of money, goods, or services, to
another, and (iii) the other party agrees to pay for the sum or items transferred at a later date.”
Id.
16
which are not funded in cash but which are repaid in cash, such as traditional
vendor and seller financing agreements.39 The fact that loans under credit
agreements are typically funded in cash does not mean that the word “loan” cannot
even in that context encompass borrowings funded otherwise. Moreover, such
hyper-technical arguments seem out of place when made by a non-party to the
contract being interpreted.
B.
Does The Credit Agreement Require Loans To Be Funded With Cash?
The Trustee relies on a number of provisions, taken in the aggregate, in an
attempt to prove that the Credit Agreement does not permit the creation of loans
funded other than with cash. These arguments fundamentally fall into two
categories: (1) arguments based on the use of loan denominations in terms of
amounts of currency; and (2) arguments based on various procedural and
ministerial provisions.
1.
Arguments Based On Currency Terms
The Trustee points out that the Credit Agreement frequently speaks about
loans in terms of quantities of currency, and cites to these provisions as evidence
that only cash loans are permitted. First, the Trustee points out, Section 2.01(d)
39
The court also notes the existence of “consolidation loans” for student loan indebtedness.
These consolidation loans are often offered by the same lender that made the original loans to
the student borrower. Thus a lender funds the new consolidation loan by tendering all of the
borrower’s earlier incurred promissory notes. The lender then takes back from the borrower a
new promissory note evidencing the aggregate indebtedness. This new promissory note often
contains materially different terms than the original notes.
17
requires lenders to make Incremental Term Loans (which includes Other Term
Loans) “in an aggregate principal amount not to exceed its Incremental Term Loan
Commitment.” “Principal,” the Trustee says, refers to the amount of money that
Realogy will receive in the borrowing. The Trustee then points to Section
2.20(a)(ii) as evidence that the Incremental Term Loan Commitment is
denominated in dollars.40 Thus, the Trustee says, “[n]one of these word choices
makes any sense except with reference to loans funded by cash.”41
The court is unconvinced. The use of the term “principal,” denominated in
dollars, still has an obvious meaning with respect to the Second Lien Term Loans.
It is the amount that Realogy will be required to repay to the Incremental Term
Lenders upon maturation of the Second Lien Term Loans. This is no different than
any other term loan, whether originally funded in cash or other valuable
consideration. Similarly, the reasoning for denominating the Incremental Term
Loan Commitments in dollars is applicable to term loans regardless of their means
of funding. The Incremental Term Loan Commitment of an Incremental Term
Lender indicates the maximum value he will be required to deliver under his
commitment. He may be asked to fund in cash, or in notes, or otherwise. But he
40
Section 2.20(a)(ii) states “the aggregate amount of all Incremental Term Loan Commitments
and Incremental Revolving Facility Commitments, when taken together with all other
Incremental Commitments, shall not exceed $650.0 million in the aggregate . . . .”
41
Pls.’ Answering Br. 10.
18
can be assured that he will not be asked to deliver consideration of value any
greater than the dollar value of his Incremental Term Loan Commitment.
The Trustee also focuses briefly on the use in Section 2.20 of the Credit
Agreement of certain terms which it argues are indicative of the requirement that
funding be in cash. In reference to the Incremental Term Loans, Section 2.20 in
various places refers to lenders “mak[ing] term loans” or “provid[ing] loans” in an
“amount” specified by Realogy.42 For the the same reasons set forth above, these
are uncompelling arguments.
The Trustee lastly points to the reference to the “application of the proceeds”
of incremental loans in Section 2.20, arguing that this is likewise proof of the
necessity of funding the loans in cash.43 Reading the clause which refers to
“proceeds” in context obviates the need for such an interpretation. Section
2.20(c)(iii) requires that at the time new loans are made Realogy be in compliance,
on a pro forma basis, with certain financial performance covenants after giving
effect to the loans made and the application of the proceeds from those loans.44 In
the case of the Second Lien Term Loans, the application of the proceeds would
42
See Pls.’ Answering Br. 12.
Id.
44
Section 2.20(c)(iii) of the Credit Agreement states:
[T]he Borrower shall be in Pro Forma Compliance after giving effect to such Incremental
Term Loan Commitment and/or Incremental Revolving Facility Commitments, the Loans
to be made thereunder and the application of the proceeds therefrom as if made and
applied on such date.
43
19
mean the cancellation of the prior indebtedness evidenced by the surrendered
notes. This would result in a decrease in both the unsecured debt of Realogy and
the annual interest expense of Realogy. This decrease could be a key factor in
determining whether Realogy would conform with its financial performance
covenants under the Credit Agreement after giving effect to the new term loans.
The reference to the “application of proceeds” in Section 2.20(c)(iii) is therefore
just as vital in the note-funded loan context as in the cash-funded one.
2.
Arguments Based On Procedural And Ministerial Terms
The Trustee points to certain procedural and administrative provisions of the
Credit Agreement as evidence that only cash-funded loans are permitted. Section
2.03, entitled “Requests for Borrowings,” requires that as part of the required
notice of a borrowing request, Realogy “shall specify . . . the location and number
of the Borrower’s account to which funds are to be disbursed.”45 Because, the
Trustee argues, Section 2.03 states that Realogy “shall specify” bank account
information in borrowing requests, it must be that all loans are required to be
funded in cash. “Otherwise,” the Trustee seemingly asks, “why require the bank
account?”
The Trustee makes too much of this provision. The purpose of Section 2.03
is to specify the process for initiating a loan. In a typical borrowing under the
45
See Credit Agreement § 2.03(vi).
20
Credit Agreement, the new loan will be funded in cash. It will therefore of course
be necessary for JPM as the administrative agent to disburse the funds to Realogy.
In order to facilitate this process, the borrowing request procedure thus “requires”
an account into which funds are to be disbursed. It proves too much, however, to
read this as permitting only transactions in which a disbursal account would be
necessary. Such a requirement would prohibit transactions explicitly anticipated
and authorized by the very same section of the Credit Agreement. Section 2.03
permits Realogy to request a new revolving loan in order to fund an obligation to
reimburse a letter of credit disbursement.46 The creation of such a loan requires no
disbursement of funds. Rather, the loan is created in consideration of the
extinguishment of Realogy’s obligation to reimburse the Lenders for funding under
a letter of credit drawn on the credit facility. Thus, if Section 2.03 were read to
prohibit transactions that did not require the disbursal of cash to bank accounts, a
nonsensical result would occur. Under that interpretation, the Credit Agreement
46
Section 2.03 of the Credit Agreement requires that “any such notice of an ABR Revolving
Facility Borrowing to finance the reimbursement of an L/C Disbursement as contemplated by
Section 2.05(e) may be given not later than 10:00 a.m., Local Time, on the date of the proposed
Borrowing.” Section 2.05(e)(i) reads, in pertinent part:
If the applicable Issuing Bank shall make any L/C Disbursement in respect of a Letter of
Credit, the Borrower shall reimburse such L/C Disbursement by paying to the
Administrative Agent an amount equal to such L/C Disbursement in Dollars . . . ;
provided, that, in the case of any L/C Disbursement made in Dollars, the Borrower may,
subject to the conditions to borrowing set forth herein, request in accordance with
Section 2.03 or 2.04 that such payment be financed with an ABR Revolving Facility
Borrowing . . . in an equivalent amount and, to the extent so financed, the Borrower’s
obligation to make such payment shall be discharged and replaced by the resulting ABR
Resolving Facility Borrowing . . . .
21
would, in Section 2.03, specify the rules for initiating the revolver draw to fund the
letter of credit repayment obligation, then go on to forbid that same transaction.
This cannot possibly be right. The better reading is that Section 2.03 places
procedural requirements on the initiation of borrowings, and not substantive
requirements on the form of the borrowing transaction.
The Trustee makes similar arguments with respect to Section 2.06 of the
Credit Agreement.47 For the same reasons, these arguments cannot prevail.48
47
See Pls.’ Answering Br. 10. Section 2.06(a) of the Credit Agreement states, in pertinent part:
Each Lender shall make each Loan to be made by it hereunder on the proposed date
thereof by wire transfer of immediately available funds by 12:00 noon, Local Time, to
the account of the Administrative Agent most recently designated by it for such purpose
by notice to the Lenders . . . . The Administrative Agent will make such Loans available
to the Borrower by promptly crediting the amounts so received, in like funds, to an
account of the Borrower as specified in the Borrowing Request; provided, that ABR
Revolving Loans . . . made to finance the reimbursement of a L/C Disbursement and
reimbursements as provided in Section 2.05(e) shall be remitted by the Administrative
Agent by the Administrative Agent to the applicable Issuing Bank.
48
The court finds the Trustee’s argument that the Credit Agreement forbids the proposed
transaction because it is not funded in cash unconvincing for another reason as well. The
Trustee does not appear to dispute that (at least in the absence of the restriction in Section 6.09
discussed below) the proposed refinancing would be permissible if the Second Lien Term Loans
were funded in cash. Thus, for example, the noteholders could hypothetically be invited to
commit to fund (in cash) Incremental Term Loans under the Credit Agreement. In order to
participate as Incremental Term Lenders, the noteholders would also have to tender their notes
for redemption at an announced price. (Specifically, the noteholders would be required to tender
their notes for redemption at the price implied by the present exchange offer. See supra, I.B.
notes 4-6 and accompanying text.) Noteholders would only be allowed to offer commitments up
to the exchange value of the notes they were tendering.
On the closing date, the participating noteholders would then wire their commitments to
JPM, who would in turn wire the aggregate amount to Realogy. Realogy would then wire the
whole thing back to JPM Securities. JPM Securities, acting as dealer-manager, would use the
wired funds to take up the tendered notes, delivering the funds to the tendering noteholders. Of
course, these would be the same parties as the Incremental Term Lenders. Moreover, each
lender would receive the exact amount of cash they had remitted at the beginning of this Rube
Goldberg-esque hypothetical transaction. (continued . . .)
22
V.
The Trustee also urges that the proposed transaction is prohibited by the
negative covenants contained in Section 6.09 of the Credit Agreement.
Specifically, the Trustee argues, the refinancing of the Senior Notes with the
Second Lien Term Loans does not constitute Permitted Refinancing Indebtedness
under the Credit Agreement.49 Thus, the Trustee argues, the proposed exchange
transaction for the Senior Notes is prohibited by Section 6.09(b)(i). Because the
language of the Credit Agreement is more than a little complex, a short overview is
in order.
Article VI of the Credit Agreement contains a series of negative covenants
which restrict Realogy’s ability to take certain actions.50 Section 6.09(b) addresses
The entire transfer of money from the lenders, to JPM, to Realogy, to a JPM affiliate, and
back to the lenders, would have, taken as a whole, no economic reality whatsoever. The final
state of affairs, meanwhile, would be identical to that of the actual proposed transaction. The
tendered notes would be cancelled, and in their place the Incremental Term Lenders would now
hold new Second Lien Term Loans. Thus, in the Trustee’s view, the actual proposed transaction,
while far simpler and more efficient, would be prohibited. Meanwhile, the economically
equivalent hypothetical transaction, with all its unnecessary complication, would be permitted.
It strikes the court as less than commercially reasonable that the parties to the Credit Agreement
would have intended such a result, at least in the absence of more explicit language requiring it.
It only tends to fuel the court’s skepticism that it is a non-party to the Credit Agreement that
urges this absurdist conclusion, purely for its own benefit.
49
Both parties agree that as to the Senior Subordinated Notes, the proposed exchange cannot,
and need not, meet the requirements for Permitted Financing Indebtedness. This is because only
$125 million of Second Lien Term Loans will be offered in exchange for Senior Subordinated
Notes. This allows the proposed exchange transaction for the Senior Subordinated Notes to fit
within the $150 million basket in Section 6.09(b)(i)(F). See infra, note 51.
50
The preamble to Article VI states, in pertinent part:
The Borrower covenants and agrees with each lender that, so long as this Agreement
shall remain in effect . . ., unless the Required Lenders shall otherwise consent in writing,
the Borrower will not, and will not permit any of the Material Subsidiaries to:
23
limitations on Realogy’s right to make payments on the “Notes,” which is a
defined term encompassing both the Senior Notes and the Senior Subordinated
Notes. Unless a specific exception exists, Section 6.09(b)(i) flatly prohibits any
payment of principal or interest, or any distribution of property in redemption or
exchange for the Notes.51 The key provision at issue here is found in Section
6.09(b)(i)(A), which excepts refinancings permitted by Section 6.01(l).
Section 6.01 contains a general prohibition against the incurrence of new
indebtedness by Realogy, subject to a litany of exceptions. Section 6.01(l) enables
Realogy to initially incur the debt under the Senior and Senior Subordinated Notes.
Each section of Article VI is then devoted to a specific category of prohibited activity. The
sections generally begin with a broad prohibition, which is then followed by a series of
exceptions.
51
Section 6.09(b)(i) of the Credit Agreement reads, in pertinent part:
[Realogy covenants not to] [m]ake, or agree to pay or make, directly or indirectly, any
payment or other distribution (whether in cash, securities or other property) of or in
respect of principal or of interest on Indebtedness outstanding under the Notes or any
Permitted Refinancing Indebtedness in respect thereof . . . (“Junior Financing”), or any
payment or other distribution (whether in cash, securities or other property), including
any sinking fund or similar deposit, on account of the purchase, redemption, retirement,
acquisition, cancellation or termination in respect of any Junior Financing except for
(A)
Refinancings permitted by Section 6.01(l), (r), or (v),
(B)
payments of regularly scheduled interest, and, to the extent this Agreement is then
in effect, principal on the scheduled maturity date of any Junior Financing,
*
*
*
(F)
so long as no Default or Event of Default has occurred and is continuing or would
result therefrom and after giving effect to such payment or distribution the
Borrower would be in Pro Forma Compliance, payments or distributions in
respect of Junior Financings prior to their scheduled maturity made, in an
aggregate amount, not to exceed . . . (x) $150 million . . . .
24
It also permits Realogy to incur Permitted Refinancing Indebtedness in order to
refinance the Senior and Senior Subordinated Notes.52
Permitted Refinancing Indebtedness is defined, subject to a number of
significant restrictions, to be any indebtedness issued in exchange for, or the net
proceeds of which are used to refinance, the indebtedness being refinanced.53 The
parties do not dispute the proposed transaction’s conformance with the majority of
those restrictions. The restriction at issue is contained in subpart (d) of the
definition.54
52
Section 6.01(l) of the Credit Agreement provides, in pertinent part:
[Realogy shall not incur, create, assume or permit to exist any Indebtedness, except:]
(l)
Indebtedness of the Borrower pursuant to (i) the Senior Unsecured Notes in an
aggregate principal amount that is not in excess of $2,250.0 million (plus any
interest paid by increases to principal), (ii) the Senior Subordinated Notes in an
aggregate principal amount that is not in excess of $900.0 million, and (iii) any
Permitted Refinancing Indebtedness incurred to Refinance such Indebtedness.
53
Section 1.01 of the Credit Agreement defines Permitted Refinancing Indebtedness to mean, in
pertinent part:
“Permitted Refinancing Indebtedness” shall mean any Indebtedness issued in exchange
for, or the net proceeds of which are used to extend, refinance, renew, replace, defease or
refund (collectively, to “Refinance”), the Indebtedness being Refinanced (or previous
refinancings thereof constituting Permitted Refinancing Indebtedness); provided that . . .
(d) no Permitted Refinancing Indebtedness shall have different obligors, or greater
guarantees or security, than the Indebtedness being Refinanced; (provided that
(i) Indebtedness (other than the Notes) (A) of any Loan Party may be Refinanced to add
or substitute as an obligor another Loan Party that is reasonably satisfactory to the
Administrative Agent and (B) of any Subsidiary that is not a Loan Party may be
Refinanced to add or substitute as an obligor another Subsidiary that is not a Loan Party
and is reasonably satisfactory to the administrative Agent and (ii) other guarantees and
security may be added to the extent then permitted under Article VI) . . . .
54
Although the Trustee asserts that the proposed transaction also fails to comply with subpart (e)
of the definition of Permitted Refinancing Indebtedness, this argument lacks any merit
whatsoever. On its face, subpart (e) only applies “if the Indebtedness being Refinanced is
secured by any collateral . . . .” The refinanced indebtedness at issue here is the Senior Notes,
which are unsecured. Thus subpart (e) cannot be applicable to the present transaction.
25
Subpart (d) contains an admittedly strange structure. It begins by flatly
prohibiting the granting of greater security to the Permitted Refinancing
Indebtedness than the indebtedness being refinanced had. It then contains a
notable proviso. Subpart (d)(ii) provides that “other guarantees and security may
be added to the extent then permitted under Article VI . . . .” It is the meaning of
this proviso which the parties dispute.
It is clear that absent the proviso in subpart (d)(ii), the proposed exchange
transaction would as presently structured be prohibited. The proposed Second
Lien Term Loans are secured. The Senior Notes are unsecured. The refinancing
indebtedness would thus have greater security than the indebtedness being
refinanced.
But what then of subpart (d)(ii)? Realogy argues that it means that,
notwithstanding the prohibition in the initial part of subpart (d), if the security
interest being granted is permitted by the negative covenants of Article VI, it may
be added to the refinancing indebtedness. Realogy then points to Section 6.02(b),
which permits the creation of liens under the Loan Documents, which includes the
Credit Agreement. Since Article VI permits the creation of liens under the Credit
Agreement, Realogy argues, those liens may be “added” to the Permitted
Refinancing Indebtedness over and above the security to which the refinanced
indebtedness was entitled, by virtue of subpart (d)(ii).
26
The Trustee responds that such an interpretation of subpart (d)(ii) would
make (d)(ii) the exception that swallows the rule of subpart (d). Because any
transaction would ultimately be required to meet the restrictions contained in
Article VI, the existence or non-existence of subpart (d) would have no effect on
the ability of Realogy to lien up refinancing indebtedness. In other words, with
respect to the granting of security interests to Permitted Refinancing Indebtedness,
subpart (d) as to the definition of that term would be mere surplusage. The Trustee
argues that because interpretations of an unambiguous contract that render
provisions meaningless are disfavored under the law,55 that this interpretation is
wrong.56
Instead, the Trustee urges, subpart (d)(ii) means that to the extent that the
indebtedness being refinanced could then be liened up in accordance with Article
VI, the corresponding Permitted Refinancing Indebtedness would likewise be
allowed to be liened up. Thus, for example, certain unsecured notes might be
55
See, e.g., Whitebox Convertible ArbitragePartners, L.P. v. IVAX Corp., 482 F.3d 1018, 102122 (8th Cir. 2007) (applying New York law to a trust indenture).
56
The Trustee also makes a gratuitous argument that if the Credit Agreement meant sections
other than 6.01(l), (r), or (v) to act as exceptions to Section 6.09(b)(i), it would have explicitly
listed them along with sections 6.01(l), (r) and (v) in Section 6.09(b)(i)(A). This argument is
wrong for two reasons. First, even under Realogy’s interpretation, none of the provisions of
Article VI become additional exceptions to Section 6.09(b)(i). Although subpart (d)(ii) may
eviscerate the restrictions on the adding of security contained in the beginning of subpart (d), the
other restrictions on Permitted Refinancing Indebtedness contained in subparts (a) through (c)
and (e) would remain unaffected. Second, as a practical matter, if every indirect reference to a
provision in the Credit Agreement were expanded out, it would turn the document from difficult
to read into impossible to read.
27
permitted to be granted security under certain conditions. To the extent those
conditional rights had vested, such security could be added when refinancing those
notes.
The Trustee’s interpretation is the better one. It renders all of subpart (d)
meaningful, without turning any of it into apparent surplusage. The alternative
interpretation would allow a mere proviso clause to entirely sap the vitality of what
would otherwise be a significant restriction.
There is no right in the Senior Notes to additional security, nor is there any
provision in Section 6.02 that would permit it. As a result, the refinancing of the
Senior Notes with Second Lien Term Loans does not qualify as Permitted
Refinancing Indebtedness. The exception in Section 6.01(l) to the general
prohibition under Section 6.09(b)(i) of the Credit Agreement therefore does not
apply. Lacking any other applicable exception under Section 6.09(b)(i), the
Second Lien Term Loans (and the liens supporting them) are prohibited under
Section 6.09 of the Credit Agreement. The Second Lien Term Loans therefore
cannot constitute indebtedness “under the Credit Agreement.”57 As such, the liens
supporting the Second Lien Term Loans do not constitute Permitted Liens under
subsection (6)(B) of the definition of Permitted Liens in the Indenture. The
defendant can point to no other provision of the definition of Permitted Liens to
57
Indenture § 4.09(b)(1).
28
require a different outcome. The creation of these liens is therefore not exempted
from the requirements of Section 4.12 of the Indenture. As such, the proposed
transaction if consummated will constitute a breach of the Indenture.
Realogy argues that, even if the current terms of the Credit Agreement do
not permit the proposed transaction, by virtue of Section 2.20(b), the Credit
Agreement is automatically deemed amended to permit it.58 Realogy further avers,
and offers evidence to show that, JPM as administrative agent has approved and
will execute the Incremental Assumption Agreement for the Second Lien Term
Loans.
Realogy’s argument reads the words of Section 2.20(b) too selectively.
Section 2.20 of the Credit Agreement reads, in pertinent part:
Each of the parties hereto hereby agrees that, upon the effectiveness of
any Incremental Assumption Agreement, this Agreement shall be
amended to the extent (but only to the extent) necessary to reflect the
existence and terms of the Incremental Term Loan Commitments . . .
evidenced thereby as provided for in Section 10.08(e). Any such
deemed amendment may be memorialized in writing by the
Administrative Agent with the Borrower’s Consent (not to be
unreasonably withheld) and furnished to the other parties hereto.
From this alone, the clear import of the language is that execution of the
Incremental Assumption Agreement acts to amend the Credit Agreement to
incorporate the terms of the new Term Loans. This does not mean, however, that
58
Def.’s Answering Br. 23.
29
prohibited transactions under the Credit Agreement are transmogrified into
permitted transactions by virtue of engaging in them under the accordion facility.
In case there might be any doubt as to the matter, Section 10.08(e) removes it.
Section 10.08(e) reads:
Notwithstanding the foregoing, technical and conforming
modifications to the Loan Documents may be made with the consent
of the Borrower and the Administrative Agent to the extent necessary
to integrate any Incremental Term Loan Commitments or Incremental
Revolving Facility Commitments on substantially the same basis as
the Term Loans or Revolving Facility Loans, as applicable.
Read together, it is clear that Section 2.20(b) and 10.08(e) only permit “technical
and conforming modifications” to the terms of the Credit Agreement by virtue of
the consent of Realogy and the administrative agent alone. Whatever else a
modification that eviscerates a prohibition under the negative covenants of Article
VI may be, it is not “technical and conforming.” Section 2.20(b) is thus no help to
Realogy’s predicament. If Realogy wishes to engage in the proposed transaction, it
would need to obtain agreement from the required number of its bank lenders to
amend or waive certain provisions of the Credit Agreement.59
59
The court notes the irony contained in the present situation. The Trustee, a non-party to the
Credit Agreement, is suing to enforce a document whose terms are not for the Trustee’s benefit.
Moreover, those terms can be amended to remedy the prohibitions the Trustee relies on at any
time, without the consent of the Trustee or the Senior Toggle Noteholders. Thus, as to the
Trustee and the Senior Toggle Noteholders, it is little more than fortunate happenstance that they
are able to find a provision in the Credit Agreement on which to rely to block the proposed
transaction. Nevertheless, the court must construe the agreements as they stand, not as they
might be.
30
VI.
For the reasons set forth above, judgment for the plaintiffs is granted as to
Counts I and II. Counsel for the plaintiffs shall submit an order in conformity with
this opinion, on notice, by Monday, December 22, 2008.
31
SUPREME COURT OF CANADA
CITATION: BCE Inc. v. 1976 Debentureholders, 2008 SCC 69 DATE OF JUDGMENT:
20080620
REASONS DELIVERED:
20081219
DOCKET: 32647
BETWEEN:
BCE Inc. and Bell Canada
Appellants / Respondents on cross-appeals
and
A Group of 1976 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Assurance Company of Canada, CIBC Global Asset Management Inc., Her Majesty the
Queen in Right of Alberta, as represented by the Minister of Finance, Manitoba Civil
Service Superannuation Board, TD Asset Management Inc. and Manulife Financial
Corporation
A Group of 1996 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Insurance (Canada) Limited, CIBC Global Asset Management Inc., Manitoba Civil Service
Superannuation Board and TD Asset Management Inc.
A Group of 1997 Debentureholders composed of: Addenda Capital Management Inc.,
Manulife Financial Corporation, Phillips, Hager & North Investment Management Ltd.,
Sun Life Assurance Company of Canada, CIBC Global Asset Management Inc., Her
Majesty the Queen in Right of Alberta, as represented by the Minister of Finance,
Wawanesa Life Insurance Company, TD Asset Management Inc., Franklin Templeton
Investments Corp. and Barclays Global Investors Canada Limited
Respondents / Appellants on cross-appeals
and
Computershare Trust Company of Canada
and CIBC Mellon Trust Company
Respondents
- and Director Appointed Pursuant to the CBCA, Catalyst Asset
Management Inc. and Matthew Stewart
Interveners
AND BETWEEN:
6796508 Canada Inc.
Appellant / Respondent on cross-appeals
and
A Group of 1976 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Assurance Company of Canada, CIBC Global Asset Management Inc., Her Majesty the
Queen in Right of Alberta, as represented by the Minister of Finance, Manitoba Civil
Service Superannuation Board, TD Asset Management Inc. and Manulife Financial
Corporation
A Group of 1996 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Insurance (Canada) Limited, CIBC Global Asset Management Inc., Manitoba Civil Service
Superannuation Board and TD Asset Management Inc.
A Group of 1997 Debentureholders composed of: Addenda Capital Management Inc.,
Manulife Financial Corporation, Phillips, Hager & North Investment Management Ltd.,
Sun Life Assurance Company of Canada, CIBC Global Asset Management Inc., Her
Majesty the Queen in Right of Alberta, as represented by the Minister of Finance,
Wawanesa Life Insurance Company, TD Asset Management Inc., Franklin Templeton
Investments Corp. and Barclays Global Investors Canada Limited
Respondents / Appellants on cross-appeals
and
Computershare Trust Company of Canada
and CIBC Mellon Trust Company
Respondents
- and Director Appointed Pursuant to the CBCA, Catalyst Asset
Management Inc. and Matthew Stewart
Interveners
CORAM: McLachlin C.J. and Bastarache,* Binnie, LeBel, Deschamps, Abella and Charron JJ.
REASONS FOR JUDGMENT:
(paras. 1 to 167)
The Court
* Bastarache J. joined in the judgment of June 20, 2008, but took no part in these reasons for
judgment.
NOTE: This document is subject to editorial revision before its reproduction in final form in the
Canada Supreme Court Reports.
______________________________
bce v. 1976 debentureholders
BCE Inc. and Bell Canada
Appellants/Respondents on cross-appeals
v.
A Group of 1976 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Assurance Company of Canada, CIBC Global Asset Management Inc., Her Majesty
the Queen in Right of Alberta, as represented by the Minister of Finance, Manitoba
Civil Service Superannuation Board, TD Asset Management Inc. and Manulife
Financial Corporation
A Group of 1996 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Insurance (Canada) Limited, CIBC Global Asset Management Inc., Manitoba Civil
Service Superannuation Board and TD Asset Management Inc.
A Group of 1997 Debentureholders composed of: Addenda Capital Management Inc.,
Manulife Financial Corporation, Phillips, Hager & North Investment Management
Ltd., Sun Life Assurance Company of Canada, CIBC Global Asset Management Inc.,
Her Majesty the Queen in Right of Alberta, as represented by the Minister of Finance,
Wawanesa Life Insurance Company, TD Asset Management Inc., Franklin Templeton
Investments Corp. and Barclays Global Investors
Respondents/Appellants
Canada Limited on cross-appeals
and
Computershare Trust Company of Canada
and CIBC Mellon Trust Company
and
Respondents
Director Appointed Pursuant to the CBCA, Catalyst Asset
Management Inc. and Matthew Stewart
Interveners
and between
6796508 Canada Inc.
Appellant/Respondent on cross-appeals
v.
A Group of 1976 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Assurance Company of Canada, CIBC Global Asset Management Inc., Her Majesty
the Queen in Right of Alberta, as represented by the Minister of Finance, Manitoba
Civil Service Superannuation Board, TD Asset Management Inc. and Manulife
Financial Corporation
A Group of 1996 Debentureholders composed of: Aegon Capital Management Inc.,
Addenda Capital Inc., Phillips, Hager & North Investment Management Ltd., Sun Life
Insurance (Canada) Limited, CIBC Global Asset Management Inc., Manitoba Civil
Service Superannuation Board and TD Asset Management Inc.
A Group of 1997 Debentureholders composed of: Addenda Capital Management Inc.,
Manulife Financial Corporation, Phillips, Hager & North Investment Management
Ltd., Sun Life Assurance Company of Canada, CIBC Global Asset Management Inc.,
Her Majesty the Queen in Right of Alberta, as represented by the Minister of Finance,
Wawanesa Life Insurance Company, TD Asset Management Inc., Franklin Templeton
Investments Corp. and Barclays Global Investors
Respondents/Appellants
Canada Limited on cross-appeals
and
Computershare Trust Company of Canada
and CIBC Mellon Trust Company
Respondents
and
Director Appointed Pursuant to the CBCA, Catalyst Asset
Management Inc. and Matthew Stewart
Interveners
Indexed as: BCE Inc. v. 1976 Debentureholders
Neutral citation: 2008 SCC 69.
File No.: 32647.
2008: June 17; 2008: June 20.
Reasons delivered: December 19, 2008.
Present: McLachlin C.J. and Bastarache,* Binnie, LeBel, Deschamps, Abella and
Charron JJ.
on appeal from the court of appeal for quebec
Commercial law — Corporations — Oppression — Fiduciary duty of directors
of corporation to act in accordance with best interests of corporation — Reasonable
*
Bastarache J. joined in the judgment of June 20, 2008, but took no part in these
reasons for judgment.
expectation of security holders of fair treatment — Directors approving change of control
transaction which would affect economic interests of security holders — Whether evidence
supported reasonable expectations asserted by security holders — Whether reasonable
expectation was violated by conduct found to be oppressive, unfairly prejudicial or that
unfairly disregards a relevant interest — Canada Business Corporations Act, R.S.C. 1985,
c. C-44, ss. 122(1)(a), 241.
Commercial law — Corporations — Plan of arrangement — Proposed plan of
arrangement not arranging rights of security holders but affecting their economic interests
— Whether plan of arrangement was fair and reasonable — Canada Business Corporations
Act, R.S.C. 1985, c. C-44, s. 192.
At issue is a plan of arrangement that contemplates the purchase of the shares
of BCE Inc. (“BCE”) by a consortium of purchasers (“the Purchaser”) by way of a leveraged
buyout. After BCE was put “in play”, an auction process was held and offers were submitted
by three groups. All three offers contemplated the addition of a substantial amount of new
debt for which Bell Canada, a wholly-owned subsidiary of BCE, would be liable. BCE’s
board of directors found that the Purchaser’s offer was in the best interests of BCE and
BCE’s shareholders. Essentially, the arrangement provides for the compulsory acquisition
of all of BCE’s outstanding shares. The price to be paid by the Purchaser represents a
premium of approximately 40 percent over the market price of BCE shares at the relevant
time. The total capital required for the transaction is approximately $52 billion, $38.5 billion
of which will be supported by BCE. Bell Canada will guarantee approximately $30 billion
of BCE’s debt. The Purchaser will invest nearly $8 billion of new equity capital in BCE.
The plan of arrangement was approved by 97.93 percent of BCE’s shareholders,
but was opposed by a group of financial and other institutions that hold debentures issued
by Bell Canada. These debentureholders sought relief under the oppression remedy under
s. 241 of the Canada Business Corporations Act (“CBCA”). They also alleged that the
arrangement was not “fair and reasonable” and opposed court approval of the arrangement
under s. 192 of the CBCA. The crux of their complaints is that, upon the completion of the
arrangement, the short-term trading value of the debentures would decline by an average of
20 percent and could lose investment grade status.
The Quebec Superior Court approved the arrangement as fair and dismissed the
claim for oppression. The Court of Appeal set aside that decision, finding the arrangement
had not been shown to be fair and held that it should not have been approved. It held that
the directors had not only the duty to ensure that the debentureholders’ contractual rights
would be respected, but also to consider their reasonable expectations which, in its view,
required directors to consider whether the adverse impact on debentureholders’ economic
interests could be alleviated. Since the requirements of s. 192 of the CBCA were not met,
the court found it unnecessary to consider the oppression claim. BCE and Bell Canada
appealed the overturning of the trial judge’s approval of the plan of arrangement, and the
debentureholders cross-appealed the dismissal of the claims for oppression.
Held: The appeals should be allowed and the cross-appeals dismissed.
The s. 241 oppression action and the s. 192 requirement for court approval of a
change to the corporate structure are different types of proceedings, engaging different
inquiries. The Court of Appeal’s decision rested on an approach that erroneously combined
the substance of the s. 241 oppression remedy with the onus of the s. 192 arrangement
approval process, resulting in a conclusion that could not have been sustained under either
provision, read on its own terms. [47] [165]
1. The Section 241 Oppression Remedy
The oppression remedy focuses on harm to the legal and equitable interests of
a wide range of stakeholders affected by oppressive acts of a corporation or its directors.
This remedy gives a court a broad jurisdiction to enforce not just what is legal but what is
fair. Oppression is also fact specific: what is just and equitable is judged by the reasonable
expectations of the stakeholders in the context and in regard to the relationships at play. [45]
[58-59]
In assessing a claim of oppression, a court must answer two questions: (1) Does
the evidence support the reasonable expectation asserted by the claimant? and (2) Does the
evidence establish that the reasonable expectation was violated by conduct falling within the
terms “oppression”, “unfair prejudice” or “unfair disregard” of a relevant interest? For the
first question, useful factors from the case law in determining whether a reasonable
expectation exists include: general commercial practice; the nature of the corporation; the
relationship between the parties; past practice; steps the claimant could have taken to protect
itself; representations and agreements; and the fair resolution of conflicts between corporate
stakeholders. For the second question, a claimant must show that the failure to meet the
reasonable expectation involved unfair conduct and prejudicial consequences under s. 241.
[68] [72] [89] [95]
Where conflicting interests arise, it falls to the directors of the corporation to
resolve them in accordance with their fiduciary duty to act in the best interests of the
corporation. The cases on oppression, taken as a whole, confirm that this duty comprehends
a duty to treat individual stakeholders affected by corporate actions equitably and fairly.
There are no absolute rules and no principle that one set of interests should prevail over
another. In each case, the question is whether, in all the circumstances, the directors acted
in the best interests of the corporation, having regard to all relevant considerations, including
— but not confined to — the need to treat affected stakeholders in a fair manner,
commensurate with the corporation’s duties as a responsible corporate citizen. Where it is
impossible to please all stakeholders, it will be irrelevant that the directors rejected
alternative transactions that were no more beneficial than the chosen one. [81-83]
Here, the debentureholders did not establish that they had a reasonable
expectation that the directors of BCE would protect their economic interests by putting forth
a plan of arrangement that would maintain the investment grade trading value of their
debentures. The trial judge concluded that this expectation was not made out on the
evidence, given the overall context of the relationship, the nature of the corporation, its
situation as the target of a bidding war, the fact that the claimants could have protected
themselves against reductions in market value by negotiating appropriate contractual terms,
and that any statements by Bell Canada suggesting a commitment to retain investment grade
ratings for the debentures were accompanied by warnings precluding such expectations. The
trial judge recognized that the content of the directors’ fiduciary duty to act in the best
interests of the corporation was affected by the various interests at stake in the context of the
auction process, and that they might have to approve transactions that were in the best
interests of the corporation but which benefited some groups at the expense of others. All
three competing bids required Bell Canada to assume additional debt. Under the business
judgment rule, deference should be accorded to the business decisions of directors acting in
good faith in performing the functions they were elected to perform. In this case, there was
no error in the principles applied by the trial judge nor in his findings of fact. [96-100]
The debentureholders also did not establish that they had a reasonable
expectation that the directors would consider their economic interests in maintaining the
trading value of the debentures. While the evidence, objectively viewed, supports a
reasonable expectation that the directors would consider the position of the debentureholders
in making their decisions on the various offers under consideration, it is apparent that the
directors considered the interests of debentureholders, and concluded that while the
contractual terms of the debentures would be honoured, no further commitments could be
made. This fulfilled the duty of the directors to consider the debentureholders’ interests and
did not amount to “unfair disregard” of the interests of debentureholders. What the
claimants contend is, in reality, an expectation that the directors would take positive steps
to restructure the purchase in a way that would provide a satisfactory price to shareholders
and preserve the high market value of the debentures. There was no evidence that it was
reasonable to suppose this could be achieved, since all three bids involved a substantial
increase in Bell Canada’s debt. Commercial practice and reality also undermine their claim.
Leveraged buyouts are not unusual or unforeseeable, and the debentureholders could have
negotiated protections in their contracts. Given the nature and the corporate history of Bell
Canada, it should not have been outside the contemplation of debentureholders that plans of
arrangements could occur in the future. While the debentureholders rely on the past practice
of maintaining the investment grade rating of the debentures, the events precipitating the
leveraged buyout transaction were market realities affecting what were reasonable practices.
No representations had been made to debentureholders upon which they could reasonably
rely. [96] [102] [104-106] [108-110]
With respect to the duty on directors to resolve the conflicting interests of
stakeholders in a fair manner that reflected the best interests of the corporation, the
corporation’s best interests arguably favoured acceptance of the offer at the time. The trial
judge accepted the evidence that Bell Canada needed to undertake significant changes to be
successful, and the momentum of the market made a buyout inevitable. Considering all the
relevant factors, the debentureholders failed to establish a reasonable expectation that could
give rise to a claim for oppression. [111-113]
2. The Section 192 Approval Process
The s. 192 approval process is generally applicable to change of control
transactions where the arrangement is sponsored by the directors of the target company and
the goal is to require some or all shareholders to surrender their shares. The approval
process focuses on whether the arrangement, viewed objectively, is fair and reasonable. Its
purpose is to permit major changes in corporate structure to be made while ensuring that
individuals whose rights may be affected are treated fairly, and its spirit is to achieve a fair
balance between conflicting interests. In seeking court approval of an arrangement, the onus
is on the corporation to establish that (1) the statutory procedures have been met; (2) the
application has been put forth in good faith; and (3) the arrangement is “fair and reasonable”.
[119] [126] [128] [137]
To approve a plan of arrangement as fair and reasonable, courts must be satisfied
that (a) the arrangement has a valid business purpose, and (b) the objections of those whose
legal rights are being arranged are being resolved in a fair and balanced way. Whether these
requirements are met is determined by taking into account a variety of relevant factors,
including the necessity of the arrangement to the corporation’s continued existence, the
approval, if any, of a majority of shareholders and other security holders entitled to vote, and
the proportionality of the impact on affected groups. Where there has been no vote, courts
may consider whether an intelligent and honest business person, as a member of the class
concerned and acting in his or her own interest, might reasonably approve of the plan.
Courts must focus on the terms and impact of the arrangement itself, rather than the process
by which it was reached, and must be satisfied that the burden imposed by the arrangement
on security holders is justified by the interests of the corporation. Courts on a s. 192
application should refrain from substituting their views of the “best” arrangement, but should
not surrender their duty to scrutinize the arrangement. [136] [138] [145] [151] [154-155]
The purpose of s. 192 suggests that only security holders whose legal rights
stand to be affected by the proposal are envisioned. It is the fact that the corporation is
permitted to alter individual rights that places the matter beyond the power of the directors
and creates the need for shareholder and court approval. However, in some circumstances,
interests that are not strictly legal could be considered. The fact that a group whose legal
rights are left intact faces a reduction in the trading value of its securities generally does not,
without more, constitute a circumstance where non-legal interests should be considered on
a s. 192 application. [133-135]
Here, the debentureholders no longer argue that the arrangement lacks a valid
business purpose. The debate focuses on whether the objections of those whose rights are
being arranged were resolved in a fair and balanced way. Since only their economic interests
were affected by the proposed transaction, not their legal rights, and since they did not fall
within an exceptional situation where non-legal interests should be considered under s. 192,
the debentureholders did not constitute an affected class under s. 192, and the trial judge was
correct in concluding that they should not be permitted to veto almost 98 percent of the
shareholders simply because the trading value of their securities would be affected.
Although not required, it remained open to the trial judge to consider the debentureholders’
economic interests, and he did not err in concluding that the arrangement addressed the
debentureholders’ interests in a fair and balanced way.
The arrangement did not
fundamentally alter the debentureholders’ rights, as the investment and return they
contracted for remained intact. It was well known that alteration in debt load could cause
fluctuations in the trading value of the debentures, and yet the debentureholders had not
contracted against this contingency. It was clear to the judge that the continuance of the
corporation required acceptance of an arrangement that would entail increased debt and debt
guarantees by Bell Canada. No superior arrangement had been put forward and BCE had
been assisted throughout by expert legal and financial advisors. Recognizing that there is
no such thing as a perfect arrangement, the trial judge correctly concluded that the
arrangement had been shown to be fair and reasonable. [157] [161] [163-164]
Cases Cited
Referred to: Peoples Department Stores Inc. (Trustee of) v. Wise, [2004] 3
S.C.R. 461, 2004 SCC 68; Bradbury v. English Sewing Cotton Co., [1923] A.C. 744;
Zwicker v. Stanbury, [1953] 2 S.C.R. 438; Sparling v. Quebec (Caisse de dépôt et placement
du Québec), [1988] 2 S.C.R. 1015; Maple Leaf Foods Inc. v. Schneider Corp. (1998), 42
O.R. (3d) 177; Kerr v. Danier Leather Inc., [2007] 3 S.C.R. 331, 2007 SCC 44; The Queen
in right of Canada v. Saskatchewan Wheat Pool, [1983] 1 S.C.R. 205; Scottish Co-operative
Wholesale Society Ltd. v. Meyer, [1959] A.C. 324; Diligenti v. RWMD Operations Kelowna
Ltd. (1976), 1 B.C.L.R. 36; Stech v. Davies, [1987] 5 W.W.R. 563; First Edmonton Place
Ltd. v. 315888 Alberta Ltd. (1988), 40 B.L.R. 28, var’d (1989), 45 B.L.R. 110; 820099
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APPEALS and CROSS-APPEALS from judgments of the Quebec Court of
Appeal (Robert C.J. and Otis, Nuss, Pelletier and Dalphond JJ.A.), [2008] R.J.Q. 1298, 43
B.L.R. (4th) 157, [2008] Q.J. No. 4173 (QL), 2008 CarswellQue 4179, 2008 QCCA 935;
[2008] Q.J. No. 4170 (QL), 2008 QCCA 930; [2008] Q.J. No. 4171 (QL), 2008 QCCA 931;
[2008] Q.J. No. 4172 (QL), 2008 QCCA 932; [2008] Q.J. No. 4174 (QL), 2008 QCCA 933;
[2008] Q.J. No. 4175 (QL), 2008 QCCA 934, setting aside decisions by Silcoff J., [2008]
R.J.Q. 1029, 43 B.L.R. (4th) 39, [2008] Q.J. No. 4376 (QL), CarswellQue. 1805, 2008
QCCS 898; (2008), 43 B.L.R.(4th) 69, [2008] Q.J. No. 1728 (QL), CarswellQue 2226, 2008
QCCS 899; [2008] R.J.Q. 1097, 43 B.L.R. (4th) 1, [2008] Q.J. No. 1788 (QL), 2008
CarswellQue 2227, 2008 QCCS 905; (2008), 43 B.L.R. (4th) 135, [2008] Q.J. No. 1789
(QL), CarswellQue 2228, 2008 QCCS 906; [2008] R.J.Q. 1119, 43 B.L.R.(4th) 79, [2008]
Q.J. No. 1790 (QL), 2008 CarswellQue 2229, 2008 QCCS 907. Appeals allowed and
cross-appeals dismissed.
Guy Du Pont, Kent E. Thomson, William Brock, James Doris, Louis-Martin
O’Neill, Pierre Bienvenu and Steve Tenai, for the appellants/respondents on cross-appeals
BCE Inc. and Bell Canada.
Benjamin Zarnett, Jessica Kimmel, James A. Woods and Christopher L. Richter,
for the appellant/respondent on cross-appeals 6796508 Canada Inc.
John Finnigan, John Porter, Avram Fishman and Mark Meland, for the
respondents/appellants on cross-appeals Group of 1976 Debentureholders and Group of 1996
Debentureholders.
Markus Koehnen, Max Mendelsohn, Paul Macdonald, Julien Brazeau and Erin
Cowling, for the respondent/appellant on cross-appeals Group of 1997 Debentureholders.
Written submissions only by Robert Tessier and Ronald Auclair, for the
respondent Computershare Trust Company of Canada.
Christian S. Tacit, for the intervener Catalyst Asset Management Inc.
Raynold Langlois, Q.C., and Gerald Apostolatos, for the intervener Matthew
Stewart.
The following is the judgment delivered by
THE COURT —
I. Introduction
[1]
These appeals arise out of an offer to purchase all shares of BCE Inc.
(“BCE”), a large telecommunications corporation, by a group headed by the Ontario
Teachers Pension Plan Board (“Teachers”), financed in part by the assumption by Bell
Canada, a wholly owned subsidiary of BCE, of a $30 billion debt. The leveraged buyout
was opposed by debentureholders of Bell Canada on the ground that the increased debt
contemplated by the purchase agreement would reduce the value of their bonds. Upon
request for court approval of an arrangement under s. 192 of the Canada Business
Corporations Act, R.S.C. 1985, c. C-44 (“CBCA”), the debentureholders argued that it
should not be found to be fair. They also opposed the arrangement under s. 241 of the
CBCA on the ground that it was oppressive to them.
[2]
The Quebec Superior Court, per Silcoff J., approved the arrangement as fair
under the CBCA and dismissed the claims for oppression. The Quebec Court of Appeal
found that the arrangement had not been shown to be fair and held that it should not have
been approved. Thus, it found it unnecessary to consider the oppression claim.
[3]
On June 20, 2008, this Court allowed the appeals from the Court of Appeal’s
disapproval of the arrangement and dismissed two cross-appeals from the dismissal of the
claims for oppression, with reasons to follow. These are those reasons.
II. Facts
[4]
At issue is a plan of arrangement valued at approximately $52 billion, for the
purchase of the shares of BCE by way of a leveraged buyout. The arrangement was
opposed by a group, comprised mainly of financial institutions, that hold debentures
issued by Bell Canada. The crux of their complaints is that the arrangement would
diminish the trading value of their debentures by an average of 20 percent, while
conferring a premium of approximately 40 percent on the market price of BCE shares.
[5]
Canada.
Bell Canada was incorporated in 1880 by a special Act of the Parliament of
The corporation was subsequently continued under the CBCA.
BCE, a
management holding company, was incorporated in 1970 and continued under the CBCA
in 1979. Bell Canada became a wholly owned subsidiary of BCE in 1983 pursuant to a
plan of arrangement under which Bell Canada’s shareholders surrendered their shares in
exchange for shares of BCE. BCE and Bell Canada are separate legal entities with
separate charters, articles and bylaws. Since January 2003, however, they have shared a
common set of directors and some senior officers.
[6]
At the time relevant to these proceedings, Bell Canada had $7.2 billion in
outstanding long-term debt comprised of debentures issued pursuant to three trust
indentures: the 1976, the 1996 and the 1997 trust indentures. The trust indentures contain
neither change of control nor credit rating covenants, and specifically allow Bell Canada
to incur or guarantee additional debt subject to certain limitations.
[7]
Bell Canada’s debentures were perceived by investors to be safe investments
and, up to the time of the proposed leveraged buyout, had maintained an investment
grade rating. The debentureholders are some of Canada’s largest and most reputable
financial institutions, pension funds and insurance companies. They are major
participants in the debt markets and possess an intimate and historic knowledge of the
financial markets.
[8]
A number of technological, regulatory and competitive changes have
significantly altered the industry in which BCE operates. Traditionally highly regulated
and focused on circuit-switch line telephone service, the telecommunication industry is
now guided primarily by market forces and characterized by an ever-expanding group of
market participants, substantial new competition and increasing expectations regarding
customer service. In response to these changes, BCE developed a new business plan by
which it would focus on its core business, telecommunications, and divest its interest in
unrelated businesses. This new business plan, however, was not as successful as
anticipated. As a result, the shareholder returns generated by BCE remained significantly
less than the ones generated by its competitors.
[9]
Meanwhile, by the end of 2006, BCE had large cash flows and strong
financial indicators, characteristics perceived by market analysts to make it a suitable
target for a buyout. In November 2006, BCE was made aware that Kohlberg Kravis
Roberts & Co. (“KKR”), a United States private equity firm, might be interested in a
transaction involving BCE. Mr. Michael Sabia, President and Chief Executive Officer of
BCE, contacted KKR to inform them that BCE was not interested in pursuing such a
transaction at that time.
[10]
In February 2007, new rumours surfaced that KKR and the Canada Pension
Plan Investment Board were arranging financing to initiate a bid for BCE. Shortly
thereafter, additional rumours began to circulate that an investment banking firm was
assisting Teachers with a potential transaction involving BCE. Mr. Sabia, after meeting
with BCE’s board of directors (“Board”), contacted the representatives of both KKR and
Teachers to reiterate that BCE was not interested in pursuing a “going-private”
transaction at the time because it was set on creating shareholder value through the
execution of its 2007 business plan.
[11]
On March 29, 2007, after an article appeared on the front page of the Globe
and Mail that inaccurately described BCE as being in discussions with a consortium
comprised of KKR and Teachers, BCE issued a press release confirming that there were
no ongoing discussions being held with private equity investors with respect to a “goingprivate” transaction for BCE.
[12]
On April 9, 2007, Teachers filed a report (Schedule 13D) with the United
States Securities and Exchange Commission reflecting a change from a passive to an
active holding of BCE shares. This filing heightened press speculation concerning a
potential privatization of BCE.
[13]
Faced with renewed speculation and BCE having been put “in play” by the
filing by Teachers of the Schedule 13D report, the Board met with its legal and financial
advisors to assess strategic alternatives. It decided that it would be in the best interests of
BCE and its shareholders to have competing bidding groups and to guard against the risk
of a single bidding group assembling such a significant portion of available debt and
equity that the group could preclude potential competing bidding groups from
participating effectively in an auction process.
[14]
In a press release dated April 17, 2007, BCE announced that it was reviewing
its strategic alternatives with a view to further enhancing shareholder value. On the same
day, a Strategic Oversight Committee (“SOC”) was created. None of its members had
ever been part of management at BCE. Its mandate was, notably, to set up and supervise
the auction process.
[15]
Following the April 17 press release, several debentureholders sent letters to
the Board voicing their concerns about a potential leveraged buyout transaction. They
sought assurance that their interests would be considered by the Board. BCE replied in
writing that it intended to honour the contractual terms of the trust indentures.
[16]
On June 13, 2007, BCE provided the potential participants in the auction
process with bidding rules and the general form of a definitive transaction agreement.
The bidders were advised that, in evaluating the competitiveness of proposed bids, BCE
would consider the impact that their proposed financing arrangements would have on
BCE and on Bell Canada’s debentureholders and, in particular, whether their bids
respected the debentureholders’ contractual rights under the trust indentures.
[17]
Offers were submitted by three groups. All three offers contemplated the
addition of a substantial amount of new debt for which Bell Canada would be liable. All
would have likely resulted in a downgrade of the debentures below investment grade.
The initial offer submitted by the appellant 6796508 Canada Inc. (“the Purchaser”), a
corporation formed by Teachers and affiliates of Providence Equity Partners Inc. and
Madison Dearborn Partners LLC, contemplated an amalgamation of Bell Canada that
would have triggered the voting rights of the debentureholders under the trust indentures.
The Board informed the Purchaser that such an amalgamation made its offer less
competitive. The Purchaser submitted a revised offer with an alternative structure for the
transaction that did not involve an amalgamation of Bell Canada. Also, the Purchaser’s
revised offer increased the initial price per share from $42.25 to $42.75.
[18]
The Board, after a review of the three offers and based on the
recommendation of the SOC, found that the Purchaser’s revised offer was in the best
interests of BCE and BCE’s shareholders. In evaluating the fairness of the consideration
to be paid to the shareholders under the Purchaser’s offer, the Board and the SOC
received opinions from several reputable financial advisors.
In the meantime, the
Purchaser agreed to cooperate with the Board in obtaining a solvency certificate stating
that BCE would still be solvent (and hence in a position to meet its obligations after
completion of the transaction). The Board did not seek a fairness opinion in respect of the
debentureholders, taking the view that their rights were not being arranged.
[19]
On June 30, 2007, the Purchaser and BCE entered into a definitive
agreement. On September 21, 2007, BCE’s shareholders approved the arrangement by a
majority of 97.93 percent.
[20]
Essentially, the arrangement provides for the compulsory acquisition of all of
BCE’s outstanding shares. The price to be paid by the Purchaser is $42.75 per common
share, which represents a premium of approximately 40 percent to the closing price of the
shares as of March 28, 2007. The total capital required for the transaction is
approximately $52 billion, $38.5 billion of which will be supported by BCE. Bell
Canada will guarantee approximately $30 billion of BCE’s debt. The Purchaser will
invest nearly $8 billion of new equity capital in BCE.
[21]
As a result of the announcement of the arrangement, the credit ratings of the
debentures by the time of trial had been downgraded from investment grade to below
investment grade. From the perspective of the debentureholders, this downgrade was
problematic for two reasons. First, it caused the debentures to decrease in value by an
average of approximately 20 percent. Second, the downgrade could oblige
debentureholders with credit-rating restrictions on their holdings to sell their debentures
at a loss.
[22]
The debentureholders at trial opposed the arrangement on a number of
grounds. First, the debentureholders sought relief under the oppression provision in s.
241 of the CBCA. Second, they opposed court approval of the arrangement, as required
by s. 192 of the CBCA, alleging that the arrangement was not “fair and reasonable”
because of the adverse effect on their economic interests. Finally, the debentureholders
brought motions for declaratory relief under the terms of the trust indentures, which are
not before us ((2008), 43 B.L.R. (4th) 39, 2008 QCCS 898; (2008), 43 B.L.R. (4th) 69,
2008 QCCS 899).
III. Judicial History
[23]
The trial judge reviewed the s. 241 oppression claim as lying against both
BCE and Bell Canada, since s. 241 refers to actions by the “corporation or any of its
affiliates”. He dismissed the claims for oppression on the grounds that the debt guarantee
to be assumed by Bell Canada had a valid business purpose; that the transaction did not
breach the reasonable expectations of the debentureholders; that the transaction was not
oppressive by reason of rendering the debentureholders vulnerable; and that BCE and its
directors had not unfairly disregarded the interests of the debentureholders: (2008), 43
B.L.R. (4th) 79, 2008 QCCS 907; (2008), 43 B.L.R. (4th) 135, 2008 QCCS 906.
[24]
In arriving at these conclusions, the trial judge proceeded on the basis that the
BCE directors had a fiduciary duty under s. 122 of the CBCA to act in the best interests of
the corporation. He held that while the best interests of the corporation are not to be
confused with the interests of the shareholders or other stakeholders, corporate law
recognizes fundamental differences between shareholders and debt security holders. He
held that these differences affect the content of the directors’ fiduciary duty. As a result,
the directors’ duty to act in the best interests of the corporation might require them to
approve transactions that, while in the interests of the corporation, might also benefit
some or all shareholders at the expense of other stakeholders. He also noted that in
accordance with the business judgment rule, Canadian courts tend to accord deference to
business decisions of directors taken in good faith and in the performance of the
functions they were elected to perform by shareholders.
[25]
The trial judge held that the debentureholders’ reasonable expectations must
be assessed on an objective basis and, absent compelling reasons, must derive from the
trust indentures and the relevant prospectuses issued in connection with the debt
offerings. Statements by Bell Canada indicating a commitment to retaining investment
grade ratings did not assist the debentureholders, since these statements were
accompanied by warnings, repeated in the prospectuses pursuant to which the debentures
were issued, that negated any expectation that this policy would be maintained
indefinitely. The reasonableness of the alleged expectation was further negated by the
fact that the debentureholders could have guarded against the business risks arising from
a change of control by negotiating protective contract terms. The fact that the
shareholders stood to benefit from the transaction and that the debentureholders were
prejudiced did not in itself give rise to a conclusion that the directors had breached their
fiduciary duty to the corporation. All three competing bids required Bell Canada to
assume additional debt, and there was no evidence that the bidders were prepared to treat
the debentureholders any differently. The materialization of certain risks as a result of
decisions taken by the directors in accordance with their fiduciary duty to the corporation
did not constitute oppression against the debentureholders or unfair disregard of their
interests.
[26]
Having dismissed the claim for oppression, the trial judge went on to
consider BCE’s application for approval of the transaction under s. 192 of the CBCA
((2008), 43 B.L.R. (4th) 1, 2008 QCCS 905). He dismissed the debentureholders’ claim
for voting rights on the arrangement on the ground that their legal interests were not
compromised by the arrangement and that it would be unfair to allow them in effect to
veto the shareholder vote. However, in determining whether the arrangement was fair
and reasonable — the main issue on the application for approval — he considered the
fairness of the transaction with respect to both the shareholders and the debentureholders,
and concluded that the arrangement was fair and reasonable. He considered the necessity
of the arrangement for Bell Canada’s continued operations; that the Board, comprised
almost entirely of independent directors, had determined the arrangement was fair and
reasonable and in the best interests of BCE and the shareholders; that the arrangement
had been approved by over 97 percent of the shareholders; that the arrangement was the
culmination of a robust strategic review and auction process; the assistance the Board
received throughout from leading legal and financial advisors; the absence of a superior
proposal; and the fact that the proposal did not alter or arrange the debentureholders’
legal rights. While the proposal stood to alter the debentureholders’ economic interests,
in the sense that the trading value of their securities would be reduced by the added debt
load, their contractual rights remained intact.
The trial judge noted that the
debentureholders could have protected themselves against this eventuality through
contract terms, but had not. Overall, he concluded that taking all relevant matters into
account, the arrangement was fair and reasonable and should be approved.
[27]
The Court of Appeal allowed the appeals on the ground that BCE had failed
to meet its onus on the test for approval of an arrangement under s. 192, by failing to
show that the transaction was fair and reasonable to the debentureholders. Basing its
analysis on this Court’s decision in Peoples Department Stores Inc. (Trustee of) v. Wise,
[2004] 3 S.C.R. 461, 2004 SCC 68, the Court of Appeal found that the directors were
required to consider the non-contractual interests of the debentureholders. It held that
representations made by Bell Canada over the years could have created reasonable
expectations above and beyond the contractual rights of the debentureholders. In these
circumstances, the directors were under a duty, not simply to accept the best offer, but to
consider whether the arrangement could be restructured in a way that provided a
satisfactory price to the shareholders while avoiding an adverse effect on the
debentureholders. In the absence of such efforts, BCE had not discharged its onus under
s. 192 of showing that the arrangement was fair and reasonable. The Court of Appeal
therefore overturned the trial judge’s order approving the plan of arrangement: (2008), 43
B.L.R. (4th) 157, 2008 QCCA 930, 2008 QCCA 931, 2008 QCCA 932, 2008 QCCA 933,
2008 QCCA 934, 2008 QCCA 935.
[28]
The Court of Appeal found it unnecessary to consider the s. 241 oppression
claim, holding that its rejection of the s. 192 approval application effectively disposed of
the oppression claim. In its view, where approval is sought under s. 192 and opposed,
there is generally no need for an affected security holder to assert an oppression remedy
under s. 241.
[29]
BCE and Bell Canada appeal to this Court arguing that the Court of Appeal
erred in overturning the trial judge’s approval of the plan of arrangement.
While
formally cross-appealing on s. 241, the debentureholders argue that the Court of Appeal
was correct to consider their complaints under s. 192, such that their appeals under s. 241
became moot.
IV. Issues
[30]
The issues, briefly stated, are whether the Court of Appeal erred in
dismissing the debentureholders’ s. 241 oppression claim and in overturning the Superior
Court’s s. 192 approval of the plan of arrangement. These questions raise the issue of
what is required to establish oppression of debentureholders in a situation where a
corporation is facing a change of control, and how a judge on an application for approval
of an arrangement under s. 192 of the CBCA should treat claims such as those of the
debentureholders in these actions. These reasons will consider both issues.
[31]
In order to situate these issues in the context of Canadian corporate law, it
may be useful to offer a preliminary description of the remedies provided by the CBCA to
shareholders and stakeholders in a corporation facing a change of control.
[32]
Accordingly, these reasons will consider:
(1) the rights, obligations and remedies under the CBCA in overview;
(2) the debentureholders’ entitlement to relief under the s. 241 oppression
remedy;
(3) the debentureholders’ entitlement to relief under the requirement for
court approval of an arrangement under s. 192.
[33]
We note that it is unnecessary for the purposes of these appeals to distinguish
between the conduct of the directors of BCE, the holding company, and the conduct of
the directors of Bell Canada.
The same directors served on the boards of both
corporations. While the oppression remedy was directed at both BCE and Bell Canada,
the courts below considered the entire context in which the directors of BCE made their
decisions, which included the obligations of Bell Canada in relation to its
debentureholders. It was not found by the lower courts that the directors of BCE and Bell
Canada should have made different decisions with respect to the two corporations.
Accordingly, the distinct corporate character of the two entities does not figure in our
analysis.
V. Analysis
A. Overview of Rights, Obligations and Remedies under the CBCA
[34]
An essential component of a corporation is its capital stock, which is divided
into fractional parts, the shares: Bradbury v. English Sewing Cotton Co., [1923] A.C. 744
(H.L.), at p. 767; Zwicker v. Stanbury, [1953] 2 S.C.R. 438. While the corporation is
ongoing, shares confer no right to its underlying assets.
[35]
A share “is not an isolated piece of property ... [but] a ‘bundle of inter-related
rights and liabilities”: Sparling v. Quebec (Caisse de dépôt et placement du Québec),
[1988] 2 S.C.R. 1015, at p. 1025, per La Forest J. These rights include the right to a
proportionate part of the assets of the corporation upon winding-up and the right to
oversee the management of the corporation by its board of directors by way of votes at
shareholder meetings.
[36]
The directors are responsible for the governance of the corporation. In the
performance of this role, the directors are subject to two duties: a fiduciary duty to the
corporation under s. 122(1)(a) (the fiduciary duty); and a duty to exercise the care,
diligence and skill of a reasonably prudent person in comparable circumstances under s.
122(1)(b) (the duty of care). The second duty is not at issue in these proceedings as this is
not a claim against the directors of the corporation for failing to meet their duty of care.
However, this case does involve the fiduciary duty of the directors to the corporation, and
particularly the “fair treatment” component of this duty, which, as will be seen, is
fundamental to the reasonable expectations of stakeholders claiming an oppression
remedy.
[37]
The fiduciary duty of the directors to the corporation originated in the
common law. It is a duty to act in the best interests of the corporation. Often the
interests of shareholders and stakeholders are co-extensive with the interests of the
corporation. But if they conflict, the directors’ duty is clear — it is to the corporation:
Peoples Department Stores.
[38]
The fiduciary duty of the directors to the corporation is a broad, contextual
concept. It is not confined to short-term profit or share value. Where the corporation is
an ongoing concern, it looks to the long-term interests of the corporation. The content of
this duty varies with the situation at hand. At a minimum, it requires the directors to
ensure that the corporation meets its statutory obligations. But, depending on the context,
there may also be other requirements. In any event, the fiduciary duty owed by directors
is mandatory; directors must look to what is in the best interests of the corporation.
[39]
In Peoples Department Stores, this Court found that although directors must
consider the best interests of the corporation, it may also be appropriate, although not
mandatory, to consider the impact of corporate decisions on shareholders or particular
groups of stakeholders. As stated by Major and Deschamps JJ., at para. 42:
We accept as an accurate statement of law that in determining whether they
are acting with a view to the best interests of the corporation it may be
legitimate, given all the circumstances of a given case, for the board of
directors to consider, inter alia, the interests of shareholders, employees,
suppliers, creditors, consumers, governments and the environment.
As will be discussed, cases dealing with claims of oppression have further clarified the
content of the fiduciary duty of directors with respect to the range of interests that should
be considered in determining what is in the best interests of the corporation, acting fairly
and responsibly.
[40]
In considering what is in the best interests of the corporation, directors may
look to the interests of, inter alia, shareholders, employees, creditors, consumers,
governments and the environment to inform their decisions. Courts should give
appropriate deference to the business judgment of directors who take into account these
ancillary interests, as reflected by the business judgment rule. The “business judgment
rule” accords deference to a business decision, so long as it lies within a range of
reasonable alternatives: see Maple Leaf Foods Inc. v. Schneider Corp. (1998), 42 O.R.
(3d) 177 (C.A.); Kerr v. Danier Leather Inc., [2007] 3 S.C.R. 331, 2007 SCC 44. It
reflects the reality that directors, who are mandated under s. 102(1) of the CBCA to
manage the corporation’s business and affairs, are often better suited to determine what is
in the best interests of the corporation.
This applies to decisions on stakeholders’
interests, as much as other directorial decisions.
[41]
Normally only the beneficiary of a fiduciary duty can enforce the duty. In
the corporate context, however, this may offer little comfort. The directors who control
the corporation are unlikely to bring an action against themselves for breach of their own
fiduciary duty. The shareholders cannot act in the stead of the corporation; their only
power is the right to oversee the conduct of the directors by way of votes at shareholder
assemblies. Other stakeholders may not even have that.
[42]
To meet these difficulties, the common law developed a number of special
remedies to protect the interests of shareholders and stakeholders of the corporation.
These remedies have been affirmed, modified and supplemented by the CBCA.
[43]
The first remedy provided by the CBCA is the s. 239 derivative action, which
allows stakeholders to enforce the directors’ duty to the corporation when the directors
are themselves unwilling to do so. With leave of the court, a complainant may bring (or
intervene in) a derivative action in the name and on behalf of the corporation or one of its
subsidiaries to enforce a right of the corporation, including the rights correlative with the
directors’ duties to the corporation. (The requirement of leave serves to prevent frivolous
and vexatious actions, and other actions which, while possibly brought in good faith, are
not in the interest of the corporation to litigate.)
[44]
A second remedy lies against the directors in a civil action for breach of duty
of care. As noted, s. 122(1)(b) of the CBCA requires directors and officers of a
corporation to “exercise the care, diligence and skill that a reasonably prudent person
would exercise in comparable circumstances”.
This duty, unlike the s. 122(1)(a)
fiduciary duty, is not owed solely to the corporation, and thus may be the basis for
liability to other stakeholders in accordance with principles governing the law of tort and
extracontractual liability: Peoples Department Stores.
Section 122(1)(b) does not
provide an independent foundation for claims. However, applying the principles of The
Queen in right of Canada v. Saskatchewan Wheat Pool, [1983] 1 S.C.R. 205, courts may
take this statutory provision into account as to the standard of behaviour that should
reasonably be expected.
[45]
A third remedy, grounded in the common law and endorsed by the CBCA, is
a s. 241 action for oppression. Unlike the derivative action, which is aimed at enforcing
a right of the corporation itself, the oppression remedy focuses on harm to the legal and
equitable interests of stakeholders affected by oppressive acts of a corporation or its
directors. This remedy is available to a wide range of stakeholders — security holders,
creditors, directors and officers.
[46]
Additional “remedial” provisions are found in provisions of the CBCA
providing for court approval in certain cases. An arrangement under s. 192 of the CBCA
is one of these. While s. 192 cannot be described as a remedy per se, it has remedial-like
aspects. It is directed at the situation of corporations seeking to effect fundamental
changes to the corporation that affects stakeholder rights. The Act provides that such
arrangements require the approval of the court. Unlike the civil action and oppression,
which focus on the conduct of the directors, a s. 192 review requires a court approving a
plan of arrangement to be satisfied that: (i) the statutory procedures have been met; (ii)
the application has been put forth in good faith; and (iii) the arrangement is fair and
reasonable. If the corporation fails to discharge its burden of establishing these elements,
approval will be withheld and the proposed change will not take place. In assessing
whether the arrangement should be approved, the court will hear arguments from
opposing security holders whose rights are being arranged. This provides an opportunity
for security holders to argue against the proposed change.
[47]
Two of these remedies are in issue in these actions: the action for oppression
and approval of an arrangement under s. 192. The trial judge treated these remedies as
involving distinct considerations and concluded that the debentureholders had failed to
establish entitlement to either remedy. The Court of Appeal, by contrast, viewed the two
remedies as substantially overlapping, holding that both turned on whether the directors
had properly considered the debentureholders’ expectations. Having found on this basis
that the requirements of s. 192 were not met, the Court of Appeal concluded that the
action for oppression was moot. As will become apparent, we do not endorse this
approach. In our view, the s. 241 oppression action and the s. 192 requirement for court
approval of a change to the corporate structure are different types of proceedings,
engaging different inquiries. Accordingly, we find it necessary to consider both the
claims for oppression and the s. 192 application for approval.
[48]
The debentureholders have formally cross-appealed on the oppression
remedy. However, due to the Court of Appeal’s failure to consider this issue, the
debentureholders did not advance separate arguments before this Court. As certain
aspects of their position are properly addressed within the context of an analysis of
oppression under s. 241, we have considered them here.
[49]
Against this background, we turn to a more detailed consideration of the
claims.
B. The Section 241 Oppression Remedy
[50]
The debentureholders in these appeals claim that the directors acted in an
oppressive manner in approving the sale of BCE, contrary to s. 241 of the CBCA.
[51]
Security holders of a corporation or its affiliates fall within the class of
persons who may be permitted to bring a claim for oppression under s. 241 of the CBCA.
The trial judge permitted the debentureholders to do so, although in the end he found the
claim had not been established.
dismissing the claim.
The question is whether the trial judge erred in
[52]
We will first set out what must be shown to establish the right to a remedy
under s. 241, and then review the conduct complained of in the light of those
requirements.
(1) The Law
[53]
Section 241(2) provides that a court may make an order to rectify the matters
complained of where
(a) any act or omission of the corporation or any of its affiliates effects a
result,
(b) the business or affairs of the corporation or any of its affiliates are or
have been carried on or conducted in a manner, or
(c) the powers of the directors of the corporation or any of its affiliates are
or have been exercised in a manner
that is oppressive or unfairly prejudicial to or that unfairly disregards the
interests of any security holder, creditor, director or officer....
[54]
Section 241 jurisprudence reveals two possible approaches to the
interpretation of the oppression provisions of the CBCA: M. Koehnen, Oppression and
Related Remedies (2004), at pp. 79-80 and 84. One approach emphasizes a strict reading
of the three types of conduct enumerated in s. 241 (oppression, unfair prejudice and
unfair disregard): see Scottish Co-operative Wholesale Society Ltd. v. Meyer, [1959] A.C.
324 (H.L.); Diligenti v. RWMD Operations Kelowna Ltd. (1976), 1 B.C.L.R. 36 (S.C.);
Stech v. Davies, [1987] 5 W.W.R. 563 (Alta. Q.B.). Cases following this approach focus
on the precise content of the categories “oppression”, “unfair prejudice” and “unfair
disregard”.
While these cases may provide valuable insight into what constitutes
oppression in particular circumstances,
a categorical approach to oppression is
problematic because the terms used cannot be put into watertight compartments or
conclusively defined. As Koehnen puts it (at p. 84), “[t]he three statutory components of
oppression are really adjectives that try to describe inappropriate conduct ....
The
difficulty with adjectives is they provide no assistance in formulating principles that
should underline court intervention.”
[55]
Other cases have focused on the broader principles underlying and uniting
the various aspects of oppression: see First Edmonton Place Ltd. v. 315888 Alberta Ltd.
(1988), 40 B.L.R. 28 (Alta. Q.B.), var’d (1989), 45 B.L.R. 110 (Alta. C.A.); 820099
Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 B.L.R. (2d) 113 (Ont. Div. Ct.); Westfair
Foods Ltd. v. Watt (1991), 79 D.L.R. (4th) 48 (Alta. C.A.).
[56]
In our view, the best approach to the interpretation of s. 241(2) is one that
combines the two approaches developed in the cases. One should look first to the
principles underlying the oppression remedy, and in particular the concept of reasonable
expectations. If a breach of a reasonable expectation is established, one must go on to
consider whether the conduct complained of amounts to “oppression”, “unfair prejudice”
or “unfair disregard” as set out in s. 241(2) of the CBCA.
[57]
We preface our discussion of the twin prongs of the oppression inquiry by
two preliminary observations that run throughout all the jurisprudence.
[58]
First, oppression is an equitable remedy. It seeks to ensure fairness — what
is “just and equitable”. It gives a court broad, equitable jurisdiction to enforce not just
what is legal but what is fair: Wright v. Donald S. Montgomery Holdings Ltd. (1998), 39
B.L.R. (2d) 266 (Ont. Ct. (Gen. Div.)), at p. 273; Re Keho Holdings Ltd. and Noble
(1987), 38 D.L.R. (4th) 368 (Alta. C.A.), at p. 374; see, more generally, Koehnen, at pp.
78-79. It follows that courts considering claims for oppression should look at business
realities, not merely narrow legalities: Scottish Co-operative Wholesale Society, at p. 343.
[59]
Second, like many equitable remedies, oppression is fact-specific. What is
just and equitable is judged by the reasonable expectations of the stakeholders in the
context and in regard to the relationships at play. Conduct that may be oppressive in one
situation may not be in another.
[60]
Against this background, we turn to the first prong of the inquiry, the
principles underlying the remedy of oppression. In Ebrahimi v. Westbourne Galleries
Ltd., [1973] A.C. 360 (H.L.), at p. 379, Lord Wilberforce, interpreting s. 222 of the U.K.
Companies Act, 1948, described the remedy of oppression in the following seminal
terms:
The words [“just and equitable”] are a recognition of the fact that a limited
company is more than a mere legal entity, with a personality in law of its
own: that there is room in company law for recognition of the fact that behind
it, or amongst it, there are individuals, with rights, expectations and
obligations inter se which are not necessarily submerged in the company
structure.
[61]
Lord Wilberforce spoke of the equitable remedy in terms of the “rights,
expectations and obligations” of individuals.
“Rights” and “obligations” connote
interests enforceable at law without recourse to special remedies, for example, through a
contractual suit or a derivative action under s. 239 of the CBCA. It is left for the
oppression remedy to deal with the “expectations” of affected stakeholders.
The
reasonable expectations of these stakeholders is the cornerstone of the oppression
remedy.
[62]
As denoted by “reasonable”, the concept of reasonable expectations is
objective and contextual.
The actual expectation of a particular stakeholder is not
conclusive. In the context of whether it would be “just and equitable” to grant a remedy,
the question is whether the expectation is reasonable having regard to the facts of the
specific case, the relationships at issue, and the entire context, including the fact that
there may be conflicting claims and expectations.
[63]
Particular circumstances give rise to particular expectations. Stakeholders
enter into relationships, with and within corporations, on the basis of understandings and
expectations, upon which they are entitled to rely, provided they are reasonable in the
context: see 820099 Ontario; Main v. Delcan Group Inc. (1999), 47 B.L.R. (2d) 200
(Ont. S.C.J.). These expectations are what the remedy of oppression seeks to uphold.
[64]
Determining whether a particular expectation is reasonable is complicated by
the fact that the interests and expectations of different stakeholders may conflict. The
oppression remedy recognizes that a corporation is an entity that encompasses and affects
various individuals and groups, some of whose interests may conflict with others.
Directors or other corporate actors may make corporate decisions or seek to resolve
conflicts in a way that abusively or unfairly maximizes a particular group’s interest at the
expense of other stakeholders.
The corporation and shareholders are entitled to
maximize profit and share value, to be sure, but not by treating individual stakeholders
unfairly.
Fair treatment — the central theme running through the oppression
jurisprudence — is most fundamentally what stakeholders are entitled to “reasonably
expect”.
[65]
Section 241(2) speaks of the “act or omission” of the corporation or any of its
affiliates, the conduct of “business or affairs” of the corporation and the “powers of the
directors of the corporation or any of its affiliates”. Often, the conduct complained of is
the conduct of the corporation or of its directors, who are responsible for the governance
of the corporation. However, the conduct of other actors, such as shareholders, may also
support a claim for oppression: see Koehnen, at pp. 109-10; GATX Corp. v. Hawker
Siddeley Canada Inc. (1996), 27 B.L.R. (2d) 251 (Ont. Ct. (Gen. Div.)). In the appeals
before us, the claims for oppression are based on allegations that the directors of BCE
and Bell Canada failed to comply with the reasonable expectations of the
debentureholders, and it is unnecessary to go beyond this.
[66]
The fact that the conduct of the directors is often at the centre of oppression
actions might seem to suggest that directors are under a direct duty to individual
stakeholders who may be affected by a corporate decision. Directors, acting in the best
interests of the corporation, may be obliged to consider the impact of their decisions on
corporate stakeholders, such as the debentureholders in these appeals. This is what we
mean when we speak of a director being required to act in the best interests of the
corporation viewed as a good corporate citizen. However, the directors owe a fiduciary
duty to the corporation, and only to the corporation. People sometimes speak in terms of
directors owing a duty to both the corporation and to stakeholders. Usually this is
harmless, since the reasonable expectations of the stakeholder in a particular outcome
often coincides with what is in the best interests of the corporation. However, cases
(such as these appeals) may arise where these interests do not coincide. In such cases, it
is important to be clear that the directors owe their duty to the corporation, not to
stakeholders, and that the reasonable expectation of stakeholders is simply that the
directors act in the best interests of the corporation.
[67]
Having discussed the concept of reasonable expectations that underlies the
oppression remedy, we arrive at the second prong of the s. 241 oppression remedy. Even
if reasonable, not every unmet expectation gives rise to claim under s. 241. The section
requires that the conduct complained of amount to “oppression”, “unfair prejudice” or
“unfair disregard” of relevant interests. “Oppression” carries the sense of conduct that is
coercive and abusive, and suggests bad faith. “Unfair prejudice” may admit of a less
culpable state of mind, that nevertheless has unfair consequences.
Finally, “unfair
disregard” of interests extends the remedy to ignoring an interest as being of no
importance, contrary to the stakeholders’ reasonable expectations: see Koehnen, at pp.
81-88. The phrases describe, in adjectival terms, ways in which corporate actors may fail
to meet the reasonable expectations of stakeholders.
[68]
In summary, the foregoing discussion suggests conducting two related
inquiries in a claim for oppression: (1) Does the evidence support the reasonable
expectation asserted by the claimant? and (2) Does the evidence establish that the
reasonable expectation was violated by conduct falling within the terms “oppression”,
“unfair prejudice” or “unfair disregard” of a relevant interest?
[69]
Against the background of this overview, we turn to a more detailed
discussion of these inquiries.
(a) Proof of a Claimant’s Reasonable Expectations
[70]
At the outset, the claimant must identify the expectations that he or she
claims have been violated by the conduct at issue and establish that the expectations were
reasonably held.
As stated above, it may be readily inferred that a stakeholder has a
reasonable expectation of fair treatment. However, oppression, as discussed, generally
turns on particular expectations arising in particular situations. The question becomes
whether the claimant stakeholder reasonably held the particular expectation. Evidence of
an expectation may take many forms depending on the facts of the case.
[71]
It is impossible to catalogue exhaustively situations where a reasonable
expectation may arise due to their fact-specific nature. A few generalizations, however,
may be ventured. Actual unlawfulness is not required to invoke s. 241; the provision
applies “where the impugned conduct is wrongful, even if it is not actually unlawful”:
Dickerson Committee (R. W. V. Dickerson, J. L. Howard and L. Getz), Proposals for a
New Business Corporations Law for Canada (1971), vol. 1, at p. 163. The remedy is
focused on concepts of fairness and equity rather than on legal rights. In determining
whether there is a reasonable expectation or interest to be considered, the court looks
beyond legality to what is fair, given all of the interests at play: Re Keho Holdings Ltd.
and Noble. It follows that not all conduct that is harmful to a stakeholder will give rise to
a remedy for oppression as against the corporation.
[72]
Factors that emerge from the case law that are useful in determining whether
a reasonable expectation exists include: general commercial practice; the nature of the
corporation; the relationship between the parties; past practice; steps the claimant could
have taken to protect itself; representations and agreements; and the fair resolution of
conflicting interests between corporate stakeholders.
(i) Commercial Practice
[73]
Commercial practice plays a significant role in forming the reasonable
expectations of the parties. A departure from normal business practices that has the
effect of undermining or frustrating the complainant’s exercise of his or her legal rights
will generally (although not inevitably) give rise to a remedy: Adecco Canada Inc. v. J.
Ward Broome Ltd. (2001), 12 B.L.R. (3d) 275 (Ont. S.C.J.); SCI Systems Inc. v. Gornitzki
Thompson & Little Co., (1997), 147 D.L.R. (4th) 300 (Ont. Ct. (Gen. Div.)), var’d
(1998), 110 O.A.C. 160 (Div. Ct.); Downtown Eatery (1993) Ltd. v. Ontario (2001), 200
D.L.R. (4th) 289, leave to appeal refused, [2002] 2 S.C.R. vi.
(ii) The Nature of the Corporation
[74]
The size, nature and structure of the corporation are relevant factors in
assessing reasonable expectations: First Edmonton Place; G. Shapira, “Minority
Shareholders’ Protection — Recent Developments” (1982), 10 N.Z. Univ. L. Rev. 134, at
pp. 138 and 145-46. Courts may accord more latitude to the directors of a small, closely
held corporation to deviate from strict formalities than to the directors of a larger public
company.
(iii)
[75]
Relationships
Reasonable expectations may emerge from the personal relationships
between the claimant and other corporate actors. Relationships between shareholders
based on ties of family or friendship may be governed by different standards than
relationships between arm’s length shareholders in a widely held corporation. As noted
in Re Ferguson and Imax Systems Corp., (1983), 150 D.L.R. (3d) 718 (Ont. C.A.),
“when dealing with a close corporation, the court may consider the relationship between
the shareholders and not simply legal rights as such” (p. 727).
(iv) Past Practice
[76]
Past practice may create reasonable expectations, especially among
shareholders of a closely held corporation on matters relating to participation of
shareholders in the corporation’s profits and governance: Gibbons v. Medical Carriers
Ltd. (2001), 17 B.L.R. (3d) 280, 2001 MBQB 229; 820099 Ontario. For instance, in
Gibbons, the court found that the shareholders had a legitimate expectation that all
monies paid out of the corporation would be paid to shareholders in proportion to the
percentage of shares they held. The authorization by the new directors to pay fees to
themselves, for which the shareholders would not receive any comparable payments, was
in breach of those expectations.
[77]
It is important to note that practices and expectations can change over time.
Where valid commercial reasons exist for the change and the change does not undermine
the complainant’s rights, there can be no reasonable expectation that directors will resist
a departure from past practice: Alberta Treasury Branches v. SevenWay Capital Corp.
(1999), 50 B.L.R. (2d) 294 (Alta. Q.B.), aff’d (2000), 8 B.L.R. (3d) 1, 2000 ABCA 194.
(v) Preventive Steps
[78]
In determining whether a stakeholder expectation is reasonable, the court
may consider whether the claimant could have taken steps to protect itself against the
prejudice it claims to have suffered. Thus it may be relevant to inquire whether a secured
creditor claiming oppressive conduct could have negotiated protections against the
prejudice suffered: First Edmonton Place; SCI Systems.
(vi) Representations and Agreements
[79]
Shareholder agreements may be viewed as reflecting the reasonable
expectations of the parties: Main; Lyall v. 147250 Canada Ltd. (1993), 106 D.L.R. (4th)
304 (B.C.C.A.).
[80]
Reasonable expectations may also be affected by representations made to
stakeholders or to the public in promotional material, prospectuses, offering circulars and
other communications: Tsui v. International Capital Corp., [1993] 4 W.W.R. 613 (Sask.
Q.B.), aff’d (1993), 113 Sask. R. 3 (C.A.); Deutsche Bank Canada v. Oxford Properties
Group Inc. (1998), 40 B.L.R. (2d) 302 (Ont. Ct. (Gen. Div.)); Themadel Foundation v.
Third Canadian Investment Trust Ltd. (1995), 23 O.R. (3d) 7 (Gen. Div.), var’d (1998),
38 O.R. (3d) 749 (C.A.).
(vii)
[81]
Fair Resolution of Conflicting Interests
As discussed, conflicts may arise between the interests of corporate
stakeholders inter se and between stakeholders and the corporation. Where the conflict
involves the interests of the corporation, it falls to the directors of the corporation to
resolve them in accordance with their fiduciary duty to act in the best interests of the
corporation, viewed as a good corporate citizen.
[82]
The cases on oppression, taken as a whole, confirm that the duty of the
directors to act in the best interests of the corporation comprehends a duty to treat
individual stakeholders affected by corporate actions equitably and fairly. There are no
absolute rules. In each case, the question is whether, in all the circumstances, the
directors acted in the best interests of the corporation, having regard to all relevant
considerations, including, but not confined to, the need to treat affected stakeholders in a
fair manner, commensurate with the corporation’s duties as a responsible corporate
citizen.
[83]
Directors may find themselves in a situation where it is impossible to please
all stakeholders. The “fact that alternative transactions were rejected by the directors is
irrelevant unless it can be shown that a particular alternative was definitely available and
clearly more beneficial to the company than the chosen transaction”: Maple Leaf Foods,
per Weiler J.A., at p. 192.
[84]
There is no principle that one set of interests — for example the interests of
shareholders — should prevail over another set of interests. Everything depends on the
particular situation faced by the directors and whether, having regard to that situation,
they exercised business judgment in a responsible way.
[85]
On these appeals, it was suggested on behalf of the corporations that the
“Revlon line” of cases from Delaware support the principle that where the interests of
shareholders conflict with the interests of creditors, the interests of shareholders should
prevail.
[86]
The “Revlon line” refers to a series of Delaware corporate takeover cases, the
two most important of which are Revlon Inc. v. MacAndrews & Forbes Holdings Inc.,
506 A.2d 173 (Del. 1985), and Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del.
1985). In both cases, the issue was how directors should react to a hostile takeover bid.
Revlon suggests that in such circumstances, shareholder interests should prevail over
those of other stakeholders, such as creditors. Unocal tied this approach to situations
where the corporation will not continue as a going concern, holding that although a board
facing a hostile takeover “may have regard for various constituencies in discharging its
responsibilities, ... such concern for non-stockholder interests is inappropriate when . . .
the object no longer is to protect or maintain the corporate enterprise but to sell it to the
highest bidder” (p. 182).
[87]
What is clear is that the Revlon line of cases has not displaced the
fundamental rule that the duty of the directors cannot be confined to particular priority
rules, but is rather a function of business judgment of what is in the best interests of the
corporation, in the particular situation it faces.
In a review of trends in Delaware
corporate jurisprudence, former Delaware Supreme Court Chief Justice E. Norman
Veasey put it this way:
[It] is important to keep in mind the precise content of this “best interests”
concept — that is, to whom this duty is owed and when. Naturally, one often
thinks that directors owe this duty to both the corporation and the
stockholders. That formulation is harmless in most instances because of the
confluence of interests, in that what is good for the corporate entity is usually
derivatively good for the stockholders. There are times, of course, when the
focus is directly on the interests of the stockholders [i.e., as in Revlon]. But,
in general, the directors owe fiduciary duties to the corporation, not to the
stockholders. [Emphasis in original.]
(E. Norman Veasey with Christine T. Di Guglielmo, “What Happened in
Delaware Corporate Law and Governance from 1992-2004? A Retrospective
on Some Key Developments” (2005), 153 U. Pa. L. Rev. 1399, at p. 1431)
[88]
Nor does this Court’s decision in Peoples Department Stores suggest a fixed
rule that the interests of creditors must prevail. In Peoples Department Stores, the Court
had to consider whether, in the case of a corporation under threat of bankruptcy, creditors
deserved special consideration (para. 46). The Court held that the fiduciary duty to the
corporation did not change in the period preceding the bankruptcy, but that if the
directors breach their duty of care to a stakeholder under s. 122(1)(b) of the CBCA, such
a stakeholder may act upon it (para. 66).
(b) Conduct which is Oppressive, is Unfairly Prejudicial or Unfairly
Disregards the Claimant’s Relevant Interests
[89]
Thus far we have discussed how a claimant establishes the first element of an
action for oppression — a reasonable expectation that he or she would be treated in a
certain way. However, to complete a claim for oppression, the claimant must show that
the failure to meet this expectation involved unfair conduct and prejudicial consequences
within s. 241 of the CBCA. Not every failure to meet a reasonable expectation will give
rise to the equitable considerations that ground actions for oppression. The court must be
satisfied that the conduct falls within the concepts of “oppression”, “unfair prejudice” or
“unfair disregard” of the claimant’s interest, within the meaning of s. 241 of the CBCA.
Viewed in this way, the reasonable expectations analysis that is the theoretical foundation
of the oppression remedy, and the particular types of conduct described in s. 241, may be
seen as complementary, rather than representing alternative approaches to the oppression
remedy, as has sometimes been supposed. Together, they offer a complete picture of
conduct that is unjust and inequitable, to return to the language of Ebrahimi.
[90]
In most cases, proof of a reasonable expectation will be tied up with one or
more of the concepts of oppression, unfair prejudice, or unfair disregard of interests set
out in s. 241, and the two prongs will in fact merge. Nevertheless, it is worth stating that
as in any action in equity, wrongful conduct, causation and compensable injury must be
established in a claim for oppression.
[91]
The concepts of oppression, unfair prejudice and unfairly disregarding
relevant interests are adjectival. They indicate the type of wrong or conduct that the
oppression remedy of s. 241 of the CBCA is aimed at. However, they do not represent
watertight compartments, and often overlap and intermingle.
[92]
The original wrong recognized in the cases was described simply as
oppression, and was generally associated with conduct that has variously been described
as “burdensome, harsh and wrongful”, “a visible departure from standards of fair
dealing”, and an “abuse of power” going to the probity of how the corporation’s affairs
are being conducted: see Koehnen, at p. 81. It is this wrong that gave the remedy its
name, which now is generally used to cover all s. 241 claims. However, the term also
operates to connote a particular type of injury within the modern rubric of oppression
generally — a wrong of the most serious sort.
[93]
The CBCA has added “unfair prejudice” and “unfair disregard” of interests to
the original common law concept, making it clear that wrongs falling short of the harsh
and abusive conduct connoted by “oppression” may fall within s. 241.
“[U]nfair
prejudice” is generally seen as involving conduct less offensive than “oppression”.
Examples include squeezing out a minority shareholder, failing to disclose related party
transactions, changing corporate structure to drastically alter debt ratios, adopting a
“poison pill” to prevent a takeover bid, paying dividends without a formal declaration,
preferring some shareholders with management fees and paying directors’ fees higher
than the industry norm: see Koehnen, at pp. 82-83.
[94]
“[U]nfair disregard” is viewed as the least serious of the three injuries, or
wrongs, mentioned in s. 241. Examples include favouring a director by failing to properly
prosecute claims, improperly reducing a shareholder’s dividend, or failing to deliver
property belonging to the claimant: see Koehnen, at pp. 83-84.
(2) Application to these Appeals
[95]
As discussed above (at para. 68), in assessing a claim for oppression a court
must answer two questions: (1) Does the evidence support the reasonable expectation the
claimant asserts? and (2) Does the evidence establish that the reasonable expectation was
violated by conduct falling within the terms “oppression”, “unfair prejudice” or “unfair
disregard” of a relevant interest?
[96]
The debentureholders in this case assert two alternative expectations. Their
highest position is that they had a reasonable expectation that the directors of BCE would
protect their economic interests as debentureholders in Bell Canada by putting forward a
plan of arrangement that would maintain the investment grade trading value of their
debentures. Before this Court, however, they argued a softer alternative — a reasonable
expectation that the directors would consider their economic interests in maintaining the
trading value of the debentures.
[97]
As summarized above (at para. 25), the trial judge proceeded on the
debentureholders’ alleged expectation that the directors would act in a way that would
preserve the investment grade status of their debentures.
He concluded that this
expectation was not made out on the evidence, since the statements by Bell Canada
suggesting a commitment to retaining investment grade ratings were accompanied by
warnings that explicitly precluded investors from reasonably forming such expectations,
and the warnings were included in the prospectuses pursuant to which the debentures
were issued.
[98]
The absence of a reasonable expectation that the investment grade of the
debentures would be maintained was confirmed, in the trial judge’s view, by the overall
context of the relationship, the nature of the corporation, its situation as the target of a
bidding war, as well as by the fact that the claimants could have protected themselves
against reduction in market value by negotiating appropriate contractual terms.
[99]
The trial judge situated his consideration of the relevant factors in the
appropriate legal context. He recognized that the directors had a fiduciary duty to act in
the best interests of the corporation and that the content of this duty was affected by the
various interests at stake in the context of the auction process that BCE was undergoing.
He emphasized that the directors, faced with conflicting interests, might have no choice
but to approve transactions that, while in the best interests of the corporation, would
benefit some groups at the expense of others. He held that the fact that the shareholders
stood to benefit from the transaction and that the debentureholders were prejudiced did
not in itself give rise to a conclusion that the directors had breached their fiduciary duty
to the corporation. All three competing bids required Bell Canada to assume additional
debt, and there was no evidence that bidders were prepared to accept less leveraged debt.
Under the business judgment rule, deference should be accorded to business decisions of
directors taken in good faith and in the performance of the functions they were elected to
perform by the shareholders.
[100]
We see no error in the principles applied by the trial judge nor in his findings
of fact, which were amply supported by the evidence. We accordingly agree that the first
expectation advanced in this case — that the investment grade status of the debentures
would be maintained — was not established.
[101]
The alternative, softer, expectation advanced is that the directors would
consider the interests of the bondholders in maintaining the trading value of the
debentures. The Court of Appeal, albeit in the context of its reasons on the s. 192
application, accepted this as a reasonable expectation. It held that the representations
made over the years, while not legally binding, created expectations beyond contractual
rights. It went on to state that in these circumstances, the directors were under a duty, not
simply to accept the best offer, but to consider whether the arrangement could be
restructured in a way that provided a satisfactory price to the shareholders while avoiding
an adverse effect on debentureholders.
[102]
The evidence, objectively viewed, supports a reasonable expectation that
the directors would consider the position of the debentureholders in making their
decisions on the various offers under consideration. As discussed above, reasonable
expectations for the purpose of a claim of oppression are not confined to legal
interests. Given the potential impact on the debentureholders of the transactions under
consideration, one would expect the directors, acting in the best interests of the
corporation, to consider their short and long-term interests in the course of making
their ultimate decision.
[103]
Indeed, the evidence shows that the directors did consider the interests of
the debentureholders.
A number of debentureholders sent letters to the Board,
expressing concern about the proposed leveraged buyout and seeking assurances that
their interests would be considered. One of the directors, Mr. Pattison, met with
Phillips, Hager & North, representatives of the debentureholders. The directors’
response to these overtures was that the contractual terms of the debentures would be
met, but no additional assurances were given.
[104]
It is apparent that the directors considered the interests of the
debentureholders and, having done so, concluded that while the contractual terms of
the debentures would be honoured, no further commitments could be made. This
fulfilled the duty of the directors to consider the debentureholders’ interests. It did not
amount to “unfair disregard” of the interests of the debentureholders. As discussed
above, it may be impossible to satisfy all stakeholders in a given situation. In this
case, the Board considered the interests of the claimant stakeholders. Having done so,
and having considered its options in the difficult circumstances it faced, it made its
decision, acting in what it perceived to be the best interests of the corporation.
[105]
What the claimants contend for on this appeal, in reality, is not merely an
expectation that their interests be considered, but an expectation that the Board would
take further positive steps to restructure the purchase in a way that would provide a
satisfactory purchase price to the shareholders and preserve the high market value of
the debentures. At this point, the second, softer expectation asserted approaches the
first alleged expectation of maintaining the investment grade rating of the debentures.
[106]
The difficulty with this proposition is that there is no evidence that it was
reasonable to suppose it could have been achieved. BCE, facing certain takeover,
acted reasonably to create a competitive bidding process. The process attracted three
bids. All of the bids were leveraged, involving a substantial increase in Bell Canada’s
debt. It was this factor that posed the risk to the trading value of the debentures.
There is no evidence that BCE could have done anything to avoid that risk. Indeed,
the evidence is to the contrary.
[107]
We earlier discussed the factors to consider in determining whether an
expectation is reasonable on a s. 241 oppression claim. These include commercial
practice; the size, nature and structure of the corporation; the relationship between the
parties; past practice; the failure to negotiate protections; agreements and
representations; and the fair resolution of conflicting interests. In our view, all these
factors weigh against finding an expectation beyond honouring the contractual
obligations of the debentures in this particular case.
[108]
Commercial practice — indeed commercial reality — undermines the
claim that a way could have been found to preserve the trading position of the
debentures in the context of the leveraged buyout.
This reality must have been
appreciated by reasonable debentureholders. More broadly, two considerations are
germane to the influence of general commercial practice on the reasonableness of the
debentureholders’ expectations. First, leveraged buyouts of this kind are not unusual
or unforeseeable, although the transaction at issue in this case is noteworthy for its
magnitude. Second, trust indentures can include change of control and credit rating
covenants where those protections have been negotiated. Protections of that type
would have assured debentureholders a right to vote, potentially through their trustee,
on the leveraged buyout, as the trial judge pointed out. This failure to negotiate
protections was significant where the debentureholders, it may be noted, generally
represent some of Canada’s largest and most reputable financial institutions, pension
funds and insurance companies.
[109]
The nature and size of the corporation also undermine the reasonableness
of any expectation that the directors would reject the offers that had been presented
and seek an arrangement that preserved the investment grade rating of the debentures.
As discussed above (at para. 74), courts may accord greater latitude to the
reasonableness of expectations formed in the context of a small, closely held
corporation, rather than those relating to interests in a large, public corporation. Bell
Canada had become a wholly owned subsidiary of BCE in 1983, pursuant to a plan of
arrangement which saw the shareholders of Bell Canada surrender their shares in
exchange for shares of BCE. Based upon the history of the relationship, it should not
have been outside the contemplation of debentureholders acquiring debentures of Bell
Canada under the 1996 and 1997 trust indentures, that arrangements of this type had
occurred and could occur in the future.
[110]
The debentureholders rely on past practice, suggesting that investment
grade ratings had always been maintained. However, as noted, reasonable practices
may reflect changing economic and market realities. The events that precipitated the
leveraged buyout transaction were such realities. Nor did the trial judge find in this
case that representations had been made to debentureholders upon which they could
have reasonably relied.
[111]
Finally, the claim must be considered from the perspective of the duty on
the directors to resolve conflicts between the interests of corporate stakeholders in a
fair manner that reflected the best interests of the corporation.
[112]
The best interests of the corporation arguably favoured acceptance of the
offer at the time. BCE had been put in play, and the momentum of the market made a
buyout inevitable. The evidence, accepted by the trial judge, was that Bell Canada
needed to undertake significant changes to continue to be successful, and that
privatization would provide greater freedom to achieve its long-term goals by
removing the pressure on short-term public financial reporting, and bringing in equity
from sophisticated investors motivated to improve the corporation’s performance.
Provided that, as here, the directors’ decision is found to have been within the range of
reasonable choices that they could have made in weighing conflicting interests, the
court will not go on to determine whether their decision was the perfect one.
[113]
Considering all the relevant factors, we conclude that the debentureholders
have failed to establish a reasonable expectation that could give rise to a claim for
oppression. As found by the trial judge, the alleged expectation that the investment
grade of the debentures would be maintained is not supported by the evidence. A
reasonable expectation that the debentureholders’ interests would be considered is
established, but was fulfilled. The evidence does not support a further expectation that
a better arrangement could be negotiated that would meet the exigencies that the
corporation was facing, while better preserving the trading value of the debentures.
[114]
Given that the debentureholders have failed to establish that the
expectations they assert were reasonable, or that they were not fulfilled, it is
unnecessary to consider in detail whether conduct complained of was oppressive,
unfairly prejudicial, or unfairly disregarded the debentureholders’ interests within the
terms of s. 241 of the CBCA. Suffice it to say that “oppression” in the sense of bad
faith and abuse was not alleged, much less proved. At best, the claim was for “unfair
disregard” of the interests of the debentureholders. As discussed, the evidence does
not support this claim.
C. The Section 192 Approval Process
[115]
The second remedy relied on by the debentureholders is the approval
process for complex corporate arrangements set out under s. 192 of the CBCA. BCE
brought a petition for court approval of the plan under s. 192.
At trial, the
debentureholders were granted standing to contest such approval. The trial judge
concluded that “[i]t seemed “only logical and ‘fair’ to conduct this analysis having
regard to the interests of BCE and those of its shareholders and other stakeholders, if
any, whose interests are being arranged or affected” ((2008), 43 B.L.R. (4th) 1, 2008
QCCS 905, at para. 151). On the basis of Corporations Canada’s Policy concerning
Arrangements under Section 192 of the CBCA, November 2003 (“Policy Statement
15.1”), the trial judge held that the s. 192 approval did not require the Board to afford
the debentureholders the right to vote. He nonetheless considered their interests in
assessing the fairness of the arrangement. After a full hearing, he approved the
arrangement as “fair and reasonable”, despite the debentureholders’ objections that the
arrangement would adversely affect the trading value of their securities.
[116]
The Court of Appeal reversed this decision, essentially on the ground that
the directors had not given adequate consideration to the debentureholders’ reasonable
expectations. These expectations, in its view, extended beyond the debentureholders’
legal rights and required the directors to consider whether the adverse impact on the
debentureholders’ economic interests could be alleviated or attenuated. The court held
that the corporation had failed to discharge the burden of showing that it was
impossible to structure the sale in a manner that avoided the adverse economic effect
on debentureholdings, and consequently had failed to establish that the proposed plan
of arrangement was fair and reasonable.
[117]
Before considering what must be shown to obtain approval of an
arrangement under s. 192, it may be helpful to briefly return to the differences between
an action for oppression under s. 241 of the CBCA and a motion for approval of an
arrangement under s. 192 of the CBCA alluded to earlier.
[118]
As we have discussed (at para. 47), the reasoning of the Court of Appeal
effectively incorporated the s. 241 oppression claim into the s. 192 approval
proceeding, converting it into an inquiry based on reasonable expectations.
[119]
As we view the matter, the s. 241 oppression remedy and the s. 192
approval process are different proceedings, with different requirements.
While a
conclusion that the proposed arrangement has an oppressive result may support the
conclusion that the arrangement is not fair and reasonable under s. 192, it is important
to keep in mind the differences between the two remedies. The oppression remedy is a
broad and equitable remedy that focuses on the reasonable expectations of
stakeholders, while the s. 192 approval process focuses on whether the arrangement,
objectively viewed, is fair and reasonable and looks primarily to the interests of the
parties whose legal rights are being arranged. Moreover, in an oppression proceeding,
the onus is on the claimant to establish oppression or unfairness, while in a s. 192
proceeding, the onus is on the corporation to establish that the arrangement is “fair and
reasonable”.
[120]
These differences suggest that it is possible that a claimant might fail to
show oppression under s. 241, but might succeed under s. 192 by establishing that the
corporation has not discharged its onus of showing that the arrangement in question is
fair and reasonable. For this reason, it is necessary to consider the debentureholders’
s. 192 claim on these appeals, notwithstanding our earlier conclusion that the
debentureholders have not established oppression.
[121]
Whether the converse is true is not at issue in these proceedings and need
not detain us. It might be argued that in theory, a finding of s. 241 oppression could
be coupled with approval of an arrangement as fair and reasonable under s. 192, given
the different allocations of burden of proof in the two actions and the different
perspectives from which the assessment is made. On the other hand, common sense
suggests, as did the Court of Appeal, that a finding of oppression sits ill with the
conclusion that the arrangement involved is fair and reasonable.
We leave this
interesting question to a case where it arises.
(1) The Requirements for Approval under Section 192
[122]
We will first describe the nature and purpose of the s. 192 approval
process. We will then consider the philosophy that underlies s. 192 approval; the
interests at play in the process; and the criteria to be applied by the judge on a s. 192
proceeding.
(a) The Nature and Purpose of the Section 192 Procedure
[123]
The s. 192 approval process has its genesis in 1923 legislation designed to
permit corporations to modify their share capital: Companies Act Amending Act,
1923, S.C. 1923, c. 39, s. 4. The legislation’s concern was to permit changes to
shareholders’ rights, while offering shareholders protection.
In 1974, plans of
arrangements were omitted from the CBCA because Parliament considered them
superfluous and feared that they could be used to squeeze out minority shareholders.
Upon realizing that arrangements were a practical and flexible way to effect
complicated transactions, an arrangement provision was reintroduced in the CBCA in
1978: Consumer and Corporate Affairs Canada, Detailed background paper for an Act
to amend the Canada Business Corporations Act (1977), p. 5 (“Detailed Background
Paper”).
[124]
In light of the flexibility it affords, the provision has been broadened to
deal not only with reorganization of share capital, but corporate reorganization more
generally. Section 192(1) of the present legislation defines an arrangement under the
provision as including amendments to articles, amalgamation of two or more
corporations, division of the business carried on by a corporation, privatization or
“squeeze-out” transactions, liquidation or dissolution, or any combination of these.
[125]
This list of transactions is not exhaustive and has been interpreted broadly
by courts. Increasingly, s. 192 has been used as a device for effecting changes of
control because of advantages it offers the purchaser: C. C. Nicholls, Mergers,
Acquisitions, and Other Changes of Corporate Control (2007), at p. 76. One of these
advantages is that it permits the purchaser to buy shares of the target company without
the need to comply with provincial takeover bid rules.
[126]
The s. 192 process is generally applicable to change of control transactions
that share two characteristics: the arrangement is sponsored by the directors of the
target company; and the goal of the arrangement is to require some or all of the
shareholders to surrender their shares to either the purchaser or the target company.
[127]
Fundamentally, the s. 192 procedure rests on the proposition that where a
corporate transaction will alter the rights of security holders, this impact takes the
decision out of the scope of management of the corporation’s affairs, which is the
responsibility of the directors. Section 192 overcomes this impediment through two
mechanisms. First, proposed arrangements generally can be submitted to security
holders for approval. Although there is no explicit requirement for a security holder
vote in s. 192, as will be discussed below, these votes are an important feature of the
process for approval of plans of arrangement. Second, the plan of arrangement must
receive court approval after a hearing in which parties whose rights are being affected
may partake.
(b) The Philosophy Underlying Section 192
[128]
The purpose of s. 192, as we have seen, is to permit major changes in
corporate structure to be made, while ensuring that individuals and groups whose
rights may be affected are treated fairly. In conducting the s. 192 inquiry, the judge
must keep in mind the spirit of s. 192, which is to achieve a fair balance between
conflicting interests.
In discussing the objective of the arrangement provision
introduced into the CBCA in 1978, the Minister of Consumer and Corporate Affairs
stated:
... the Bill seeks to achieve a fair balance between flexible management
and equitable treatment of minority shareholders in a manner that is
consonant with the other fundamental change institutions set out in Part
XIV.
(Detailed Background Paper, at p. 6)
[129]
Although s. 192 was initially conceived as permitting and has principally
been used to permit useful restructuring while protecting minority shareholders against
adverse effects, the goal of ensuring a fair balance between different constituencies
applies with equal force when considering the interests of non-shareholder security
holders recognized under s. 192. Section 192 recognizes that major changes may be
appropriate, even where they have an adverse impact on the rights of particular
individuals or groups. It seeks to ensure that the interests of these rights holders are
considered and treated fairly, and that in the end the arrangement is one that should
proceed.
(c) Interests Protected by Section 192
[130]
The s. 192 procedure originally was aimed at protecting shareholders
affected by corporate restructuring. That remains a fundamental concern. However,
this aim has been subsequently broadened to protect other security holders in some
circumstances.
[131]
Section 192 clearly contemplates the participation of security holders in
certain situations. Section 192(1)(f) specifies that an arrangement may include an
exchange of securities for property. Section 192(4)(c) provides that a court can make
an interim order “requiring a corporation to call, hold and conduct a meeting of
holders of securities ...”. The Director appointed under the CBCA takes the view that,
at a minimum, all security holders whose legal rights stand to be affected by the
transaction should be permitted to vote on the arrangement: Policy Statement 15.1, s.
3.08.
[132]
A difficult question is whether s. 192 applies only to security holders
whose legal rights stand to be affected by the proposal, or whether it applies to
security holders whose legal rights remain intact but whose economic interests may be
prejudiced.
[133]
The purpose of s. 192, discussed above, suggests that only security holders
whose legal rights stand to be affected by the proposal are envisioned. As we have
seen, the s. 192 procedure was conceived and has traditionally been viewed as aimed
at permitting a corporation to make changes that affect the rights of the parties. It is
the fact that rights are being altered that places the matter beyond the power of the
directors and creates the need for shareholder and court approval. The distinction
between the focus on legal rights under arrangement approval and reasonable
expectations under the oppression remedy is a crucial one. The oppression remedy is
grounded in unfair treatment of stakeholders, rather than on legal rights in their strict
sense.
[134]
This general rule, however, does not preclude the possibility that in some
circumstances, for example threat of insolvency or claims by certain minority
shareholders, interests that are not strictly legal should be considered: see Policy
Statement 15.1, s. 3.08, referring to “extraordinary circumstances”.
[135]
It is not necessary to decide on these appeals precisely what would amount
to “extraordinary circumstances” permitting consideration of non-legal interests on a s.
192 application. In our view, the fact that a group whose legal rights are left intact
faces a reduction in the trading value of its securities would generally not, without
more, constitute such a circumstance.
(d) Criteria for Court Approval
[136]
Section 192(3) specifies that the corporation must obtain court approval of
the plan. In determining whether a plan of arrangement should be approved, the court
must focus on the terms and impact of the arrangement itself, rather than on the
process by which it was reached. What is required is that the arrangement itself,
viewed substantively and objectively, be suitable for approval.
[137]
In seeking approval of an arrangement, the corporation bears the onus of
satisfying the court that: (1) the statutory procedures have been met; (2) the
application has been put forward in good faith; and (3) the arrangement is fair and
reasonable: see Trizec Corp., Re (1994), 21 Alta. L.R. (3d) 435 (Q.B.), at p. 444. This
may be contrasted with the s. 241 oppression action, where the onus is on the claimant
to establish its case. On these appeals, it is conceded that the corporation satisfied the
first two requirements. The only question is whether the arrangement is fair and
reasonable.
[138]
In reviewing the directors’ decision on the proposed arrangement to
determine if it is fair and reasonable under s. 192, courts must be satisfied that (a) the
arrangement has a valid business purpose, and (b) the objections of those whose legal
rights are being arranged are being resolved in a fair and balanced way. It is through
this two-pronged framework that courts can determine whether a plan is fair and
reasonable.
[139]
In the past, some courts have answered the question of whether an
arrangement is fair and reasonable by applying what is referred to as the business
judgment test, that is whether an intelligent and honest business person, as a member
of the voting class concerned and acting in his or her own interest would reasonably
approve the arrangement: see Trizec, at p. 444; Pacifica Papers Inc. v. Johnstone
(2001), 15 B.L.R. (3d) 249, 2001 BCSC 1069. However, while this consideration may
be important, it does not constitute a useful or complete statement of what must be
considered on a s. 192 application.
[140]
First, the fact that the business judgment test referred to here and the
business judgment rule discussed above (at para. 40) are so similarly named leads to
confusion.
The business judgment rule expresses the need for deference to the
business judgment of directors as to the best interests of the corporation. The business
judgment test under s. 192, by contrast, is aimed at determining whether the proposed
arrangement is fair and reasonable, having regard to the corporation and relevant
stakeholders.
The two inquiries are quite different.
Yet the use of the same
terminology has given rise to confusion. Thus, courts have on occasion cited the
business judgment test while saying that it stands for the principle that arrangements
do not have to be perfect, i.e. as a deference principle: see Abitibi-Consolidated Inc.
(Arrangement relatif à), [2007] Q.J. No. 16158 (QL), 2007 QCCS 6830. To conflate
the business judgment test and the business judgment rule leads to difficulties in
understanding what “fair and reasonable” means and how an arrangement may satisfy
this threshold.
[141]
Second, in instances where affected security holders have voted on a plan
of arrangement, it seems redundant to ask what an intelligent and honest business
person, as a member of the voting class concerned and acting in his or her own
interest, would do. As will be discussed below (at para. 150), votes on arrangements
are an important indicator of whether a plan is fair and reasonable. However, the
business judgment test does not provide any more information than does the outcome
of a vote. Section 192 makes it clear that the reviewing judge must delve beyond
whether a reasonable business person would approve of a plan to determine whether
an arrangement is fair and reasonable. Insofar as the business judgment test suggests
that the judge need only consider the perspective of the majority group, it is
incomplete.
[142]
In summary, we conclude that the business judgment test is not useful in
the context of a s. 192 application, and indeed may lead to confusion.
[143]
The framework proposed in these reasons reformulates the s. 192 test for
what is fair and reasonable in a way that reflects the logic of s. 192 and the authorities.
Determining what is fair and reasonable involves two inquiries: first, whether the
arrangement has a valid business purpose; and second, whether it resolves the
objections of those whose rights are being arranged in a fair and balanced way. In
approving plans of arrangement, courts have frequently pointed to factors that answer
these two questions as discussed more fully below: Canadian Pacific Ltd. (Re) (1990),
73 O.R. (2d) 212 (H.C.); Cinar Corp. v. Shareholders of Cinar Corp. (2004), 4 C.B.R.
(5th) 163 (Que. Sup. Ct.); PetroKazakhstan Inc. v. Lukoil Overseas Kumkol B.V.
(2005), 12 B.L.R. (4th) 128, 2005 ABQB 789.
[144]
We now turn to a more detailed discussion of the two prongs.
[145]
The valid business purpose prong of the fair and reasonable analysis
recognizes the fact that there must be a positive value to the corporation to offset the
fact that rights are being altered. In other words, courts must be satisfied that the
burden imposed by the arrangement on security holders is justified by the interests of
the corporation. The proposed plan of arrangement must further the interests of the
corporation as an ongoing concern. In this sense, it may be narrower than the “best
interests of the corporation” test that defines the fiduciary duty of directors under
s. 122 of the CBCA (see paras. 38-40).
[146]
The valid purpose inquiry is invariably fact-specific. Thus, the nature and
extent of evidence needed to satisfy this requirement will depend on the
circumstances. An important factor for courts to consider when determining if the plan
of arrangement serves a valid business purpose is the necessity of the arrangement to
the continued operations of the corporation.
Necessity is driven by the market
conditions that a corporation faces, including technological, regulatory and
competitive conditions. Indicia of necessity include the existence of alternatives and
market reaction to the plan. The degree of necessity of the arrangement has a direct
impact on the court’s level of scrutiny. Austin J. in Canadian Pacific concluded that
while courts are prepared to assume jurisdiction notwithstanding a lack of
necessity on the part of the company, the lower the degree of necessity, the
higher the degree of scrutiny that should be applied. [Emphasis added; p.
223.]
If the plan of arrangement is necessary for the corporation’s continued existence,
courts will more willingly approve it despite its prejudicial effect on some security
holders. Conversely, if the arrangement is not mandated by the corporation’s financial
or commercial situation, courts are more cautious and will undertake a careful analysis
to ensure that it was not in the sole interest of a particular stakeholder. Thus, the
relative necessity of the arrangement may justify negative impact on the interests of
affected security holders.
[147]
The second prong of the fair and reasonable analysis focuses on whether
the objections of those whose rights are being arranged are being resolved in a fair and
balanced way.
[148]
An objection to a plan of arrangement may arise where there is tension
between the interests of the corporation and those of a security holder, or there are
conflicting interests between different groups of affected rights holders. The judge
must be satisfied that the arrangement strikes a fair balance, having regard to the
ongoing interests of the corporation and the circumstances of the case. Often this will
involve complex balancing, whereby courts determine whether appropriate
accommodations and protections have been afforded to the concerned parties.
However, as noted by Forsyth J. in Trizec, at para. 36:
[T]he court must be careful not to cater to the special needs of one
particular group but must strive to be fair to all involved in the transaction
depending on the circumstances that exist. The overall fairness of any
arrangement must be considered as well as fairness to various individual
stakeholders.
[149]
The question is whether the plan, viewed in this light, is fair and
reasonable. In answering this question, courts have considered a variety of factors,
depending on the nature of the case at hand. None of these alone is conclusive, and
the relevance of particular factors varies from case to case. Nevertheless, they offer
guidance.
[150]
An important factor is whether a majority of security holders has voted to
approve the arrangement. Where the majority is absent or slim, doubts may arise as to
whether the arrangement is fair and reasonable; however, a large majority suggests the
converse. Although the outcome of a vote by security holders is not determinative of
whether the plan should receive the approval of the court, courts have placed
considerable weight on this factor. Voting results offer a key indication of whether
those affected by the plan consider it to be fair and reasonable: St. Lawrence &
Hudson Railway Co. (Re), [1998] O.J. No. 3934 (QL) (Ont. Ct. (Gen. Div.)).
[151]
Where there has been no vote, courts may consider whether an intelligent
and honest business person, as a member of the class concerned and acting in his or
her own interest, might reasonably approve of the plan: Re Alabama, New Orleans,
Texas and Pacific Junction Railway Co., [1891] 1 Ch. 213 (C.A.); Trizec.
[152]
Other indicia of fairness are the proportionality of the compromise
between various security holders, the security holders’ position before and after the
arrangement and the impact on various security holders’ rights: see Canadian Pacific;
Trizec. The court may also consider the repute of the directors and advisors who
endorse the arrangement and the arrangement’s terms. Thus, courts have considered
whether the plan has been approved by a special committee of independent directors;
the presence of a fairness opinion from a reputable expert; and the access of
shareholders to dissent and appraisal remedies: see Stelco Inc. (Re) (2006), 18 C.B.R.
(5th) 173 (Ont. S.C.J.); Cinar; St. Lawrence & Hudson Railway; Trizec; Pacifica
Papers; Canadian Pacific.
[153]
This review of factors represents considerations that have figured in s. 192
cases to date. It is not meant to be exhaustive, but simply to provide an overview of
some factors considered by courts in determining if a plan has reasonably addressed
the objections and conflicts between different constituencies. Many of these factors
will also indicate whether the plan serves a valid business purpose. The overall
determination of whether an arrangement is fair and reasonable is fact-specific and
may require the assessment of different factors in different situations.
[154]
We arrive then at this conclusion: in determining whether a plan of
arrangement is fair and reasonable, the judge must be satisfied that the plan serves a
valid business purpose and that it adequately responds to the objections and conflicts
between different affected parties. Whether these requirements are met is determined
by taking into account a variety of relevant factors, including the necessity of the
arrangement to the corporation’s continued existence, the approval, if any, of a
majority of shareholders and other security holders entitled to vote, and the
proportionality of the impact on affected groups.
[155]
As has frequently been stated, there is no such thing as a perfect
arrangement.
What is required is a reasonable decision in light of the specific
circumstances of each case, not a perfect decision: Trizec; Maple Leaf Foods. The
court on a s. 192 application should refrain from substituting their views of what they
consider the “best” arrangement. At the same time, the court should not surrender
their duty to scrutinize the arrangement. Because s. 192 facilitates the alteration of
legal rights, the Court must conduct a careful review of the proposed transactions. As
Lax J. stated in UPM-Kymmene Corp. v. UPM-Kymmene Miramichi Inc. (2002), 214
D.L.R. (4th) 496 (Ont. S.C.J.), at para. 153: “Although Board decisions are not subject
to microscopic examination with the perfect vision of hindsight, they are subject to
examination.”
(2) Application to these Appeals
[156]
As discussed above (at paras. 137-38), the corporation on a s. 192
application must satisfy the court that: (1) the statutory procedures are met; (2) the
application is put forward in good faith; and (3) the arrangement is fair and reasonable,
in the sense that: (a) the arrangement has a valid business purpose; and (b) the
objections of those whose rights are being arranged are resolved in a fair and balanced
way.
[157]
The first and second requirements are clearly satisfied in this case. On the
third element, the debentureholders no longer argue that the arrangement lacks a valid
business purpose. The debate before this Court focuses on whether the objections of
those whose rights are being arranged were resolved in a fair and balanced way.
[158]
The debentureholders argue that the arrangement does not address their
rights in a fair and balanced way. Their main contention is that the process adopted by
the directors in negotiating and concluding the arrangement failed to consider their
interests adequately, in particular the fact that the arrangement, while upholding their
contractual rights, would reduce the trading value of their debentures and in some
cases downgrade them to below investment grade rating.
[159]
The first question that arises is whether the debentureholders’ economic
interest in preserving the trading value of their bonds was an interest that the directors
were required to consider on the s. 192 application.
We earlier concluded that
authority and principle suggest that s. 192 is generally concerned with legal rights,
absent exceptional circumstances. We further suggested that the fact that a group
whose legal rights are left intact faces a reduction in the trading value of its securities
would generally not constitute such a circumstance.
[160]
Relying on Policy Statement 15.1, the trial judge in these proceedings
concluded that the debentureholders were not entitled to vote on the plan of
arrangement because their legal rights were not being arranged; “[t]o do so would
unjustly give [them] a veto over a transaction with an aggregate common equity value
of approximately $35 billion that was approved by over 97% of the shareholders”
(para. 166). Nevertheless, the trial judge went on to consider the debentureholders’
perspective.
[161]
We find no error in the trial judge’s conclusions on this point. Since only
their economic interests were affected by the proposed transaction, not their legal
rights, and since they did not fall within an exceptional situation where non-legal
interests should be considered under s. 192, the debentureholders did not constitute an
affected class under s. 192. The trial judge was thus correct in concluding that they
should not be permitted to veto almost 98 percent of the shareholders simply because
the trading value of their securities would be affected. Although not required, it
remained open to the trial judge to consider the debentureholders’ economic interests
in his assessment of whether the arrangement was fair and reasonable under s. 192, as
he did.
[162]
The next question is whether the trial judge erred in concluding that the
arrangement addressed the debentureholders’ interests in a fair and balanced way. The
trial judge emphasized that the arrangement preserved the contractual rights of the
debentureholders as negotiated. He noted that it was open to the debentureholders to
negotiate protections against increased debt load or the risks of changes in corporate
structure, had they wished to do so. He went on to state:
... the evidence discloses that [the debentureholders’] rights were in fact
considered and evaluated. The Board concluded, justly so, that the terms
of the 1976, 1996 and 1997 Trust Indentures do not contain change of
control provisions, that there was not a change of control of Bell Canada
contemplated and that, accordingly, the Contesting Debentureholders
could not reasonably expect BCE to reject a transaction that maximized
shareholder value, on the basis of any negative impact [on] them.
((2008), 43 B.L.R. (4th) 1, 2008 QCCS 905, at para. 162, quoting (2008),
43 B.L.R. (4th) 79, 2008 QCCS 907, at para. 199)
[163]
We find no error in these conclusions.
fundamentally alter the debentureholders’ rights.
The arrangement does not
The investment and the return
contracted for remain intact. Fluctuation in the trading value of debentures with
alteration in debt load is a well-known commercial phenomenon.
The
debentureholders had not contracted against this contingency. The fact that the trading
value of the debentures stood to diminish as a result of the arrangement involving new
debt was a foreseeable risk, not an exceptional circumstance. It was clear to the judge
that the continuance of the corporation required acceptance of an arrangement that
would entail increased debt and debt guarantees by Bell Canada: necessity was
established. No superior arrangement had been put forward, and BCE had been
assisted throughout by expert legal and financial advisors, suggesting that the
proposed arrangement had a valid business purpose.
[164]
Based on these considerations, and recognizing that there is no such thing
as a perfect arrangement, the trial judge concluded that the arrangement had been
shown to be fair and reasonable. We see no error in this conclusion.
[165]
The Court of Appeal’s contrary conclusion rested, as suggested above, on
an approach that incorporated the s. 241 oppression remedy with its emphasis on
reasonable expectations into the s. 192 arrangement approval process. Having found
that the debentureholders’ reasonable expectations (that their interests would be
considered by the Board) were not met, the court went on to combine that finding with
the s. 192 onus on the corporation. The result was to combine the substance of the
oppression action with the onus of the s. 192 approval process. From this hybrid
flowed the conclusion that the corporation had failed to discharge its burden of
showing that it could not have met the alleged reasonable expectations of the
debentureholders. This result could not have obtained under s. 241, which places the
burden of establishing oppression on the claimant. By combining s. 241’s substance
with the reversed onus of s. 192, the Court of Appeal arrived at a conclusion that could
not have been sustained under either provision, read on its own terms.
VI. Conclusion
[166]
We conclude that the debentureholders have failed to establish either
oppression under s. 241 of the CBCA or that the trial judge erred in approving the
arrangement under s. 192 of the CBCA.
[167]
For these reasons, the appeals are allowed, the decision of the Court of
Appeal set aside, and the trial judge’s approval of the plan of arrangement is affirmed
with costs throughout. The cross-appeals are dismissed with costs throughout.
Appeals allowed with costs. Cross-appeals dismissed with costs
Solicitors for the appellants/respondents on cross-appeals BCE and Bell
Canada: Davies, Ward, Phillips & Vineberg, Montréal.
Solicitors for the appellant/respondent on cross-appeals 6796508 Canada
Inc.: Woods & Partners, Montréal.
Solicitors for the respondents/appellants on cross-appeals Group of 1976
Debentureholders and Group of 1996 Debentureholders: Fishman, Flanz, Meland,
Paquin, Montréal.
Solicitors for the respondent/appellant on cross-appeals Group of 1997
Debentureholders: McMillan, Binch, Mendelsohn, Toronto.
Solicitors for the respondent Computershare Trust Company of
Canada: Miller, Thomson, Pouliot, Montréal.
Solicitor for the intervener Catalyst Asset Management Inc.: Christian
Tacit, Kanata.
Solicitors for the intervener Matthew Stewart:
Langlois, Kronström,
Desjardins, Montréal.
Neutral Citation Number: [2007] EWHC 2402_2 (Ch)
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
COMPANIES COURT
Royal Courts of Justice
Date: Wednesday, 12th September 2007
Before
MR. JUSTICE BRIGGS
_________
IN THE MATTER OF CHEYNE FINANCE PLC (in Receivership)
AND
IN THE MATTER OF THE INSOLVENCY ACT 1986
_________
Transcribed by BEVERLEY F NUNNERY & CO
Official Shorthand Writers and Tape Transcribers
Quality House, Quality Court, Chancery Lane, London WC2A 1HP
Tel: 020 7831 5627 Fax: 020 7831 7737
_________
MR. D. SHELDON QC and MR. B. ISAACS (instructed by Lovells) appeared on behalf of the
Receiver.
MR. W. TROWER QC and MR. J. GOLDRING (Instructed by Hunton & Williams) appeared on
behalf of Party A.
MR. S. MORTIMORE QC and MISS H. STONEFROST (instructed by Milbank Tweed) appeared
on behalf of the Party B.
_________
JUDGMENT
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
2
3
MR. JUSTICE BRIGGS:
1
This is an urgent application for directions by Messrs. Nicholas Edwards,
4
Neville Kahn and Nicholas Dargan, all of Deloitte & Touche LLP, as
5
Receivers of the business and assets of Cheyne Finance Plc, having been
6
appointed on 4th September of this year pursuant to the terms of a Security
7
Trust Deed dated 3rd August 2005, and made between Cheyne and the Bank of
8
New York. The Receivers seek directions as to how to apply monies coming
9
into their hands on the basis that, on advice, they consider that they need the
10
Court’s answer to an underlying difficult issue of the construction of the
11
Security Trust Deed.
12
13
2
For that purpose the Receivers have identified two beneficiaries of the Security
14
Trust Deed with interests served by the only two alternative constructions
15
which have been identified, both of whom, or which, wish for commercial
16
reasons to remain anonymous. They have each indicated through counsel that
17
they are only prepared to participate in this hearing on that basis. Their
18
identity is of no relevance to the issues and it appears that the preservation of
19
their anonymity is the only way in which the adversarial argument on the
20
issues can be arranged at the necessarily short notice. I am satisfied that the
21
two alternative constructions have, despite the shortness of time, been fully
22
argued. Preserving the anonymity of the two beneficiaries has enabled both
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
the argument and this judgment to be heard and given in open court. I shall
2
refer to the proponents of the rival arguments as Parties A and B. Another
3
interested party initially appeared, also anonymously, to support Party B, but
4
on reading the skeleton argument prepared on Party B’s behalf by leading and
5
junior counsel decided that there was nothing that could usefully be added.
6
7
3
The urgency of the matter, it being recognised on all sides that the Receivers
8
need directions today after a hearing yesterday afternoon, means that this
9
judgment has had to be both extempore and in a relatively abbreviated form
10
without the full explanation to the uninitiated of the relevant and complex
11
contractual and commercial background which I would have preferred to
12
provide. Since both the relevant facts and the contractual framework are
13
common ground I can confine myself to a judgment which identifies the
14
construction which I have decided is to be preferred and which provides brief
15
reasons.
16
17
4
The Bank of New York, as Security Trustee, became obliged to appoint the
18
Receivers pursuant to clause 10 of the Security Trust Deed because of the
19
occurrence and notification by the Trustee of an Enforcement Event. As with
20
most defined terms, the meaning of this phrase is to be found in Clause 2 of a
21
Common Terms Agreement of even date. The Enforcement Event in the
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
present case consisted of the breach by Cheyne of a Major Capital Loss test,
2
also as defined, which I am told is itself the consequence of the fact that a
3
significant part of Cheyne’s assets consisted of securities backed by assets
4
consisting in part of United States of America home equity loans, some of
5
which have suffered recently as a result of the USA sub-prime mortgage crisis.
6
Nonetheless, it is not the present view of the Receivers, after a brief initiation
7
into the affairs of the company, that it is at present insolvent in the sense either
8
than it is unable to pay its debts as they fall due or in the sense that its assets
9
are exceeded in value by its liabilities.
10
11
5
More specifically, it is common ground that there has not yet occurred an
12
Insolvency Event within the meaning of the Security Trust Deed or the
13
Common Terms Agreement, which is defined as follows:
14
15
“Insolvency Event means a determination by the Manager or any
16
Receiver that the Issuer is, or is about to become, unable to pay its
17
debts as they fall due to Senior Creditors and any other persons whose
18
claims against the Issuer are required to be paid in priority thereto, as
19
contemplated by Section 123(1) of the United Kingdom Insolvency
20
Act 1986 (such subsection being applied for this purpose only as if the
21
Issuer’s only liabilities were those to Senior Creditors and any other
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
persons whose claims against the Issuer are required under the Security
2
Trust Deed to be paid in priority thereto).”
3
4
6
In order for that definition to be intelligible I must explain that the Issuer is
5
Cheyne. The Senior Creditors are defined as persons to whom Senior
6
Obligations are owing, and Senior Obligations are defined so as to include
7
secured, but limited recourse Loan Notes issued by Cheyne to raise finance for
8
its investment activities.
9
10
7
The reference to Section 123(1) of the Insolvency Act necessarily excludes
11
balance sheet insolvency as defined by Section 123(2) of the Act. Thus, it is
12
submitted by Party A and not seriously challenged by Party B, that if the
13
Receivers were hypothetically to determine that Cheyne is able to pay its debts
14
as they fall due now and in the near future, but not in the more distant future
15
because of a balance sheet deficit, that would not constitute an Insolvency
16
Event. I am prepared for present purposes to assume, without deciding, that
17
the definition of Insolvency Event in the Common Terms Agreement does
18
operate in that rather narrow and unusual way. I make it clear that the
19
Receivers have not concluded that Cheyne is balance sheet insolvent at
20
present.
21
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
8
The Receivers recognise a real risk that the present volatility and illiquidity in
2
the market for some of Cheyne’s investments may lead to an Insolvency Event
3
occurring in the future such that, although the present value of Cheyne’s assets
4
is believed to be sufficient to pay all its creditors, that may change to an extent
5
that even Senior Creditors will not be paid in full on the maturity of their
6
Notes, which will occur on a rolling series of dates during the next two years.
7
8
9
The Receivers have cash available to pay maturing Senior Obligations through
9
to early November 2007, but payments thereafter require asset realisations, the
10
amount and speed of which are hard to predict having regard to the state of the
11
relevant market.
12
13
10
During the period between appointment due to an Enforcement Event and the
14
happening of an Insolvency Event the Receivers’ obligations are defined
15
mainly by Clauses 10 to 12 of the Security Trust Deed. The relevant parts of
16
Clause 10 are as follows:
17
18
“10.2 It shall be a term of any appointment of a Receiver under
19
subclause 10.1 that such Receiver shall, unless and until an Insolvency
20
Event Notice is delivered by the Security Trustee in accordance with
21
Clause 9:
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
2
(a)
manage the Security Assets and the business of the Chargor with
3
the objective of arranging for timely payment in full of the Chargor’s
4
obligations to the Senior Creditors and any creditors ranking in priority
5
to the Senior Creditors in the Payment Priority and, unless in the
6
opinion of such Receiver the interests of the Senior Creditors and any
7
creditors ranking in priority to the Senior Creditors in the Payment
8
Priority would be adversely affected thereby, the other Secured
9
Creditors, in each case as and when they fall due for payment in
10
accordance with Clause 12 below and, in so doing, shall ensure that the
11
business of the Chargor is managed in accordance with the Restricted
12
Funding Restrictions and Guidelines contained in subclause 6.2 of the
13
Management Agreement …”
14
15
Clause 10.2(c) provides that the Receivers must, during the same period, also:
16
17
“determine, as often as it, acting in good faith, thinks fit, whether the
18
Chargor is or is about to become unable to pay its debts to Senior
19
Creditors and any other persons whose claims against the Chargor are
20
required to be paid in priority thereto in accordance with the definition
21
of Insolvency Event, and forthwith upon determining that the Chargor
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
is or is about to become so unable, notify the Security Trustee
2
accordingly.”
3
4
11
Clause 11 confers wide powers on the Receivers, the precise ambit of which is
5
not relevant for the present issue. Clause 11.12 provides that those powers are
6
available to the Receivers during the period from their appointment until the
7
happening of an Insolvency Event.
8
9
12
Clause 12 sets out a detailed table of priorities which must be applied by the
10
Receivers in paying creditors out of monies coming into their hands. Ten
11
successive priorities are identified. The present issue arises not, as it were, as
12
between any of those ten priorities but internally in relation to the second of
13
them. The relevant parts of Clause 12 are as follows:
14
15
“Any moneys received by the Security Trustee or a Receiver after the
16
occurrence of an Enforcement Event shall, subject to the payment of
17
any claims having priority to the security constituted by the Security
18
Trust Deed and to subclause 11.11, be applied in the following order of
19
priority (the ‘Payment Priority’) …”
20
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
Subclause (a) provides for first priority for certain expenses and remuneration;
2
and subclause (b) provides as follows:
3
4
“secondly, in satisfaction of or provision for all Senior Obligations as
5
and when the same become payable and, if more than one such Senior
6
Obligation is payable at the relevant time, pari passu and in proportion
7
to the amounts payable in respect thereof;”
8
9
10
There then follow the remaining priorities, and after all ten have been listed the
clause continues as follows:
11
12
“… and, for the avoidance of doubt, no such moneys shall be applied at
13
any point in the Payment Priority unless and until payment for all
14
amounts at a more senior position in the Payment Priority have been
15
discharged, except to the extent that the Security Trustee or, as the case
16
may be, the Receiver considers that sufficient cash has been realised
17
from the disposal or maturity of the Security Assets to enable all such
18
obligations at a more senior position in the Payment Priority which are
19
not then due and payable to be discharged as and when they fall due
20
for payment …”
21
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
13
The issue arises from two rival interpretations of clause 12.1(b). I shall
2
describe them in the form into which they had developed by the end of the
3
hearing. Under the first, referred in argument as the “pay as you go”
4
construction, the Receivers are, on any particular day, obliged to use available
5
moneys after compliance with Clause 12.1(a) in paying in full Senior
6
Obligations by then due and payable, then in using any surplus as a cash
7
provision for Senior Obligations not yet due and payable and only if a full cash
8
provision leaves a surplus moving down to the third and subsequent priorities
9
set out in Clause 12.1. This construction was advanced by Mr. Trower QC and
Mr. Goldring for Party A.
10
11
12
14
Under the second construction, referred to in argument as the “pari passu”
13
construction, the Receivers are obliged to apply moneys left after compliance
14
with Clause 12.1(a), first, in making provision for payment of all Senior
15
Obligations whether or not immediately due and payable, and making full
16
payment in satisfaction of presently payable obligations only if the available
17
moneys are sufficient to do so after making full provision and, if not sufficient,
18
paying a reduced sum pari passu to all Senior Creditors. This construction
19
was advanced by Mr. Mortimore QC and Miss Stonefrost for Party B.
20
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
15
On analysis the issue is therefore whether, prior to the happening of an
2
Insolvency Event, Clause 12.1(b) sets up an internal priority between on the
3
one hand payment of debts due and payable in full, and on the other hand
4
provision for all relevant debts whether or not due and payable.
5
16
Before expressing my conclusion on this issue it is material to note certain
6
aspects of the relevant provisions and certain consequences of the rival
7
constructions. First, Clause 12 regulates the priority of payments by the
8
Receivers not merely prior to an Insolvency Event but after it. This is because,
9
for example, the definition of an Enforcement Event includes an Insolvency
10
Event and because, by contrast with Clause 10.2, Clause 12 applies throughout
11
the period of office of Receivers, who must be appointed under Clause 10.1
12
upon both an Enforcement Event and an Insolvency Event. Accordingly, it is
13
not to be supposed that the numerous references in Clause 12.1 to pari passu
14
distribution are meaningless unless they applied prior to the happening of
15
Insolvency Event. It may be that they are intended to apply only after the
16
happening of an Insolvency Event.
17
18
17
Secondly, if the operation of Clause 12.1 ever leads to any Senior Creditor
19
being paid less than the full amount of a debt immediately due and payable,
20
that will of itself automatically constitute an Insolvency Event. Thus, on the
21
pari passu construction the inability of the Receivers to satisfy themselves that
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
all future liabilities to Senior Creditors are fully provided for will itself trigger
2
an Insolvency Event due to their inability to pay in full those Senior
3
Obligations which are already due and payable.
4
5
18
Thirdly, once there has been an Insolvency Event, the rival constructions
6
produce the same result, since by Clause 9.2 of the Security Trust Deed all
7
Secured Obligations, which include most if not all Senior Obligations, are
8
immediately due and payable and the distinction between Obligations payable
9
now and Obligations payable only in the future therefore disappears.
10
11
19
Fourthly, it is therefore difficult to see how the second part of Clause 12.1(b)
12
calling for pari passu payment between Senior Obligations with the same
13
maturity dates could ever arise during the only period – i.e. after an
14
Enforcement Event but prior to an Insolvency Event – when this issue of
15
construction actually matters. If the Senior Obligations cannot be paid in full
16
at any relevant time Cheyne is unable to pay its debts to its Senior Creditors as
17
they fall due. It follows that the second part of Clause 12.1(b) is, in my
18
judgment, of little weight in understanding how Clause 12 is intended to
19
operate prior to an Insolvency Event.
20
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
20
I have concluded that Clause 12.1(b) is to be construed in accordance with the
2
pay as you go construction. My reasons follow. The provision of the Security
3
Trust which is most clearly expressed to be applicable to the relevant period –
4
i.e. between the happening of an Enforcement Event and the happening of
5
Insolvency Event – is clause 10.2, which requires the Receivers to manage the
6
Company’s assets with the express objective of achieving the timely payment
7
in full of debts to Senior Creditors as and when they fall due for payment.
8
9
21
The pay as you go construction of Clause 12.1(b) operates in complete
10
harmony with that objective. By contrast, that objective, designed to produce
11
cash-flow from realisations aligned with the amounts and maturity dates of the
12
Senior Obligations, is at complete variance with the pari passu construction of
13
12.1(b). As Mr. Trower and Mr. Goldring put it in their skeleton argument:
14
15
“It would be illogical for the Receivers to be obliged to manage the
16
Security Assets in a way aimed at allowing timely payment of the
17
Company’s debts as they fall due but for the moneys received from
18
such management to be distributed to Senior Noteholders in a different
19
way.”
20
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
22
There is nothing in the language of Clause 12.1(b) itself which either points to
2
or requires the Receivers to treat full provision for future Senior Obligations as
3
a necessary condition precedent to payment of Senior Obligations already due
4
and payable, nor, it is fair to say, does the language of Clause 12.1(b), viewed
5
on its own, unambiguously require the opposite – i.e. payment of due debts in
6
full before provisioning. In my judgment, the whole of Clause 12 is concerned
7
with the order of priorities – that is the ten priorities identified – rather than
8
with the internal administration of a particular priority, such as that identified
9
compendiously in favour of Senior Obligations in Clause 12.1(b).
10
11
23
Nonetheless, the payment requirement in Clause 12.1(b) precedes the
12
provision requirement and, although not as clear as it might have been, the
13
language is, in my judgment, more easily reconciled with an obligation first to
14
pay what is due and then to use as much as is necessary of the balance of the
15
moneys as a cash provision against Senior Obligations due in the future.
16
17
24
The analysis is fortified by the avoidance of doubt section of Clause 12, which
18
I have read, which forbids the Receivers from paying debts of lesser priority
19
until full cash provision has been made for future more senior obligations.
20
Implicit in that language is the contemplation that after payment of present
21
Senior Obligations there may be some, but not enough, cash for provision
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
against future Senior Obligations with the result that more junior debts, even
2
though immediately payable, do not get paid. This will not, of itself, cause an
3
Insolvency Event because that definition refers only to debts due to
4
Senior Creditors.
5
6
25
Mr. Mortimore sought to avoid that interpretation by submitting that provision
7
in Clause 12.1(b), although out of moneys in the Receivers’ hands, could
8
nonetheless be made having regard to the other non-cash assets of Cheyne,
9
whereas cash provision under the avoidance of doubt section of Clause 12
10
could not. Although ingenious, I am not persuaded by that argument. In my
11
judgment, all references to “provision” in Clause 12 are about cash provision,
12
as the avoidance of doubt section makes clear.
13
14
26
In reaching that conclusion I have not ignored Mr. Mortimore’s other
15
submissions to the contrary. His main point was that the pay as you go
16
construction involved the real risk that creditors of equivalent – that is senior –
17
priority might get paid unequally to the prejudice of those with later maturity
18
dates, who might get little or nothing if an Insolvency Event followed a
19
significant period of pay as you go – i.e. in full – distribution by the Receivers
20
after an Enforcement Event.
21
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
27
The pay as you go construction clearly does involve that risk, and on the
2
assumption about the narrowness of the definition of Insolvency Event which
3
I have been invited to make, even a probability of such unfairness where the
4
Company’s balance sheet shows a likely inability to pay debts in full but only
5
later rather than sooner. But the unfairness in question arises primarily from
6
the narrowness of the definition of Insolvency Event deliberately chosen by
7
the parties so as exclude balance sheet insolvency.
8
9
28
It would, in my judgment, be wrong to adopt a strained construction of Clause
10
12 merely to remedy, as I accept it would do, a potential for what some would
11
regard as unfairness where the risk appears to have been deliberately
12
undertaken in a detailed regime designed, as is common ground, entirely to
13
replace the statutory insolvency scheme as between the parties, who include
14
the Senior Creditors.
15
16
29
Furthermore, there is, prior to an Insolvency Event, an equal and opposite
17
chance that an orderly run-off of Cheyne’s business pursuant to the objectives
18
set out in Clause 10 will lead to the payment on time and in full of all
19
Senior Creditors, even though the Receivers could not be sure at the outset that
20
full provision could be made. The pari passu construction would prevent that
21
objective from being achieved in such cases and would appear, therefore, to
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
1
risk defeating an expressly stated commercial purpose of the contractual
2
structure. In short, the structure appears to be the product of a deliberate
3
decision by its participants to maximise the prospects of an orderly run-off at
4
some risk to strict pari passu fairness if insolvency as defined later ensues.
5
Whatever the general public policy enshrined in the insolvency legislation,
6
there is no reason, in my judgment, why the court should seek to defeat that
7
commercial objective freely agreed, as it was, between Cheyne and its no
8
doubt highly sophisticated secured creditors.
9
10
30
Mr. Mortimore submitted that such an outcome would also be inconsistent
11
with passages in the information memoranda relating to some of the Senior
12
Obligations which describe the relevant Loan Notes as ranking pari passu
13
amongst themselves. I do not agree. There are, on any construction of Clause
14
12.1(b), powerful pari passu elements built into the structure, both in the
15
priority provisions and in the acceleration provisions triggered by the
16
happening of an Insolvency Event. In any case, the true construction of the
17
contractual provisions must prevail.
18
19
31
It seems to me at least possible that by reference to Section 123(1)(e) of the
20
Insolvency Act 1986 incorporated into the definition of an Insolvency Event in
21
the Common Terms Agreement, the definition might not be quite as narrow as
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1
that which I am invited to assume. For example, if the Receivers were to
2
become certain after realising all Cheyne’s assets for cash that it will default in
3
payment of Senior Creditors’ debts as they fall due in the distant rather than
4
the near future, that certainty of future default may arguably constitute a
5
present status of inability to pay debts as they fall due within the definition.
6
The present circumstances do not require me to decide that question, nor do
7
I, but it may arise for decision in the future. If that slightly broader definition
8
were to prevail, it would, for present purposes, merely reduce the scope for
9
alleged unfairness of the pay as you go construction.
10
11
32
It follows that I resolve the construction issue underlying this application in
12
favour of the pay as you go construction, and I will hear submissions as to an
13
appropriate form of order.
14
15
BEVERLEY F NUNNERY & CO
OFFICIAL SHORTHAND WRITERS
_________
No.6745 of 2007
Neutral Citation Number: [2007] EWHC 2402 (Ch)
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
COMPANIES COURT
Royal Courts of Justice
Date: Wednesday, 17th October 2007
Before
MR. JUSTICE BRIGGS
_________
(in Private)
IN THE MATTER OF CHEYNE FINANCE PLC (in Receivership)
AND
IN THE MATTER OF THE INSOLVENCY ACT 1986
_________
Transcribed by BEVERLEY F NUNNERY & CO
Official Shorthand Writers and Tape Transcribers
Quality House, Quality Court, Chancery Lane, London WC2A 1HP
Tel: 020 7831 5627 Fax: 020 7831 7737
([email protected])
_________
MR. R. SHELDON QC and MR. B. ISAACS (instructed by Lovells) appeared on
behalf of the Receivers.
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MR. W. TROWER QC and MR. R. FISHER (instructed by Hunton & Williams)
appeared on behalf of Party A.
MR. S. MORTIMORE QC and MISS H. STONEFROST (instructed by Milbank
Tweed, Hadley and McCloy LLP) appeared on behalf of Party B.
MR. M. PASCOE QC and MR. D. ALLISON (instructed by Ashurst and Kay
Scholer LLP) appeared on behalf of Party C.
MR. S. ISAACS QC and MR. D. BAYFIELD (instructed by Jones Day, Herbert
Smith and Sidley Austin) appeared on behalf of Party D.
_________
JUDGMENT
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MR. JUSTICE BRIGGS:
1.
This is a second urgent application for directions by Receivers of the
business and assets of Cheyne Finance Plc (“Cheyne”), appointed on 4th
September 2007 pursuant to a Security Trust Deed (“the Trust Deed”) dated
3rd August 2005 between Cheyne and the Bank of New York.
2.
I heard and determined an earlier application in mid-September. The
opening paragraphs of my judgment on that application are a sufficient
general introduction to this application.
3.
That application raised an issue as to how the Receivers should apply
monies coming into their hands during the period between their
appointment and the happening, if one should happen, of an Insolvency
Event, as defined. That issue turned on a question of construction of the
Trust Deed. The only factual assumption then required was that at that time
an Insolvency Event had not occurred.
4.
My decision on that application, which has not been appealed, was that
pending the happening of an Insolvency Event the Receivers should apply
monies coming into their hands, first, in prompt payment of the debts of
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Senior Creditors and any prior debts as and when they fell due; secondly,
in making provision for payment of the same classes of debt not yet due
and, if that left any surplus - which then seemed unlikely, at least in the
short term - in the manner provided for in the payment priority established
in clause 12.1(c) and following of the Trust Deed.
5.
I shall refer in this judgment to debts of Senior Creditors and those ranking
in priority to them collectively as “Senior Debts”. I use that phrase rather
than “Senior Obligations”, which is a defined term with a slightly narrower
meaning in the Common Terms Agreement.
6.
I preferred the “pay as you go” construction over a rival “pari passu”
construction pursuant to which full provisioning for payment of all Senior
Debts was to take precedence over payment on time and in full of such
debts as and when they fell due. I was not asked by the Receivers on that
occasion to construe the definition of “Insolvency Event” in the Common
Terms Agreement, principally because, as at that time, the Receivers had
not formed the view that Cheyne was insolvent on any arguable
construction of that definition, or even that Cheyne was balance sheet
insolvent, a concept apparently deliberately omitted from the Common
Terms Agreement and Trust Deed by confining the incorporation of the
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Insolvency Act definition so as to exclude s.123(2).
7.
It appeared to be more or less assumed, both by the Receivers and the
proponents of the rival arguments on that occasion, that for as long as the
Receivers had the wherewithal to pay Senior Debts actually due and those
falling due in the very near future then they could not make an Insolvency
Event determination even though they regarded a default in payment of
Senior Debts as inevitable in the middle or longer term future (see para.7 of
my earlier judgment).
8.
My determination of the issue of construction then raised did not depend
upon that assumption about the meaning of Insolvency Event, and I then
regarded it as one which might need to be tested if the Receivers'
expectations as to Cheyne's longer term ability to pay its Senior Debts
changed.
9.
Intensive work which has since been carried out by and at the Receivers'
direction into Cheyne's likely future cash flow has caused a change in the
Receivers' expectations and has precipitated an urgent need for the meaning
of the Insolvency Event definition to be determined.
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10.
The happening of an Insolvency Event depends upon a determination by the
Receivers that Cheyne is, or is about to become, unable to pay its Senior
Debts. The Receivers do not suggest that the courts should usurp their
function by making that determination itself, a process which might involve
factual issues being determined by an adversarial process. Rather they
invite the court to decide whether, on certain assumed facts, Cheyne is or is
about to become unable to pay its debts within the meaning of the
Insolvency Event definition. They recognise that the fact-finding part of
the task entrusted to them is to remain their responsibility and the invitation
to the court to decide the insolvency question on assumed facts is in
substance designed as a convenient vehicle for resolving all relevant issues
of construction of the Insolvency Event definition.
THE ASSUMED FACTS
11.
These are stated fully but concisely in the second witness statement of
Neville Barry Kahn, one of the three Receivers. Since they are, by
definition, not in dispute before me I need only summarise their
consequences. They are derived from work done by the Receivers in
defining the dates upon which the Senior Debts will all fall due and the
amounts falling due on each relevant date, and from work done and
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opinions formulated by the Receivers' chosen valuers on the amounts of
cash capable of being made available for payment on those dates on various
hypotheses as to the manner in which the Receivers carry out the necessary
asset realisation programme.
12.
By way of introduction, first, it is plain that Cheyne could not pay its Senior
Debts in full as they fall due merely by letting its own investments run to
maturity and collecting the resulting cash. The investments must be sold in
an uncertain market before maturity so that any estimation of Cheyne's
incoming cash flow is critically dependent upon assumptions about the
future market for Cheyne's assets, and in particular about the effect on that
market, in which Cheyne is a substantial player, of any particular sales
campaign.
13.
Secondly, in advising as to Cheyne's likely incoming cash flow in the
future, its advisors have, I suspect prudently and inevitably, taken and
projected forward present market values and avoided subjective guesswork
as to where the market may move hereafter.
14.
Thirdly, the valuers have subjected to intense scrutiny the effect upon
realisations of Cheyne's marketing programme driven, as it is, by the need
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to meet predictable and extremely large payment obligations in the near and
medium term future. Their opinion is that sales at the volume and rate
required to pay Senior Debts as and when they fall due will probably incur
forced sale discounts in ranges lying between 0 and 7 per cent, depending
upon the class of asset involved.
15.
The results of this exercise may be stated as follows:
(a) If the Receivers were able to avoid incurring any discounts from open
market value by reason of the size and timing of their sales
programme, they would, by selling at present market values, just be
able to pay all Senior Debts on time and in full. The prospect of
avoiding incurring such discounts is regarded by the Receivers, on
advice, as unlikely.
(b) If forced sale discounts are encountered at the mid-point of each of the
ranges advised by the valuers as being the most likely, then Cheyne
will default in paying its Senior Debts as they fall due in February
2009, with a consequential shortfall as against debts falling due then or
thereafter.
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(c) If higher but still realistically possible discounts are incurred, default
with a consequentially larger shortfall could occur as early as
November 2008.
(d) The Receivers have considered whether there is any method of
realisation of Cheyne's investment portfolio which holds out the
prospect of realising better value than forced sales at the rate necessary
to pay all Senior Debts in full and on time. Following tentative
negotiations their present view is that best value would be obtained by
a sale of the whole portfolio to an investment bank in return for an
underwritten note. This would, they think, hold out a better and
indeed realistic prospect of paying all Senior Debts in full but not on
time, i.e. not in accordance with the maturity dates of those debts.
This is because the cash flow profile required, when aggregated with
Cheyne's existing cash assets to match the maturity dates of the Senior
Debts, would not be obtainable on an underwritten note received on a
negotiated sale of the investment portfolio.
16.
Mr. Kahn summarises the position in his second witness statement as
follows:
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“As described above, the Receivers are currently in a position to
continue with the 'pay as you go' approach to approximately 31
October 2007.
The Receivers also have a substantial investment portfolio of assets
in their hands. However, the best current assessment is that the high
level of asset sales required to continue with the 'pay as you go'
approach would involve Cheyne Finance selling assets for
discounted prices which would in turn deplete its balance sheet and
render it unable to pay some of its late-maturing Senior
Obligations.”
17.
A recent further sale means that Cheyne can now pay due debts from liquid
funds until 14th November, but it is agreed before me that I should assume,
and the Receivers do not suggest otherwise, that the circumstances of that
recent sale have no effect on the best current assessment which I have
described, namely that default and a consequential shortfall will occur in
relation to Senior Debts.
THE QUESTIONS RAISED BY THIS APPLICATION
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18.
Having formed the view that the sales programme necessary to pay Senior
Debts as they fall due is not the method likely to realise best value for
Cheyne's Senior Creditors, the Receivers therefore ask for the following
questions to be determined by the court:
1. Whether, on the assumption that the facts stated in Mr. Kahn's
second witness statement are true, Cheyne Finance Plc is unable or
about to become unable to pay its debts as they fall due to Senior
Creditors within the meaning of Insolvency Event.
2. If the answer to question 1 is “No”,
(a) (i)
Are the Receivers obliged to sell assets of Cheyne
Finance Plc to ensure that so far as is possible it pays its debts to
Senior Creditors as they fall due?
(ii)
If the answer to (i) is “Yes”, are the Receivers
nevertheless permitted to cause Cheyne Finance Plc to enter into a
sale, the consequence of which is that the debt of any Senior
Creditor which would be paid in full as it falls due absent the sale is
not paid in full as it falls due? Would such a sale render Cheyne
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Finance unable, or about to become unable, to pay its debts as they
fall due to Senior Creditors within the meaning of Insolvency
Event?
(b)
Are the Receivers permitted to cause Cheyne Finance Plc
to enter into a sale, the consequence of which is that it continues to
pay Senior Obligations in full as they fall due, but which renders it
certain or most likely that not all Senior Obligations will be paid in
full as they fell due? Would such a sale render Cheyne Finance
unable or about to become unable to pay its debts as they fall due to
Senior Creditors within the meaning of Insolvency Event?
19.
That formulation of the questions is the subject of an agreed amendment
made at the outset of the hearing, and differs in that respect from the form
as it appears in the Application Notice.
20.
I have heard submissions from four interested parties, and I will call them
Parties A, B, C and D. All have appeared, as on the last occasion, on the
basis that their anonymity is to be preserved. But this time all the parties
also seek that the hearing be conducted, and judgment given (at least at this
stage) in private, so as to avoid confidential information - for example,
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about the Receivers' expectations and advice as to the value of its portfolio falling into the public domain. Maintaining anonymity of the parties will
therefore, unlike on the last occasion, not have the compensating advantage
that the hearing and judgment be conducted and given in public. I have
therefore sought and obtained on a confidential basis from the Receivers the
identity of all parties, which is not to be placed on the court file or
otherwise made public.
21.
Party A, as before, represents all Senior Creditors with short maturity dates
for whom continuation of the pay as you go regime is preferable to an early
declaration of an Insolvency Event. Party B, again as before, represents all
Senior Creditors whose interests would be served by an early declaration of
an Insolvency Event. Party C is a member of the class represented by
Party B. Party D are a group of holders of subordinated debt, i.e. not Senior
Creditors. The debt in question consists of Mezzanine Capital Notes
ranking below the Senior Obligations in the payment priority established by
clause 12 of the Trust Deed. On the assumed fact that continuing with pay
as you go is less likely than the determination of an immediate Insolvency
Event to yield anything for them, they also support Party B on the issues
before me.
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OFFICIAL SHORTHAND WRITERS
22.
Question 1 is the most important question and has occupied most of the
court's time. Strictly, question 2 falls away if question 1 is answered in the
affirmative, but I have been requested by all parties, other than Party D, to
decide question 2 in any event, regardless of the outcome of question 1. To
an extent, the analysis of the issues underlying question 2 sheds light on the
answer to question 1, to which I now turn.
23.
The definition of Insolvency Event in the Common Terms Agreement is as
follows:
“Insolvency Event means a determination by the Manager or any
Receiver that the Issuer [Cheyne] is, or is about to become, unable
to pay its debts as they fall due to Senior Creditors and any other
persons whose claims against the Issuer are required to be paid in
priority thereto, as contemplated by Section 123(1) of the United
Kingdom Insolvency Act 1986 (such subsection being applied for
this purpose only as if the Issuer's only liabilities were those to
Senior Creditors and any other persons whose claims against the
Issuer are required under the Security Trust Deed to be paid in
priority thereto).”
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24.
The argument on question 1 has revealed two related issues as to the
construction of the Insolvency Event definition in the Common Terms
Agreement, namely:
1.
To what extent, if at all, is it permissible for the Receivers to have
regard to Senior Debts falling due in the future when addressing Cheyne's
commercial solvency (“the Future Debts question”); and,
2.
With what degree of confidence must the Receivers have formed the
view that Cheyne is or is about to become unable to pay its relevant debts as
they fall due before they can properly make an Insolvency Event
determination (“the Standard of Proof question”).
Most of the debate has centred on the first of those two questions.
THE FUTURE DEBTS QUESTION
25.
For Party A, Mr. Trower QC and Mr. Fisher submitted that on the question
whether Cheyne is unable to pay its debts as they fall due only those Senior
Debts which are presently due are to be considered. On the question
whether Cheyne is about to become so unable, then that admits in addition
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only those Senior Debts which are about to become - i.e. on the point of
becoming - due, and excludes all Senior Debts with medium or longer term
maturities.
26.
Parties B, C and D all submit that, both in principle and because all
Cheyne's Senior Debts have fixed maturity dates and amounts and because
Cheyne is in run-off rather than a going concern, all Senior Debts can and
must be considered whenever falling due.
27.
In its essentials, Party A's submission was simple, and may be summarised
as follows:
1. Leaving aside s.123(1)(a), (b), (c) and (d), none of which apply
on the assumed facts, the deliberate omission of subsection (2)
shows that the parties agreed that the Receivers had to apply the
English test of commercial or cash flow insolvency to be found
in s.123(1)(e).
2. When compared with s.123(2), the language of s.123(1)(e)
omits, and therefore requires to be ignored, all contingent and
prospective liabilities.
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3. The draftsmen of the insolvency legislation were perfectly
capable of requiring reference to the future where it was
intended (see, apart from s.123(2), ss.8 and 89 of the
Insolvency Act, and ss.152, 173(3)(b), s.643(1)(b)(ii) and
s.714(3)(b)(ii) of the Companies Act 1985).
4. Any doubt as to the admissibility of future events, including the
falling due of future debts, is resolved in the Trust Deed by the
phrase “is about to become”.
5. There is nothing uncommercial in the parties to the Trust Deed
adopting a clear and simple test of insolvency which excludes
the need to make difficult judgments about the value of
Cheyne's assets in the future, even if, as Mr. Trower accepted, it
introduces an element of priority in favour of short maturity as
against long maturity Senior Debts, which is not found spelt out
in terms in the Payment Priority in clause 12.
28.
Attractively though those submissions were presented, I have come to the
conclusion that they lead to the wrong result and must be rejected. My
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reasons follow.
29.
Section 123(1)(e) dates only from the Insolvency Act 1985. There is very
little authority on its present form, and its previous form was rather
different. Putting on one side the improbability that the draftsman of, still
less the parties to, the Common Terms Agreement or the Trust Deed knew
its history, that history may be summarised as follows.
30.
Section 80 of the Companies Act 1862 provided to the extent relevant as
follows:
“A Company under this Act shall be deemed to be unable to pay its
Debts…
Whenever it is proved to the satisfaction of the Court that the
Company is unable to pay its debts.”
31.
In re European Life Assurance Society (1869) 9 LR Eq 122, it was held that
'debts' in s.80 meant only those actually due. Furthermore, prospective
creditors had no locus to petition.
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32.
Section 28 of the Companies Act 1907 both permitted prospective creditors
to petition and required the court to have regard to contingent and
prospective liabilities when applying the 1862 Act. That new provision was
consolidated in the Companies (Consolidation) Act 1908 in s.130 in the
following form:
“A company shall be deemed to be unable to pay its debts -…
(iv)
if it is proved to the satisfaction of the court that the
company is unable to pay its debts, and, in determining whether a
company is unable to pay its debts, the court shall take into account
the contingent and prospective liabilities of the company.”
33.
No substantive change occurred in 1929 in s.169(4) of that Act; or in 1948
in s.223(d) of that Act; nor indeed in the 1985 Companies Act in
s.518(1)(e), despite slight changes in the language.
34.
During the long period from 1907 to 1985 English courts addressed the
questions posed by, for example, s.223(d) of the 1948 Act, without any
rigid distinction between commercial and cash flow insolvency on the one
hand and balance sheet insolvency on the other. The submission that
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commercial insolvency could not be established by reference to future debts
could not have succeeded. This is reflected, for example, in the decision of
the Court of Appeal in Byblos Bank SAL v. Al-Khudhairy [1987] BCLC
232, in which inability to pay debts within s.223 of the Companies Act
1948 was incorporated into a debenture as a trigger for the appointment of
Receivers. At p.247 Nicholls L.J. said this:
“Construing this section first without reference to authority, it seems
to me plain that, in a case where none of the deeming paras (a), (b)
or (c) is applicable, what is contemplated is evidence of (and, if
necessary, an investigation into) the present capacity of a company
to pay all its debts. If a debt presently payable is not paid because
of lack of means, that will normally be sufficient to prove that the
company is unable to pay its debts. That will be so even if, on an
assessment of all the assets and liabilities of the company, there is a
surplus of assets over liabilities. That is trite law.
It is equally trite to observe that the fact that a company can meet all
its presently payable debts is not necessarily the end of the matter,
because para.(d) requires account to be taken of contingent and
prospective liabilities. Take the simple, if extreme, case of a
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company whose liabilities consist of an obligation to repay a loan of
£100,000 one year hence, and whose only assets are worth £10,000.
It is obvious that, taking into account its future liabilities, such a
company does not have the present capacity to pay its debts and as
such it 'is' unable to pay its debts. Even if all its assets were realised
it would still be unable to pay its debts, viz, in this example, to meet
its liabilities when they became due.”
35.
Mr. Trower described this as a case about balance sheet insolvency.
I disagree. Nicholls L.J. is speaking about the ability of the company to meet
its liabilities when they became due. What is striking, and for present
purposes persuasive, is his explanation that the phrase “is unable to pay” is a
reference to the company's present capacity, not to the date upon which
relevant debts will fall due.
36.
In the Insolvency Act 1985, repeated in s.123 of the 1986 Act, commercial
and balance sheet insolvency are for the first time split apart. In place of the
mandatory requirement to take account of contingent and prospective
liabilities there has been added in s.123(1)(e) the phrase “as they fall due”
after “debts”. The mandatory requirement to consider contingent and
prospective liabilities now only appears in s.123(2). There is no English
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authority on the question whether, as Mr. Trower submitted, those changes
prevent reference to prospective, i.e. future, debts under s.123(1)(e).
37.
To the limited extent that academic writers have addressed this point, they
are divided. In their Annotated Guide to the Insolvency Legislation
2006/2007 (9th Ed) Messrs. Sealy and Millman say this at p. 149:
“Paragraph (e) (as Companies Act 1985 s.518(1)(e)) formerly
read: “if it is proved to the satisfaction of the court that the
company is unable to pay its debts (and, in determining that
question, the court shall take into account the company's
contingent and prospective liabilities)”. This formula was
unhelpful in that it ran together two issues: (1) the question of
whether current debts could be met as they fell due, i.e.
“commercial” solvency; and (2) the question whether the
company would ultimately prove solvent if its future as well as
present liabilities were brought into the reckoning. The confusion
was resolved by the amendment made by [the Insolvency Act]
1985: contingent and prospective liabilities are no longer to be
taken into account for the purposes of para.(e), while insolvency
calculated on a balance-sheet basis becomes a separate test under
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s.123(2).”
38.
The English version of Professor Keay's McPherson's Law of Company
Liquidation reaches the same conclusion.
39.
Professor Goode in his Principles of Corporate Insolvency Law (3rd Ed)
treats the developed Australian jurisprudence on this question as applicable
to cash flow insolvency under s.123(1)(e), and as permitting what he
describes as “an element of futurity”, at least by reference to the near future.
In fact, the Australian jurisprudence is not necessarily limited to considering
debts falling due in the near future, although typical fact situations may often
impose that restriction in practice.
40.
The third edition of Professor Fletcher's Law of Insolvency assumes that
contingent and prospective liabilities logically have no part to play in the
cash flow evaluation of the company's affairs. For reasons which appear
from the Australian jurisprudence, I doubt that supposed logic.
41.
There is a wealth of Australian authority on the question of whether a cash
flow or commercial insolvency test permits references to debts which will fall
due in the future, i.e. in English terminology “prospective debts”, rather than
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“prospective or contingent liabilities”. The reason why this question has,
unlike in England, been analysed in such detail in Australia is probably that
neither the Australian courts nor legislature have developed a balance sheet
test of the type found in s.123(2).
42.
Prior to 1992 the statutory test for insolvency in force in Australia was one
based on inability to pay debts as they become due - see, for example, ss.107
to 109 of the Queensland Insolvency Act 1874.
43.
In Bank of Australasia v. Hall (1907) 4 CLR 1514, Griffith C.J. said this at
p.1527:
“It was argued that only debts then actually payable and the
amounts of which were then actually ascertained should be taken
into consideration. One answer to this argument is that the matter
for determination is the ability of the debtor, which is a state or
condition that cannot be determined without having regard to all
the facts. Another answer is that the debts referred to are not his
debts 'then' payable, but his debts 'as they become due' - a phrase
which looks to the future.”
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On p.1528 he said this:
“The words 'as they become due' require, as already pointed out,
that some consideration shall be given to the immediate future;
and, if it appears that the debtor will not be able to pay a debt
which will certainly become due in, say, a month (such as the
wages payable by Robertson for the month of July) by reason of
an obligation already existing, and which may before that day
exhaust all his available resources, how can it be said that he is
able to pay his debts 'as they become due' out of his own
moneys?”
The only dissenting judge, Higgins J., agreed on the meaning of the
phrase “as they become due”. At p.1554 he said this:
“The critical words are 'as they become due'; so that, on the one
hand, a debtor in making a payment or giving a security to a
creditor, has to take into account, not only his debts immediately
payable, but his debts which will become payable …”
44.
In Sandell v. Porter (1966) 115 CLR 666, construing s.95 of the Bankruptcy
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Acts 1924 to 1960, Barwick CJ said this at p.670:
“The conclusion of insolvency ought to be clear from a
consideration of the debtor's financial position in its entirety and
generally speaking ought not to be drawn simply from evidence
of a temporary lack of liquidity. It is the debtor's inability,
utilizing such cash resources as he has or can command through
the use of his assets, to meet his debts as they fall due which
indicates insolvency.”
45.
In Hymix Concrete Property Ltd. v. Garrity [1977] 13 ALR 321, Jacobs J
(with whom Barwick CJ and Gibbs J agreed) said at p.328 that an inability to
pay debts as they become due was to be recognised in an endemic shortage of
working capital rather than in a temporary lack of liquidity. Such an analysis
requires some review of the future.
46.
In Taylor v. Australia and New Zealand Banking Group Ltd. [1988] 6 ACLC
808, McGarvie J. said at p.811 that the question of whether a company was
able to pay its debts as they fell due was a question of fact to be decided as a
matter of commercial reality in the light of all the circumstances. In that case
the company had sold its main business asset and paid off its overdraft with
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part of the proceeds. In deciding whether it was then insolvent for the
purposes of a preference claim against the bank the judge conducted a
detailed review of the company's present and future debts before concluding
that its finite assets were insufficient to enable it to pay them as they fell due.
47.
From 1992 onwards the question of whether a company was solvent was to
be decided pursuant to a formula now to be found in s.95A of the
Corporations Act 2001, which is as follows. Under the heading “Solvency
and Insolvency”:
“(1)
A person is solvent if, and only if, the person is able to
pay all the person's debts, as and when they become due and
payable.
(2)
A person who is not solvent is insolvent.”
The familiar phrase “as and when they become due” has been
supplemented by the words “and payable”.
48.
In Cuthbertson v. Thomas (1998) 28 ACSR 310 Einfeld J. said this at p.319:
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“Certain predicted events about which there is little uncertainty,
such as the planned sale of a major asset or the falling due of a
substantial loan, may influence whether the company is able to
pay its debts as they become due and payable.”
On p.320 he said this:
“In essence the issue of a company's solvency should be viewed
as it would by someone operating in a practical business
environment.”
49.
In Southern Cross Interiors Pty. Ltd. v. The Deputy Commissioner for
Taxation (1998) 29 ACSR 130, Palmer J. held that the addition of the words
“and payable” added nothing to the old formula based on “due”. In his
judgment, both in English and in Australian company legislation the word
“due” had always meant “due and payable”.
50.
Finally, in Lewis v. Doran [2005] NSWCA 243, at para.103 there is a helpful
explanation of the question how far into the future the enquiry as to present
insolvency may go. In short, it is a fact sensitive question depending upon
the nature of the company's business and, if known, of its future liabilities.
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51.
It is clear from that brief review of the Australian decisions that in an
environment shorn of any balance sheet test for insolvency, cash flow or
commercial insolvency is not to be ascertained by a slavish focus only on
debts due as at the relevant date. Such a blinkered review will, in some
cases, fail to see that a momentary inability to pay is only the result of a
temporary lack of liquidity soon to be remedied, and in other cases fail to see
that due to an endemic shortage of working capital a company is on any
commercial view insolvent, even though it may continue to pay its debts for
the next few days, weeks or even months before an inevitable failure.
52.
Furthermore, the common sense requirement not to ignore the relevant future
was found to be implicit in the Australian cases in the simple phrase “as they
become due”.
53.
Returning to the English legislation, it is, in my view, critical to note that
when separating out balance sheet insolvency from commercial insolvency in
1985 the legislature did not merely remove the requirement to include
contingent and prospective liabilities in framing s.123(1)(e) out of its
predecessor, but added what in Australia have always been regarded as the
key words of futurity, namely the phrase “as they fall due”. In that context
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“fall due” is, in my judgment, synonymous with “become due”.
54.
Mr. Trower submitted that the existence of the balance sheet test in s.123(2)
makes an Australian type of approach to the commercial insolvency test
unnecessary, because a company will always be balance sheet insolvent in
circumstances where a review of future debts shows that it is commercially
insolvent. I disagree. First, I can see no good reason why the developed
understanding in Australia of the nature of the exercise required by the
phrase “unable to pay debts as they become (or fall) due” should not be
recognised when the same phrase is, for the first time, deliberately inserted
into the English insolvency test. The Australian approach makes commercial
sense, whereas the blinkered approach of ignoring the future does not.
55.
Secondly, a company may not always be balance sheet insolvent where an
Australian style test for commercial insolvency is satisfied, as in this
example: The company has £1,000 ready cash and a very valuable but very
illiquid asset worth £250,000 which cannot be sold for two years. It has
present debts of £500, but a future debt of £100,000 due in six months. On
any commercial view the company clearly cannot pay its debts as they fall
due, but it is, or would be, balance sheet solvent.
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56.
In my judgment, the effect of the alterations to the insolvency test made in
1985 and now found in s.123 of the 1986 Act was to replace in the
commercial solvency test now in s.123(1)(e), one futurity requirement,
namely to include contingent and prospective liabilities, with another more
flexible and fact sensitive requirement encapsulated in the new phrase “as
they fall due”.
57.
In the case of a company which is still trading, and where there is therefore a
high degree of uncertainty as to the profile of its future cash flow, an
appreciation that s.123(1)(e) permits a review of the future will often make
little difference. In many, if not most, cases the alternative balance sheet test
will afford a petitioner for winding up a convenient alternative means of
proof of a deemed insolvency.
58.
The irony of the present case is that the Insolvency Event test, when applied
by the Receivers appointed under the Trust Deed, will be in relation to a
company in run-off, closed to future business, when its future cash flow
profile is abnormally clear and when no balance sheet alternative test is
available.
59.
This leads me to my second main reason for rejecting Party A's case on the
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future debts issue. In my judgment, the presumed common intention to be
derived from the parties' choice to define inability to pay debts by reference
to s.123(1) rather than s.123(2) is simply that they wished Cheyne's solvency
to be adjudicated on a commercial rather than balance sheet basis, and
nothing more than that. The definition incorporates the whole of s.123(1),
not just s.123(1)(e). The common feature of the lettered sub-sub-sections of
s.123(1) is that they are indiciae of commercial rather than balance sheet
insolvency. Companies which fail to pay their judgment debts or, without
good reason, to respond to statutory demands, are usually unable to pay their
debts as they fall due regardless of the state of their balance sheets.
60.
Even if my view as to the meaning and effect of s.123(1)(e) were wrong and
a higher court concluded that it was to be interpreted as imposing the blinkers
for which Mr. Trower contends, it would, in my judgment, be perverse to
conclude that the parties to the Common Terms Agreement and Trust Deed
intended that consequence, because of its potentially bizarre and
uncommercial effects in the context of the affairs of Cheyne. In my last
judgment I questioned whether, if the Receivers had sold all Cheyne's assets
for cash, and knew for sure that it would default in the distant rather than
near future, it could not be determined to be insolvent until that distant event
of default was about to occur. The Receivers would be obliged to go on
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paying early maturing Senior Debts in full, knowing that a failure to pay
anything in respect of later maturing debts of identical seniority was a racing
certainty. I cannot envisage any reason why the parties to the Common
Terms Agreement and Trust Deed should have intended thereby to confer an
absolute priority on the holders of early maturing Senior Debt. The manner
in which that priority would impact on Senior Creditors would depend, not
upon anything to be found in the Payment Priority, but upon the
unpredictable outcome of a run-off which, at the time both of the framing of
the contractual documents and the making of any investment in Cheyne
pursuant to them, must have been regarded by the participants as an
unpleasant but hopefully remote future risk.
61.
Mr. Trower accepted that his construction had that consequence but
submitted that it was commercially understandable because later maturing
paper carried a slightly higher coupon and because investors with later
maturity dates are always exposed to greater risks due to the longer time line
in which those risks may occur.
62.
In my judgment, the extra coupon on the longer notes does not begin to
explain a deliberate choice of Mr. Trower's construction in preference to that
advocated by Parties B to D. Furthermore, incurring a risk of future adverse
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events, such as is inherent in the pay as you go regime during a run-off while
insolvency is merely a risk rather than a probability, is different in kind from
a contractual choice absolutely to prefer earlier Senior Debt where insolvency
is not merely a risk but a dead certainty.
63.
Party A's construction also produces a conflict between the Insolvency Event
definition and the Receivers' obligation under clause 10.2(a) of the Trust
Deed, whereas the alternative construction does not. Clause 10.2(a), it will
be recalled, is as follows:
“It shall be a term of any appointment of a Receiver under
subclause 10.1 that such Receiver shall, unless and until an
Insolvency Event Notice is delivered by the Security Trustee in
accordance with Clause 9:
(a)
manage the Security Assets and the business of the
Chargor with the objective of arranging for timely payment in
full of the Chargor's obligations to the Senior Creditors and any
creditors ranking in priority to the Senior Creditors in the
Payment Priority and … in each case as and when they fall due
for payment in accordance with Clause 12 below …”
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64.
In my judgment, the management objective thereby identified is to ensure, if
possible, the timely payment in full of all Senior Debts as and when they fall
due. It would be extraordinary if, during a run-off period when the Receivers
knew that a medium or long term default was inevitable but could not
determine an Insolvency Event until just before default occurred, they were
to be saddled with an impossible objective, impossible because they knew
that good management could not enable all Senior Debts to be paid in full.
65.
Mr. Trower submitted that it was implicit in clause 10.2(a) that if a choice
had to be made between payments of all debts in full or payment of early
maturing debts on time, the Receivers had to choose a management method
best calculated to secure the latter, even if it caused a greater failure to
achieve the former. Again, I disagree because of the commercially bizarre
results which this would produce. I put to Mr. Trower the example where
Cheyne had liabilities of £1 billion falling due in one month and £6 billion
falling due in six months. To raise the £1 billion would require a fire sale for
£3 billion of a portfolio which, if sold in an orderly manner over six months,
could raise £6 billion. Plainly, no commercially rational framers of the Trust
Deed would impose upon the Receivers an obligation to effect that fire sale.
Yet Mr. Trower submitted on that precise example that this is what clause
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10.2(a) required.
66.
On the alternative construction there is substantial harmony between the
definition of Insolvency Event and clause 10.2(a). For as long as, paying due
regard to future debts, it appears that Cheyne can pay all its Senior Debts in
full as they fall due, the obligation in clause 10.2(a) is attainable. Once it
appears that Cheyne can no longer expect to pay all its Senior Debts in full as
and when they fall due, the objective in 10.2(a) ceases to be attainable, but
the Receivers can at exactly the same time determine that there has been an
Insolvency Event. All debts are then accelerated and the 10.2(a) obligation
ceases to apply.
67.
Party A's best point, in my judgment, was the effect of the phrase “or is about
to become” in the Insolvency Event definition. As a matter of language, the
phrase does, on the face of it, point to a review only of the immediate future,
and may suggest that the draftsman thought, so that the parties should be
presumed to have intended, that “is unable” otherwise required the Receivers
to wear the blinkers for which Mr. Trower contended, and then lifted the
blinkers slightly so as to permit a very restricted look ahead at debts which
will fall due imminently.
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68.
If the test whether Cheyne is unable to pay its debts when they fall due
permits a review of all Cheyne's future Senior Debt then it is hard to envisage
how, if Cheyne is about to fail that test, it is not already insolvent.
Mr. Mortimore QC for Party B suggested that “is about to become” was
designed to deal with a situation where the Receivers proposed a transaction
which, once consummated, would cause Cheyne to fail the test, rather like a
preference which renders a company insolvent under the Insolvency Act
s.240(2)(b).
69.
I cannot see how the discharge of the clause 10.2(a) duty while Cheyne is not
insolvent could lead to a situation where the proposed transaction makes it
insolvent on Party B's approach to the future debts issue. As will appear, on
Party A's approach the answer to that question may be different. It may be
that, in truth, the phrase “or is about to become” is a piece of thoughtless
drafting which adds little or nothing to “is”. Though mindful that contracts
should, if possible, be construed to avoid such a conclusion, the other factors
which lead me to resolve the future debts question against Party A's
construction easily outweigh this apparent contra-indication.
70.
I therefore conclude that the definition of Insolvency Event does permit the
Receivers to have regard to Cheyne's ability to pay Senior Debts falling due
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in the future.
THE STANDARD OF PROOF QUESTION
71.
I turn, therefore, to the standard of proof question. Here the rival contentions
range between Party C's Australian type submission that the Receivers should
determine an Insolvency Event unless satisfied on the balance of probabilities
that Cheyne will be able to pay all Senior Debts when they fall due, to
Party A's submission that the Receivers should not determine an Insolvency
Event unless satisfied that there is no reasonable prospect that Cheyne will be
able to pay its debts when they fall due. In the middle lay Parties B and D's
submission that the burden was on the Receivers to satisfy themselves of
Cheyne's insolvency on the balance of probabilities.
72.
Party A's approach would prevent an Insolvency Event where, as on the
presently assumed facts, the prospect that Cheyne will pay its Senior Debts in
full when they fall due is less than likely but more than fanciful. By contrast,
all the other parties advocated the balance of probabilities which, regardless
of the burden of proof which separated Party C's submission from that of
Parties B and D, would require a determination of insolvency on the assumed
facts.
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73.
In using the language of litigation, (standard and burden of proof, balance of
probabilities, reasonable and fanciful prospects), both counsel and I have
borne in mind throughout that the Trust Deed calls for experienced
professionals working in the commercial world to make the determination,
not the court at the end of a trial or a summary judgment application under
CPR Part 24. The language is, however, useful because it compresses well
understood concepts into short phrases.
74.
I have come to the conclusion that the level of confidence with which, before
determining an Insolvency Event, the Receivers must consider that Cheyne is
or is about to become unable to pay its Senior Debts as they fall due is better
reflected in a balance of probabilities than in a view that the contrary
prospect is so unlikely as to have become fanciful. They must be satisfied, (a
state of mind which calls for careful and thorough enquiry), that inability to
pay is more likely than not. My reasons follow.
75.
Parties B to D are entitled to take some comfort from the fact that the
incorporation of s.123(1) as the relevant test of itself uses a definition which
is framed to be used in court and resolved on a balance of probabilities, even
though the test is, in fact, to be applied outside court and not by a judge. By
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contrast with a state of mind requisite for a finding of wrongful trading - that
is, knowledge that there was no reasonable prospect that the company would
avoid going into insolvent liquidation - which is used as a test for directors'
personal liability, the Insolvency Event test is imposed upon the Receivers in
the Trust Deed to determine the time at which run-off by fiduciaries with pay
as you go is replaced by a pari passu distribution by the same fiduciaries in
accordance with the Payment Priority. If that change is postponed for as long
as there is more than a fanciful prospect of payment in full, its consequences
may work grave prejudice to Senior Creditors with later maturing debts out
of all proportion to the prejudice to early maturing creditors of becoming
subject to pari passu distribution of assets realised to produce best value
rather than early cash. The fact that the market for Cheyne's investment
portfolio may go up as well as down may well make it hard to say that the
prospect of payment in full is only fanciful, even though unlikely.
76.
Being satisfied on the balance of probabilities is, in my judgment, typical of
the standards on which commercial fiduciaries are accustomed to act when
making important business decisions in the best interests of their
beneficiaries. I can see no good reason in the present case to impose any
higher hurdle.
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77.
The assumed facts are, as I have said, summarised by the passage in the
second witness statement of Mr. Kahn at para.93, where he states that on the
Receivers' best current assessment Cheyne is now unable to pay all its Senior
Debts as they fall due. Accordingly, I answer question 1 in the affirmative.
QUESTION 2
78.
It follows that question 2 does not strictly arise on the assumed facts, since
the Receivers will presumably make a determination of insolvency if those
facts do not change for the better. I am asked nonetheless to address question
2 in any event in case, on appeal, a different answer is given to question 1
than that which I have given. I shall do so briefly, reflecting the brevity of
the submissions made on these further questions.
79.
I do so, first, on the assumption that I am correct in my construction of
Insolvency Event, but assuming that, perhaps because the assumed facts
change or are found to differ from the true facts, the Receivers nonetheless do
not make an Insolvency Event determination. A future default in paying
Senior Debts is therefore assumed to be improbable, but there may still be a
real risk of it.
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80.
Question 2(a)(i). In advance of an Insolvency Event clause 10.2(a) of the
Trust Deed requires the Receivers to manage the assets so as to maximise the
prospect (which, although probable, may be still subject to real risk), of a
timely payment in full of all Senior Debts. If a proposed asset sale
maximises that prospect, then the Receivers should sell. If not, they should
not. The question as framed omits the words “all”, “timely” and “in full”,
which should be added to any affirmative answer.
81.
Question 2(a)(ii). On my construction of Insolvency Event, the answer must
be no. Such a sale would convert Cheyne from a company probably able to
pay all Senior Debts in full on time, and therefore solvent, into one that could
not. No sensible interpretation of clause 10.2(a) could permit such a sale, not
least because it would cause an Insolvency Event where it was otherwise
improbable.
82.
Question 2(b). On my construction of Insolvency Event the answer must
again be no, because if there has been no Insolvency Event absent the sale
Cheyne will probably be able to pay all its Senior Debts in full, and clause
10.2(a) requires the Receivers to maximise that prospect, whereas the sale
would prevent it.
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83.
I turn now to question 2 on the alternative construction of Insolvency Event
to that which I have preferred. On that construction it is, on the assumed
facts, probable, but not necessarily certain, that Cheyne will fail to pay all
Senior Debts in full as they fall due, but the Receivers are unable to declare
an Insolvency Event, so remain bound by clause 10.2(a) of the Trust Deed.
84.
One of the reasons why I have rejected that construction of Insolvency Event
is that, in my judgment, it gives rise to extraordinary difficulties in
understanding how the clause 10.2(a) duty is to be performed, it being
unlikely that the stated objective can be achieved in full. The same problems
are magnified if future default is not merely probable, but certain.
85.
Question 2(a)(i). Again, in my judgment, the answer must be yes, but with
the addition of the words “all”, “on time” and “in full”. Where a proposed
sale increases the prospects of achieving that objective from, for example,
just better than fanciful to, for example, just less than even, then they should
sell. If not, they should not sell.
86.
Question 2(a)(ii). This question raises the problem that a proposed
transaction may affect the prospects of achieving different parts of the clause
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10.2(a) objective in different ways. For example, a proposed sale may
substantially increase the prospects of payment of all Senior Debts in full, but
at the price of making it certain that some will be paid late. The portfolio
sale referred to in the assumed facts is just such a transaction.
87.
Unsurprisingly, on my construction of Insolvency Event, clause 10.2(a)
provides no answer to this conundrum. On the alternative construction of
Insolvency Event no other provision of the Trust Deed does either. In my
judgment, the Receivers would have to make that choice by applying their
own judgment as to which course would best serve the interests of the Senior
Creditors as a whole. I reject Party A's submission that clause 10.2(a)
impliedly prefers prompt payment of early maturing debts over all other parts
of the stated objective.
88.
The consequence of such a decision may be to accelerate the date when, on
the alternative construction of Insolvency Event, an actual or imminent
default in payment of a Senior Debt on time triggers an Insolvency Event. If
so, so be it. If the beneficial transaction made such a default imminent, then
it would trigger an immediate Insolvency Event even prior to the sale. But to
treat that consequence as meaning that therefore the Receivers should not sell
would be to allow the tail to wag the dog. It would almost, by definition, be a
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transaction which the Receivers would wish to pursue after an Insolvency
Event, so the fact that a decision to sell would trigger an Insolvency Event
would not, in my judgment, matter.
89.
Question 2(b). This question presumably contemplates some kind of
distressed sale which, although it fails to achieve best value, generates the
early cash necessary to postpone an immediate or early Insolvency Event
constituted by an actual or imminent default. On the alternative construction
it would not trigger an Insolvency Event. Again, unsurprisingly, in my view,
clause 10.2(a) provides no clear answer to this conundrum. I would answer
it, like question 2(a)(ii), by reference to the Receivers' judgment as to the best
interests of the Senior Creditors as a whole. From the evidence it seems most
unlikely that the Receivers would think that such a transaction was in the best
interests of Senior Creditors as a whole, unless perhaps the increased
probability of a later default was marginal, whereas the proposed transaction
secured major advantage in terms of earlier payment.
90.
In my judgment, the Receivers would not be obliged slavishly to effect any
sale which would postpone an early or imminent default regardless of the
gravity of later defaults thereby caused by failing to obtain best value.
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MR. SHELDON: My Lord, I am very much obliged. My Lord, I am not going to
attempt, on my feet, to suggest a form of directions. I think we will have to
have a look at transcript and then agree, because we have to incorporate
various assumptions.
MR. JUSTICE BRIGGS: I think you do. I may have gone slightly beyond my
brief in addressing question 2 on my construction.
MR. SHELDON: No, it has been very helpful, my Lord.
MR. JUSTICE BRIGGS: It seemed to me rather stupid not at least to try.
MR. SHELDON: No, it is extremely helpful. We will do that and we will circulate
to respective counsel to agree it.
MR. JUSTICE BRIGGS: You may have to come back if you cannot agree it.
MR. SHELDON: Yes, if we cannot agree it we may have to come back to your
Lordship.
That is the substantive part of the order. Could I just invite your Lordship to
look at the application because there are one or two other consequentials.
Your Lordship sees on p.2 of the application that we seek a sealing order
under Rule 7.3(1)(v). My Lord, can I suggest that we add words along the
following lines - it is basically to ensure that two things happen - first of all,
an application is made to a judge rather than to a registrar; and also to make
sure that any such application is made on notice to the applicants' solicitors.
What I would suggest is something along the following lines at the end of
what appears, “Not to be made open to inspection without the court's
permission, such permission to be made on application to the judge on 48
hours notice to the applicants' solicitors”.
MR. JUSTICE BRIGGS: I would say “to a judge and to Mr. Justice Briggs, if
available”. It would save time, since I know the background, compared to it
going, say, to the Queen's Bench applications judge, who might have other
things on his mind.
MR. SHELDON: My Lord, that is very helpful. I do not suppose anybody here
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will object to that form of words.
My Lord, then there is the question of costs. On the last occasion your
Lordship directed that that the costs of all parties be costs in the receivership.
My Lord, the Receivers, subject to one caveat, would have no objection to a
similar order here. My Lord, the caveat concerns interested Party D who has
no less than three instructing solicitors. My Lord, I think it is agreed that only
one set of solicitors' costs of Party D would be permitted.
MR. BAYFIELD: My Lord, that is right.
MR. JUSTICE BRIGGS: That seems eminently sensible to me, but otherwise you
are amenable to that set being allowed?
MR. SHELDON: Yes.
MR. JUSTICE BRIGGS: Unless there is any objection, I would think it sensible to
make that costs order.
MR. MORTIMORE: Yes, my Lord, and we strongly support the change to the
confidentiality order suggested by my learned friend.
MR. JUSTICE BRIGGS: Yes, you want skeleton arguments.
MR. MORTIMORE: It should be all the evidence, because there has been an
additional statement beyond Kahn 2, which was referred to.
MR. JUSTICE BRIGGS: It ought to be the statement, exhibits - you can re-draft it
at leisure, but the statements, exhibits, what about the judgment?
MR. SHELDON: And the judgment?
MR. JUSTICE BRIGGS: The question does arise under article 6, which is not
merely an inter partes question, but a public interest question, whether it is
right that a judgment should be given on the basis that it is permanently in
private.
MR. SHELDON: My Lord, I was going to come on to that. Clearly one would
hope that when the dust settles this judgment could be made public. Whereas
clause 12.1(b) was perhaps a peculiar, unique set of wording, the definition of
Insolvency Event has been adopted I think in a number of similar transactions.
So there will clearly be interest in the outcome.
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MR. JUSTICE BRIGGS: It seems to be hallowed practice going right back to
Byblos, albeit with an older definition. That was an older definition but it was
still being incorporated into a party's document.
MR. SHELDON: Yes, it is the cash flow definition that is a slightly novel one.
My Lord, what I would suggest is that we undertake to come back to your
Lordship to release the judgment into public when the need for confidentiality
has lapsed.
MR. JUSTICE BRIGGS: It would still be there, even if there was an insolvency
determination because you want to do a deal in relation to the assets?
MR. SHELDON: Yes.
MR. JUSTICE BRIGGS: So it may lapse later than sooner. The only alternative
I can think of is a sanitised judgment, but I find it quite difficult to see how
that would be workable without treading on confidential matters.
MR. SHELDON: I think it would be difficult.
MR. JUSTICE BRIGGS: It cannot be workable just by anonymising the name of
the company because there is reference back to my earlier decision which was
given in public. It is difficult to see how, if you get rid of all the assumed
facts, it makes sense.
MR. SHELDON: Yes, exactly. I think, just from having listened to it, it would
look very odd. One cannot simply do a blue pencil test.
MR. JUSTICE BRIGGS: No, I do not think so. Yes, an undertaking to come back
as and when the dust has settled is sensible, but I am not sure there ought not
to be built in some automatic review, otherwise it might get forgotten, even in
the best run offices.
MR. SHELDON: Yes, my Lord, perhaps we ought to undertake to bring the matter
back before your Lordship at the end of a given period.
MR. JUSTICE BRIGGS: I suppose an alternative view is a kind of Beddoe
application in relation to which there is some authority that article 6 is not
engaged. You probably know the case I am thinking of. I am quite content to
go down the route you propose. Indeed, I think it would be preferable.
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MR. SHELDON: My Lord, yes. I do not know what an appropriate periodwould
be.
MR. JUSTICE BRIGGS: Six months?
MR. SHELDON: Yes, that is what I had in mind, six months.
MR. JUSTICE BRIGGS: The obligation is to refer to me - that is a sensible course in six months. It can be done on paper. If the paper says fine, then fine; if it
says not fine, then probably not fine unless I am not satisfied with the
explanation.
MR. SHELDON: In which case we will have to persuade your Lordship.
MR. JUSTICE BRIGGS: Yes, there might have to be a hearing. It does not seem
to me that it need involve Parties A to D. This is really just protection of the
commercial value of the assets in the hands of the Receivers.
MR. SHELDON: Yes.
MR. JUSTICE BRIGGS: Is that agreed?
MR. MORTIMORE: Yes, my Lord.
MR. SHELDON: My Lord, I think that is all I need to say now, although if there
are further applications I may want to address your Lordship further.
MR. JUSTICE BRIGGS: I am anticipating there might well be!
MR. SHELDON: My Lord, yes.
MR. FISHER: My Lord, I am instructed to make an application for permission to
appeal against your Lordship's judgment, my Lord, in short, on both the
grounds that there is a real prospect of success or some other good reason why
permission should be given.
My Lord, three short points: there is a point on construction on which
reasonable parties could differ; it does involve within the drafting a point of
law of significance, being the meaning of ---MR. JUSTICE BRIGGS: Section 123(1)(e).
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MR. FISHER: Yes, and Mr. Sheldon has made the point in terms of wider
significance, the drafting in issue and the incorporation of 123 definition is
something which has wide usage in the industry.
My Lord, for all those reasons we would ask that we do have permission to
appeal against your Lordship's judgment.
I am aware that Mr. Sheldon may want to something about the timing. Your
Lordship's order on the last occasion was to make an order that the appeal
would be pursued with extreme diligence.
MR. JUSTICE BRIGGS: I think I suggested last time, did I not, that it was
probably quicker to give you permission but attach some really nasty strings to
it than to refuse it. I may have suggested that anyway, I have done on a
number of occasions.
MR. FISHER: My Lord, I was not unfortunately there at the last hearing.
MR. JUSTICE BRIGGS: I can anticipate that there is urgency. There may be
difficulty in it being dealt with in private in the Court of Appeal, but that is a
separate problem.
MR. FISHER: There is both the locus point that your Lordship carved out in the
last order, which was that you gave permission but without prejudice to the
question of locus standi to appeal where we were not formally parties. My
Lord, we can deal with that, we say, before the Court of Appeal.
MR. JUSTICE BRIGGS: Yes.
MR. FISHER: My Lord, in terms of the timing, perhaps I can get my shot in before
Mr. Sheldon fires on this, we do need time to consider the judgment, we do
need time certainly to analyse the commercial consequences of it for our client
in the light of the notes it does hold and where its interests best lie. Advice
needs to be given to the client and a decision is going to have to be made at a
very high level in terms of whether or not an appeal is to be pursued.
Whilst we would want, and anticipate trying to bring the appeal on next week,
my position is that I can undertake that we will notify the other parties as to
whether or not we do intend to take up the permission to appeal by close of
business UK time on Monday, and lodge an application, an appellant's notice
on Tuesday, and then take all steps to have the matter brought on as quickly as
possible.
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MR. JUSTICE BRIGGS: So you would suggest undertaking to lodge by when?
MR. FISHER: To lodge the appellant's notice by 4.30 on Tuesday, my Lord, and
we will give notice to all parties by ---MR. JUSTICE BRIGGS: That is the 23rd, is it not - yes.
MR. FISHER: -- and give notice to all parties by 4.30 pm on Monday as to
whether or not we do propose to move forward with your Lordship's
permission for leave being granted.
My Lord, I appreciate there is urgency but, my Lord, realistically that is what
I am in a position to offer your Lordship.
MR. JUSTICE BRIGGS: Right, who wants to respond to that?
MR. SHELDON: My Lord, the response in part may depend on whether there is
going to be an application for some form of stay. In the light of your
Lordship's judgment, and the clearly the Receivers will have to go away and
check that there has been no change in the circumstances, but assuming there
has been no change one would anticipate the determination of an Insolvency
Event very soon.
MR. JUSTICE BRIGGS: Likewise, if a stay is not granted, an appeal would be
nugatory, would it not?
MR. SHELDON: Exactly.
MR. JUSTICE BRIGGS: Bearing in mind the transaction which you hope to be
able to negotiate.
MR. SHELDON: My Lord, once an Insolvency Event has been determined it
would render an appeal nugatory because you cannot undo it really.
MR. JUSTICE BRIGGS: Until something is done pursuant to it it is a piece of
paper.
MR. SHELDON: It is, but I think one would have anticipate that action would be
taken pursuant to it and it could be very difficult to unravel.
My Lord, Mr. Fisher has not addressed that yet, but can I perhaps deal with
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the timing issue. We clearly need to know where we stand as soon as
possible. There are these negotiations, refinancing negotiations, which are
going on.
I must say, I am a little concerned that the timetable proposed by my learned
friend is a little bit on the slack side. We really need to know whether or not
there is going to be an appeal by the end of this week so that we can take steps I do not know if your Lordship is in any position to assist on this - to have a
hearing before the Court of Appeal next week. I think, on the timetable my
friend suggests, that it is likely to push it back a week. What I would propose
is that everyone be told by close of business on Friday. That should give my
friend's clients enough time to think about it. Then we are in your Lordship's
hands about when the notice of appeal is actually filed.
My Lord, I do not want to anticipate an application for a stay, my Lord, but it
does raise issues about the holding the fort at the moment, but we do have
certain ----MR. JUSTICE BRIGGS: We had better deal with everything before we deal with
any of it, I think. Logically, you deal with whether there is going to be an
appeal first, but I take your point that a stay is closely bound up with it.
MR. SHELDON: Yes, as long as your Lordship is aware that there are suggestions
that we have. I do not know if your Lordship wants to deal with that now.
MR. JUSTICE BRIGGS: Are those ones you have got, or just made?
MR. SHELDON: My Lord, there is another one, because the other issue is that if
we do not, in the meantime, declare an Insolvency Event - if your Lordship
were to direct us not to declare an Insolvency Event pending the outcome of
an appeal - there is then the issue of the payments. There is $300 million
which is due to be paid today.
MR. JUSTICE BRIGGS: So you want a stay of any further current payments so as
to freeze the position all ways?
MR. SHELDON: Indeed, absolutely. My Lord, the third element of it is that we
would invite your Lordship to direct us not to make a determination that
Insolvency Event has occurred by reason of us not making those payments.
My Lord, I do not know if it is helpful, I do have a form of words.
MR. JUSTICE BRIGGS: I am just wondering if I can do that. Can I do that?
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I cannot amend the parties' contract without their consent. It is common
ground that if today $300 million is not paid there is an Insolvency Event.
I suppose you would say it is one of those events rather like a temporary cash
flow crisis, there is not really a commercial insolvency because it is just that
some judge has interfered and stopped you paying when you have the money?
MR. SHELDON: My Lord, that is right. My Lord, there does not seem to be any
alternative.
MR. JUSTICE BRIGGS: Yes, I can see the point. Otherwise you say all the
parties are prejudiced by the stay in a way that is unnecessary?
MR. SHELDON: Yes, and it means that Mr. Fisher's clients, they win even though
they have lost!
MR. JUSTICE BRIGGS: I can see the force of your point. I am just hesitant that
I can, as it were, declare here and now without hearing any argument that if
you did not pay the $300 million due today there would be no insolvency
consequences.
MR. SHELDON: My Lord, with respect, it is almost the same as the position on
the first limb.
MR. JUSTICE BRIGGS: I suppose what I could do is not to prevent you from
declaring an Insolvency Event which would let you off paying the $300
million, because there had been an Insolvency Event and then you do not have
to pay anything immediately, in the sense that what you do is you do an
orderly administration, but not let you do a transaction which would prevent
you going back to the current pay as you go regime if the Court of Appeal
took a different view. I am just trying to think of a way of construing a stay in
terms that would not involve the court magically varying the contract. I say
that out of a desire to help, Mr. Sheldon.
MR. SHELDON: Yes, I do understand.
MR. MORTIMORE: My Lord, if I might assist. We have certainly come to the
view that your Lordship was putting forward, namely that the consequences of
your Lordship's decision on the first point are that the Receivers' are free to
determine an Insolvency Event if they think fit.
MR. JUSTICE BRIGGS: And probably will.
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MR. MORTIMORE: Consequent from that two things would follow. One is a
payment, but the $300 million would not be paid today ---MR. JUSTICE BRIGGS: But is kept safe.
MR. MORTIMORE: -- and there are further outflows over the next days certainly
into next week, very serious outflows.
The other matter is the potential sale which might render the appeal nugatory.
As regards the Insolvency Event and payments out, the position would be that
if the Court of Appeal took a different view the determination by the
Receivers on the basis of your Lordship's interpretation would simply be a
nullity.
MR. JUSTICE BRIGGS: They would all be paid slightly late, and it would harder
in those circumstances for anybody to say that that was because of the
insolvency, it was because a judge got it all wrong.
MR. MORTIMORE: It comes entirely within the temporary blip in the Australian
cases, so that no one would be the worse off. That is not a problem. The only
problem one is left with then is the major sale, and that must be dealt with, as
my learned friend says, by a highly urgent application to the Court of Appeal,
so that we are definitely in the Court of Appeal next week.
MR. JUSTICE BRIGGS: Which is perfectly attainable, I know, because it has
happened on other occasions.
MR. MORTIMORE: My Lord, that is our position.
MR. JUSTICE BRIGGS: Yes, understood. Mr. Pascoe?
MR. PASCOE: My Lord, we would support the position Party B. There are very
substantial funds to be paid out shortly which should not be paid out.
MR. JUSTICE BRIGGS: If they declare insolvency.
MR. PASCOE: My Lord, yes, but at the same time the appeal needs to be done
very urgently. While it is obviously right that a transaction such as the
proposal should not be entered into pending an appeal, but the quid pro quo
for that, given that there must be a risk that ----
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MR. JUSTICE BRIGGS: Is that they get on with the appeal.
MR. PASCOE: Absolutely, my Lord, and the timescale that my learned friend
Mr. Fisher was suggesting ---MR. JUSTICE BRIGGS: The only slight downside is that if you put somebody
under such a timetable to appeal, they spend all their living moments just
doing it without thinking whether it is a good idea or not. It has happened
before. I suspect that is what is behind Mr. Fisher's sensible observation that a
moment for a cooling off period might be sensible.
MR. PASCOE: My Lord, plainly an opportunity has to be given to consider the
application for leave, but that has got to be a compressed one. We do say that
Mr. Fisher's timetable is too leisurely.
MR. JUSTICE BRIGGS: Yes, very well.
MR. BAYFIELD: My Lord, I do not think I can usefully add anything.
MR. JUSTICE BRIGGS: Well, Mr. Fisher? Do you want to say anything else
before we go back to Mr. Fisher?
MR. SHELDON: My Lord, I am just a little bit concerned. If we do make a
determination that an Insolvency Event has occurred we have to give notice,
and there is, I think, a very real issue which I think we need to think about a
little bit more about whether you can undo the Insolvency Event if the Court
of Appeal were to disagree with your Lordship.
MR. JUSTICE BRIGGS: Tell me why you cannot. There may be an issue, but at
the moment I have not seen it. It may be that Mr. Fisher should be telling me.
MR. SHELDON: Yes, I will see what he has to say.
MR. JUSTICE BRIGGS: At the moment my impression is that providing nothing
is done which would prevent a return to the pay as you go regime if the
determination and any notice is given pursuant to it were held to be invalid,
then what is the problem? I may be wrong. You know this more deeply than,
Mr. Sheldon.
MR. SHELDON: I think there is concern about the effect on the rating, for
example.
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MR. JUSTICE BRIGGS: On the what?
MR. SHELDON: On the rating of the ---MR. JUSTICE BRIGGS: I suppose there will be - with all that hindsight delivered
by the Court of Appeal - a temporary blip in your ratings.
MR. SHELDON: That may be, although of course one does not know what knockon effect it will have.
MR. JUSTICE BRIGGS: Let us hear from Mr. Fisher. I can rise while you take
instructions if there are thought to be other problems you have not had a
chance to formulate.
MR. FISHER: My Lord, I am grateful for that. My Lord, I had left the stay to one
side simply because I could tell it was going to be most difficult, and I will not
mention anything again on the permission to appeal point.
On the stay point, Mr. Pascoe set out timetable is somewhat leisurely, but we
will not get the approved judgment, or at least the transcript of the judgment
until about 24 hours time from now and we have got to take instructions ---MR. JUSTICE BRIGGS: I am slightly surprised there has not been a shorthand
writer in court if it is all that urgent. There has, good. Madam Shorthand
Writer, when do we think, in practice, a judgment could be available?
SHORTHAND WRITER: Tomorrow morning.
MR. JUSTICE BRIGGS: Any rough idea of time, one for correction by parties and
me.
SHORTHAND WRITER: Tomorrow morning.
MR. JUSTICE BRIGGS: There you are, Mr. Fisher.
MR. FISHER: My Lord, I am grateful for that. We do need to consider it, and, as
your Lordship said, it is appropriate that my clients are given advice on the
merits of proceeding with an appeal and whether or not it is in their best
interests to do so and that there are grounds to do so before heading off to the
Court of Appeal willy-nilly and just trying to get an appeal in because it suits
everyone else in the circumstances. My Lord, that is what I say in terms of
permission and the timing.
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The only undertakings I am in a position to give to your Lordship are those
which I set out when I was on my feet a few moments ago. If your Lordship
puts a tighter timetable on it, then so be it, but we do need time to consider it
carefully and those are the undertakings I am instructed to give.
My Lord, in terms of a stay, we would just make a couple of observations. The
current position, assuming your Lordship is minded to give permission, is that
the Receivers have a judgment, but it will be one in respect of which your
Lordship has given permission, and therefore it is accepted that there is a real
prospect that the Court of Appeal may go the other way.
MR. JUSTICE BRIGGS: Yes, real, in the sense of more than fanciful.
MR. FISHER: A real prospect of success, my Lord, yes.
My Lord, it is then a matters for the Receivers, in the light of that judgment, as
to whether they feel confident enough in circumstances, where your Lordship
has given a judgment which they say has one conclusion but permission has
been given to appeal, to call an Insolvency Event.
My Lord, in terms of a stay, my clients would like the position to be preserved
so that an appeal is not rendered nugatory. It does seem to us that a sensible
solution to that would be that payments are not made on a pay as you go basis,
but that a book sale is not effected so that there is no irreversible change of
position. Then, were the Court of Appeal to say we disagree with your
Lordship and give directions which therefore lead to the Receivers to
reconsider whether or not an Insolvency Event had occurred, the position,
albeit there would be some late payments, could be restored to that which ---MR. JUSTICE BRIGGS: That is very helpful. The question is where does the
determination of Insolvency Event fit into that. Which side of the dividing
line does that come? At the moment I have some difficulty in seeing how the
Receivers can stop payments unless they determine an Insolvency Event.
I cannot rewrite the contract. Until then, how can they stop payments?
MR. FISHER: My Lord, there is a limited degree of comfort that my clients can
give, and your Lordship can give to the Receivers in the circumstances. We
would ask for a stay to the extent that it is necessary to protect the ability of
the appeal to go forward. It will remain a question for the Receivers as to
whether or not, in the light of the judgment, where leave to appeal has been
given, whether they feel they should declare an Insolvency Event.
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MR. JUSTICE BRIGGS: I see, leave it to the Receivers, not stay it. Thank you.
That is helpful. I think everybody has had their say on the subject.
91.
I must deal with the question of appeal. In my judgment, the issues which
I have determined are issues where it is difficult to say there is no reasonable
prospect of Party A persuading the Court of Appeal to a different view.
Furthermore, they do involve a determination of the meaning and effect of
s.123(1)(e) of the Insolvency Act, about which there is no current authority,
and which may affect other similarly drafted contractual structures, even if it
does not affect petitioners to winding up to any great degree. Therefore, it is
right that I, in principle, ought to give permission to appeal.
92.
Nonetheless, it is apparent from the evidence, and indeed I think common
ground, that the question of whether this judgment is to be the subject of an
appeal, and a consequential appeal, needs to be conducted with the greatest
possible urgency because there are very large payments due to be made by
the Receivers if no Insolvency Event is determined, and because the
Receivers wish to conduct a transaction in the very near future which they
believe will secure better value than continuing with the present profile of
asset disposals.
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93.
I have been offered undertakings by Party A to notify the other parties,
including the Receivers, whether they intend to appeal by 4.30 on Monday,
and to lodge a notice of appeal by 4.30 on Tuesday, and thereafter to
prosecute the appeal with the utmost diligence. In my judgment, it is
desirable, if possible, that this appeal should be got on next week, as has been
possible before on similar appeals from this Division on matters of urgency.
94.
In those circumstances, while I recognise that Party A, if only because it is in
a representative capacity, needs to consider the judgment and obtain advice
as to whether to pursue an appeal, nonetheless, I am of the view that it is
appropriate to set a tighter timeframe for notice to appeal than that which has
been proposed. The timeframe which I propose to set is that permission to
appeal is given, but the time for lodging notice of appeal is abridged to 4.30
this Friday, 19th October 2007, and that the other parties all be notified of an
intention so to do at the same time.
95.
I also direct, in so far as it is possible for me to do so, that this matter is dealt
with urgently, and I direct the parties - I do not think the Receivers need any
direction - to prosecute the appeal with the utmost diligence. I anticipate
that, those words having been said, the getting of an appeal quickly is likely
to be best conducted directly between the parties and the Civil Appeals
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Office.
96.
The question of stay then arises. It is common ground, whether or not the
Receivers declare an Insolvency Event, if they were to complete the
transaction to which I have already referred pending the hearing of an appeal,
that would in all probability render the appeal nugatory, and for that reason
there should be a stay to this extent, that no transaction of the type
contemplated in the evidence and desired by the Receivers should be
conducted pending the conclusion of the appeal unless the Court of Appeal
otherwise directs.
97.
I am not, however, minded, and indeed not invited by Mr. Fisher for Party A,
to direct a complete stay of my judgment, such that, for example, the
Receivers could not, on the basis of the judgment which I have given,
determine that an Insolvency Event has occurred, and therefore so notify the
Trustee with consequential service of notice as contemplated by the Trust
Deed.
98.
It seems to me, during the short time I have had to consider that question, that
nothing irretrievable would take place as a result of that determination and
the consequential sending of notice, except possibly a dip in the credit rating
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assigned to Cheyne Finance's securities.
99.
If the Court of Appeal were to determine that I have got question 1 wrong
such that the Receivers are unable at the moment to determine that there has
been an Insolvency Event it would be open to the Court of Appeal to declare
that their determination of insolvency and all notices connected with it was
void, with the consequence, one supposes, that rating agencies would cease
to take account of those notices in their assessment of the standing to be
attributed to the company's securities.
100. Accordingly, I do propose to direct that pending the outcome of the appeal,
or any other order in the meantime from the Court of Appeal, the Receivers
do not carry out the transaction which they wish to carry out by way of a sale
of the investment portfolio, but that they otherwise be at liberty to act as they
think appropriate in the light of the judgment.
As for getting this judgment perfected into a state when the Court of Appeal
have it, it may be sensible at the moment the Shorthand Writer has obtained it
in transcript form, for it to be immediately distributed in that form to the
parties so that I can receive, as quickly as possible, comments on it. For my
part, it would be easiest if I could receive the comments of all the parties, as it
were, collected on to one version of the judgment, rather than have to develop
four eyes and look at four parallel sets of comments.
MR. SHELDON: My Lord, we will undertake to take charge of that and gather all
the parties' comments.
MR. JUSTICE BRIGGS: What I would like to have is one draft back with all the
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comments on it. I do not really mind who the comments come from. They
can all be in the same colour. Indeed, they can all be, if necessary, if it is an
electronic document, in the form of proposed track changes. I do not mind
how it is done. That seems to me the quickest way of getting an approved
judgment to the Court of Appeal.
MR. SHELDON: My Lord, we will undertake to gather comments and then pass
them to your Lordship.
MR. JUSTICE BRIGGS: Good, and I will simply do my best to get it out as
quickly as I can.
MR. SHELDON: The only thing is, would your Lordship give liberty to apply?
MR. JUSTICE BRIGGS: What sort of liberty to apply? I have given you liberty to
apply to the Court of Appeal. If it is something to do with the appeal, it seems
to me they have got carriage of it rather than me once the appeal is under way.
What did you have in mind?
MR. SHELDON: My Lord, it is the unforeseen.
MR. JUSTICE BRIGGS: All right, but do not assume that if you apply to me I will
not send you off to the Court of Appeal.
MR. SHELDON: We do understand that now that your Lordship has dealt with the
matter. It is just that there may be something new that arises.
MR. JUSTICE BRIGGS: In particular, if, on reflection, you realise there is some
irretrievable consequence of an Insolvency Event determination that nobody
has yet thought of.
MR. SHELDON: Yes.
MR. JUSTICE BRIGGS: Very well. I will give all parties liberty to apply but
I think they should do it on notice to the Receivers, if it is not the Receivers.
MR. SHELDON: I am obliged. Would your Lordship give me a minute. (After a
pause) My Lord, I have assumed, and I am asked just to confirm this, that if
we think it is a good deal we can continue to make piecemeal sales of assets.
I think when your Lordship said ---MR. JUSTICE BRIGGS: I have said nothing to stop you.
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MR. SHELDON: Absolutely, I did not think your Lordship had.
MR. JUSTICE BRIGGS: If someone comes and offers you something which you
should bite their hands off for, I do not see why you should not sell it.
Insolvency does not seems to me to have fundamental consequence in terms of
your power of sale, it just changes the objectives.
MR. SHELDON: It just changes the objectives, and the size of the body which we
must principally have regard to.
MR. JUSTICE BRIGGS: Very well. Thank you for all your assistance.
_________
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Neutral Citation Number: [2008] EWHC 463 (Ch)
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
Case No: 01753 of 2008
Royal Courts of Justice
Strand, London, WC2A 2LL
Date: 5th March 2008
MR JUSTICE ETHERTON
--------------------IN THE MATTER OF WHISTLEJACKET CAPITAL LIMITED (IN RECEIVERSHIP)
AND IN THE MATTER OF THE INSOLVENCY ACT 1986
----------------------------------------Mr Simon Mortimore QC and Mr Barry Isaacs (instructed by Clifford Chance) for the
Receivers
Ms Susan Prevezer QC and Mr Paul Stanley (instructed by Bingham McCutchen (London)
LLP) for Interested Party A
Mr Stephen Atherton QC (instructed by Morgan Lewis) for Interested Party B
Hearing dates: 3rd March and 4th March
---------------------
JUDGMENT
Mr Justice Etherton :
Introduction
1.
This is an Originating Application (“the Application”) by the receivers of
Whistlejacket Capital Limited (“the Company”) for directions as to the
management of the Company’s business. The receivers are Neville Barry
Kahn, Nicholas Guy Edwards and Nicholas James Dargan (“the Receivers”).
2.
There are no named respondents to the Application. Two interested parties
have appeared and made submissions on the hearing of the Application. They
wish to preserve anonymity. Following a procedure used by Briggs J in Re
Cheyne Finance plc [2007] EWHC 2402 (Ch) (“Cheyne Finance (No 1)”)
and Re Cheyne Finance plc [2007] EWHC 2402 (Ch) (“Cheyne Finance (No
2)”), I shall refer to them as Party A and Party B.
3.
Party A holds US$220,797,902 US Medium Term Notes issued by the
Company with a stated maturity date of 15 February 2008 (“Party A’s US
Notes”). Party B holds various US Medium Term Notes issued by the
Company, with various maturity dates, of which US$110,393,502 US Medium
Term Notes with a stated maturity date of 25 February 2008 (“Party B’s US
Notes”) are relevant to the Application. The Receivers seek directions as to
the manner in which they should manage and apply the Company’s assets
having regard to Party A’s US Notes and Party B’s US Notes and other note
holders in a similar position to them.
4.
The Application raises relatively short but important questions of
interpretation.
Factual background
2
5.
The Company was incorporated and has its registered office in Jersey. It is a
structured investment vehicle, known as a SIV, which was established for the
business of investing in a portfolio of particular types of investments.
6.
One of the features of this type of vehicle is that it makes the Company
“insolvency remote”, that is to say more difficult to make the subject of
insolvency proceedings, and limits the recourse of note holders.
7.
The Company has been financed primarily by issuing securities. It issued euro
medium term notes (“Euro MTN”), US medium term notes (“US MTN”), euro
commercial paper (“Euro CP”) and US Commercial Paper (“US CP”). In
addition to the Euro MTN, the US MTN and the Euro CP (“the Senior
Notes”), the Company issued capital notes (“the Capital Notes”) that are
subordinated to the Senior Notes.
8.
The Senior Notes were issued with a variety of maturity dates and interest
rates.
9.
The Company’s US MTN and US CP were co-issued by a subsidiary company
incorporated in Delaware, Whistlejacket Capital LLC (“the Co-Issuer”).
10.
The US MTN are governed by the terms of an Indenture dated 19 July 2002
as amended by two subsequent indentures (“the Indenture”), a Global Note
(“the US Global Note”) and, in respect of each issue, a Pricing Supplement
containing details of the maturity date and the interest rate. The US MTN and
the Indenture are governed by New York law. There is no evidence, and no
one has contended on the hearing of the Application, that there is any
difference between the law of New York and English law relevant to the
issues I have to decide.
11.
The Euro MTN and the Euro CP are governed by the terms of their respective
Global Notes.
3
12.
The Company also entered into four Global Master Repurchase Agreements
with various counterparties (“the Repos”), two of which are currently
outstanding. It is not necessary, for the purpose of this Judgment, to explain
further the objective and operation of the Repos.
13.
The Company also entered into five committed liquidity facilities. Again, it is
not necessary for me to explain these further.
14.
The Company has also entered into eleven derivative contracts with various
institutions as counterparties on various dates (“the Derivative Contracts”), ten
of which are still outstanding.
15.
The Company appointed Standard Chartered Bank as its investment manager
(“the Investment Manager”) to provide advice and assistance in relation to its
investment activities. The Investment Manager’s duties are set out in an
agreement dated 13 June 2007 (“the Investment Management Agreement”).
16.
By a security trust deed dated 19 July 2002 as amended by a deed dated 13
June 2007 (together “the Security Trust Deed”) the Company created security
over certain assets. The security trustee under the Security Trust Deed is BNY
Corporate Trustee Services Limited (“the Security Trustee”). The Security
Trust Deed gave the Security Trustee the power to appoint receivers of the
assets, property and undertaking subject to the security created by the Security
Trust Deed in certain circumstances. The Security Trust Deed also sets out the
order of priority in which the Receivers should pay the Company’s creditors.
17.
A Master Framework Agreement dated 19 August 2002, as amended on 13
June 2007, contains a schedule of definitions relevant to other transactional
documents, including the Investment Management Agreement, the Security
Trust Deed and the Indenture.
4
18.
On 12 February 2008 the Security Trustee appointed the Receivers to be
receivers and managers of all the undertaking, property and assets of the
Company pursuant to the provisions of the Security Trust Deed.
19.
The principal amount of Party A’s US Notes was not paid on 15 February
2008.
20.
At 1.38pm New York time on 15 February 2008 the Security Trustee served
on the Company a notice (“the Security Trustee’s Notice”), the effect of which
under the Indenture, the Receivers say, was in all the circumstances to
substitute for the obligation to pay the principal of all outstanding US MTN
maturing prior to 16 March 2008, including in particular Party A’s US Notes
on 15 February 2008 and Party B’s US Notes on 25 February 2008, an
obligation to pay on 16 March 2008 “the Enforcement Redemption Amount”
as defined in the Indenture. Party A and Party B reject that contention. They
assert that the service of the Security Trustee’s Notice had no effect on the
obligation to pay the principal amount of their US Notes (and of any other US
MTN the stated maturity dates of which were prior to 16 March 2008) on the
respective stated maturity dates.
21.
The Receivers further contend that, even if they are wrong about the effect of
the Security Trustee’s Notice under the Indenture, the Receivers would be
acting properly by making pari passu distributions to all holders of Senior
Notes (“Senior Creditors”), including Party A and Party B, taking into account
amounts owing but not yet due among the whole class of Senior Creditors.
Party A and Party B reject that contention. They assert that under clause 6.6
of the Security Trust Deed the Receivers must apply cash received by them in
payment of Senior Creditors as their debts fall due, ignoring any amounts not
yet due to be paid.
22.
Putting to one side the effect of the Indenture and the Security Trust Deed on
any Senior Notes with a stated maturity date before 16 March 2008, the
5
Company faces obligations from 15 February to 16 March 2008 inclusive to
pay Senior Creditors as follows.
US MTN
Euro MTN
Repos
US$
673,024,944
152,747,650
1,060,324,518
1,886,097,112
In addition rather smaller amounts become due for payment during that period
under derivative contracts.
23.
At 16 March 2008 the following further Senior Notes will become due for
payment.
US$ million
US MTN
3,697.98
Euro MTN
1,914.07
Euro CP
43.78
5,655.83
24.
I have heard the Application over the last two days as a matter of urgency. I
have been asked to give my judgment speedily.
The relevant documents and provisions
The Global Note and the Pricing Supplement
25.
The US Global Note provides that the holder of US MTN is entitled to the
benefit of, and is deemed to have notice of, all the provisions of the Indenture
and the Security Trust Deed.
26.
In the Global Note the Company and the Co-Issuer jointly and severally
promise, in accordance with the Indenture and the Pricing Supplement, to pay
to Cede & Co Inc, the New York Depositary, on the specified maturity date or
on such earlier date as the same may become payable, the principal amount,
interest and all other sums as may become payable pursuant to the terms of the
Indenture and the Pricing Supplement.
6
27.
As I have said, in the case of Party A, the specified maturity date in the Pricing
Supplement was 15 February 2008. The Pricing Supplement also stated that
the aggregate principal amount was US$220 million, the issue price was US$
99.955, the rate of interest was a variable rate payable monthly, and the
redemption amount was 100 per cent. In the case of Party B, the specified
maturity date in the Pricing Supplement was, as I have said, 25 February 2008.
The Pricing Supplement also stated that the aggregate principal amount was
US$150 million, the issue price was US$99.94, the interest rate was a variable
rate, payable quarterly, and the redemption amount was 100 per cent.
The Investment Management Agreement
28.
The Investment Management Agreement contains provisions for investment
management and other services to be provided by the Investment Manager,
including giving notice to the Security Trustee of an “Insolvency Event” as
follows:
“12.3
The Investment Manager shall monitor the ability of the Company
to pay amounts owing to Senior Creditors as they fall due and shall notify the
Security Trustee forthwith upon becoming actually aware of the occurrence of
an Insolvency Event.”
“Insolvency Event” was defined in the Master Framework Agreement to
mean, so far as relevant, an “Insolvency Acceleration Event”; and the latter
expression was defined to mean: “the Company is or becomes unable to pay
its debts as they fall due to Senior Creditors and any other persons whose
claims against the Company are required by applicable law to be paid in
priority thereto”
The Indenture
29.
The Indenture was made between the Company (1), the Co-Issuer (2) and the
Bank of New York Trust Company NA, as trustee (“the Trustee”) (3).
7
30.
Section 5.07 limits claims by note holders for the appointment of a receiver, a
trustee or other remedy under the Indenture.
31.
By section 9.02(a) the Company and the Co-Issuer jointly and severally
covenanted, for the benefit of every person in whose name US MTN were
registered, “duly and punctually” to pay the principal of (and premium or
redemption amounts, if any) and interest on the Notes in accordance with the
terms of the Notes and the Indenture.
32.
Section 9.02(g) contained a joint and several covenant by the Company and
the Co-Issuer that, unless otherwise specified with respect to the US MTN,
they would designate “as a Place of Payment for each Series of Notes the
office or agency of the Trustee in the City of New York and initially appoint
the Trustee at its Corporate Trust Office as Paying Agent in such city …”.
33.
By section 9.02 (h) they covenanted:
“Whenever the Co-Issuers shall have one or more Paying Agents for
any Series of Notes, the [Company] will, on behalf of the Co-Issuers,
before 10:00 am New York City time on each due date of the principal
of (and premium, if any) or interest on any Notes of that Series, deposit
with a Paying Agent a sum sufficient to pay the principal (and
premium, if any) or interest so becoming due, such sum to be held in
trust for the benefit of the Persons entitled to such principal (and
premium, if any) or interest, and (unless such Paying Agent is the
Trustee) the Parent will promptly notify the Trustee of its action or
failure so to act.”
34.
Section 10.01(c) provided as follows.
“Insolvency Early Redemption. If the Security Trustee delivers
to the [Company] notice of an Insolvency Acceleration Event (an
“Insolvency Redemption Event”), the [Company] shall be
obliged, by giving not less than 20 nor more than 30 days’ notice
to the Trustee or (as applicable) the Registrar and the Holders of
Notes (which notice shall be irrevocable), to pay the Holders of
the Notes in whole, but not in part, the Enforcement Redemption
Amount (as defined below) on the date specified in such notice,
which date shall be not later than the date which falls 30 days
8
after the day on which the notice of an Insolvency Acceleration
Event is served (the “Insolvency Redemption Date”). In the
event that the [Company] does not duly deliver such a notice, the
Insolvency Redemption Date shall be the date which falls 30
days after the day on which the notice of an Insolvency
Acceleration Event was delivered to the [Company]. The Notes
shall be paid at the Enforcement Redemption Amount together
with interest accrued at LIBOR (and as aforesaid) on the
Enforcement Redemption Amount from the Redemption Price
Calculation Date (as defined below) to (but excluding) the
Insolvency Redemption Date. Not less than 10 days before the
Insolvency Redemption Date, the Fiscal Agent or (as applicable)
the Registrar shall give notice to the Holders of Notes of the
Enforcement Redemption Amount.”
35.
On 15 February 2008 the Security Trustee gave notice to the Company
of an Insolvency Acceleration Event; but no notice was then served by
the Company under section 10.01(c).
Accordingly, the Insolvency
Redemption Date in the present case is 16 March 2008.
36.
Section 10.01(e), so far as relevant, provided that, for the purposes of
section 10.01:
“(1)
the “Redemption Price Calculation Date” shall mean …
in the case of redemption pursuant to paragraph (c), the date on
which the Insolvency Redemption Event occurred ...
(2)
the “Enforcement Redemption Amount” shall be, for
each Note, the greater of (a) par and (b) the issue price of the
Note (including interest accrued but unpaid, if any) as at 12:00
noon New York City time on the Redemption Price Calculation
Date ... were it to be issued at that time by an issuer receiving the
highest ratings of the Rating Agencies.”
The Security Trust Deed
37.
The Security Trust Deed contains fixed and floating charges over the
Company’s Assets (cl 3), provision for the enforcement of the security by the
appointment of a Receiver on the occurrence of an Automatic Enforcement
9
Event (cll 5, 6, 14 and Schedule 1), and provisions making the Company
“insolvency remote” and limiting the recourse of note holders (cl 28).
38.
By clause 2 the Company covenanted with the Security Trustee that it “shall
duly, unconditionally and punctually pay and discharge in full all monies and
liabilities whatsoever constituting the Secured Liabilities which from time to
time become due, owing or payable by it at the time and in the manner
provided for under the Secured Creditors’ Documents under which such
Secured Liabilities arise.”
39.
Clause 3.4 provided:
“The Security Trustee shall hold the benefit of the Security on the
terms of the trusts herein provided and shall deal with the Assets
and apply all payments, recoveries or receipts in respect of the
Assets in accordance with Clause 6.6 (Application of Proceeds).”
40.
Clause 5.1, so far as relevant, provided:
“If the Investment Manager notifies the Security Trustee of the
occurrence of an Automatic Enforcement Event or the Security
Trustee actually becomes aware of the occurrence of an Automatic
Enforcement Event…the Security Trustee shall forthwith give
notice of the same (an “Enforcement Notice”) to the Company…”
41.
So far as relevant to the issues on this Application, the Master Framework
Agreement provided that “Automatic Enforcement Event” meant “breach of
the Capital Loss Limit” as defined in Schedule 7 to the Investment
Management Agreement or an Insolvency Event. Under Schedule 7 to the
Investment Management Agreement there is a breach of the Capital Loss
Limit if the Capital Value of the Company is less than 50 per cent of the par
amount of all issued and fully paid up outstanding Capital Notes.
The
expression “Insolvency Event” was defined in the Master Framework
Agreement as I have described earlier.
10
42.
On 11 February 2008 the Investment Manager notified the Security Trustee
that the Company had breached the Capital Loss Limit.
43.
Under clause 5.3 the Security Trustee, as soon as reasonably practicable after
the “Enforcement Date”, shall appoint a receiver. The Enforcement Date was
defined to mean the “earlier of (a) the date upon which the Security Trustee
delivers an Enforcement Notice pursuant to Clause 5 … and (b) the date on
which an Automatic Enforcement Event occurs”.
44.
Under clause 6.3, the receiver is (unless and until an Insolvency Acceleration
Event occurs) required to manage the Company’s business in accordance with
the “Enforcement Management Procedures”, but authorised to depart from
them “to the extent that such compliance…
would adversely affect the
interests of the Secured Creditors” and, in case of conflict between the
interests of Senior Creditors and other Secured Creditors, to “give priority to
the interests of the Senior Creditors”. After the occurrence of an Insolvency
Acceleration Event the receiver is no longer bound to manage the Company’s
business in accordance with the Enforcement Management Procedures or
[subject to an immaterial exception] the applicable provisions in the relevant
Compliance Manual, and shall be entitled to sell secured assets and apply the
proceeds in accordance with clause 6.6.
45.
The expression “Senior Creditors” was defined in the Master Framework
Agreement to mean:
“Liquidity Providers, holders of Senior Notes, the Custodian, the
Security Trustee, any Receiver, Repo Agreement counterparties,
Derivative counterparties, the Paying Agents, the ECP Issue Agent,
the USMTN Trustee, the WP Indemnified Party and the WP Senior
Creditors”.
46.
Clause 6.6 (as amended) provided:
“Subject to Clause 16.18 (Deductions on account of Tax), any
monies shall be applied in the following order of priority:
11
6.6.1 first, to pay any fees, costs, expenses and other amounts
then due to the Security Trustee or any Receiver in connection
with the enforcement of the Security;
6.6.2 second, to pay, pari passu and pro rata in accordance
with the respective amounts then owing thereto, (i) all
amounts then due to the WP Indemnified Party in respect of
any claims under the WP Indemnity and (ii) any fees, costs,
expenses and other amounts then due to the Security Trustee
or any Receiver (other than those amounts referred to in clause
6.6.1 above);
6.6.3 third, to pay, pari passu and pro rata in accordance with
the respective amounts then owing thereto, any amounts due
to Senior Creditors other than the Security Trustee and any
Receiver and the WP Indemnified Party…”
There follows a list (clauses 6.6.4–6.6.8) of five further types of payment
in successive order of priority. The clause then continues:
“For the avoidance of doubt, no such monies shall be applied
in accordance with Clauses 6.6.4, 6.6.5, 6.6.6, 6.6.7 or 6.6.8
unless (a) payment and/or provision for all amounts referred to
in Clauses 6.6.1, 6.6.2 and 6.6.3 above have been made (and,
in the case of the application of monies in accordance with
Clause 6.6.5, unless all amounts referred to in Clauses 6.6.1,
6.6.2, 6.6.3 and 6.6.4 have been paid) and all amounts owing
to Senior Creditors which are then due and payable have been
unconditionally and irrevocably paid in full and discharged or
(b) except to the extent that the Security Trustee or, as the case
may be, the Receiver reasonably considers that the remaining
Assets will be sufficient to enable all amounts owing to Senior
Creditors which are not then due and payable to be discharged
in full as and when they fall due for payment ... provided that
any monies received by the Security Trustee or any Receiver
after the Enforcement Date and retained to provide for
amounts owing to Senior Creditors which are not then due and
payable shall be deposited on a call basis with any Approved
Bank or shall be invested in [specified securities having a
maturity of not more than 90 days]….
All payments to Senior Creditors shall be made in accordance
with the provisions concerning payments contained in the
relevant Liquidity Facility Agreements, Euro Notes, US
Notes, Derivatives and Repo Agreements.”
12
47.
Clause 6.7. provided that:
“Payments made under this Clause 6 … shall be made in accordance
with the provisions (if any) concerning payments contained in the
Secured Creditors’ Documents and this Deed and any payment so
made shall be a good discharge to the Security Trustee or, as the
case may be, the Receiver”.
48.
Clause 6.11 provided that:
“In exercising any of its trusts, powers, authorities or discretions under
this Security Trust Deed the Security Trustee is required to have
regard to the interests of the Secured Creditors as a class provided that
if, in the opinion of the Security Trustee, there is a conflict between
the interests of the Senior Creditors and the interests of the other
Secured Creditors, the Security Trustee is required to have regard only
to the interests of the Senior Creditors…”
49.
Under clause 14.3 the receiver is the agent of the Company.
50.
By clause 14.3.2 the receiver is vested with the discretions and powers of the
Security Trustee, but is required to act under the Security Trustee’s directions
or regulations.
51.
By clause 14.3.9: “save as otherwise directed by the Security Trustee, all
monies from time to time received by such Receiver in respect of the
Assets shall be paid over to the Security Trustee to be applied by it as
specified in Clause 6.6 …”
Deed of Appointment of the Receivers
52.
As I have said, on 11 February 2008 the Investment Manager notified the
Security Trustee that the Company had breached the Capital Loss Limit; and
that, in turn, led to the service by the Security Trustee of notice under clause
5.1 of the Security Trust Deed that an Insolvency Acceleration Event had
13
occurred. That, in turn, gave rise to the requirement to appoint a receiver
under clause 6.3 of the Security Trust Deed.
53.
The Receivers were appointed by a Deed dated 12 February 2008. The Deed
of Appointment invested them with all the powers conferred by the Security
Trust Deed and by law, as agents of the Company.
54.
Clause 3 provided that the Receivers were appointed “in accordance with the
provisions of the Security Trust Deed”, as receivers and managers of all the
undertaking, property and assets of the Company comprised in and secured to
the Security Trustee by the Security Trust Deed, so that they may exercise all
the powers conferred by the Security Trust Deed and by law.
55.
Clauses 4.1 and 4.2, headed “Specific Terms of Appointment” provided for the
management prior to an Insolvency Acceleration Event in terms that mirrored
clause 6.3 of the Security Trust Deed.
The Issues
56.
The skeleton argument of the Receivers, who were represented by Mr.
Simon Mortimore QC and Mr. Barry Isaacs, sets out the two issues of
general significance to the receivership on which the directions of the
Court are sought. They are:
(1) “whether, on the true construction of the conditions of the US
MTN, all notes that had not been redeemed before the
Insolvency Redemption Event become due to be redeemed on
and not before the Insolvency Redemption Date at the
Enforcement Redemption Amount calculated as at the date of
the Insolvency Redemption Event, even though a particular
note may have a stated maturity date on or between 15
February and 16 March 2008. A and B contend that their
notes remain due to be paid on the stated maturity dates,
notwithstanding the Insolvency Early Redemption provisions
contained in Section 10.01(c) and (e) of the Indenture of the
US MTN, which they say do not apply to them. The same
issue applies to the Euro MTN and the Euro CP”; and
14
57.
(2) “whether, after an Insolvency Acceleration Event, the
Receivers are obliged to manage the Assets so that they pay
Senior Creditors promptly as their debts fall due (“Pay As
You Go”) or whether they may manage the Assets, including
cash, so as to make pari passu distributions to all Senior
Creditors, taking into account amounts owing but not yet due
among the whole class of Senior Creditors. A and B contend
that the Receivers are bound to operate Pay As You Go, even
though this may work to the prejudice of Senior Creditors
whose debts are not yet due. On 16 March 2008, the
Insolvency Redemption Date, all Senior Notes become due
for payment. Since there is no prospect of the Company
being able to pay all Senior Creditors in full on and after that
date, it is inevitable that thereafter all Senior Creditors will
receive distributions pari passu and pro rata.”
These issues, being of general significance to the receivership, and no “long”
note holder having agreed to appear to oppose the arguments of Party A and
Party B, the Receivers have taken the view that it is appropriate for the
Receivers to do so.
58.
In the course of argument I was referred by each of the parties to the
judgments of Briggs J in Cheyne Finance ( No. 1) and Cheyne Finance (No.
2), which concerned an investment vehicle and arrangements in some respects
similar to those I am considering on this Application. The critical documents
or parts of document in those cases were, however, materially different from
those relevant to my decision in this case and so, impressive as those
judgments are, I do not propose to refer to them further.
Issue (1)
59.
Leaving aside, for the moment, the special feature of Party A’s position that its
US Notes matured on 15 February 2008 and were due to be paid by 10 am on
that day, the day of the Security Trustee’s Notice, the arguments advanced by
Party A, which was represented by Ms. Susan Prevezer QC and Mr. Paul
Stanley, and Party B, which was represented by Mr. Stephen Atherton QC,
were as follows on this issue.
60.
They submit that the terms of Article 10.01(c) of the Indenture only apply to
the liabilities of the Company to holders of US MTN which mature after the
Insolvency Redemption Date.
61.
The effect of the Receivers’ interpretation, they submit, would be to postpone
the date for payment of Party A’s and Party B’s US Notes from 15 February
15
2008 and 25 February 2008 respectively to 16 March 2008 contrary to the
plain intention of the Notes and section 10.01(c) of the Indenture.
62.
They point out that the Notes themselves state that they will be paid “on the
maturity date or such earlier date as the same may become payable” [my
emphasis]. There are materially identical provisions in the Euro MTN.
63.
Section 10.01(c), they say, is plainly dealing with early redemption, as is
apparent from its introduction - “Insolvency Early Redemption” - and from
the reference to an “Insolvency Acceleration Event”.
64.
That interpretation of section 10.01(c), they observe, is consistent with section
10.01(a) and section 10.01(b) of the Indenture. The former, the introduction to
which is “Applicability of Article”, refers to Notes “which by their terms are
redeemable before their Stated Maturity”. The introduction to the latter is “Early Redemption For Tax Reasons”.
65.
Party A and Party B submit that paragraph 10(a) of the Euro MTN Global
Notes is even clearer:
unless “previously” redeemed, the Notes will be
redeemed on the maturity date, the remaining provisions dealing with
circumstances of acceleration (“… there will be no acceleration prior to the
Maturity Date except as set out in paragraphs (b), (c) and (e) below”).
66.
Further, they emphasise that, the obligation to pay the Notes at the stated
maturity date being the most basic and fundamental obligation, one would
have expected any suspension of that obligation and postponement of payment
to be stated in clear and express terms. There are no such clear and express
terms in clause 10.01(c) of the Indenture.
67.
They submit that postponement of payment of the Notes carries with it
significant financial detriment, underscoring the absence of clear and express
wording to support the Receivers’ interpretation. First, they say that the
provisions for interest at LIBOR in section 10.01(c) (on the Enforcement
Redemption Amount from the Redemption Price Calculation Date to the
Insolvency Redemption Date) would not be as much as the return if the
amount due on the Notes was paid and reinvested and nor is it as high as the
default rate of interest payable under section 10.01(e)(5) payable if the due
amount is not paid on the Insolvency Redemption Date (LIBOR compounded
monthly). Second, bearing in mind the terms of clause 6.6. of the Security
Trust Deed, the effect of postponement would be to compel Party A and Party
16
B and others in a similar position to share pari passu with holders of later
maturing Notes in circumstances where, but for the postponement, they would
not have done so. Third, they would see their ability to obtain payment
prejudiced by payments becoming due sooner to other Senior Creditors, for
example Repo counterparties, payment to whom would not be deferred under
Article 10.01(c) or otherwise.
68.
In my judgment, notwithstanding those arguments, the provisions of section
10.01(c) apply to Party B and all other holders of US MTN the stated maturity
dates of which fall after 15 February 2008. They do not, however, apply to
Party A.
69.
I approach the issue in the conventional way by seeking to ascertain the
intentions of the parties, having regard to the language they have used, the
relevant factual background, including the commercial purpose of the
arrangements, and the provisions in linked documents.
As Ms. Prevezer
emphasised, I must, of course, respect the autonomy of the parties to decide
whatever they wish, particularly in a case like this in which sophisticated
parties are advised by highly experienced and competent advisers, including
lawyers.
The question is not what the Court considers would be fair or
reasonable terms for the parties to have agreed, but what the parties have in
fact agreed, including implied terms where necessary to make the agreement
work.
70.
The starting point, as Mr. Mortimore submitted, is that under the terms of
clause 10.01(c), upon the occurrence of an Insolvency Acceleration Event, the
Company is obliged to give notice to, among others, “the Holders of Notes” to
pay “the Holders of Notes” the Enforcement Redemption Amount on the
Insolvency Redemption Date.
No category of Holder of Notes still
outstanding at the time of an Insolvency Acceleration Event is expressly
excluded.
71.
At the core of the submissions of Party A and Party B on this issue is their
emphasis that references in section 10.01(c) to “Insolvency Early
Redemption” and “Insolvency Acceleration Event” clearly indicate early
payment and not postponed payment of Note Holders, and that such an
interpretation is consistent with provisions in section 10.01(a) and (b).
17
72.
That point, in my judgment, is effectively undermined by the provisions for
the calculation of the Enforcement Redemption Amount and the payment of
interest on that Amount from the Redemption Price Calculation Date to the
Insolvency Redemption Date.
The Enforcement Redemption Amount is
calculated as at the Redemption Price Calculation Date, which is the date on
which the Insolvency Redemption Event occurred (in the present case 15
February 2008), and interest is payable from that date to the Insolvency
Redemption Date (in the present case 16 March 2008).
The provisions,
therefore, substitute for the stated maturity dates of US MTN outstanding on
the date of the Insolvency Redemption Event a deemed payment date of the
Insolvency Redemption Event, with provision for interest from that deemed
payment date to the date of actual payment.
I do not consider that this
interpretation is undermined by the fact that section 10.01(e)(5) provides for a
higher rate of interest in the event of non-payment on the Insolvency
Redemption Date.
73.
Nor is this interpretation in any way undermined by the provisions of section
10.01(a) or (b), or by the terms of the Global Note. Under its express terms,
the latter is to be read in conjunction with the Indenture.
74.
The commercial result is not in any sense absurd or unworkable. On the
contrary, it provides a coherent scheme for dealing with insolvency or possible
insolvency. It puts all holders of US MTN on an equal footing as at the date
of the Insolvency Redemption Event. It does mean, on the “Pay As You Go”
interpretation of clause 6.6. of the Security Trust Deed (which I consider is the
correct interpretation of that clause), that the holders of US MTN will take
subject to, and so be prejudiced by, the claims of other Senior Creditors who
do not fall within clause 10.01(c). That, however, is the commercial deal
which was concluded. Indeed, the interpretation of Party A and Party B would
result in a situation in which even more Senior Creditors would be entitled to
claim priority over others of the same class so leading to a situation in which
limited assets would be more likely to be wholly consumed in payment of only
a proportion of the class of Senior Creditors rather than being shared among
the class as a whole. It is not possible to say that is a more commercially
likely objective than the Receivers’ interpretation.
18
75.
For those reasons, I conclude that Party B and other holders of US MTN with
stated maturity dates after the Insolvency Redemption Event fall within the
provisions of section 10.01(c) of the Indenture.
76.
I consider the position is different, however, as regards Party A. Under the
provisions of the Indenture, the Company, acting by the Receivers, should
have deposited with its Paying Agent in New York before 10am on 15
February 2008 the amount due on Party A’s US Notes.
That amount would
then have been held in trust for Party A. No such sum was paid even though
there were assets to do so.
77.
The Insolvency Redemption Event, that is the Security Trustee’s letter to the
Company under section 10.01(c), did not arrive until 1.38pm New York time.
78.
The effect of the Receivers’ submissions, so far as concerns Party A, is that,
by a deliberate failure to comply with the obligation to pay Party A by 10 am
on 15 February 2008, Party A has been pushed into the regime under clause
10.01(a) of the Indenture to its considerable financial disadvantage.
79.
Mr. Mortimore submitted that this was not a proper way of looking at the
matter since, he said, time for payment was not of the essence. I am inclined
to think, however, that time may well have been implicitly of the essence in
the light of the covenant in section 9.02(a) of the Indenture to pay “duly and
punctually”, the provisions of section 9.02(h) of the Indenture, and the
covenant in clause 2 of the Security Trust Deed to “duly … and punctually
pay”. In any event, whether or not time was of the essence, the failure to pay
by 10 am on 15 February 2008 was undoubtedly a breach of contract.
80.
Mr. Mortimore also emphasised that the provisions of section 10.01(c) should
not be interpreted so as to make distinctions, possibly fine ones, between
different parts of a day. That would, he submitted, be contrary to principle
and to the likely commercial intention of the parties. Under section 10.01(c)
and (e) the Redemption Price Calculation Date in the present case is, the
Receivers would contend, the whole of 15 February 2008, and so the holder of
any US MTN outstanding at any time during that day should fall within the
section 10.01(c) regime.
81.
I do not accept that contention. I agree with Party A and Party B that section
10.01(c) is intended to set in place a regime in which there is an actual or
notional acceleration of the due time for payment of the Notes. In the case of
19
Party A, there is no actual or, importantly, even notional acceleration of the
time for payment.
82.
Distinctions between different parts of the day are important in the section
10.01 regime.
So, section 10.01(e)(2) of the Indenture provides that the
Enforcement Redemption Amount of each Note shall be the greater of par and
the issue price of the Note as at 12 noon New York City time on the
Redemption Calculation Date were it to be issued at that time by an issuer
receiving the highest ratings of the Rating Agencies. That higher amount was
inherently incapable of applying to Party A’s US Notes since they matured
prior to noon on 15 February 2008 or, at any event, they matured on that day.
83.
For those reasons, I conclude that Party A’s US Notes do not fall within
section 10.01(a) of the Indenture.
Issue 2
84.
In the light of my earlier conclusions, this issue only arises in relation to Party
A.
85.
The Receivers submit that clause 6.6.3 of the Security Trust Deed requires
them to make distributions among Senior Creditors on a pari passu basis,
taking into account amounts owing but not yet due among the whole class of
Senior Creditors, and that they should manage the business of the Company in
the interests of Senior Creditors as a whole.
86.
In my judgment, that is not the correct interpretation of clause 6.6.3. Rather, I
accept the argument of Party A that the obligation of the Receivers is to
distribute money received by them pari passu to Senior Creditors whose debts
are then due for payment, without taking into account amounts not yet due.
87.
The Receivers say that, had they operated Pay As You Go, they would have
exhausted the Company’s cash by 26 February 2008 and the realisation of
breakable deposits by 29 February 2008.
88.
Mr. Mortimore’s starting point on this issue is his submission that clause 6.6 is
a priority clause, which operates as between different classes of Secured
Creditors, but not internally between Creditors of the same level.
89.
He submitted that the proviso to clause 6.6 (introduced with the words “For
the avoidance of doubt…”) supports the contention that the Receivers may
make provision for Senior Creditors whose debts are not yet due.
20
90.
Mr. Mortimore contended that the interpretation of Party A “contradicts the
very nature of the Insolvency Acceleration Event”. He submitted that, since
such an Event presupposes that the assets are not sufficient to pay all Senior
Creditors, it would be absurd for the limited funds to be applied on a first
come, first served basis.
91.
He submitted, further, that a priority based on timing would create a lottery.
Whether or not, and how much, Senior Creditors would be paid would depend
on whether and how much cash was available at any time.
A delay in
applying money under clause 6.6 could have significant implications for the
amount received by a particular Senior Creditor.
92.
He submitted that Party A’s interpretation would have serious implications for
the Receivers’ management of the assets. On that interpretation, they would
have to sell assets in a depressed market quickly in order to make payments to
Senior Creditors whose debts are due, regardless of the prejudice to other
Senior Creditors whose debts are not yet due for payment.
93.
That approach, he suggested would be at odds with the general principles of
law concerning the exercise of the powers of a receiver. He referred to the
provisions of the Law of Property Act s.109(8) which state how a receiver
“shall apply all money received by him”. He submitted it is well established
that, under that section, a receiver has an element of discretion as to when and
to whom payments may be made, and that a creditor of a company, not being
the mortgagee, cannot enforce s.109(8) against the receiver. He cited Sargent
v Customs & Excise Commissioners [1995] 1 WLR 821 and Brown v City of
London Corporation [1996] 1 WLR 1070 in support of those propositions.
Here, he said, Senior Creditors, not being party to the Security Trust Deed, do
not have claims that they can enforce against the Receivers personally.
94.
Mr. Mortimore also said that in most receiverships creditors are paid after the
contractual date for payment, and that companies in receivership frequently
breach contractual obligations to unsecured parties. Similarly, he suggested,
after an Insolvency Acceleration Event the Court might consider that the
Receivers could reasonably delay in making payments due.
95.
Finally, he said that receivers generally should not favour one creditor over
another unless it is commercially justified. He submitted that, in the present
case, the Receivers owe an equitable duty to the Security Trustee to manage
21
the assets and to exercise their power of sale for the benefit of the Secured
Creditors as a class and to try to bring about a situation in which the secured
debts are repaid. He referred to various provisions of the Security Trust Deed
giving the Receivers the same powers as the Security Trustee, including
powers of sale and management of the assets; and then to the provision in
clause 6.11 of the Security Trust Deed that “in exercising any of its trusts,
powers, authorities or discretion under [the] Security Trust Deed the Security
Trustee is required to have regard to the interests of the Secured Creditors as a
class” subject to a proviso that, in the case of a conflict between the interests
of the Senior Creditors and the other Secured Creditors, the Security Trustee is
to have regard only to the interests of the Senior Creditors.
96.
In my judgment, the correct starting point is the actual language in clause 6.6
in relation to payment to the Senior Creditors. The clause stipulates that “any
monies received by … any Receiver after the Enforcement Date shall be
applied ….: … third, to pay, pari passu and pro rata ….in accordance with the
respective amounts then owing thereto, any amounts due to Senior Creditors”
[my emphasis].
97.
On the literal wording of the clause, money received by the Receivers is to be
paid out pari passu and pro rata in respect of amounts then due. There is no
provision for money to be held back. The clause, therefore, plainly envisages
that, if and when money is received by the Receivers, it is then paid out to
Senior Creditors in respect of, and only in respect of, debts then due to be
paid, and not debts due to be paid in the future.
98.
I see no reason why the proviso to clause 6.6 should undermine that
interpretation.
99.
It is important to note that the provisions of clause 6.6 apply both before and
after an Insolvency Acceleration Event, that is to say it will operate at a time
when the expectation is that creditors can be paid in full. The interpretation of
the Receivers is inconsistent with the obligation, at such a time, for payment
to, for example, holders of US MTN in accordance with the provisions of their
Notes and at the stated maturity dates. So, prior to an Insolvency Acceleration
Event, concern about future insolvency would be irrelevant and would not
entitle the receiver to refuse to pay the Senior Creditors as the maturity dates
22
of their Notes arrive. The meaning and operation of clause 6.6.3 does not
change once an Insolvency Acceleration Event occurs.
100.
This interpretation does not produce an absurd or unworkable result. Some
Senior Creditors will be paid out sooner than others, but that, again, is
consistent with the fact that some creditors, such as Repo counterparties, are
not caught by a regime similar to section 10.01(c) of the Indenture, and Party
A is not caught by that regime. Indeed, the interpretation of Party A may be
said to be consistent with the different way in which, in other documents,
different creditors are treated on insolvency.
Further, Ms. Prevezer
acknowledged that the Receivers are not deprived of their general right to
determine the appropriate time to achieve the best realisation of the value of
an asset.
101.
I do not consider that any assistance, on this issue of interpretation, is to be
gained by reference to more general duties of Receivers in relation to the
management and distribution of assets. The obligations imposed directly on
the Receivers by the Security Trust Deed, and with which they were required
to comply by the Deed which appointed them, cannot be qualified or ousted by
any general management discretion that might otherwise exist.
102.
For those reasons, I conclude that clause 6.6 of the Security Trust Deed is to
be interpreted in the manner for which Party A has contended.
23
Neutral Citation Number: [2008] EWHC 2997 (Ch)
Case No: 9750 of 2008
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
COMPANIES COURT
Royal Courts of Justice
Strand, London, WC2A 2LL
Date: 07/11/2008
Before :
THE HONOURABLE MR JUSTICE SALES
--------------------In the Matter of Sigma Finance Corporation
(in Administrative Receivership)
- and In the Matter of the Insolvency Act 1986
----------------------------------------Mr G. Moss QC and Mr B. Isaacs (instructed by Lovells) for the Receivers
Mr M. Howard QC and Mr J. Dawid (instructed by Mayer Brown) for Party A
Mr R. Sheldon QC and Ms F. Toube (instructed by Dechert) for Party B
Mr S. Mortimore QC and Mr D. Bayfield (instructed by Jones Day) for Party C
Ms S. Prevezer QC and Mr Edmund King (instructed by Quinn Emmanuel) for Party D
Mr J. Potts (instructed by Allen & Overy) for Deutsche Trustee Co Ltd
Hearing date: 4/11/08
---------------------
Judgment
Mr Justice Sales :
Introduction
1.
This is an application pursuant to section 35 of the Insolvency Act 1986 by the
Receivers appointed on 6 October 2008 in respect of the assets of Sigma Finance
Corporation (“Sigma”) for directions from the court regarding their obligations
concerning management of those assets. The directions to be given depend upon the
proper construction of clause 7.6 of the Amended and Restated Security Trust Deed
dated 27 March 2003 between Sigma as Issuer and Deutsche Trustee Company Ltd as
Security Trustee (“the Security Trust Deed”). The court has been assisted on the
application by submissions on behalf of four companies (referred to below as Parties
A, B, C and D) which are each representative of a defined group of creditors of Sigma
with different and competing interests in relation to the construction of clause 7.6.
The Receivers and the Security Trustee have adopted a neutral position in relation to
that question.
2.
At the outset of the hearing I gave directions that the hearing of the application should
take place in private and that no person should be permitted to inspect the documents
on the Court file in respect of the application without the permission of the court or
the written consent of the Receivers. I gave these directions on the basis that, were
the market to become aware of the factual circumstances in which the application is
made, Sigma’s status as a distressed and vulnerable seller of assets would be made
apparent in a way and at a point in time which would be likely to result in prejudice to
Sigma’s creditors. I also gave a direction that the true identities of Parties A, B, C and
D should not be disclosed. This was on the basis that disclosure of their identities
could be detrimental to their market position, that they are not in strict terms parties to
the application but only appeared to assist the court by their submissions and that in
the absence of anonymity being granted in such circumstances the court might in
future cases be deprived of the benefit of such assistance.
3.
Sigma is a company incorporated under the laws of the Cayman Islands. It is what is
commonly known as a structured investment vehicle, established to invest in certain
types of asset-backed securities and other financial instruments. It has no other
business. Sigma sought to profit from the difference between its cost of funding its
activities and the returns made on its investment portfolio.
4.
Sigma carried on its specialised form of business with a limited pool of creditors,
comprising holders of instruments (Euro Medium Term Notes and US Medium Term
Notes) issued or guaranteed by it in relation to the funds it obtained to fund its
investment activities, providers of liquidity under liquidity facilities obtained by
Sigma, counterparties in relation to derivative instruments used as a hedge against
currency and interest rate risk, “repo” counterparties (in respect of repurchase
agreements and securities lending agreements) and holders of Capital Notes issued by
Sigma in respect of capital provided to support Sigma’s secured obligations.
Substantially all of Sigma’s assets are charged to its secured creditors under the
Security Trust Deed.
5.
The Security Trust Deed created a floating charge in relation to Sigma’s assets, which
has now crystallised. The Security Trustee has exercised its powers under that Deed to
appoint the Receivers over Sigma’s assets. Most, but not all, of Sigma’s creditors are
secured creditors for the purposes of the Security Trust Deed, in which they are
described as “Beneficiaries”. The holders of Capital Notes and “repo” counterparties
are not secured creditors under the Deed.
6.
7.
Each of the main groups of secured creditors under the Security Trust Deed is
represented by Parties A, B, C and D respectively:
i)
Party A is the holder of US Medium Term Notes with a face value of US$225
million issued by Sigma Finance Incorporated (a wholly-owned subsidiary of
Sigma) and guaranteed by Sigma. Those Notes matured, so that payment was
due under them, on 23 October 2008. No payment has yet been made, and the
question arises whether the Receivers should be directed to use Sigma’s assets
to satisfy Sigma’s payment obligation in respect of these Notes. In the
terminology used in the Security Trust Deed, Party A is a “Beneficiary” in
respect of “Short Term Liabilities” which fall due in the “Realisation Period”;
ii)
Party B is the holder of Notes maturing on 30 October 2008 (with a face value
of US$428 million) and on 14 November 2008 (with a face value of US$430
million). For the purposes of the Security Trust Deed, therefore, Party B is
also a Beneficiary in respect of Short Term Liabilities which fall due in the
Realisation Period. However, it is apparent that Sigma is massively insolvent.
Its financial position is such that if the Receivers use its assets to pay the Notes
held by Party A which matured on 23 October, no funds will remain to meet
Sigma’s payment obligations in relation to the Notes held by Party B;
iii)
Party C is an advisory institution which represents a group of holders of US
Medium Term Notes with a face value in excess of US$400 million. These are
all due to mature in June 2009. For the purposes of the Security Trust Deed,
Party C’s clients are Beneficiaries in respect of Short Term Liabilities which
fall due only after the end of the Realisation Period. If the Receivers use
Sigma’s assets to pay the Notes held by Party A, or those held by Party A and
Party B, then it is clear that no funds will remain to meet Sigma’s payment
obligations in relation to the Notes held by the clients of Party C;
iv)
Party D is the holder of Notes maturing more than 365 days after the
“Enforcement Date” for the purposes of the Security Trust Deed. The
Enforcement Date is 2 October 2008. For the purposes of the Deed, Party D is
a Beneficiary in respect of “Long Term Liabilities”. Again, if the Receivers
use Sigma’s assets to pay the Notes held by Party A, or by Party A and Party
B, then it is clear that no funds will remain to meet Sigma’s payment
obligations in relation to the Notes held by Party D.
All of the assets which Sigma currently owns are in a form which allows them to be
realised promptly. It is party to certain swap transactions where it is as yet uncertain
whether or not the transactions will close for Sigma’s overall advantage, with it being
“in the money”, or with it being “out of the money” and so having to meet further
liabilities under them. For present purposes, the detail does not matter. The Receivers
estimate that Sigma’s liabilities to creditors comprise secured liabilities of
approximately US$6.2 billion and unsecured liabilities of approximately US$3.658
billion. Even leaving aside possible swap liabilities, the Receivers assess Sigma to
have an insolvent deficit in excess of US$5.5 billion in respect of secured liabilities,
and in excess of US$9 billion in respect of all liabilities (secured and unsecured).
8.
It appears that Sigma has arrived at this position as a result of problems it has
experienced in funding its activities consequent upon the negative impact upon the
financial markets over the last year or so stemming from perceived difficulties arising
from the sub-prime mortgage market in the United States. These have caused the
value of a variety of asset backed and other financial securities of the kind held by
Sigma to fall substantially in value and the market for such securities to become less
liquid, in that there are now many fewer investors willing to purchase such
instruments. The market for debt securities of the kind issued by Sigma has also fallen
away, thereby reducing its ability to fund its activities. For many months prior to
October 2008 Sigma had been unable to issue debt securities, which meant that it
became unable to “roll over” its obligations in relation to the Notes and other financial
instruments which it had previously issued, and which were falling due for repayment
from time to time. The result of this was that Sigma had to resort to funding its
activities through various other techniques, including the sale of assets in its portfolio
and entering into securities lending arrangements and “repo” agreements (both of
which, as a matter of commercial substance, involved borrowing money against the
provision of security in the form of assets taken from its asset portfolio).
9.
“Repo” agreements which Sigma entered into included provision for the relevant
counterparty to make a “margin call” for provision by Sigma of further cash or assets,
if the value of the assets provided by Sigma by way of security for the transaction fell
below a certain level. In September 2008, Sigma received such margin calls which it
did not honour. Sigma’s board of directors resolved on 30 September 2008 that
Sigma’s position as a going concern was no longer sustainable, that it might then be
or might become insolvent, and that “the required steps under the relevant transaction
documents entered into by [Sigma] should therefore be taken to provide for an orderly
winding down of [Sigma’s] affairs.” Liabilities of Sigma falling due on that day (in
the sum of US$541,944 in respect of the interest coupon due in relation to Notes
issued or guaranteed by Sigma), on 1 October 2008 (in the sum of US$901,146 in
respect of the interest coupon due in relation to other such Notes) and subsequently
have not been met by payment.
10.
On 1 October 2008, Sigma wrote to the Security Trustee stating that it had been
resolved that there was “no reasonable likelihood of Sigma avoiding an insolvent
liquidation” and that the non-payment of the coupon due on 30 September 2008
constituted a “Potential Enforcement Event” for the purposes of the Security Trust
Deed. Sigma also notified counterparties that it had decided to make no further
payments on liabilities falling due.
11.
On 2 October 2008, one of Sigma’s liquidity providers served notice of an event of
default under its liquidity facility agreement with Sigma upon the Security Trustee. It
is common ground that as a result an “Enforcement Event” for the purposes of the
Security Trust Deed took place on 2 October 2008, which date became the
“Enforcement Date” as defined in that Deed. The floating charge under clause 4.1 of
the Security Trust Deed crystallised and on 6 October 2008 the Security Trustee
appointed the Receivers under clause 14.1 of that Deed.
12.
The occurrence of an Enforcement Event also had the effect of starting the 60 day
“Realisation Period” stipulated in the Security Trust Deed. That period commenced
on the Enforcement Date and will end on 29 November 2008. The Realisation Period
is an important concept governing the operation of various provisions in the Security
Trust Deed.
The Security Trust Deed
13.
The question of construction of the Security Trust Deed which arises in these
circumstances relates to clause 7.6, and in particular its last sentence. Clause 7
provides in relevant part as follows:
“7.
ENFORCEMENT
7.1
The Security Trustee shall be entitled to enforce the
Security on and from the Enforcement Date only in accordance
with this Clause notwithstanding any contrary instruction or
direction from any Beneficiary or any other person. The
Security Trustee shall not exercise any of its powers under this
Clause until the Enforcement Date.
7.2
Without prejudice to any rule of law which may have a
similar effect, the floating charge constituted by Clause 4.1.2
shall on the Enforcement Date automatically be converted with
immediate effect into a fixed charge as regards the assets
subject to such floating charge and without notice from the
Security Trustee to the Issuer. On the Enforcement Date the
Security Trustee shall be entitled to exercise the Issuer's rights
in and under the Transaction Documents having given notice to
the other parties to such documents of its intention to do so.
7.3
On the Enforcement Date or as soon thereafter as can
practicably be arranged the Security Trustee shall (to the extent
that the relevant Liquidity Facility has not been cancelled by
the relevant Liquidity Provider) on behalf of, and as attorney
for, the Issuer draw Advances under each Liquidity Facility up
to the Available Amount and shall specify repayment dates
(except in the case of Swing-line Advances) for such Advances
falling after the Realisation Period. If the Issuer has Committed
Liquidity (as defined in the IMC) and more than one Liquidity
Facility, the Security Trustee shall ensure that, as between
Liquidity Facilities, any drawings are made pro rata to the
aggregate available commitments under such Liquidity
Facilities. Advances drawn shall be used in order (i) to
discharge the Issuer's obligations to pay sums due and owing to
Beneficiaries in accordance with the relevant Beneficiaries'
Documents and (ii) to effect repayment of any Advance made
under a Liquidity Facility. If and to the extent that all or any
part of the Advances drawn down are not immediately required
by the Security Trustee for the purposes of (i) or (ii) above, the
Security Trustee shall deposit the unutilised portion(s) of such
Advances on a call basis with any bank or financial institution
whose short-term unsecured, unguaranteed and unsubordinated
debt is rated A-1 by S&P, P-1 by Moody's and F1 by Fitch or
shall invest such portion(s) in certificates of deposit, United
States or United Kingdom government securities or commercial
paper rated A-1+ by S&P and P-1 by Moody's.
7.4
If the Security Trustee applies an Advance (or part
thereof) to discharge any of the Issuer's Short Term Liabilities
because of the default, late payment or non-performance of any
Asset in the Short Term Pool (a "non-performing asset") any
monies subsequently recovered or received in respect of such
non-performing asset shall be applied by the Security Trustee
in repayment (or part payment) of such Advance before being
applied pursuant to the trust declared in Clause 7.11.2.
7.5
If the Security Trustee applies an Advance (or part
thereof) to discharge any of the Issuer's Long Term Liabilities
because of the default, late payment or non-performance of any
Asset in the Long Term Pool (a "non-performing asset"), any
monies subsequently recovered or received by the Security
Trustee in respect of such non-performing asset shall be applied
pursuant to the trust declared in Clause 7.12.2 and the Liquidity
Provider's claim for repayment of that Advance (or such part
thereof as is used to discharge the Issuer's obligations to pay
sums due in respect of Long Term Liabilities) and interest
thereon shall be treated as a claim on the relevant Long Term
Pool notwithstanding that the repayment date of such Advance
falls within 365 days of the Enforcement Date.
7.6
The Security Trustee shall use its reasonable
endeavours (and in doing so may rely upon the advice of any
investment or other advisers as it shall in its absolute discretion
consider appropriate and shall not be responsible for any loss
which results from such reliance) to establish by the end of the
Realisation Period a Short Term Pool, a number of Long Term
Pools (one in relation to each Series of [relevant Notes], and
one in relation to each other group of Long Term Liabilities
having the same payment and/or maturity dates), and a
Residual Equity Pool. In order to establish such Pools, the
Security Trustee shall during Realisation Period (but not
thereafter) realise, dispose of or otherwise deal with the Assets
in such manner as, in its absolute discretion, it deems
appropriate. During the Realisation Period the Security Trustee
shall so far as possible discharge on the due dates therefor any
Short Term Liabilities falling due for payment during such
period, using cash or other realisable or maturing Assets of the
Issuer. [Emphasis added]
7.7
The Security Trustee shall use its reasonable
endeavours (and in doing so may rely upon the advice of any
investment or other advisers as it shall in its absolute discretion
consider appropriate and shall not be responsible for any loss
which results from such reliance) to ensure that at the time the
Short Term Pool and each Long Term Pool is established (1)
the aggregate principal amount of the Assets allocated to each
such Pool is equal to the aggregate principal amount of the
liabilities to which such Pool has been allocated, (2) the Assets
allocated to each such Pool have maturity and payment dates
corresponding to the relevant liabilities and (3) payments,
recoveries and receipts in respect of the Assets allocated to
each such Pool are scheduled to be made or received in the
currency in which the relevant liabilities are denominated and
(4) the aggregate principal value of Assets rated AA/Aa or
lower (or if the Asset has a short-term rating, A-1 + or lower)
issued or guaranteed by any one single body corporate or
sovereign or by separate bodies corporate which are members
of the same group does not exceed an amount equal to 50% of
the Residual Equity Pool Stake attributable to such Short Term
Pool or, as the case may be, Long Term Pool and (5) the
aggregate principal value of Assets rated A (or if the Asset has
a short term rating, A-1/P-1) issued or guaranteed by any one
single body corporate or sovereign or by separate bodies
corporate which are members of the same group does not
exceed an amount equal to 50% of the Residual Equity Pool
Stake attributable to the Issuer's Short Term Liabilities or, as
the case may be, those of its Long Term Liabilities in relation
to which a Long Term Pool is established. The Security Trustee
shall also use its reasonable endeavours to ensure that the credit
quality by rating category and percentage of Assets comprising
the Short Term Pool and each Long Term Pool is the same or
better than the following … [details were then set out]
7.8
Subject to Clause 7.7, it is a matter for the Security
Trustee's absolute discretion which Assets are allocated to
which Pool and no liability shall attach to the Security Trustee
if its allocation of Assets between Pools proves to be
unfavourable or disadvantageous to any person. Provided that
the Security Trustee uses its reasonable endeavours as provided
in Clause 7.7, no liability shall attach to the Security Trustee if
the purpose for which such endeavours were to be made fails to
be realised and the Security Trustee shall be under no liability
to any Beneficiary if the Assets allocated to any Pool are
insufficient to meet the liabilities of the Issuer to which such
Pool related in full or in a timely manner, notwithstanding that
the claim of any other Beneficiary shall have been discharged
in full. For the avoidance of doubt, the Security Trustee shall
not be obliged to ensure that each Pool complies with the
criteria set out in the Second Schedule to the IMC. Subject to
the above and to Clause 7.7, the Security Trustee (i) shall have
no regard to the credit quality of each Asset when establishing
the Short Term and Long Term Pools and when determining
which Assets should be allocated to which Pool and (ii) shall
not be concerned with the ultimate composition of each of the
Short Term Pool and Long Term Pools with regard to the
concentration of assets by rating category nor to the spread
across the Pools of Assets of any given rating category.
7.9
If the principal amount of the Assets is less than the
principal amount of the Issuer's Total Indebtedness, the
Security Trustee shall calculate the proportion borne by the
deficit to the Issuer's Total Indebtedness and shall reduce the
principal amount of the Assets allocable to the Short Term Pool
and each Long Term Pool accordingly.
7.10
The Security Trustee shall open and maintain and
operate with any bank or financial institution in the United
Kingdom or the United States of America whose short-term
unsecured, unguaranteed and unsubordinated debt is rated A-1
by S&P, P-1 by Moody's and F1 by Fitch or which is otherwise
acceptable to each of the Rating Agencies: [specified
investment and cash accounts]
7.11
Subject to Clause 7.4, all payments, recoveries or
receipts in respect of Assets in the Short Term Pool shall be
held by the Security Trustee on trust and shall be applied in
accordance with the following priority of payments:
7.11.1 first, to pay the Relevant Proportion of the
remuneration payable to the Security Trustee pursuant to this
Deed and of any amount due in respect of costs, charges,
liabilities and expenses incurred by the Security Trustee or a
Receiver appointed by it
(and for the purposes of this sub-clause the "Relevant
Proportion" shall be the principal amount of the Issuer's Short
Term Liabilities divided by the Issuer's Total Indebtedness,
both such amounts to be determined on the last day of the
Realisation Period);
7.11.2 second, to pay when due or as soon thereafter as can
practicably be arranged all principal, interest or other amounts
in respect of the Issuer's Short Term Liabilities to Beneficiaries
(pro rata to the respective amounts of the Short Term Liabilities
due, owing or incurred to each Beneficiary); and
7.11.3 third, in accordance with the provisions of Clause 7.13
Provided that (in respect of 7.11.2 above):
(a)
if at any time after the Realisation Period the Security
Trustee reasonably believes that payments, recoveries and
receipts in respect of Assets allocated to the Short Term Pool
will be insufficient to meet the Issuer's Short Term Liabilities,
the Security Trustee shall calculate the proportion of the Short
Term Liabilities which, in its reasonable opinion, can be met
and shall pay only that proportion of any amounts due in
respect of the Issuer's Short Term Liabilities to any
Beneficiary; and
(b)
if at the time a payment is proposed to be made to a
Beneficiary pursuant to this Clause such Beneficiary is in
default under any of its obligations to make a payment to the
Issuer pursuant to any Beneficiaries' Document (the "defaulted
payment") the amount of the payment which shall be made to
such Beneficiary shall be reduced by an amount equal to the
amount of the defaulted payment. Any amount so withheld
shall be paid to the relevant Beneficiary as and when (and pro
rata to the extent that) the defaulted payment is duly paid by
that Beneficiary.
7.12
Subject to Clause 7.5, all payments, recoveries and
receipts in respect of Assets placed in each Long Term Pool
shall be held by the Security Trustee on trust and shall be paid
in accordance with the following priority of payments:
7.12.1 first, to pay when due the Relevant Proportion of the
remuneration payable to the Security Trustee under this Deed
and of any amount due in respect of costs, charges, liabilities
and expenses incurred by the Security Trustee or a Receiver
appointed by it;
(and for the purposes of this sub-clause the “Relevant
Proportion" shall be the principal amount outstanding of the
Long Term Liabilities to which such Long Term Pool relates
divided by the amount of the Issuer's Total Indebtedness, both
amounts to be determined on the last day of the Realisation
Period);
7.12.2 second, to pay when due or as soon thereafter as can
practicably be arranged all principal, interest or other amounts
in respect of the Issuer's Long Term Liabilities to the relevant
Beneficiaries (pro rata to the respective amounts of the Long
Term Liabilities due, owing or incurred to each Beneficiary);
and
7.12.3 third, in accordance with Clause 7.13 below
Provided that (in respect of 7.12.2 above):
(a)
if at any time the Security Trustee reasonably believes
that payments, recoveries and receipts in respect of Assets
allocated to any Long Term Pool will be insufficient to meet
the Long Term Liabilities of the Issuer to which such Long
Term Pool relates, the Security Trustee shall calculate the
proportion of such liabilities which in its reasonable opinion
can be met and shall pay only that proportion of any amounts
due in respect of the Long Term Liabilities to which such Long
Term Pool relates; and
(b)
if at the time a payment is proposed to be made to a
Beneficiary pursuant to this Clause such Beneficiary is in
default under any of its obligations to make a payment to the
Issuer pursuant to any Beneficiaries' Document (the "defaulted
payment") the amount of the payment which shall be made to
such Beneficiary shall be reduced by an amount equal to the
amount of the defaulted payment. Any amount so withheld
shall be paid to the relevant Beneficiary as and when (and pro
rata to the extent that) the defaulted payment is duly paid by
that Beneficiary….”
14.
Other relevant provisions of the Security Trust Deed are as follows:
“1. DEFINITIONS
1.1
…“Beneficiaries” means [the holders of various Notes
issued or guaranteed by Sigma]… (vi) Liquidity Providers
…(viii) the Security Trustee … and “Beneficiary” means any
of them;
“Beneficiaries’ Documents” means: [various Notes issued or
guaranteed by Sigma] …
(h) the Revolving Credit And Swing-Line Facility Agreements
between the Issuer and the banks named therein, and any other
agreement evidencing a Liquidity Facility; …
(p) this Deed; …
“Liquidity Provider” means any bank or financial institution
who is for the time being party to a Liquidity Facility; …
“Long Term Liabilities” means any liabilities of the Issuer to a
Beneficiary which are not Short Term Liabilities (including any
liabilities of the Issuer to a Liquidity Provider which pursuant
to Clause 7.5 are required to be treated as Long Term
Liabilities);
“Long Term Pool” means each pool of Assets required to be
established by the Security Trustee on or after the Enforcement
Date pursuant to Clause 7.6 and placed in a separate investment
account, payments, recoveries and receipts in respect of which
shall be applied in accordance with Clause 7.10; …
“Realisation Period” means the period commencing on (and
including) the Enforcement Date and ending on (but excluding)
the day which is 60 days after the Enforcement Date; …
“Short Term Liabilities” means those outstanding payment
obligations of the Issuer to Beneficiaries (i) which are due and
payable or which have scheduled maturity or payment dates
falling less than 365 days from the Enforcement Date or (ii)
which in accordance with Clause 5.3 or 6.10 are required to be
treated as Short Term Liabilities;
“Short Term Pool” means the pool of Assets allocated by the
Security Trustee and placed in a separate investment account to
be named “Short Term Pool – Investment Account” and/or a
separate cash account to be named “Short Term Pool – Cash
Account”, payments, recoveries or receipts in respect of which
shall be applied pursuant to Clause 7.11; …
“Total Indebtedness” means the total principal amount owing
for the time being by the Issuer to [(i) and (ii): holders of
various Notes (iii) Liquidity Providers in respect of Advances
under a Liquidity Facility and (iv) [various other liabilities …]
3. COVENANT TO PAY
The Issuer hereby covenants with the Security Trustee that it
will pay and discharge in full each Secured Obligation at the
time and in the manner provided for under the Beneficiaries’
Documents and the provisions of the Notes and [other
instruments] under which such Secured Obligation arises.
4. SECURITY
4.1
The Issuer as beneficial owner hereby as security for
the payment and discharge of the Secured Obligations: …
4.1.2 charges in favour of the Security Trustee as trustee for
the Beneficiaries with the payment and discharge of the
Secured Obligations by way of first floating charge the whole
of the Issuer’s Assets …
4.2
The Security Trustee shall hold the benefit of the
Security on the terms of the trusts herein provided and shall
deal with the Assets and apply all payments, recoveries or
receipts in respect of the Assets in accordance with Clause 7.
…
11.
REMUNERATION OF THE SECURITY TRUSTEE
11.1
The Issuer hereby covenants with the Security Trustee
to pay to the Security Trustee remuneration for its services as
security trustee as from the date of this Deed, such
remuneration to be at such rate and payable on such dates as
may from time to time be agreed between the Issuer and the
Security Trustee. At any time after the occurrence of an
Enforcement Event or Automatic Enforcement Event or in the
event of the Security Trustee finding it necessary or expedient
to undertake any exceptional duties (or duties otherwise outside
the scope of the normal duties of the Security Trustee under
these presents) the Issuer shall pay such additional special
remuneration as may be agreed between the issuer and the
Security Trustee. In the event of the Security Trustee and the
Issuer failing to agree upon whether such duties are of an
exceptional nature or otherwise outside the scope of the normal
duties of the Security Trustee under these presents, or failing to
agree upon such remuneration or such increased or additional
remuneration, such matters shall be determined by a merchant
bank (acting as an expert and not as an arbitrator) selected by
the Issuer and approved by the Security Trustee or, failing such
approval, nominated by the President for the time being of The
Law Society of England and Wales, the Expenses involved in
such nomination and the fee of such merchant bank being
shared equally between the Security Trustee and the Issuer and
the determination of such merchant bank shall be conclusive
and binding on the issuer and the Security Trustee. …
13.
POWERS OF POSSESSION AND SALE
… 13.2 The Security Trustee may, out of the profits and
income of the Assets and monies received by it in the exercise
of any of the foregoing powers, pay and discharge all expenses
and outgoings incurred in and about the exercise of any such
powers.
14.
APPOINTMENT AND POWERS OF RECEIVER
14.1 The Security Trustee may, if it thinks fit, appoint a
Receiver at any time on or after the Enforcement Date. …
14.3 The following provisions as to the appointment, powers,
rights and duties of a Receiver shall have effect: …
14.3.4 the Security Trustee may from time to time fix the
remuneration of such receiver and direct payment thereof out of
the Assets, but the Issuer alone shall be liable for the payment
of such remuneration; …
14.3.6 subject to any direction by the Security Trustee to the
contrary, any such Receiver may for the purpose of defraying
any costs, charges, losses and expenses (including its
remuneration) which shall be incurred by it or which it
anticipates may be incurred by it in the exercise of the powers,
authorities and discretions vested in it or for any purposes of
these presents advance, raise or borrow money on the security
of the Assets from the Security Trustee or otherwise, either in
priority to the sums hereby secured and the Security or
otherwise and at such rate or rates of interest and generally on
such terms and conditions as it may think fit, and for the
purposes aforesaid may execute and do all such assurances,
deeds, acts and things as it may think fit; …”
15.
The present application concerns the duties of the Receivers in acting for the Security
Trustee in dealing with the assets of Sigma under the Security Trust Deed during the
Realisation Period. In view of the insolvency of Sigma, there is an acute divergence
between the interests of the different groups of creditors in relation to the construction
of the last sentence of clause 7.6:
“During the Realisation Period the Security Trustee shall so far
as possible discharge on the due dates therefor any Short Term
Liabilities falling due for payment during such period, using
cash or other realisable or maturing Assets of the Issuer”.
The positions of the Parties on the construction of clause 7.6
16.
Mr Howard QC for Party A submitted that the natural meaning of this provision is
that during the Realisation Period the Security Trustee should use the available and
realisable assets of Sigma to pay its liabilities in full or (if there are insufficient assets)
to the greatest extent possible in order as they fall due within that Period. At the
hearing, this construction was conveniently labelled the “pay as you go” construction.
The effect of this construction would be that Sigma’s liabilities to Party A falling due
on 23 October 2008 would be met (or substantially met) out of its assets, but leaving
little or nothing over to meet any other liabilities falling due on later dates within that
Period (including the liabilities which have arisen or are due to arise in relation to the
Notes held by Party B) or falling due on dates after that Period.
17.
Mr Howard QC made the powerful points that the Security Trust Deed and the
various financial instruments connected with it are sophisticated and carefully drafted
documents, prepared by and entered into with the advice of specialist commercial law
firms, made by sophisticated commercial parties well able to determine the nature of
the rights and obligations assumed thereunder and whose intention should be taken
from the clear and natural meaning of the words which are used in the Security Trust
Deed in the last sentence of clause 7.6. He submitted that the mere fact that the
practical effect of that provision in the circumstances which have arisen might be
thought to be surprising or unfair in some way was not a proper basis on which the
court would be justified in departing from the clear natural meaning of the words
used, so as to re-write the Deed: see BP Exploration Operating Co. Ltd v Kvaerner
Oilfield Products Ltd [2005] 1 Lloyds LR 307, [93] per Colman J for a statement of
familiar basic principle in this area which I did not understand the other Parties to
dispute in any significant respect.
18.
Mr Howard emphasised the distinction which appears in the Security Trust Deed
between the Realisation Period (leading up to the establishment of the Short Term
Pool, Long Term Pools and the Residual Pool by the end of the Period), and the
regime which applies after the Realisation Period when Sigma’s remaining assets (if
any) have been placed into the Pools and a form of distribution pari passu depending
on the extent of the assets and the extent of the liabilities allocated to each Pool
governs. He submitted that the last sentence of clause 7.6 of the Security Trust Deed
creates a discrete payment regime applicable in the Realisation Period, separate from
that applicable under the Pool regime. He contended that the words in that provision,
“shall so far as possible discharge …”, referred to the practical possibility of
discharge of liabilities having regard to the assets which proved to be available, and
made it clear that the obligation of the Security Trustee did not extend beyond
procuring payment of such liabilities out of those available assets.
19.
Mr Sheldon QC for Party B was at pains to agree with Mr Howard regarding the
distinction between the payment regime applicable during the Realisation Period and
that applicable thereafter once the Pools are established, but submitted that the proper
and natural interpretation of the last sentence of clause 7.6 was to the effect that the
Receivers should establish the total value of the liabilities falling due within the
Realisation Period and then allocate the available assets pari passu as between those
liabilities. He submitted that this construction was required (since on Party A’s
construction he maintained that the words in that provision, “falling due for payment
during such period”, would be otiose) and was the intended effect of the use of the
phrase, “shall so far as possible discharge …”. The possibility referred to in that
phrase was, he suggested, what was to be regarded as possible having regard to the
assets of Sigma which were available and to all of the liabilities which were scheduled
to fall due in the Realisation Period. The effect of the construction put forward by Mr
Sheldon would be that the limited assets available to Sigma should be shared pari
passu between Party A, Party B and any other Beneficiary in relation to liabilities
falling due within the Realisation Period. There would be nothing left for other
Beneficiaries in the position of Party C and Party D.
20.
Mr Mortimore QC for Party C and Miss Prevezer QC for Party D made common
cause, albeit there were differences in the detail of the arguments they presented. The
main thrust of their submissions was that the Security Trust Deed did not create any
sharp distinction between the payment regime applicable in the Realisation Period and
that applicable thereafter, once the Pools were set up. Rather, the intention was, they
said, that even during the Realisation Period the Receivers were required to make an
assessment of the likely total secured liabilities of Sigma extending into the future and
not to pay Short Term Liabilities in full as they fell due in the Realisation Period in
the event that they considered that there were insufficient assets to meet all secured
liabilities. They said that the possibility referred to in the words, “shall so far as
possible discharge …”, was what was possible having regard to the need for general
distribution of Sigma’s available assets on a pari passu basis between all its creditors
(not just those whose debts fell due within the Realisation Period). They sought to
support this interpretation by reference to clause 7.9 of the Security Trust Deed,
which they submitted required the Receivers to apply a general pari passu approach
to the distribution of Sigma’s assets, rather than a “pay as you go” approach.
21.
They submitted that the constructions contended for by Party A and Party B
respectively would operate unfairly as between different groups of creditors, resulting
in distribution of Sigma’s available assets on the basis of adventitious happenstance
depending upon the particular dates when liabilities fell due; and in that regard they
relied in particular on dicta of the Court of Appeal in In the Matter of Whistlejacket
Capital Ltd (in Receivership) [2008] EWCA Civ 575 at [43], [58]-[59] and [63]. They
also submitted that those constructions did not make allowance for payment of the
fees and expenses of the Security Trustee and the Receivers in relation to realising the
security created under the Security Trust Deed, which they said would be a very
surprising result which the parties cannot have intended. They said that the
constructions supported by Parties A and B would produce another absurd effect,
which could not have been intended: liabilities falling due before the Realisation
Period but not paid by Sigma would not be treated in the same way as liabilities
falling due within the Realisation Period, but would be postponed and have to be
treated as liabilities falling into the Short Term Pool to be met out of the assets (if
any) available at that stage.
22.
Mr Mortimore and Miss Prevezer relied upon the speech of Lord Steyn in Sirius
Insurance Co v (Publ) v FAI General Insurance Ltd [2004] 1 WLR 3251 at [18]-[19],
where he said
“18 ….The aim of the inquiry is not to probe the real intentions
of the parties but to ascertain the contextual meaning of the
relevant contractual language. The inquiry is objective: the
question is what a reasonable person, circumstanced as the
actual parties were, would have understood the parties to have
meant by the use of specific language. The answer to that
question is to be gathered from the text under consideration and
its relevant contextual scene.
19 There has been a shift from literal method of interpretation
towards a more commercial approach. In Antaios Compania
Naviera SA v Salen Rederierna AB [1985] AC 191, 201, Lord
Diplock, in an opinion concurred by his fellow Law Lords,
observed: “if detailed semantic and syntactical analysis of a
word in a commercial contract is going to lead to a conclusion
that flouts business common sense, it must be made to yield to
business common sense.” In Mannai Investment Co Ltd v
Eagle Star Life Assurance Co Ltd [1997] AC 749, 771, I
explained the rationale of this approach as follows:
“In determining the meaning of the language of a
commercial contract … the law … generally favours a
commercially sensible construction. The reason for this
approach is that a commercial construction is more likely to
give effect to the intention of the parties. Words are therefore
interpreted in the way in which a reasonable commercial person
would construe them. And the standard of the reasonable
commercial person is hostile to technical interpretations and
undue emphasis on niceties of language.”
The tendency should therefore generally speaking be against
literalism. What is literalism? It will depend on the context.
But an example is given in The Works of William Paley (1838
ed), vol III, p 60. The moral philosophy of Paley influenced
thinking on contract in the 19th century. The example is as
follows: the tyrant Temures promised the garrison of Sebastia
that no blood would be shed if they surrendered to him. They
surrendered. He shed no blood. He buried them all alive. This
is literalism.
If possible it should be resisted in the
interpretative process. This approach was affirmed by the
decisions of the House in Mannai Investment Co Ltd v Eagle
Star Life Assurance Co Ltd [1997] AC 749, 775E-G, per Lord
Hoffmann and in Investors Compensation Scheme Ltd v West
Bromwich Building Society [1998] 1 WLR 896, 913D-E, per
Lord Hoffmann.”
23.
The effect of the construction contended for by Parties C and D would be that the
available assets of Sigma would not be wholly used up in meeting Sigma’s
obligations to Party A, or to Party A, Party B and other creditors with instruments
maturing during the Realisation Period, but would have to be used pari passu as
between all Sigma’s secured creditors. In other words, Parties C and D and those of
Sigma’s creditors in an equivalent position would derive some benefit from Sigma’s
remaining assets, whereas otherwise they would derive none.
Discussion
24.
After the hearing and having listened to all the learned arguments advanced by
Counsel on all sides, I find myself coming back to the last sentence of clause 7.6 and
still reading it as I did at the outset in preparing for the hearing, as a provision which
bears the natural and ordinary meaning for which Mr Howard for Party A contends. It
is true that such an interpretation exposes certain limited infelicities in the drafting of
other parts of the Security Trust Deed to which I refer below; but I do not consider
that addressing those infelicities involves a degree of strain in construing the Deed
which begins to approach the extent of the strain which would in my opinion be
required to arrive at the constructions for which the other Parties contend. It is not
suggested that there is any interpretative presumption in favour of a pari passu basis
for distribution of the assets of Sigma: the rights and obligations of the parties under
the Security Trust Deed fall to be determined according to ordinary principles of
construction of the words used in the Deed in their proper context. In that regard, the
natural, “pay as you go” construction put forward by Party A is strongly supported by
comparison of the specific provision in the last sentence of clause 7.6 with other
provisions in the enforcement regime in clause 7.
25.
It is also the case that Party A’s “pay as you go” construction produces a regime for
distribution of Sigma’s assets in the Realisation Period which operates on an
adventitious basis (depending upon the maturity dates of particular instruments) and
which could be regarded as being in a certain sense unfair, at least from the point of
view of creditors of Sigma, such as Parties B, C and D, who happen to lose out as a
result of adoption of such a construction. But in my judgment neither of these
features of the enforcement regime created by the Security Trust Deed “flouts
business common sense” in the sense referred to by Lord Diplock in the passage
quoted by Lord Steyn in the Sirius Insurance case at [18], and neither justifies a
departure from the ordinary meaning of the last sentence of clause 7.6 as derived from
its language and the contrast between it and its immediate contextual context in the
form of other provisions of clause 7.
26.
Judged from the perspective of lenders to Sigma who accept its Notes on the basis of
the Security Trust Deed, or who enter into liquidity arrangements with it again on the
basis of the Deed, none of them could know when entering into those transactions
how the operation of clause 7.6 might ultimately affect them. The provisions in clause
7 operate both in relation to events of default on the part of Sigma involving Sigma’s
insolvency and in relation to events of default which do not (e.g. a simple refusal to
meet one of its obligations or a downgrading of the credit rating status of its Notes).
Even in relation to insolvency, it is by no means obvious that the parties expected
Sigma to become so massively insolvent as in fact in the unusual economic
circumstances now applicable it has become, such that its available assets will be
exhausted partway through the Realisation Period and before creation of the various
Pools. No-one could know in advance when an Enforcement Event might occur and
when the Realisation Period might commence. Each of the lenders to Sigma took a
chance (depending upon the date when any Realisation Period commenced and the
maturity dates in respect of any repayment obligations) that it might be in the
advantageous position in which Party A now finds itself in respect of distributions to
be made or might have to take its chances in relation to repayment in the later part of
the Realisation Period or in the Pool arrangements. In that regard, when entering into
the relevant transactions they were all “in the same boat” and each assumed risks
similar to those which everyone else assumed. It does not seem to me to be unfair that
they should bear the risks specified in the contractual and security documentation in
accordance with the clear terms set out in that documentation when those risks happen
to arise (even when they do so, as here, in a particularly acute form). Moreover, in
relation to the suggestion of unfairness, I would adopt the same approach as Briggs J
in Re Cheyne Finance plc (in receivership) (No. 1) [2008] 1 BCLC 732 at [28]:
“It would, in my judgment, be wrong to adopt a strained
construction of cl. 12 merely to remedy, as I accept it would do,
a potential for what some would regard as unfairness where the
risk appears to have been deliberately undertaken in a detailed
regime designed … entirely to replace the statutory insolvency
scheme as between the parties …”
27.
It may seem somewhat surprising that the various parties did not wish to provide that
as soon as an event of default occurred involving Sigma’s insolvency the shutters
should come down in relation to payment of its liabilities such that all assets and all
its outstanding liabilities at that time should fall to be treated on a general pari passu
basis within the Pool arrangements. However, that is not what the relevant provisions
provide for, and it is not for the court to seek to re-write the agreement on the basis of
its own views of what might be a fairer solution or its speculation about what the
parties might have wished to achieve had they applied their minds more directly in
advance to the particular situation which has now arisen. I do not find the judgment of
the Court of Appeal in the Whistlejacket Capital case of direct assistance in relation to
the very different contractual provisions which apply in the present case. In my view,
the “pay as you go” construction of the last sentence of clause 7.6 does not in any way
come close to the standard of flouting business common sense adverted to by Lord
Steyn in Sirius Insurance. It is a construction which cannot properly be castigated as
unfair or unjust, and it produces a somewhat crude but practical and workable regime
for managing Sigma’s affairs in the Realisation Period leading up to the creation of
the Pools. Since the parties obviously considered that the Security Trustee (or
Receivers appointed by it) might well need a 60 day period in order to establish the
liabilities and assets to go into the Pools and how they should be allocated, I do not
think that the perceived desirability of having a simple and workable system telling
the Security Trustee what to do in relation to maturing liabilities while that process
was being carried out can be discounted. It should also be recalled that the normal
operation of Sigma’s business was on a “pay as you go” basis. Against that
background it does not seem implausible that the parties intended that its business
should be continued on that same basis during the Realisation Period until the Pools
could be established in a considered and orderly fashion, at which stage a new, pari
passu regime should come into operation. The parties already accepted certain risks to
themselves inherent in the “pay as you go” nature of Sigma’s business, and by
providing for “pay as you go” during the Realisation Period they appear to me to have
agreed to continue to bear such risks until the Pools are set up.
28.
I turn to consider the detail of the provisions of the Security Trust Deed. In my view,
it is a striking feature of the scheme of enforcement set out in clause 7 that the
Realisation Period operates as a distinct phase separate from the operation of the
Pools which are to be established at the end of it. I accept Mr Howard’s and Mr
Sheldon’s submissions to this effect. The Realisation Period is specially defined as a
specified period in the Deed. The first two sentences of Clause 7.6 set out what is to
be done by the Security Trustee in that Period, namely that reasonable endeavours
should be used to establish the various Pools by the end of it. The second sentence of
clause 7.3 (ensuring that any drawdown by the Security Trustee under a liquidity
facility after the Enforcement Date should provide for repayment dates “falling after
the Realisation Period”) also emphasises that the Realisation Period is, in the structure
of clause 7, to be treated as a special and distinct period governed by its own regime.
It is only once the Pools have been established that the special provisions for
distribution on a pari passu basis as set out in clause 7.11 (Short Term Pool) and
clause 7.12 (Long Term Pool) apply.
29.
Although clause 7.6 provides that the Pools are to be established “by the end of the
Realisation Period”, it appears from clause 7.11.1 and clause 7.12.1 that the Pools
could only be operated after the first charge upon them (in each case, “the Relevant
Proportion of the remuneration payable to the Security Trustee …”) has been
determined, which can only be done as at “the last day of the Realisation Period”.
This interpretation is reinforced by clauses 7.11.3 and 7.12.3, which provide for later
adjustment “if at any time after the Realisation Period” it appears that there may be a
further shortfall in the assets available to meet liabilities as both have been allocated
to the Short Term and Long Term Pools respectively. It would not make sense for
these provisions to be drafted in this way if it was contemplated that the Pools could
be established and made operational before the end of the Realisation Period.
30.
Meanwhile, the last sentence of clause 7.6 governs how the Security Trustee should
throughout the whole of the Realisation Period deal with liabilities maturing during it.
The second sentence of clause 7.6, and particularly the words, “(but not thereafter)”,
emphasise that the regime to apply in the Realisation Period is distinct from the
regime which then follows. In my view, the enforcement scheme in clause 7
contemplates a sharp conceptual division between the Realisation Period and what
happens from the end of the Realisation Period, when it is the Pool arrangements
which govern. In the light of that clear structure, I do not find it possible to read back
into the last sentence of clause 7.6 the Pool payment arrangements set out in clauses
7.11 and 7.12, as Mr Mortimore and Miss Prevezer submitted I should.
31.
Clause 7.9 cannot bear the weight which Mr Mortimore and Miss Prevezer sought to
place upon it. I do not read it as creating any conflict with the last sentence of clause
7.6; nor in my view does it inform in any other way the interpretation to be placed on
that sentence. Clause 7.9 is directed to the point at which the Pools are established,
and sets out how assets are to be allocated to the Pools. In practice, this is an exercise
which falls to be conducted alongside that necessary to determine the “Relevant
Proportion” in each case under clauses 7.11.1 and 7.12.1, which state that the
“Relevant Proportion” is to be established by reference to the Total Indebtedness as at
the last day of the Realisation Period. In my view, it is clear that the exercise in
clause 7.9 is intended to be conducted by reference to the same point in time. Up to
that point, it is clause 7.6 which governs how the Security Trustee is to act.
32.
The last sentence of clause 7.6 creates an especially strong obligation upon the
Security Trustee (“shall so far as possible discharge …”). This may be contrasted with
the weaker obligation in the first sentence of clause 7.6 (“shall use its reasonable
endeavours …”) and with those in clause 7.3 (“On the Enforcement Date or as soon
thereafter as can practicably be arranged the Security Trustee shall …”) and in clauses
7.11.2 and 7.12.2 (“to pay when due or as soon thereafter as can practicably be
arranged …”). This again emphasises the distinct nature of the payment regime which
is to apply during the Realisation Period.
33.
In my judgment, the words in clause 7.6, “shall so far as possible discharge on the due
dates therefor [etc]”, read with the closing words of the clause (“using cash or other
realisable or maturing Assets of the Issuer”), naturally relate to the possibility of being
able to pay the Short Term Liabilities referred to on their due dates having regard to
the extent of the realisable or maturing assets of Sigma which are in practical terms
available to the Security Trustee. I accept Mr Howard’s submission on this point. The
words both make it clear what the Security Trustee’s positive duty is and also specify
the limits of that duty so that no question could arise of the Security Trustee having to
use its own assets to meet those liabilities.
34.
I do not find it any more viable to spell out of the word, “possible”, in clause 7.6 a
reference to future Short Term Liabilities maturing later in the Realisation Period and
an intention that they be paid pari passu with such Liabilities maturing earlier in the
Period (as Mr Sheldon submitted) than I do in relation to the wider submissions of Mr
Mortimore and Miss Prevezer. If such an elaborate scheme had been intended, the
parties would have spelled it out clearly as they did spell out the elaborate pari passu
arrangements in respect of the Pools, in clauses 7.11 and 7.12. There is nothing of that
kind in the last sentence of clause 7.6. On the contrary, it seems to me to set out a very
simple and clear obligation upon the Security Trustee with no specification of any
pari passu element within it. I regard the contrast between clause 7.6 and clauses 7.11
and 7.12 as a very powerful indicator that clause 7.6 was intended to operate in a
different manner and without any pari passu element.
35.
Further, on Party A’s “pay as you go” construction, I do not think that the words in
the final sentence of the provision, “falling due for payment during such period”, are
otiose in a manner which demands adoption of a strained interpretation of the other
words in that provision (as Mr Sheldon submitted). I consider that those words fulfil
the same function as the words in parenthesis in the previous sentence, namely to
emphasise strongly that the regime in clause 7.6 governs during the Realisation Period
but not thereafter.
36.
I do not accept the submissions of Mr Mortimore and Miss Prevezer that Party A’s
“pay as you go” construction would have absurd consequences, such that the parties
must have intended some different interpretation to apply. In my view, on Party A’s
construction there is no difficulty regarding accommodation within the clause 7.6
regime of payment of Short Term Liabilities which fell due but were unpaid by Sigma
before commencement of the Realisation Period (there were in fact examples falling
within this category: see paragraph [9] above). I accept Mr Howard’s submission that
where the maturity date for a debt instrument has arrived and the payment obligation
contained in the instrument has not been satisfied, the liability contained in the
instrument remains due on each day thereafter until it is satisfied. I consider that the
words, “on the due dates therefor” and “falling due for payment”, in the last sentence
of clause 7.6 are clearly intended to cover Short Term Liabilities falling within this
class of case, so that they should be paid at the same time as any such instruments
maturing on the first day of the Realisation Period.
37.
So far as concerns the objection that on Party A’s construction the holders of Notes
maturing in the Realisation Period will be paid before the remuneration and expenses
of the Receivers are met out of Sigma’s assets (which I accept would be a surprising
result), clause 14.3.4 allows the Security Trustee to direct payment of the Receivers’
remuneration out of Sigma’s assets and clause 14.3.6 allows the Receivers to cover
their expenses and remuneration by borrowing money on the security of Sigma’s
assets in priority to the sums secured by and the security constituted by the Security
Trust Deed. Therefore, provided the Security Trustee and the Receivers take prompt
steps to protect the Receivers’ position, it appears that in practical terms the “pay as
you go” construction of clause 7.6 need not leave the Receivers exposed as to their
remuneration and expenses. The need for steps to be taken to protect their position
may be somewhat inconvenient, especially when compared with the specific
provisions in clauses 7.11.1 and 7.12.1 for protection of their position in relation to
the Pool arrangements, but I do not consider that this is any more than an infelicity in
the drafting of the overall scheme of the Security Trust Deed. It is not a feature of the
drafting which could, in my view, justify adopting a different interpretation of clause
7.6.
38.
The position in relation to protection of the Security Trustee in respect of its
remuneration and expenses is slightly less clear; but, again, I do not consider that any
infelicity in the drafting here could justify adoption of a different interpretation of
clause 7.6. In fact, the Security Trustee is in a position to protect itself. It can appoint
a Receiver to act on its behalf under clause 14 (rather than acting itself), and then the
points in paragraph [37] above apply. Further, under clause 13.2 the Security Trustee
may use the profits and income of the assets and monies received by it in the exercise
of its powers of getting in and dealing with the assets to pay and discharge all
expenses and outgoings incurred in and about the exercise of any such powers. In my
view, this provision is also intended to operate in priority to the security in the
Security Trust Deed - it would be most odd if the Receivers’ expenses had such
priority, if a Receiver were appointed to act on behalf of the Security Trustee, but the
Security Trustee’s expenses did not have that priority if it simply acted itself. I also
accept the submission of Mr Howard that the term “expenses” in clause 13.2 is apt
also to cover the Security Trustee’s remuneration. The word “expenses” in relation to
a Receiver in clause 14.3.6 is followed by the words, “(including its remuneration)”,
and I consider that where the same word is used in a similar context in relation to the
Security Trustee the ambit of its meaning is properly informed by what the parties
have spelled out in relation to a Receiver.
39.
Moreover, it is possible for the Security Trustee to protect itself under the last
sentence of clause 7.6. This is because “Short Term Liabilities” are defined to mean
the “outstanding payment obligations of [Sigma] to Beneficiaries (i) which are due
and payable or which have scheduled maturity or payment dates falling less than 365
days from the Enforcement Date…”. The “Beneficiaries” are defined to include the
Security Trustee. So to the extent that the Security Trustee can make proper charges
in respect of its services and can specify that those charges should be paid on dates
within the Realisation Period, it may benefit from the “pay as you go” regime in
clause 7.6.
40.
Even if I am wrong about the interpretation and operation of clause 13.2, and even if
the operation of clause 7.6 on a “pay as you go” basis may be inconvenient for the
Security Trustee, these features of the drafting of the Security Trust Deed would not
in my view outweigh the powerful indicators referred to above regarding the proper
construction of clause 7.6 in the sense contended for by Party A.
Conclusion
41.
For the reasons given above, I have concluded that the “pay as you go” construction
of the final sentence of clause 7.6 of the Security Trust Deed contended for by Party
A is the correct construction of that provision. The directions to be given to the
Receivers should be formulated on that basis and agreed, if possible.
Neutral Citation Number: [2008] EWCA Civ 1303
Case Nos: A2 2008/2689, 2697 and 2707
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
COMPANIES COURT
MR JUSTICE SALES
Royal Courts of Justice
Strand, London, WC2A 2LL
Date: 25 November 2008
Before:
LORD NEUBERGER OF ABBOTSBURY
LORD JUSTICE LLOYD
and
LORD JUSTICE RIMER
--------------------In the matter of Sigma Finance Corporation
(in Administrative Receivership)
--------------------(Transcript of the Handed Down Judgment of
WordWave International Limited
A Merrill Communications Company
190 Fleet Street, London EC4A 2AG
Tel No: 020 7404 1400, Fax No: 020 7831 8838
Official Shorthand Writers to the Court)
--------------------Richard Sheldon Q.C. and Felicity Toube (instructed by Dechert LLP) for
Interested Party B, Appellant in appeal 2008 / 2697
Simon Mortimore Q.C. and Daniel Bayfield (instructed by Jones Day LLP) for
Interested Party C, Appellant in appeal 2008 / 2689
Sue Prevezer Q.C. and Edmund King (instructed by Quinn Emanuel Urquhart Oliver &
Hedges LLP) for Interested Party D, Appellant in appeal 2008 / 2707
Mark Howard Q.C. and Jonathan Dawid (instructed by Mayer Brown International LLP)
for Interested Party A, Respondent
Gabriel Moss Q.C. and Barry Isaacs (instructed by Lovells LLP) for the
Administrative Receivers, Respondents
James Potts (instructed by Allen & Overy) for the Security Trustee, Respondent
Hearing date: 20 November 2008
---------------------
Judgment
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
Lord Justice Lloyd:
1.
This judgment is given on three appeals from an order of Sales J made on 7
November 2008, in proceedings issued on 3 November and heard by the judge on 4
November. The case is unusual not only for the speed at which the case was brought
on and decided, at first instance and on appeal, but also because the identity of the
Appellants and the principal Respondent is not disclosed, and the hearings have taken
place, and judgments were delivered, in private. Nor was either the judge’s judgment
or our own to be disclosed, without further order of the court, because of
considerations of commercial confidentiality. Having heard argument on the appeals
on 20 November, we were asked by Counsel to give judgment, or at least to announce
the result of the appeals, no later than today, having regard to the various steps that
might need to be taken before or no later than Saturday 29 November, which is the
end of a period of relevance under the document which we have to construe, as I will
explain. For that reason we give judgment today, although, for my part at least, I
would have preferred to have had more time in which to formulate and express my
reasoning; among other things this judgment might then have been shorter.
2.
I would like to pay tribute to the judge not only for his diligence and speed in giving
judgment, but also for the clarity and comprehensive quality of his judgment. The
case is far from easy, and the proper application of large sums of money, on the one
hand, and the incidence as between competing creditors of a very large deficiency of
assets, on the other, turn on the decision. Counsel representing the classes of
competing creditors presented us with very clear, well argued and persuasive
submissions, both written and oral. In the end I have come to the clear conclusion
that the judge was right in his decision and his reasoning. As Rimer LJ is of the same
opinion, and despite the dissent on the part of Lord Neuberger in relation to the
appeals by Parties C and D, for reasons set out in their respective judgments, it
follows that all the appeals will be dismissed. I set out my own reasons for that
conclusion in what follows.
3.
The case is about the affairs of a structured investment vehicle, Sigma Finance
Corporation, incorporated under the law of the Cayman Islands, to which I will refer
as the SIV. Its business consists only of investing in asset-backed securities and other
financial instruments. It issued, or guaranteed, US dollar Medium Term Notes
(MTNs) and Euro MTNs in order to finance its activities. Its creditors include the
holders of these MTNs, and also the providers of liquidity under liquidity facilities,
counterparties in relation to derivatives used as a hedge against currency and interest
rate risks, “repo” counterparties under repurchase and securities lending agreements,
and the holders of Capital Notes. All of these creditors, other than the holders of
Capital Notes and the “repo” counterparties, are secured creditors. In effect, all of the
SIV’s assets are secured in favour of the secured creditors under a Security Trust
Deed (STD). The STD is governed by English law, and has a jurisdiction clause
under which these proceedings have been brought here.
4.
The available assets now fall very far short of the amount needed to pay even the
secured creditors of the SIV in full, hence the competition between various classes of
creditors, and the dispute as to the correct application of the STD in the present
circumstances. The judge recorded at paragraph 7 that:
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
“The Receivers estimate that Sigma’s liabilities to creditors comprise
secured liabilities of approximately US$6.2 billion and unsecured
liabilities of approximately US$3.658 billion. Even leaving aside
possible swap liabilities, the Receivers assess Sigma to have an
insolvent deficit in excess of US$5.5 billion in respect of secured
liabilities, and in excess of US$9 billion in respect of all liabilities
(secured and unsecured).”
5.
I can also conveniently quote paragraphs 8 and 9 of his judgment which set out the
circumstances in which this position arose, and in which the SIV got to the position in
which the dispute has arisen:
“8.
It appears that Sigma has arrived at this position as a result of
problems it has experienced in funding its activities consequent upon
the negative impact upon the financial markets over the last year or so
stemming from perceived difficulties arising from the sub-prime
mortgage market in the United States. These have caused the value of a
variety of asset backed and other financial securities of the kind held
by Sigma to fall substantially in value and the market for such
securities to become less liquid, in that there are now many fewer
investors willing to purchase such instruments. The market for debt
securities of the kind issued by Sigma has also fallen away, thereby
reducing its ability to fund its activities. For many months prior to
October 2008 Sigma had been unable to issue debt securities, which
meant that it became unable to “roll over” its obligations in relation to
the Notes and other financial instruments which it had previously
issued, and which were falling due for repayment from time to time.
The result of this was that Sigma had to resort to funding its activities
through various other techniques, including the sale of assets in its
portfolio and entering into securities lending arrangements and “repo”
agreements (both of which, as a matter of commercial substance,
involved borrowing money against the provision of security in the
form of assets taken from its asset portfolio).
9.
“Repo” agreements which Sigma entered into included
provision for the relevant counterparty to make a “margin call” for
provision by Sigma of further cash or assets, if the value of the assets
provided by Sigma by way of security for the transaction fell below a
certain level. In September 2008, Sigma received such margin calls
which it did not honour. Sigma’s board of directors resolved on 30
September 2008 that Sigma’s position as a going concern was no
longer sustainable, that it might then be or might become insolvent,
and that “the required steps under the relevant transaction documents
entered into by [Sigma] should therefore be taken to provide for an
orderly winding down of [Sigma’s] affairs.” Liabilities of Sigma
falling due on that day (in the sum of US$541,944 in respect of the
interest coupon due in relation to Notes issued or guaranteed by
Sigma), on 1 October 2008 (in the sum of US$901,146 in respect of
the interest coupon due in relation to other such Notes) and
subsequently have not been met by payment.”
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
6.
As the judge explained, this led to steps being taken as a result of which it is common
ground that the Enforcement Date, the significance of which I will explain, was 2
October 2008, and the Realisation Period, likewise to be explained below, runs from
that date until Saturday 29 November 2008.
7.
Four classes of creditors are represented before the court by the unnamed Interested
Parties. I take from paragraph 6 of the judge’s judgment this description of them and
their different positions:
“(i)
Party A is the holder of US Medium Term Notes with a face
value of US$225 million issued by Sigma Finance Incorporated (a
wholly-owned subsidiary of Sigma) and guaranteed by Sigma. Those
Notes matured, so that payment was due under them, on 23 October
2008. No payment has yet been made, and the question arises whether
the Receivers should be directed to use Sigma’s assets to satisfy
Sigma’s payment obligation in respect of these Notes. In the
terminology used in the Security Trust Deed, Party A is a
“Beneficiary” in respect of “Short Term Liabilities” which fall due in
the “Realisation Period”;
(ii)
Party B is the holder of Notes maturing on 30 October 2008
(with a face value of US$428 million) and on 14 November 2008 (with
a face value of US$430 million). For the purposes of the Security
Trust Deed, therefore, Party B is also a Beneficiary in respect of Short
Term Liabilities which fall due in the Realisation Period. However, it
is apparent that Sigma is massively insolvent. Its financial position is
such that if the Receivers use its assets to pay the Notes held by Party
A which matured on 23 October, no funds will remain to meet Sigma’s
payment obligations in relation to the Notes held by Party B;
(iii)
Party C is an advisory institution which represents a group of
holders of US Medium Term Notes with a face value in excess of
US$400 million. These are all due to mature in June 2009. For the
purposes of the Security Trust Deed, Party C’s clients are Beneficiaries
in respect of Short Term Liabilities which fall due only after the end of
the Realisation Period. If the Receivers use Sigma’s assets to pay the
Notes held by Party A, or those held by Party A and Party B, then it is
clear that no funds will remain to meet Sigma’s payment obligations in
relation to the Notes held by the clients of Party C;
(iv)
Party D is the holder of Notes maturing more than 365 days
after the “Enforcement Date” for the purposes of the Security Trust
Deed. The Enforcement Date is 2 October 2008. For the purposes of
the Deed, Party D is a Beneficiary in respect of “Long Term
Liabilities”. Again, if the Receivers use Sigma’s assets to pay the
Notes held by Party A, or by Party A and Party B, then it is clear that
no funds will remain to meet Sigma’s payment obligations in relation
to the Notes held by Party D.”
8.
The judge held in favour of the contentions of Party A, with the result that the
available assets would all have to be used to pay the creditors represented by that
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
Party, leaving nothing for those represented by the other three classes represented
before us. Each of Parties B, C and D appeals, with permission to appeal given by the
judge.
9.
The questions at issue on the appeal, as also those before the judge, turn on the true
construction of one sentence of clause 7.6 of the STD. However, that sentence must
be seen in the context of the STD as a whole. Although this is only in part a matter of
contract (it declares trusts as well, as its name suggests), it is a commercial document,
by reference to which the rights of investors and other creditors are to be ascertained,
and there is no doubt that it is to be construed in accordance with well-established
general principles applicable to commercial agreements and other documents. It is of
particular importance in that, as in the case of other structured investment vehicles,
the rights of secured creditors are defined and confined to those arising under the
STD. This type of vehicle was referred to in argument as being “insolvency-remote”.
That is an over-optimistic label, but it is true that creditors were not to be entitled to
resort to normal insolvency procedures to enforce their rights, but were limited to the
enforcement of rights through the STD, and therefore in accordance with its terms.
Their rights are determined by those terms, which do not necessarily (and certainly do
not in this case) correspond with those afforded by statutory insolvency procedures.
10.
The importance of Clause 7 is that it governs the position in the event of, and in the
course of, what is called “Enforcement”, a process triggered by the occurrence of an
Enforcement Date, following the happening of an Enforcement Event. The many
definitions in the STD in clauses 1 and 2 include that of an Automatic Enforcement
Event, and of other Enforcement Events.
11.
Clause 3 of the STD is a covenant by the Issuer (the SIV) with the Security Trustee
(which I will call the Trustee, for short) to pay all its secured obligations (as defined)
in accordance with the relevant obligations. Clause 4 creates a floating charge over
virtually all of its assets to secure payment of the secured obligations.
12.
Clause 5 deals with the occurrence of an Automatic Enforcement Event. This
happens if, and only if, the SIV no longer maintains both a Long Term Rating and a
Short Term Rating with at least one rating agency (namely Standard & Poor,
Moody’s, Fitch or any other internationally recognised rating agency). It seems likely
that such an occurrence would only occur in the event of a catastrophic failure of
either the SIV or rating agencies generally. If it were to happen the Enforcement Date
would be the date on which the Trustee receives notice from the SIV’s investment
manager that the event has occurred.
13.
Clause 6 deals with the more likely contingency of the occurrence of another kind of
Enforcement Event. These events are defined as meaning any of eight different
categories of occurrence. Three of them relate to events defined as an “Event of
Default” in conditions applying to various series of MTNs, another three to failure by
the SIV to pay any amount of principal or interest within ten days of the due date for
payment under various commercial paper programmes, one relates to an “Event of
Default” under a liquidity facility, and the eighth relates to failure by the SIV to pay
within ten days of the due date any sum due from the SIV to Royal Trust of Canada
under a custody agreement. In each case, however, the mere occurrence of the Event
of Default or other failure is not enough. As regards the MTNs and the commercial
paper programmes, there had to be also a resolution by holders of the relevant
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
instruments directing the Trustee to enforce the Security. As regards the others, the
Trustee must have been notified of the event under the Liquidity Facility, or in the
case of indebtedness to Royal Trust, have been instructed by Royal Trust to enforce.
14.
The evidence is that the event that triggered Enforcement in the present case was
notification by a liquidity provider of an Event of Default, and that this event was the
SIV’s inability to pay its debts as they fell due. We were told in the course of
argument that inability or failure to pay an unsecured liability might constitute an
event of default under this facility, but of course the SIV’s finances were such that, by
the beginning of October 2008, it could not pay its secured debts as they fell due, let
alone any unsecured liabilities. No doubt the occurrence of such an Event of Default
entitled the Liquidity Provider to cancel the availability of the facility.
15.
Under clause 6, because the occurrence of the Enforcement Event is not automatic,
the process is rather different from that under clause 5. If the Trustee receives notice
of the occurrence of a Potential Enforcement Event (which means, in effect, the
relevant failure to pay or Event of Default), the Trustee must notify the SIV, so as to
give it the opportunity to challenge the notice, on the basis that the event has not
occurred. If that opportunity is not taken within the 3 days allowed, or if the
challenge is made but not made good within 10 days, then the Trustee is to notify the
relevant creditor or class of creditors and, in the case of the holders of MTNs or
commercial paper, an appropriate meeting is to be held to consider whether or not to
direct the Trustee to enforce the Security, or in the case of a liquidity provider or
Royal Trust, the relevant entity is to notify the Trustee or instruct it to enforce, as the
case may be. In fact in the present case the SIV waived the provision for three days’
notice for a challenge, since it had already taken the view that it would not, because it
could not, pay any liabilities falling due for payment in future. Otherwise, however,
the occurrence of an Event of Default under the documents relating to a particular
creditor or class of creditors, or a failure to pay, would not necessarily lead to
Enforcement. Even if the SIV did not challenge the occurrence of the relevant event,
a decision remained to be taken, in one way or another, as to whether that should lead
to Enforcement.
16.
It is also to be noted that the various Enforcement Events do not include anything
concerned with the adequacy of the assets of the SIV as compared with its liabilities.
Instead they all seem to be concerned with inability to pay debts as they fall due:
cash-flow insolvency rather than balance-sheet insolvency.
17.
When the Trustee first receives a copy of a resolution passed by the relevant class of
holders of MTNs or commercial paper, or a notification from a liquidity provider or
Royal Trust, the day of such receipt is the Enforcement Date. Clause 7 then comes
into operation. The floating charge crystallises under clause 7.2. Under clause 7.3, if
any liquidity facility had not been cancelled by its provider, the Trustee is required to
draw all available sums, in order to pay the SIV’s obligations to pay sums due and
owing to beneficiaries in accordance with their rights, and to repay any advance under
a liquidity facility. In the present case any facility otherwise available had been
cancelled, so this option did not arise. The clause shows that it was envisaged that
Enforcement might occur in circumstances in which a liquidity facility had not been
cancelled, which would presumably only arise if, despite the occurrence of an
Enforcement Event, the SIV was still able to pay its debts as they fall due. It is
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
difficult to tell how likely that was, given the terms in which Enforcement Event is
defined.
18.
The judge referred to clause 7.3 but only because of the provision whereby, if the
Trustee is able to and does draw advances under such a facility, it is to specify
repayment dates for those advances which fall after the end of the Realisation Period.
19.
It is unnecessary to refer to clauses 7.4 and 7.5 which are consequential on 7.3.
Clause 7.6, on the other hand, is central to the case. It is as follows:
“7.6
The Security Trustee shall use its reasonable endeavours (and
in doing so may rely upon the advice of any investment or other
advisers as it shall in its absolute discretion consider appropriate and
shall not be responsible for any loss which results from such reliance)
to establish by the end of the Realisation Period a Short Term Pool, a
number of Long Term Pools (one in relation to each Series of [relevant
Notes], and one in relation to each other group of Long Term
Liabilities having the same payment and/or maturity dates), and a
Residual Equity Pool. In order to establish such Pools, the Security
Trustee shall during Realisation Period (but not thereafter) realise,
dispose of or otherwise deal with the Assets in such manner as, in its
absolute discretion, it deems appropriate. During the Realisation
Period the Security Trustee shall so far as possible discharge on the
due dates therefor any Short Term Liabilities falling due for payment
during such period, using cash or other realisable or maturing Assets of
the Issuer.”
20.
The point of this clause is that, unlike the position under statutory insolvency, or some
other SIVs, Enforcement does not accelerate any liabilities. Instead, the Trustee is to
set up pools of assets, matched so far as possible to the respective liabilities, and the
various classes of creditors are to be confined to recovery out of the assets allocated to
the particular pool. If the assets are inadequate, then the allocation to the pools is to
be abated pro rata, and if it turned out that the assets in a particular pool were
inadequate, then payments out of the pool would have to be abated, but the STD does
not bring forward the due date of any liabilities, nor does it provide that all liabilities
are to be discharged, pro rata, out of all available assets.
21.
The first sentence of clause 7.6 requires the Trustee, to the extent of its reasonable
endeavours, to establish by the end of the Realisation Period the required pools: one
Short-Term Pool, one or more Long-Term Pools and a Residual Equity Pool. The
Realisation Period runs for 60 days from (and including) the Enforcement Date. As
already mentioned, on the facts, it continues until (and including) Saturday 29
November. The second sentence requires the Trustee to realise, dispose of or
otherwise deal with the assets of the SIV in such manner as it deems appropriate in
order to establish the pools, and requires that this be done within that period, not
thereafter. I will leave until later, after a review of the rest of the context, quite what
the third sentence means, but it is to be noted that it might be a matter of chance
whether any Short Term Liabilities would fall due for payment during the Realisation
Period, just as it would be a matter of chance which such liabilities fell due then, if
any.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
22.
Clause 7.7 requires the Trustee to use reasonable endeavours to ensure as regards the
Short Term and Long Term Pools that the principal amount of the assets allocated is
equal to the principal amount of the corresponding liabilities, that the assets and
liabilities match in term of maturity and payment dates and currency of payment, and
that directions set out in the clause are followed as regards the rating of the assets
comprised in each pool. Clause 7.8 makes it clear that, so long as the Trustee uses its
reasonable endeavours to see that the contents of clause 7.7 is implemented, it is
under no liability to any creditor if the purpose is not achieved and if the assets in any
pool turn out to be inadequate to pay the relative liabilities.
23.
Clause 7.9 is the next important clause:
“7.9
If the principal amount of the Assets is less than the principal
amount of the Issuer’s Total Indebtedness, the Security Trustee shall
calculate the proportion borne by the deficit to the Issuer’s Total
Indebtedness and shall reduce the principal amount of the Assets
allocable to the Short Term Pool and each Long Term Pool
accordingly.”
24.
As is clear, this applies to the process of allocating assets to the pools, and is therefore
to be complied with during, or at the end of, the Realisation Period, when the pools
are set up. The calculation is applied in relation to the nominal values of the assets,
rather than their realisable values.
25.
Clause 7.10 does not need to be cited. Clause 7.11, on the other hand, sets out the
obligations of the Trustee in relation to the assets in the Short-Term Pool, and is
therefore important:
“7.11 Subject to Clause 7.4, all payments, recoveries or receipts in
respect of Assets in the Short Term Pool shall be held by the Security
Trustee on trust and shall be applied in accordance with the following
priority of payments:
7.11.1 first, to pay the Relevant Proportion of the remuneration
payable to the Security Trustee pursuant to this Deed and of any
amount due in respect of costs, charges, liabilities and expenses
incurred by the Security Trustee or a Receiver appointed by it
(and for the purposes of this sub-clause the “Relevant Proportion” shall
be the principal amount of the Issuer’s Short Term Liabilities divided
by the Issuer’s Total Indebtedness, both such amounts to be
determined on the last day of the Realisation Period);
7.11.2 second, to pay when due or as soon thereafter as can
practicably be arranged all principal, interest or other amounts in
respect of the Issuer’s Short Term Liabilities to Beneficiaries (pro rata
to the respective amounts of the Short Term Liabilities due, owing or
incurred to each Beneficiary); and
7.11.3 third, in accordance with the provisions of Clause 7.13
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
Provided that (in respect of 7.11.2 above):
(a)
if at any time after the Realisation Period the Security Trustee
reasonably believes that payments, recoveries and receipts in respect of
Assets allocated to the Short Term Pool will be insufficient to meet the
Issuer’s Short Term Liabilities, the Security Trustee shall calculate the
proportion of the Short Term Liabilities which, in its reasonable
opinion, can be met and shall pay only that proportion of any amounts
due in respect of the Issuer’s Short Term Liabilities to any Beneficiary;
and
(b)
[deals with a possibility that does not matter for present
purposes]”
26.
This provision, which sets out the trusts applying to the assets comprised in the ShortTerm Pool, creates what was referred to in argument as a waterfall, or in other words
an order of priority of payment, with the first priority being given to the remuneration
due to the Trustee itself and any sums due in respect of costs charges and expenses
incurred by the Trustee or any Receiver. An aspect of this provision on which some
reliance was placed in argument is that, because of the words in brackets in clause
7.11.1, even if, as is theoretically possible, the pools were established before the last
day of the Realisation Period (because clause 7.6 says they must be established “by
the end of”, rather than “at the end of”, the period) no payment out would be possible
until after the Realisation Period, because it is at that stage that the calculation is to be
done which ascertains what proportion of the remuneration and so on is to be paid out
of this pool.
27.
The other important aspect of this provision is proviso (a), which imposes a pari passu
distribution as regards payments out of the pool once the Trustee reasonably believes
that the assets in the pool will be inadequate to meet the corresponding liabilities.
This proviso refers to “any time after the Realisation Period”, whereas the equivalent
proviso to clause 7.12 says “if at any time”, without referring to the Realisation Period
That seems to do no more than reflect the reality, namely that what is dealt with under
clause 7.12 is Long Term Liabilities, which have maturity or payment dates of 365
days or longer from the Enforcement Date, and it is unlikely that any question would
arise in practice of applying the proviso until a long time beyond the Realisation
Period. Even as regards the Short Term Pool, because (for reasons already
mentioned) payment out of the pool before the end of the Realisation Period is not
possible, the inclusion of the words “after the Realisation Period” in proviso (a) does
not seem to be strictly necessary.
28.
I do not need to refer to other provisions of clause 7, nor to many of the later
provisions of the STD. In clause 10 the SIV covenants that it will not issue any
further Notes or commercial paper after an Enforcement Event or Automatic
Enforcement Event, and that on such an Event it will deliver to the Trustee a list of
the Assets and Liabilities forming its total indebtedness. Clause 11 entitles the
Trustee to remuneration. Under clause 13, subject to the Trustee being satisfies as to
its indemnity (for which, among other things, clauses 16 and 17.16 provide), the
Trustee may itself exercise wide powers of enforcement on and after the Enforcement
Date by taking possession and selling assets, and by clause 13.2 it may pay and
discharge all expenses and outgoings incurred in and about the exercise of such
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
powers out of the profits and income of assets and of any money received in exercise
of the powers. By clause 14 it may appoint receivers on and after the Enforcement
Date, who are to have all the powers of the Trustee. Their remuneration is fixed by
the Trustee but payable by the SIV and out of the relevant assets: see clause 14.3.4.
Clause 14.3.6 gives the receiver a power to borrow in order to defray costs, charges,
losses and expenses, including its own remuneration.
29.
Among the general provisions concerning the Trustee in clause 17 there are two to
which reference was made in argument. One is clause 17.16 by which the Trustee is
free from any obligation to expend or risk its own funds or incur any financial
liability, if it has reasonable grounds for believing that repayment of the funds or
adequate indemnity against such financial liability is not assured to it. The other is
clause 17.26 under which the Trustee is under no duty to ensure that any payment is
made when due in respect of any asset.
30.
In view of those various provisions of the STD, it seems to me that the overall context
of the provision which has to be interpreted in this case can be described and
summarised as follows. Until Enforcement, the basis on which the business of the
SIV is to be carried is that liabilities are paid as they fall due, without any requirement
to have specific regard to whether the assets are sufficient to cover the liabilities.
That is shown by the absence of any covenants or events of default defined by
reference to the ratio of assets to liabilities. Enforcement may arise as a result of an
event which does not involve cash-flow insolvency, because if that were not possible,
it would be difficult to understand in what circumstances clause 7.3 might be
applicable. In such a case the third sentence of clause 7.6 may not give rise to any
problem. But Enforcement is at least as likely to arise, and probably more so, in a
case of cash-flow insolvency, though this could in some circumstances be as regards
unsecured liabilities only, not accompanied by inability to pay secured liabilities as
they fall due. Most of the Enforcement Events are concerned with inability to pay
secured liabilities as they fall due. Thus, although solvent Enforcement is a possible
contingency, as is Enforcement in a situation of solvency as regards secured, though
not unsecured, creditors, it is more likely to occur in a case where the SIV cannot pay
its secured debts as they fall due.
31.
The STD does not accelerate any obligations on Enforcement. They all continue to be
payable in accordance with their terms. Instead the STD requires the Trustee to set up
pools of assets to provide for their payment, matching assets to liabilities so far as
possible in terms of principal amount (rather than market value), maturity and
currency, and with prescribed composition as regards credit rating. If at the time
when the pools are set up the principal amount of the assets (by no means necessarily
the same as their market value) is less than that of the liabilities, then the Trustee is to
reduce the amount of assets to be allocated to the respective pools accordingly, under
clause 7.9. Moreover, if after the pools have been set up, the Trustee believes that the
assets in a pool will not be sufficient to meet the corresponding liabilities, then the
Trustee is, in effect, to pay only a dividend on those liabilities, so far as the assets in
that pool suffice. There may well be different outcomes, as regards extent of
payment, in relation to different pools, so that although the concept of pari passu
distribution plays a part in the scheme of the STD, it is applied in a special and
unusual way, which is not pari passu across the whole body of creditors, but rather
separately within certain distinct classes of creditors.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
32.
Clause 7.6 is directed, first, at the process of setting up the pools, prescribing that this
is to be done, by the use of the Trustee’s reasonable endeavours, within the
Realisation Period, i.e. 60 days from the Enforcement Date, a timescale which is
rather firmly emphasised by the provision that the Trustee must complete the exercise
(so far as it may be necessary) of realising, disposing or otherwise dealing with assets
for this purpose by the end of the Realisation Period (see the words “but not
thereafter”). In the context of Short-Term Liabilities which may be outstanding for up
to 365 days from the Enforcement Date, and Long-Term Liabilities which extend
beyond that, it seems to me that a 60 day period is not particularly long in relation to
the practical exigencies of this situation, especially if the task is to be undertaken, in
practice, by receivers newly appointed by the Trustee, who might have no prior
knowledge of the situation and of the position of the SIV and its creditors.
33.
Because of the provisions of clause 7.11.1 and 7.12.1 as regards calculating the
proportion of the remuneration and other matters which have first priority of payment
out of the pools, no payment is possible out of a pool until after the Realisation
Period. Both for that reason and for reasons of practicality, it seems to me most
unlikely that the Pools would be set up until the last day or two of the Realisation
Period.
34.
It might be that, on particular facts, no Short-Term Liabilities would fall due for
payment during the Realisation Period, but it is clearly possible that they would, so
provision had to be made for their payment. If they had to be paid out of the ShortTerm Pool, their payment would necessarily be deferred until after the Realisation
Period. That is inconsistent with the general approach of the STD, which is to
provide for payment of liabilities on the due date. Even as regards payment out of a
pool, the obligation is to pay “when due or as soon thereafter as can practicably be
arranged”. The third sentence of clause 7.6 is directed to these particular obligations,
and requires them to be paid as they fall due, rather than being deferred. The issue
between the parties is as to the effect of the qualification “shall so far as possible
discharge”.
35.
Party A argues that the effect of the third sentence as a whole is that the Trustee is to
pay these liabilities as they fall due, day by day, until it has no more assets with which
to pay them. Once the last day arrives on which there are funds to pay, the liabilities
falling due on that day may have to be paid pro rata, but otherwise all liabilities that
are to be paid are paid in full, and those falling due later are not paid at all. This is
first-in-time priority, referred to in argument as pay-as-you-go.
36.
Party B contends that the sentence requires the Trustee to pay, as a class, “all ShortTerm Liabilities falling due for payment during such period”, i.e. during the
Realisation Period, and that any inadequacy of assets is to be taken account of by
paying all of those liabilities pro rata, rather than on the basis of priority to those first
in time.
37.
Parties C and D submit that the sentence requires pro rata payment, but over the class
of secured liabilities (short-term and long-term) as a whole, by way of the pools to be
set up under the earlier part of clause 7.6, and in accordance with clauses 7.11 and
7.12.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
38.
Counsel offered us submissions, fortified by reference to a number of decided cases,
about the proper approach to the interpretation of commercial documents. Mr
Mortimore made what seemed to me a good point in this respect, namely that the STD
is analogous to a constitutional document, such as the memorandum and articles of
association of a company, rather than to an ordinary commercial contract which deals
with the rights and obligations of its parties alone. The STD, by contrast, affects the
rights among themselves of a large number of people who are not parties to it. That
may be a reason why no party has advanced any argument based on the implication of
terms, which is especially difficult in such cases. It is also a reason why it may be
difficult to bring much in the way of surrounding circumstances into the process of
construction. Otherwise, on the part of Counsel for Parties C and D, arguments as
regards the correct approach to the interpretation of a document such as the STD were
directed, in part, to suggesting that the judge gave too much weight to his view,
formed on his first reading, of the ordinary and natural meaning of the words of the
third sentence in isolation. It seems to me that this is a somewhat arid debate, in the
present case. Of course any given words in a commercial document need to be
construed in the context of the document as a whole, and of any relevant surrounding
circumstances. But it is unavoidable to start with the words themselves, both as a
practical matter, reading into a case, and as a matter of the process of analysis. I do
not accept that the judge failed to take account of the context of the document as a
whole and of the commercial purpose discernible from it. The question is whether he
came to the right conclusion from this material.
39.
No reliance was placed on any particular surrounding circumstances except in the
case of Party D, represented by Miss Prevezer Q.C., who referred to two Information
Memoranda relating to the placing of Euro MTNs and US dollar MTNs respectively,
which bear the same date as the STD. She pointed out that these documents refer
repeatedly to the Notes as ranking pari passu and without any preference or priority
amongst themselves, and that reference was made to the Realisation Period and to
what was to be done within that period without any suggestion that any of the shortterm liabilities might attract special priority is they fell due during that period. It
seems to me that no weight can be given to these documents as regards the
interpretation of the STD. They are not intended (so far as relevant) as anything other
than an explanation of its terms and effect. If the explanation is wrong then an
investor might theoretically have a remedy arising from any misrepresentation,
subject to proof of reliance and so on, but the document cannot cast light on the
correct interpretation of the STD itself, particularly because it governs the rights of
other classes of creditors as well as the MTN holders, and those others may not have
been aware of the terms of these memoranda.
40.
We also had cited to us some other cases in which the courts have had to consider
problems in the interpretation of the relevant documents of a SIV: Re Cheyne Finance
plc (in receivership) (No. 1) [2007] EWHC (Ch) 2402 2, [2008] 1 BCLC 732, Re
Cheyne Finance plc (in receivership) (No 2) [2007] EWHC (Ch) 2402, [2008] 1
BCLC 741 and Re Whistlejacket Capital Ltd (in receivership) [2008] EWCA Civ 575.
For my part, it seems to me that the documents concerned in those cases are so
different in their relevant provisions from that which we have to consider that they are
of assistance only at the highest level of generality. I find the differences in the
regime applicable under the STD in the present case, as compared with those other
cases, more notable than the similarities.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
41.
Mr Howard, for Party A, contended that the judge was right to prefer the reading of
the third sentence of clause 7.6 which gives priority according to the date on which
relevant liabilities fall due within the Realisation Period, or first-in-time priority. He
argued that the judge was entitled, and correct, to conclude that this followed from the
natural and ordinary meaning of the words of the sentence, and was not displaced by
anything in the context of the STD or any consequences of the reading.
42.
For Parties C and D, Mr Mortimore and Miss Prevezer drew attention to a number of
points which, they said, make such a reading commercially unattractive or bizarre,
and one which flouts business common sense, and that it is therefore unlikely to have
been, objectively viewed, what the parties the intended. First and foremost is the
adventitious nature of the priority conferred by the first in time principle. On the facts
of the present case, admittedly with a deficiency of a scale greater than that which
might have been anticipated, one group of Noteholders gets paid in full, and no others
get a cent, whereas under the scheme of the STD itself, once beyond the Realisation
Period, all Noteholders would be paid in part, even though not according to a strict
pari passu distribution across all classes. Why should the pure chance of obligations
falling due during the 60 day period give rise to absolute priority over other creditors
of the same type, especially at a time when it is known that the SIV is massively
insolvent, so that the abatement provisions will operate, if and when they are
applicable?
43.
The haphazard nature of the application of the priority advocated by Party A is the
more unlikely to have been intended, according to Parties C and D, because to some
extent the timing of the Realisation Period, and therefore the identity of the creditors
who have the benefit of this first-in-time priority, is open to manipulation. Thus, the
Enforcement Date occurred some three days earlier than it might have done in the
present case because the SIV waived the three days allowed to it to challenge whether
an Enforcement Event had happened. It is not suggested that this was done otherwise
than properly or for any ulterior motive, but there was an element of choice on the
part of the SIV. Equally, in theory, the timing of meetings or of service of notice of a
resolution on behalf of Noteholders or corresponding action on the part of another
creditor, giving rise to an Enforcement Event, could possibly be arranged deliberately
in such a way as to affect the timing of the Realisation Period. It is at least a
theoretical possibility, though it seems to me rather more remote in terms of
probability than that which gave rise to a similar argument, on a very different
provision, in Re Whistlejacket Capital, referred to above.
44.
They also argued that Mr Howard’s reading gave rise to a very odd anomaly, namely
that the prior liabilities, non-payment of which gave rise to the Enforcement Event,
would not be given priority under the third sentence, since they would not fall due
during the Realisation Period, with the result that those falling due during the
Realisation Period (or during the early part of it) would be paid in full, whereas those
whose debts fell due before it, and remained unpaid, would either not be paid at all, or
at best would be relegated to share in the appropriate pool. Further, they argued that
Mr Howard’s reading appeared to require the Trustee to pay out to those creditors
whose debts fell due during the Realisation Period, without making any provision for
the remuneration and expenses of the Trustee itself or the receivers.
45.
They submitted that, in the context of the STD as a whole, it would be very surprising
to find that the third sentence of clause 7.6 sets up a sub-class of Short-Term
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
Liabilities falling due for payment during the Realisation Period, there being no other
indication that those liabilities are to be treated differently from other Short-Term
Liabilities or indeed, apart from having a separate pool provided for them, from LongTerm Liabilities. They also argued that it would be particularly surprising to find
such an effect resulting from a sentence tacked on, as it were, at the end of a clause
which otherwise deals only with practical and administrative matters, having no effect
as between different creditors. In an extreme case, such as the present, the
implementation of the obligation in the third sentence, as interpreted by the judge,
results in the subversion and frustration of the rest of the clause, because it means
that, by the end of the Realisation Period, there are no assets to go into any pool. That
is all the more the case if, as the evidence suggests in this case, the obligation to pay
on the due dates could require fire sales of assets, so as to produce something with
which to pay the first of the relevant creditors, to the substantial prejudice of other
creditors, even those with liabilities falling due later in the Realisation Period. Those
are powerful considerations, eloquently advanced in their cogent submissions by Mr
Mortimore and Miss Prevezer.
46.
However, the question is whether, and if so how, the sentence can be read so as to
produce the result for which they contend, which is (put simply) that, if the assets will
not be sufficient to pay the liabilities so that, once the pools are constituted there will
have to be an abatement, either under clause 7.9 (if the deficiency arises on nominal
values) or at any rate under proviso (a) to each of clauses 7.11.2 and 7.12.2, when
realisable values are to be taken into account, then it is not possible to discharge the
liabilities falling due within the Realisation Period, because that cannot be done
consistently with the rest of the STD.
47.
I must summarise next the arguments on behalf of Party B, which espouses Party A’s
view that Short-Term Liabilities falling due within the Realisation Period are treated
separately, but aligns itself with Parties C and D in favouring pari passu treatment
(though only within that special class) rather than first-in-time priority. On behalf of
Party B, Mr Sheldon argued that the STD does clearly treat differently those ShortTerm Liabilities which fall due during the Realisation Period as compared with other
secured liabilities, but that it treats this sub-class of Short-Term Liabilities as a whole,
by means of the use of the phrase, which he said was to be read together and not
dissected, “any Short-Term Liabilities falling due for payment during such period [i.e.
the Realisation Period]”. On his submission, Party A’s reading of the sentence would
not give proper effect to the use of this phrase, which requires all such liabilities to be
paid so far as possible, so that if there is a deficiency at that stage, it is to be borne pro
rata by each of the creditors in respect of such liabilities. He submitted that Party A’s
reading did not give any meaning to the words “during such period”. To the argument
that his own reading did not give effect to the words “on the due dates therefor”, he
countered that this is qualified by “so far as possible”, so that if an abatement is
required, for which time may have to be allowed to see what amount can be paid, a
short period of deferral may be necessary, and punctual payment may not be possible.
48.
A number of detailed points were taken on the wording of the third sentence in
particular, and clause 7.6 and other parts of the STD as a whole. I will discuss the
most important of these.
49.
As already mentioned there is an issue about the treatment, on Party A’s reading, of
unpaid amounts which fell due before the Realisation Period, whose non-payment
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
may have led to the Enforcement Event which triggered Enforcement. The third
sentence of clause 7.6 speaks of Short-Term Liabilities falling due for payment during
the Realisation Period. The pre-Enforcement liabilities would have fallen due before,
not during, the Realisation Period. On the literal words of the sentence, therefore,
they are not required to be paid under this sentence, which would be odd. Of course if
the Enforcement is not on the basis of insolvency, there would not be any such
outstanding liabilities. But if it is triggered by an event involving non-payment there
will be. One would naturally expect these to be paid with at least as high a priority as
any other liability, other than expenses of the Enforcement.
50.
The judge held that these liabilities are covered by the third sentence of clause 7.6, as
he explained in his paragraph 36:
“I accept Mr Howard’s submission that where the maturity date for a
debt instrument has arrived and the payment obligation contained in
the instrument has not been satisfied, the liability contained in the
instrument remains due on each day thereafter until it is satisfied. I
consider that the words, “on the due dates therefor” and “falling due
for payment”, in the last sentence of clause 7.6 are clearly intended to
cover Short Term Liabilities falling within this class of case, so that
they should be paid at the same time as any such instruments maturing
on the first day of the Realisation Period.”
51.
Mr Mortimore and Miss Prevezer submitted, with some justification, that if this treats
the pre-Enforcement liabilities as “falling due” on the first day of the Realisation
Period, as well as having fallen due beforehand, this would be an unorthodox
construction, to say the least. I agree, but one thing that is clear is that no specific
thought was given to these liabilities when clause 7.6 was drafted, or indeed in
relation to any part of clause 7. There was even an argument that these liabilities are
not among those to be paid out of the pools. They are within the definition of ShortTerm Liabilities, because this includes liabilities “which are due and payable or
which have scheduled maturity or payment dates falling less than 365 days from the
Enforcement Date” (my emphasis). However, clause 7.11.2 directs payment of
amounts in respect of Short-Term Liabilities to be paid “when due or as soon
thereafter as can practicably be arranged”. It was said that this does not allow for
payment of sums which have already fallen due before the Pool is constituted – in
effect before the end of the Realisation Period. I do not accept that argument, but it
does show that the fate of these pre-Enforcement liabilities was not dealt with in
express terms.
52.
The point of the argument to the effect that these liabilities are not covered by the
third sentence on the first-in-time priority reading was that this showed the latter
reading to produce an absurd anomaly, or alternatively that the literal reading which it
involves has to be qualified to produce a sensible result in this respect, and may
therefore be suspect more generally. It seems to me that, if the first-in-time priority
reading is correct, it would not be a major qualification to it to read the sentence as if
it said “any Short-Term Liabilities already due or falling due for payment during such
period”, and so required the pre-Enforcement liabilities to be paid, as the judge said,
in effect as if they had fallen due on the Enforcement Date, the first day of the
Realisation Period. I would therefore agree with the judge on this point, and I do not
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
regard this qualification of the literal effect of the sentence as sufficient by itself to
show that first-in-time priority cannot have been intended.
53.
So far as the point about the remuneration and expenses of the Trustee and the
receivers is concerned, the judge dealt with this at paragraphs 37 to 39 of his
judgment, and gave effect to this in paragraph (3) of his order. None of the three
Appellants challenges that part of the order. The respective Appellant’s Notices make
it clear that only paragraph (2), dealing with priority, is sought to be set aside. In
those circumstances I need say no more than that I agree with the judge for the
reasons he gave on this aspect of the case.
54.
In terms of the wording of the third sentence, the remaining arguments turn on
whether Party A’s reading gives enough (or any) meaning to the various parts of the
sentence, or whether on the other hand the other Parties’ readings put altogether too
much weight on words in the sentence, especially the words “so far as possible”.
55.
One criticism of the first-in-time priority reading is that it is said that it gives no
content to the words “so far as possible”. If all they mean is “so far as the available
assets allow”, they add nothing to “using cash or other realisable or maturing Assets
of the Issuer” at the end of the sentence. Clause 17.16 shows that the Trustee cannot
be required to use its own funds, so that these words are not needed (even in the
absence of the concluding words of the sentence) to protect the Trustee.
56.
The judge described the sentence as creating “an especially strong obligation” on the
Trustee (see his paragraph 32) as compared with the qualified obligation in the first
sentence (by reference to reasonable endeavours) and elsewhere such as in clause 7.3
and in clauses 7.11.2 and 7.12.2. That seems to me to be a fair point, but the words
“so far as possible” do qualify the obligation to some extent. It seems to me that one
respect in which they do so could be as regards payment on the due date. If payment
is possible, but not until a day or more late, for example because of delays or
difficulties in realisation, then the words “so far as possible” could protect the Trustee
from any claim that it was in breach of its obligations, while on the other hand the
delay in payment would not give rise to any right to interest (we were told that Notes
were issued on terms that did not carry a right to post-maturity interest) and would
also not affect the first-in-time priority, applied by reference to the date on which the
liability should have been paid.
57.
As it seems to me, the substantial force of the arguments for Parties C and D derives
from the following factors, the order in which I state them not being any indication of
their relative significance: (a) the apparent position and purpose of the third sentence
of clause 7.6 as being incidental to the rest of the clause, whereas, on the present facts,
if Party A is right, its implementation destroys the whole purpose of the rest of the
clause; (b) the fact that, on this interpretation, although it is likely to have been clear
from the Enforcement Date that the SIV was massively insolvent and that clause 7.9
would have to be invoked in setting up the pools and that (even if clause 7.9 did not
apply because the deficiency did not arise on the nominal values) there would
certainly be an abatement on all payments out of the pools under proviso (a) to each
of clauses 7.11.2 and 7.12.2, that deficiency was simply to be ignored during the
Realisation Period in favour of payment in full according to first-in-time priority; (c)
the element of pure chance as to which liabilities would be paid in full, leaving the
rest with nothing, instead of a dividend for all, together with the risk that the identity
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
of the liabilities to be paid in full might have been influenced by a degree of
manipulation; (d) the risk that the requirement to pay the first-in-time Short-Term
Liabilities in full would require an improvident fire-sale of assets for the sake of the
first in time, to the prejudice of those later in the queue.
58.
Those factors, undoubtedly powerful in themselves, do not alone explain how “so far
as possible” in the third sentence can be read so as to import a principle of pari passu
distribution, or a requirement that payment on the due dates is not to be made if there
is a deficiency of assets as against liabilities. One way of putting the argument of
construction in favour of this (not quite how it was put by Mr Mortimore or Miss
Prevezer, but expressing their arguments in a different way) might be this:
i)
The first two sentences of clause 7.6 impose an obligation on the Trustee to
form the pools, and in particular the Short Term Pool.
ii)
The terms of clause 7.11.2 require the assets in the Short Term Pool to be used
to pay the Short Term Liabilities at, but not before, the end of the Realisation
Period.
iii)
However, there is power, contained in the third sentence of clause 7.6, to pay
in full liabilities which fall due during the Realisation Period as they fall due,
but this power is only to be exercised “so far as” it is “possible”.
iv)
If there is a shortfall in the Pool, then the Short Term Liabilities are not to be
paid in full, but are to be pro-rated under proviso (a) to clause 7.11.2.
v)
As the liabilities referred to in the sentence are within the definition of Short
Term Liabilities, it is not “possible” to pay them in full, because that is
precluded by clause 7.9 and proviso (a) to clause 7.11.2, and the sentence
therefore cannot apply.
59.
However they are put, the arguments for Parties C and D involve saying that “so far
as possible” means, or includes, only if and insofar as it is possible consistently with
the scheme of pari passu distribution which is reflected in clause 7.9 and in proviso
(a) to clauses 7.11.2 and 7.12.2. One difficulty with that argument is that, as it seems
to me, either it is possible to make such payments, consistently with that scheme
(because a deficiency is not apparent) or it is not possible. The sentence does not say
“if possible” but “so far as possible”; the latter phrase seems clearly to indicate that
partial payment may be possible.
60.
An alternative reading might be that, in an insolvent Enforcement, the sentence
requires the Trustee to make payments on account in respect of the Short-Term
Liabilities falling due during the Realisation Period, at it were by way of dividend,
rather than paying them in full. A version of such an argument is at the centre of
Party B’s submissions, but in that case the argument is that all the available assets are
to be applied (so far as possible) in paying the Short-Term Liabilities falling due
during the Realisation Period, without having any regard to the Short-Term Liabilities
falling due thereafter and the Long-Term Liabilities.
Judgment Approved by the court for handing down.
61.
Re Sigma Finance Corporation (in Administrative Receivership)
In his judgment, which I have had the opportunity to read in draft, Lord Neuberger
favours a version of this approach, and formulates it as follows in paragraph [95(d)]
of his judgment (I quote it here for ease of reference):
“The words “so far as possible” mean that, while the Trustee has a duty
to pay each RP liability as it falls due, the payment is limited to the
amount which the Trustee is confident will be paid in respect of that
liability pursuant to the provisions of clause 7.11.2 and the provisos
thereto; at the end of the Realisation Period, any balance due in respect
of the RP liability is to be paid from the Short Term Pool.”
62.
With the greatest respect, I find that reading problematical. Unlike clause 7.11.2, for
example, it does not define clearly or at all what is to be the state of mind of the
Trustee in order for this to apply: is the Trustee to be satisfied of something, or to
“reasonably believe” something (as in proviso (a) to clauses 7.11.2 and 7.12.2), and if
so what? Nor does it begin to prescribe what the Trustee is to do, and what, if any, is
the scope of its discretion, or judgment, if it is in whatever is the relevant state of
mind as regards the short-term, medium-term or long-term prospects for payment in
full, or only on account, of the SIV’s various secured liabilities.
63.
The sentence is, on the face of it, clear and unequivocal as to the Trustee’s obligation
to discharge the Short-Term Liabilities falling due during the Realisation Period. It
seems to me that if this obligation was intended to be qualified so as to require only
payment on account, then, whether or not the proposed abatement is to be applied
having regard to only the Short-Term Liabilities falling due during the Realisation
Period (as Party B contends) or taking into account all of the secured liabilities, and
therefore with a view to what might be payable on account of these Short-Term
Liabilities if they fell to be met out of the Short-Term Pool, the STD would have
made it clear in what circumstances this qualification of the obligation was to arise,
and what the Trustee was required to do, if the obligation was qualified in this way,
instead of paying in full.
64.
Lord Neuberger suggests (at paragraph [111] below) that the third sentence has the
effect that, when a Short-Term Liability falls due during the Realisation Period, the
Trustee is obliged to pay on account of that liability “as much as he can be confident
that the creditor concerned will receive if he had to wait for payment under clause
7.11 from the Short Term Pool at the end of the Realisation Period”. That does not
strike me as language consistent with the approach of the STD to defining the
obligations imposed on the Trustee. I find it difficult to suppose that, if those
concerned with the drafting and negotiation of the STD had sought to cover this point
expressly, so as to achieve something along the lines of this result, they would not
have used much more specific and elaborate language, not least in order to protect the
Trustee by careful definition of its obligations and of the contingencies in which
different obligations would arise.
65.
I would not myself attach too much significance to the use of the word “discharge”,
though my impression is that the STD is quite careful in using “discharge” in relation
to Liabilities, and “pay” in relation to “amounts” (including of course amounts due in
respect of Liabilities as in clause 7.11.2). It does use “pay and discharge” in clause
13.2. In principle, it seems to me that, for a monetary liability to be discharged, it
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
must be paid in full, but a context could show that discharge pro tanto was envisaged
under a particular transaction.
66.
In the version of the argument in favour of pari passu distribution which I have set out
in paragraph [58] above, paragraph (iii) treats the third sentence as conferring a power
to pay on the due dates the Short-Term Liabilities falling due during the Realisation
Period. However, this does not give adequate recognition to the words of the sentence
which seem to me clearly to impose an obligation to pay these liabilities, on the due
dates for payment, subject only to whatever is meant by “so far as possible”.
67.
The essence of the argument in favour of Party A and first-in-time priority can be
summarised as follows. The STD is a commercial document prepared by skilled and
specialist lawyers for use in relation to sophisticated financial transactions where all
parties are likely to have had, or at least to have access to, proper legal and financial
advice as to the extent of, and any limitations on, the rights conferred on investors. Its
intention should be understood by reference to the clear and natural meaning of the
words used.
68.
The third sentence of clause 7.6 is clear in imposing an obligation on the Trustee to
pay on the due dates the Short-Term Liabilities falling due during the Realisation
Period, out of the available assets, so far as possible. It is unlike most other
provisions of the STD in imposing a specific obligation to pay as and when liabilities
fall due (even the comparable obligation in clauses 7.11.2 and 7.12.2 is specifically
qualified), and it is not subject to any clear indication that the obligation is conditional
on the Trustee being of the view that the available assets are sufficient to discharge
the corresponding liabilities, comparable to the provision which the STD does
impose, in careful and quite elaborate terms, in proviso (a) to clauses 7.11.2 and
7.12.2. If it had been intended that the obligation to pay imposed by the third
sentence should be conditional on a view being taken by the Trustee as to the
adequacy of the assets, the draftsman was perfectly capable of inserting a suitable
provision, and would have done so in careful and specific terms, defining exactly
what it was that the Trustee needed to be satisfied of, or to “reasonably believe”, and
when. The model of clause 7.9 would not by any means necessarily be sufficient for
this purpose, since it is directed to the nominal values of assets, not to their realisable
value.
69.
Looking at the sentence in the context of clause 7.6, of clause 7 overall, and of the
STD as a whole, the argument for pari passu distribution involves placing on the
words “so far as possible” a weight and significance that they cannot bear. It may be
that they are not needed to reinforce the proposition, expressed in the last words of the
sentence, that the liabilities are only to be discharged out of the available assets of the
SIV, and therefore are not to be discharged beyond the extent of those assets. It may
be that they qualify the obligation of punctual payment, so that if there is a delay, the
Trustee is not in breach. But to discern in those four words a condition which would
import something along the lines of proviso (a) to clauses 7.11.2 and 7.12.2, but by
way of an absolute bar on distribution during the Realisation Period, is just not a
legitimate or tenable reading of the words. The attempt to read these words in that
way is not in truth an exercise in interpretation but rather the creation of a set of
obligations other than those which are expressed in the STD as properly construed, in
order to avoid what, in the present extreme economic circumstances, may seem an
unfair and unexpected result.
Judgment Approved by the court for handing down.
70.
Re Sigma Finance Corporation (in Administrative Receivership)
As the judge said in paragraph 27 of his judgment:
“It may seem somewhat surprising that the various parties did not wish
to provide that as soon as an event of default occurred involving
Sigma’s insolvency the shutters should come down in relation to
payment of its liabilities such that all assets and all its outstanding
liabilities at that time should fall to be treated on a general pari passu
basis within the Pool arrangements. However, that is not what the
relevant provisions provide for, and it is not for the court to seek to rewrite the agreement on the basis of its own views of what might be a
fairer solution or its speculation about what the parties might have
wished to achieve had they applied their minds more directly in
advance to the particular situation which has now arisen.”
71.
As Mr Howard submitted to us, the parties to the STD could have provided for the
shutters to come down, in the judge’s phrase, on the Enforcement Date. Such an
approach might have been expected, at any rate in a case in which Enforcement was
likely to be proceeding in a case of cash-flow insolvency, and it might have been
qualified by a provision allowing payment in full if the assets were reasonably
believed to be sufficient. But it is clear that this is not the approach of the STD,
which does not impose its own regime of pari passu distribution except through the
pools once constituted. Later in paragraph 27 the judge went on to say this:
“It [i.e. the “pay as you go” construction of the third sentence] is a
construction which cannot properly be castigated as unfair or unjust,
and it produces a somewhat crude but practical and workable regime
for managing Sigma’s affairs in the Realisation Period leading up to
the creation of the Pools. Since the parties obviously considered that
the Security Trustee (or Receivers appointed by it) might well need a
60 day period in order to establish the liabilities and assets to go into
the Pools and how they should be allocated, I do not think that the
perceived desirability of having a simple and workable system telling
the Security Trustee what to do in relation to maturing liabilities while
that process was being carried out can be discounted. It should also be
recalled that the normal operation of Sigma’s business was on a “pay
as you go” basis. Against that background it does not seem
implausible that the parties intended that its business should be
continued on that same basis during the Realisation Period until the
Pools could be established in a considered and orderly fashion, at
which stage a new, pari passu regime should come into operation. The
parties already accepted certain risks to themselves inherent in the “pay
as you go” nature of Sigma’s business, and by providing for “pay as
you go” during the Realisation Period they appear to me to have agreed
to continue to bear such risks until the Pools are set up.”
72.
It is true, as was urged on us for the several Appellants, that the arrival of the
Enforcement Date does make a major change to the business of the SIV. The floating
charge crystallises, no more Notes or commercial paper can be issued, and the Trustee
will take charge, directly or by a Receiver. Those are among the reasons why one
might expect that the shutters would come down at that point, but the third sentence of
clause 7.6 is inconsistent with that. During the Realisation Period the Trustee is to
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
pay Short-Term Liabilities as they fall due “so far as possible”. That is altogether
different from what the Trustee is to do later and in other respects.
73.
I turn to the arguments as between Parties A and B, as to whether, within the class of
creditors with Short-Term Liabilities which fall due during the Realisation Period,
there is to be first-in-time priority or pari passu distribution. Mr Sheldon made an
attractive case for the latter, arguing that the sentence designates the special class of
such liabilities, and directs that it is these liabilities which have to be paid out of the
available assets, so far as possible. He contended that those four words can readily, in
this limited context, be understood as showing that, if the assets do not suffice to pay
all of these liabilities in full, each of them should be paid pari passu, rather than using
the available funds to pay in full the first in time. Mr Sheldon is entitled to point out
that the third sentence contains an element of meaningless duplication, on Party A’s
reading, namely the opening words “During the Realisation Period” and the later
words “during such period”, whereas on Party B’s reading, the latter words are there
as part of an overall phrase defining the class of liabilities which the Trustee is to pay,
so far as possible, during that period.
74.
Despite Mr Sheldon’s able formulation of the case, it seems to me that it cannot stand
with the requirement to pay “on the due dates therefor”, which is a clear direction in
favour of first-in-time. I agree that there may be an element of duplication in the two
references to the period. Even if “so far as possible” can be read as potentially
qualifying the obligations to pay on the due dates, it seems to me that the sentence
cannot be understood as imposing a pari passu distribution within the class of ShortTerm Liabilities falling due during the Realisation Period, any more than it can be
understood as subjecting those liabilities to pari passu treatment with all other secured
liabilities, as Parties C and D contend.
75.
In my judgment Mr Howard’s arguments, which I have referred to above and sought
to summarise in paragraphs [67] to [69] above, are correct, and the judge was right to
accept them. I do not consider that the words “so far as possible” can be read as
requiring the Trustee, in the event of a perceived deficiency of assets, either to refrain
from paying liabilities as they fall due, in accordance with the third sentence, so that
all those liabilities would fall to be satisfied (so far as they can) through the short-term
pool, or to treat as a class all Short-Term Liabilities falling due during the Realisation
Period, and paying all of those pro rata. Among the principal factors leading me to
that conclusion is that other provisions of the STD, above all proviso (a) to clauses
7.11.2 and 7.12.2, show in what elaborate and careful terms an obligation to pay
liabilities under the STD only pro rata was formulated, and I do not find it possible to
suppose that such an obligation was to be imposed by text such as that of the third
sentence of clause 7.6 which has no equivalent in terms of the precision and care of
the definition of the supposed obligation.
76.
Those and the other reasons set out above are those which have led me to the
conclusion that the judge was right in his decision on the issues raised. I would
therefore dismiss the appeals.
Lord Justice Rimer
77.
I gratefully adopt Lloyd LJ’s summary of the background position against which this
appeal arises and his full exposition of the provisions of the STD relevant to the
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
question of construction upon which it turns. Like Lloyd LJ, I too would dismiss this
appeal and would also pay my tribute to the quality of Sales J’s judgment, produced
by him in commendably short order. But for the fact that Lord Neuberger of
Abbotsbury, whose judgment I have read in draft, takes a different view, I would
probably have been content simply to express my agreement with Lloyd LJ’s reasons
for dismissing the appeal. In the circumstances I propose to explain in my own words
why I have reached the same conclusion as he has.
78.
The resolution of the problem turns on the sense of the four words -- “so far as
possible” – in the last sentence of clause 7.6. The phrase is a familiar piece of English
but the question is what it means in the context. Clause 7.6 is a sub-clause in a clause
headed “Enforcement” (meaning enforcement by the security trustee), comprising a
total of 16 sub-clauses and occupying nearly seven pages. The clause is concerned
with the mechanics of the realisation for the benefit of the secured creditors of the
fixed charge that arises in consequence of the occurrence of an enforcement event.
The interpretation of the last sentence of clause 7.6 at least requires a consideration of
it in the context of the scheme of clause 7 as a whole; and clause 7 itself needs to be
considered in the context of the STD as a whole, considered against the factual
background in which it came to be executed.
79.
The general scheme of clause 7 is clear. Following the enforcement date,
enforcement by the security trustee is governed by two consecutive phases. There is
first a 60-day realisation period during which the security trustee is required “to use
its reasonable endeavours” to constitute three pools, comprising a short term pool,
several long term pools and a residual equity pool. For that purpose, the security
trustee is required during the realisation period – “but not thereafter” – to “realise,
dispose of or otherwise deal with the Assets in such manner as, in its absolute
discretion, it deems appropriate.” None of the liabilities to the secured creditors is
accelerated; and the theory is that, following the realisation period, the assets
respectively allocated to the short and long term pools will respectively meet, at least
pro rata, the SIV’s short and long term secured liabilities as they fall due. Clause 7.9
recognises that the assets may at the outset be foreseen to be insufficient to meet all
the secured liabilities intended to be satisfied by the pools; and clause 7.11.3
recognises that the potential for such a shortfall may become apparent following the
setting up of the pools.
80.
The essential question that is raised by the third sentence of clause 7.6 is whether in a
case in which, during the currency of the realisation period, it can be foreseen that the
proportion of assets to future liabilities is such that there will be a deficiency as
regards secured creditors, the scheme of clause 7 is: (a) that all secured creditors share
in one or other of the pools so established; or (b) that those creditors whose debts fell
due during the realisation period are still entitled to be paid during that period (and, if
the assets permit, in full), with the consequence that the pools (if any) established by
its end are established exclusively for the benefit of those creditors whose debts fall
due following its end.
81.
That description of the question somewhat oversimplifies it since, in the events that
have happened, the case really concerns four classes of secured creditor. First, a class
unrepresented before us, being secured creditors whose debts (totalling less than $1m)
fell due before the realisation period but remained unpaid at its commencement (“the
pre-enforcement debts)”. Second, two classes of secured creditors whose debts fell
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
due during the realisation period (“the realisation period debts”). Party A is such a
creditor, its debt falling due on 23 October 2008. Party B is also such a creditor, its
debt falling due on 30 October 2008. Parties A and B do, however, have conflicting
interests. They both claim that the scheme of clause 7 is that all available assets must
be applied during the realisation period in or towards the discharge of their respective
debts. The difference between them is that Party A claims that the realisation period
debts fall to be paid in the date order that they respectively fall due, which means that
it is entitled to the first call on the available assets. If that is right, the consequence in
practice is that Party B will receive nothing. Party B’s argument is that all realisation
period creditors are entitled to share pari passu in the available assets. The fourth
class of secured creditors is all other short and long term secured creditors whose
debts fall due for payment after the realisation period, that class being represented by
Parties C and D.
82.
As regards pre-enforcement debts, there is, I consider, no doubt that they are short
term liabilities within the meaning of the definition of that phrase in the STD. On the
other hand, I have difficulty in seeing how they can strictly be regarded as liabilities
to which the last sentence of clause 7.6 is referring, since they did not fall due during
that period, they fell due before it. Whatever that sentence may mean, I can, however,
conceive of no commercial reason why the STD should have treated realisation period
debts differently from pre-enforcement debts and I suspect that the omission to
include an express reference to the latter debts in the regime created by that sentence
was a mistake. Party A was and is content to treat those debts as in fact covered by
the last sentence and the judge held that they were. Since I consider that Party A’s
argument is essentially correct, it is not strictly necessary to consider the position of
the pre-enforcement debts further, save in so far is it is relied upon by other parties in
support of their contrary arguments.
83.
Party A’s case is that the scheme of the STD is simple. Before the occasion of an
enforcement event the SIV will have been meeting its liabilities to its secured
creditors on a “pay as you go” basis, i.e. as they fell due for payment. The
enforcement mechanism of the STD, involving the establishment of the pools,
required time to be set up, which was fixed at the 60-day realisation period. The
scheme is that during that limited period, and whilst establishing the pools, the
security trustee will continue a like “pay as you go” practice and will discharge, in
date order as they fall due, the liabilities falling due for payment during that period;
and it is expressly obliged to discharge them “so far as possible … using cash or other
realisable or maturing Assets of the Issuer”. The test of what is possible is simple. It
is geared to the availability of cash or other realisable or maturing assets. To the
extent that there are such assets, they must be applied in discharging the realisation
period debts in the order in which they fall due for payment. The security trustee is
given no discretion not so to apply the assets. The argument is not a difficult one. It
has the merit of apparently reflecting what the last sentence of clause 7.6 says.
84.
Party B agrees with most of that, but says that the true sense of the sentence is that the
obligation of the security trustee is, so far as possible, to discharge all realisation
period debts; and, to the extent that there is a deficiency of assets enabling it to do so,
all are entitled to share in what is available on a pari passu basis. The argument
focuses on the words “falling due for payment during such period, ….”
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
85.
Parties C and D say that both arguments are wrong. Clause 7.9 reflects that it may
appear to the security trustee early in the realisation period that there is a deficiency of
assets to meet the accrued and future indebtedness to secured creditors, in which event
there will be a proportionate shortfall in the assets allocated to the short and long term
pools accordingly. All liabilities to secured creditors are, according to the definitions
in the STD, either short or long term, and the short term liabilities as defined include
both the pre-enforcement debts and realisation period debts. Since clause 7.9 reflects
that in the case of such a deficiency, there is to be a pari passu satisfaction of short
term liabilities out of the short term pool, it follows that the last sentence of clause 7.6
in such a case cannot be intended to confer priority on either the pre-enforcement
debts or the realisation period debts. Moreover, since that sentence does not even
include the former debts, the argument that it gives a special priority to the realisation
period debts is even weaker: because the pre-enforcement debts can only be satisfied
out of the short term pool. The answer of Parties C and D to the question what “so far
as possible” means is that it means “so far as possible in a manner consistent with a
pari passu treatment of all short term liabilities in the event of a deficiency of assets”.
If, therefore, the security trustee foresees during the realisation period a deficiency of
assets – however small – the shutters immediately come down on the last sentence of
clause 7.6 and not a dollar may be paid out to any realisation period creditor. That is
because payment of such creditors is to be regarded as impossible. As an alternative
argument, although one advanced only when the parties were invited by the court to
focus more precisely on the sense of the “so far as” in the key phrase, Parties C and D
submitted that its sense is that in the case of an apparent deficiency the obligation of
the security trustee is to pay a dividend in respect of the realisation period debts on the
dates they respectively fall due. That dividend would be in line with that expected to
be paid out of the short term pool in respect of all other short term liabilities as they in
turn fall due.
86.
In my judgment there are major difficulties with the arguments of Parties C and D.
First, if the thought underlying the words “so far as possible” was directed at
informing the security trustee that payment of the realisation period creditors could
only be made in circumstances in which it was perceived that the enforcement was
likely to be a solvent one, with all creditors being paid 100 per cent of their debts, the
sentence would have said so. The trust deed is a 45-page document reflecting the
considered input of (probably) a team of commercial lawyers. It is inconceivable that
if this was the thought behind the qualification in the last sentence of clause 7.6, the
qualification would have been articulated by the use of the phrase “so far as possible”
rather than by spelling it out expressly. That point is underlined by the fact that,
within three sub-clauses, clause 7.9 expressly recognises that the assets available for
allocation to the pools may be insufficient to meet all liabilities in full; and proviso (a)
to clause 7.11.2 also provides a specific regime for the administration of the short
term pool in circumstances in which a deficiency becomes apparent after the
realisation period. To suggest, as Parties C and D in effect do, that “so far as
possible” really means “(save in the case of a perceived deficiency of assets available
to satisfy all secured creditors, in which case this sentence shall have no application)”
is in my judgment an impossible one.
87.
Secondly, the words anyway do not attempt to bear the burden that Parties C and D
seek to load on to them. Their natural meaning is that the security trustee is required
to discharge the realisation period debts as they fall due to the extent that the available
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
assets so permit: that is the sense of the “so far as possible”. But the “so far as” is
given no meaning by the primary argument advanced by Parties C and D. That
argument is that the phrase imposes an absolute bar on payment in any case in which
an insolvency is foreseen; but that cannot stand with the fact that the phrase conveys
that the security trustee is required to go at least part of the forbidden distance. Again,
if the draftsman had thought that a concept of possibility was the right way to provide
that nothing in the relevant sentence was to permit payments out in the case of a
perceived insolvency, he might at least have considered that the phrase “if possible”
was more appropriate.
88.
Third, in answer to this point Parties C and D have advanced as an alternative
argument (one that did not apparently occur to them until, following the reserving of
judgment, the court invited the parties to focus on the phrase) that the sense of the “so
far as possible” is, in a case of perceived insolvency, to enable a dividend to be paid
to the realisation period creditors. I am unpersuaded by this as well. Again, it tries to
load too much on too little. If a “discharge” of the clause 7.6 liabilities in a case of a
perceived insolvency were only intended to permit a dividend to be paid, clause 7.6
would have been expanded to say so. Mr Howard, for Party A, pointed out that, quite
apart from all other considerations, the key sentence talks about the “discharge” of the
relevant obligations – that is, payment in full, albeit only “so far as possible” –
whereas proviso (a) to clause 7.11.2 provides that, in the case of a deficiency, the
security trustee is to “pay” an appropriate proportion of the due liability. The
language is different. That, he said, is because it is considering different things. The
point is a fair one. If both provisions had been focusing on like considerations, there
would have been at least some attempt to reflect that in their drafting.
89.
Fourth, the argument is anyway inconsistent with the scheme of clause 7. The
proposition that realisation period debts were intended, in a case of perceived
insolvency, to be satisfied out of the short term pool does not in my opinion fit
comfortably with the way in which that pool was supposed to operate. The definition
of the “short term pool” defines it as one that was to be applied pursuant to clause
7.11. Although the pools can be established at any time during the realisation period,
the second sub-paragraph of clause 7.11.1 shows that the application of the assets in
the short term pool is only intended to commence after the end of the realisation
period. The second charge on that fund is described in clause 7.11.2, which requires
the security trustee:
“… to pay when due or as soon thereafter as can practicably be
arranged all principal, interest or other amounts in respect of the
Issuer’s Short Term Liabilities to Beneficiaries (pro rata to the
respective amounts of the Short Term Liabilities due, owing or
incurred to each Beneficiary);”
I do not understand the sense of the words in parenthesis, which appear to state the
obvious (it is the proviso to clause 7.11.2 that deals with a perceived deficiency);
more importantly, I also do not understand how that provision can be said to include
an obligation to pay liabilities that have fallen due for payment before the expiry of
the realisation period. Interpreted in the context of clause 7 as a whole, the words
“when due” appear to me to mean “when falling due after the realisation period”.
They are inapt to catch liabilities that had accrued due during the realisation period.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
There is a good reason why they were not intended to catch such liabilities: clause 7.6
required them to be discharged during the realisation period.
90.
That interpretation admittedly leaves the pre-enforcement debts in the cold. If they
are covered neither by the third sentence of clause 7.6 nor by clause 7.11.2, how are
they to be paid? As I have said, I consider that they have simply been overlooked in
the working out of the scheme of clause 7. But I find it impossible to interpret the
STD as intending to leave them to be satisfied out of the short term pool whilst the
liabilities of the realisation period creditors were to be discharged (if only “so far as
possible”) during the realisation period. As it seems to me, the omission to deal
expressly with the pre-enforcement debts is just one of several infelicities in the
drafting of the STD, but it is not one that helps the arguments of Parties C and D. In
my view the only rational interpretation of the STD is that the pre-enforcement debts
are to be treated as impliedly included within the class of liabilities referred to in the
third sentence of clause 7.6. I agree with what Lloyd LJ has said on that.
91.
I am not, therefore, prepared to accept the arguments of Parties C and D, persuasively
though they were advanced by Mr Mortimore and Ms Prevezer. As between Parties
A and B, I agree with Lloyd LJ’s reasons for rejecting Party B’s submission,
attractively though it was presented by Mr Sheldon. I cannot usefully add to what he
has said. It follows that, like Lloyd LJ, I agree with and accept the submissions of
Party A.
92.
I think it likely that many lawyers may be instinctively surprised at such a conclusion,
since the culture with which they will be familiar is one ordinarily providing for a
pari passu sharing in an insolvency. The notion of first come, first served, or pay as
you go, is alien to that culture and so cannot be right. I too had an instinctive initial
sympathy with the case advanced by Parties C and D, since when the available pot is
too small to pay everyone in full, a pari passu distribution has an obvious appeal. But
we are not here concerned to apply any conventional insolvency regime. The STD
reflects a commercial bargain made between, or on behalf of, the interested parties
and our task is to interpret what that bargain was. It seems to be apparent that the
STD foresaw the possibility that any enforcement might be either a solvent or an
insolvent one as regards secured creditors. It is, however, improbable that it foresaw
the possibility of the extraordinary, probably unprecedented, market events that have
recently unfolded. In those extraordinary events, Party A’s successful argument can,
on one view, perhaps be regarded as having achieved an unfair result. But any such
assessment necessarily assumes that the parties had made some different bargain
which is not being respected. This litigation is concerned with ascertaining the
bargain they in fact made. I have expressed my view as to what it was, and the
court’s duty is to give effect to it. It is not the court’s function to re-write it.
Lord Neuberger of Abbotsbury
Introductory
93.
I gratefully adopt Lloyd LJ’s admirable description of the relevant facts and his recital
and explanation of the terms of the STD. I would also like to express my agreement
with him as to the quality of the judgment below, and the efficacy and concision of
the arguments we heard.
Judgment Approved by the court for handing down.
94.
Re Sigma Finance Corporation (in Administrative Receivership)
The STD is concerned to identify what occurs on the happening of an “Enforcement
Event”. The SIV’s assets effectively pass into the control of the Trustee, whose
primary duties are set out in clause 7. The Trustee has 60 days from the
“Enforcement Date” to match the realisable assets and cash (which I shall refer to as
“the assets”) of the SIV, so far as possible (if I may use that expression), against the
SIV’s liabilities as they fall due. This involves the creation of a “Short Term Pool” to
meet the “Short Term Liabilities”, and “Long Term Pools” to meet the “Long Term
Liabilities”. The issue on this appeal is the meaning and effect of the last of the three
sentences of clause 7.6 (which I shall call “the provision”), which is concerned with
those Short Term Liabilities which fall due during the Realisation Period (which I
shall call “the RP liabilities”).
The rival interpretations
95.
As the arguments developed, four possible meanings were ascribed to the provision.
These were:
a)
Any RP liability has to be paid by the Trustee in full on the date it falls
due, so long as the SIV has assets, so that there would be a “first come,
first served” approach as between RP liabilities; only if there are
sufficient assets to pay the RP liabilities in full, will there be anything
left to meet any of the liabilities falling due after the end of the
Realisation Period; this is party A’s contention, which was accepted by
the Judge;
b)
This is similar to meaning (a), in that the Trustee must devote the assets
first to paying off the RP liabilities in full, but those liabilities are to be
treated equally, rather than paid on a first come first served basis; so if
there are insufficient assets to pay the RP liabilities in full, they are to
be paid on a pari passu basis; this is party B’s contention;
c)
The consequence of the words “so far as possible” is that, while the
provision imposes a duty on the Trustee to pay off the RP liabilities in
full as they fall due, this duty only applies if there are sufficient assets
to pay all Short Term Liabilities and Long Term Liabilities in full;
otherwise the RP liabilities are to be treated as part of the Short Term
Liabilities to be met out of the Short Term Pool under clause 7.11; thus,
the provision does not apply in an insolvent situation; this is parties C
and D’s original contention;
d)
The words “so far as possible” mean that, while the Trustee has a duty
to pay each RP liability as it falls due, the payment is limited to the
amount which the Trustee is confident will be paid in respect of that
liability pursuant to the provisions of clause 7.11.2 and the provisos
thereto; at the end of the Realisation Period, any balance due in respect
of the RP liability is to be paid from the Short Term Pool; unlike
meaning (c), the provision applies both in insolvent and solvent
situations; this is a variant on parties C and D’s case, and, although
mentioned on behalf of party B, it emerged with greater significance as
a result of the oral argument in this court.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
96.
In an insolvent situation, it seems to me that the first two meanings are in one
category, and the second two meanings are in another. Meanings (a) and (b) each
involve the RP liabilities receiving preferential treatment over the other liabilities,
whereas meanings (c) and (d) each involve the RP liabilities ranking equally with all
other liabilities. So, under meanings (a) and (b), the RP liabilities are paid in full
from the assets, and it is only from any remaining assets that any subsequently
accruing liabilities can be paid. Meaning (c) involves all liabilities being treated
equally, as RP liabilities can only be paid in full during the Realisation Period if
subsequently accruing liabilities can also be paid in full. Meaning (d) also involves
all liabilities being treated equally, as no RP liability is to be met to a greater extent
during the Realisation Period under the provision than it would be out of the Short
Term Pool under the provisions of clause 7.11.
97.
In analytical terms, the first two meanings also seem to be in a different category from
the second two meanings. Meanings (a) and (b) equate the phrase “so far as possible”
with “so long as there are assets to do so”, whereas meanings (c) and (d) suggest that
the phrase amounts to “so far as is consistent with the Trustee’s other obligations in
clause 7 to do so”. Meaning (d), however, is unlike the other three meanings in that it
alone envisages part payment of RP liabilities being effected under the provision,
whereas the other three meanings all envisage it being limited to payment in full.
Thus, meaning (d) ascribes to the provision the effect of mitigating the disadvantage
which would otherwise be suffered by creditors under Short Term Liabilities which
mature during the Realisation Period of having to wait until the end of the Realisation
Period before receiving any payment. It thereby would put them, as far as possible, in
precisely the same position as all the other creditors under Short Term Liabilities, who
are to be paid pursuant to clause 7.11.2 when the liabilities fall due for payment.
The approach to construction
98.
Taking the provision on its own, there is considerable attraction in the Judge’s view
that the more natural meaning of the phrase is meaning (a) or (b). However, the
provision must, of course, be construed not merely by reference to the language used,
but also in its documentary and commercial contexts. Ms Prevezer QC, for party D,
suggested that it was illegitimate to start by considering the effect of the language of
the provision on its own. However, while one is seeking to interpret the document as
a whole, the ultimate issue between the parties turns on the meaning of the provision,
and, in order to resolve the issue, the reasoning and analysis have to start somewhere.
The natural, indeed, I would have thought, the inevitable, point of departure is the
language of the provision itself. However, where the interpretation of a word or
phrase is in dispute, the resolution of that dispute will normally involve something of
an iterative process, namely checking each of the rival meanings against the other
provisions of the document and investigating its commercial consequences.
99.
Most words, and a fortiori, most phrases, can have more than one meaning, or at least
different shades of meaning. This is certainly true, for instance, of the word
“possible”, which can, for instance, mean physically achievable or legally
permissible, to give two relevant examples. However, to consider what words could
mean in abstract is not normally a helpful exercise. What one has to do, when
assessing each rival interpretation, is to ask whether the words at issue are capable of
having the meaning contended for, but even that question cannot be judged free of the
documentary and commercial context. The more a particular interpretation, which
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
accords well with the words in question judged on their own, produces a
commercially improbable result and is hard to reconcile with other provisions in the
document, the more ready the court will be to give the words another, perhaps
linguistically more strained, interpretation, if that other interpretation complies with
the other provisions and commercial reality.
100.
The argument that the STD is a long and carefully drafted document is one which
weighed with the Judge, but I am bound to say that it does not seem to me to take
matters much further. It is certainly a full document, but it does not strike me as
particularly carefully (or, it is fair to say, particularly carelessly) drafted. Documents
such as the STD are prepared in many different ways. They often have provisions
lifted (sometimes with bespoke amendments) from other documents; they often have
different provisions drafted inserted or added to by different lawyers at different
times; they often include last-minute amendments agreed in a hurry, frequently in the
small hours of the morning after intensive negotiations, with a view to achieving
finality rather than clarity; indeed, often the skill of the drafting lawyer is in
producing obscurity, rather than clarity, so that two inconsistent interests can feel
satisfied with the result. If there is subsequent disagreement as to the effect of the
document, then other lawyers then have to do their best to determine what, in all the
circumstances, the document means.
101.
Further, I do not think it is normally convincing to argue that, if the parties had meant
a phrase to have a particular effect, they would have made the point in different or
clearer terms. That is a game which all parties can normally play on issues of
interpretation. Save in relatively rare circumstances (e.g. where the document
concerned contains a provision elsewhere in different words which has the effect
contended for by one of the parties), it does not take matters further. Of course, if the
argument amounts to saying that a particular meaning is not one the phrase naturally
bears, that is fair enough, but, in that case, it is normally an old argument in new
clothes.
Commercial common sense
102.
Meanings (a) and (b) appear to me to be unattractive in terms of business common
sense, for three reasons. First, they could well require the Trustee to realise assets in a
thoroughly uncommercial way, namely on a “fire-sale” basis, to the (potentially
extreme) detriment of those whose debts fell due after the Realisation Period. The
Trustee would be absolutely obliged to sell realisable assets at any price that could be
got, in order to meet RP liabilities on the dates they fall due during the Realisation
Period. The unattractive nature of this contention, particularly in a weak market, is
well demonstrated by what Briggs J said in Re Cheyne Finance plc (in receivership)
(No 2) [2008] 1 BCLC 741, at paras 60 and 65. No such problem arises on meanings
(c) or (d). Indeed, this is such an unattractive result that, rather unusually, the
receivers, who of course take a neutral position in these proceedings, have thought it
right to instruct Mr Moss QC to draft a short note indicating this to the court.
103.
Mr Howard QC, for party A, suggested that, in 2003, when the STD was executed, the
unexpectedly severe nature of the insolvency which has arisen, due of course to the
events in the world financial markets over the past year, and, perhaps in particular, the
last few months, could not have been foreseen. That may well be true. However, it is
inherent in meanings (a) and (b) that the drafters of the STD envisaged a situation so
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
bad that there would be insufficient assets to pay off all the RP liabilities in full:
otherwise, there would have been no point in including the words “so far as possible”.
Accordingly, a weak market, with all its concomitant consequences, must have been
within the contemplation of the drafters.
104.
I should add that it may well be that, as Mr Sheldon QC for party B contended,
meaning (b) may have a less drastic effect than meaning (a) in terms of fire-sale
consequences. However, even on meaning (b), the Trustee has to try to meet any RP
liability on the date it falls due. Further, any force in the contention would depend on
the facts. If, for instance, there were only two liabilities which fell due for payment
during the Realisation Period, and it was on the first and second days, the fire sale
consequences would be as bad as under meaning (a).
105.
Secondly, under meanings (a) and (b), a creditor whose debt falls due during the 60
days of the Realisation Period may be paid in full, whereas a creditor whose debt falls
due a day after that period will not – and he may indeed receive nothing. The
unattractiveness is reinforced by the fact that some of the liabilities of the SIV could
be made to become due during the realisation period by service of a notice, so there is
the possibility of manipulation as well as arbitrariness. A not dissimilar type of result
was described as “bizarre” by Lloyd LJ in Re Whistlejacket Capital Ltd (in
receivership) [2008] EWCA Civ 575, at para 58. No such problem is encountered if
meaning (c) or (d) is correct.
106.
Thirdly, meanings (a) and (b) give rise to the problem that liabilities that fell due
before the Enforcement Date, but had not been paid, would be treated worse than
liabilities which fell due during the Realisation Period. Such pre-Enforcement Date
liabilities would not naturally fall within the ambit of the expression “Short Term
Liabilities falling due for payment during [the Realisation P]eriod” in clause 7.6. If
meaning (a) or (b) is correct, liabilities falling due during the Realisation Period
would be met in full, whereas debts which had fallen due before the start of that
period would not only be paid later, but might not be paid in full (or even at all). Mr
Howard supported the Judge’s view that the expression I have just quoted could be
construed as treating pre-Enforcement Date liabilities as falling due each day they
remain unpaid. That involves rewording rather than interpreting the provision, and it
is scarcely consistent with the contention of parties A and B that the provision should
be given a natural meaning.
107.
It was suggested that a problem would exist in relation to unpaid pre-Enforcement
Date liabilities even on meaning (c) or (d). I do not accept that there would be much
of a problem in that connection. Under meaning (c), in an insolvent situation, the
provision would not apply, and pre-Enforcement Date liabilities would be treated like
all other Short Term Liabilities, and, in a solvent case, pre-Enforcement Date
liabilities would presumably have been met before the Enforcement Date, and, if they
had not, there would be the relatively minor oddity of such debts waiting for 60 days
before being repaid in full, whereas debts falling due during the Realisation Period
would be paid in full during that period. Effectively the same minor oddity could
occur under meaning (d). Accordingly, there is a potential, if rather small, oddity, in
relation to pre-Enforcement Date liabilities under meaning (c) or (d), but they are far
less significant than the problem which appears to arise under meaning (a) or (b).
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
108.
I accept that it may be that pre-Enforcement Date liabilities were simply overlooked
by the drafters of the STD, but that does not answer the point. First, the cause of the
failure to deal with such liabilities is a matter of speculation. Secondly, the more
surprising the result of an oversight the less likely it is to have occurred.
109.
Meaning (c) is also not without its commercial difficulties. Thus, save in a plainly
solvent or plainly insolvent situation, it appears to me that it would be rather difficult
to work in practice. It may often take quite some time from the Enforcement Date for
the Trustee to form a view as to whether the assets and liabilities are such that the
situation is a solvent one, and he can safely pay off the RP liabilities pursuant to the
provision, particularly given the obligation match assets and liabilities as required by
clauses 7.6 and 7.7. Indeed, in many cases, it may be difficult to be sure whether the
situation is one of solvency until the end of the Realisation Period and the finalisation
of the Pools.
110.
However, a not dissimilar problem arises under meaning (a), and, depending on when
the RP liabilities accrue, a not dissimilar problem could arise under meaning (b). If,
during the currency of the Realisation Period, the Trustee has to sell assets on a fire
sale basis, it could well be very difficult for him at the same time to carry out and
complete his obligation to form the Pools and comply with provisions such as clause
7.9. If he is having to sell assets at the best price he can get in order to meet the RP
liabilities as they fall due, it would be hard to estimate how many assets would remain
for the Pools, and how to distribute them, as he may well not even know which assets
he may have to sell to pay off the RP liabilities, not least because some of those
liabilities may well only become RP liabilities as a result of a notice served during the
Realisation Period.
111.
No such problem arises on meaning (d). Under that meaning, when an RP liability
falls due, the Trustee has to pay as much as he can be confident that the creditor
concerned will receive if he had to wait for payment under clause 7.11 from the Short
Term Pool at the end of the Realisation Period.
112.
A further practical criticism which was made by Mr Howard of meaning (c) was that,
if it was right, the provision would hardly ever be operated, as by far the most likely
happening giving rise to an Enforcement Event would be one involving an insolvent
situation, and therefore the provision would almost always be a dead letter. There is
something in that point, which does not apply to meaning (d) any more than it applies
to meanings (a) and (b). However, it is clear from the wording and structure of clause
7 that the STD envisages that there could be an Enforcement Event which involved no
insolvency. Further, it was conceivable that the SIV could be relevantly solvent even
after a default triggering an Enforcement Event, as meaning (c) excludes the provision
being operated in the case of balance sheet insolvency as between the SIV and the
secured creditors. The default might be attributable to a cash flow problem, or, as Ms
Prevezer pointed out, the SIV could be balance sheet insolvent only as against
unsecured creditors.
113.
Mr Howard made the seductive point that all that meaning (a) involved was the
continuation of the “pay as you go” regime in relation to repayment of liabilities
which applied during the period before the Enforcement Date. In other words, he
said, the drafters of the STD, faced with selecting a date when this regime should end,
opted for the end of the Realisation Period, rather than the beginning. Over and above
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
the points already made, Mr Sheldon pointed out the commercially unattractive nature
of this argument. Once the Enforcement Date arrives, the SIV can no longer operate
as it did before. Clause 7.1 makes it clear that the security is enforceable by the
Trustee: in other words, it is then that the floating charge crystallises. Clause 10.1.4
also makes it clear that from that date no further notes can be issued.
114.
As already explained, the attraction of meaning (d) is that it enables the RP liability
creditors to be treated as nearly as possible in the same way as the creditors under the
other Short Term Liabilities. In the absence of the provision, the former creditors
would receive nothing on the date the RP liabilities fall due, and would have to wait
till the end of the Realisation Period. The effect of the provision is to enable creditors
under RP liabilities to be repaid, at least to a substantial extent, on their respective due
dates in the same way as all other Short Term Liability creditors.
115.
It was also contended that meaning (a) resulted in a scheme which was “very clear,
simple and workable”. So it does, but the other three meanings do not present much
difficulty either. It is true that they each require the Trustee to take a view during the
Realisation Period as to the solvency or degree of insolvency of the SIV – to decide
whether to pay RP liabilities as they fall due or whether to wait till the end of the
Realisation Period under meaning (b); to decide whether the situation is solvent or not
under meaning (c); and to decide what proportion of each RP liability it is safe to pay
under meaning (d). However, these are not unclear, complex or onerous tasks. Given
also that meanings (c) and (d) produce far more commercially sensible results, and
meaning (b) produces a slightly more commercially sensible result, than meaning (a),
the contention based on clarity, simplicity and workability does not assist, in my
opinion.
The language of the provision
116.
It was said by Mr Mortimore QC, for party C, that meanings (a) and (b) give the
phrase “so far as possible” very little point. If the phrase was not there, he said, the
arguments in favour of the two meanings would be precisely the same. The Judge
suggested that the phrase was included to ensure that the Trustee had no liability for
payment under the sentence, if the SIV had insufficient funds, but, with respect, that
will not do. The closing words of the sentence make it clear that payment thereunder
is to be from the SIV’s cash and assets. However, I do not consider that there is any
need to search for a reason for including the phrase “so far as possible” if meaning (a)
or (b) is correct. To my mind, the phrase cannot fairly be described as redundant or
surplusage merely because the provision would have the same meaning without it
being there. If the drafter had intended meaning (a) or (b), and had appreciated that
there might be insufficient assets to meet all the RP liabilities, it would have been
acceptable drafting, indeed probably sensible drafting, to flag up that possibility by
using just such words as “so far as possible”.
117.
As the Judge said in para 24 of his judgment, meaning (a) does indeed accord with
“the natural and ordinary” effect of the language of the provision, and a closer, more
analytical approach to the wording of the provision in its context does not throw up
any inherent linguistic problems with that meaning. Meaning (b) does not accord
quite so well with the natural and ordinary effect of the language, as it gives little real
weight to the words “on the due dates therefor”.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
118.
As for meaning (c), it appears to me that it involves giving the phrase “so far as
possible” a rather unnatural meaning in two respects. First, it treats the word
“possible” as having the effect of “not inconsistent with the provisions of clause
7.11.2 (including the provisos thereto)”. That is not absurd, but it is rather strained.
Secondly, it attributes to the words “so far as” the meaning “if”, whereas the words
naturally mean “to the extent that”. In other words, the expression “so far as” carries
with it the notion of degree, whereas meaning (c) ascribes to them a binary effect:
depending on the solvency of the SIV, either the provision applies or it does not.
119.
Meaning (d) raises no problem with the words “so far as”, because they serve to
emphasise that, if, at the time it falls due, an RP liability is estimated to be repaid at
the rate of at least, say, 60p in the £ under clause 7.11, then that is what must be paid
at the time it falls due. At first sight, at any rate, meaning (d) raises the same problem
as meaning (c) in relation to the word “possible”. However, it seems to me that, on
any view, meaning (d) involves a more natural use of the word: in an insolvent
situation, the Trustee, would have to ask himself what proportion of an RP liability it
was safe (or “possible”) to pay, on the basis of what was the maximum reduction
which would have to be made to the repayment of Short Term Liabilities pursuant to
proviso (a) to clause 7.11.2.
120.
Indeed, there is another point in this connection, which, while very pernickety, can be
said to support meaning (d). The word “discharge” is used in the provision, which
contrasts with “pay” in clause 7.11.2 (and indeed “payment” in the provision itself).
“Pay” and “payment” appear to mean “redeem in full”, so “discharge” as used in the
provision may well mean “redeem to the extent permitted by clause 7.11.2, as
qualified by proviso (a)”. (The difference in the two verbs is not explicable on the
other three meanings, but I do not consider that that counts against them, at least in a
document such as the STD. It is more that the distinction in language provides some
slight, maybe very slight, support for meaning (d).) However, if “discharge” is
distinguishable in this way from “pay”, then it reinforces the point that, on meaning
(d), the word “possible” is there solely to indicate that the Trustee need only discharge
an RP liability under the provision to the extent that he feels would be safe, on the
basis that proviso (a) to clause 7.11.2 may or will apply to paying off the Short Term
Liabilities. That would not be quite as natural a use of the word “possible” meaning
(a) involves, but I do not regard it as a particularly strained use.
121.
Another criticism which may be made of meanings (a) and (c), which does not apply
to meanings (b) or (d), was identified by Mr Sheldon. Under meaning (a) or (c), it
would have been unnecessary to include the words “During the Realisation Period” as
well as “during such period”: if payment must be made in full “on the due dates” of
any liability falling due in the Realisation Period, then there would have been no need
to say that this obligation applies during that period. However, if, as would be the
case, under meaning (b), there may have to be a pari passu exercise carried out in
respect of the RP liabilities, there is no such duplication. Equally, under meaning (d),
if, during the Realisation Period, the Trustee may have to assess how much it is
“possible” to pay in respect of an RP liability as it falls due, there is no redundancy,
given the possibility of a further payment being made in respect of that liability after
the Realisation Period, out of the Pool pursuant to clause 7.11.2.
122.
Another point Mr Howard makes against meaning (d) is that it is striking that the
provision contains no “complex and elaborate” terms such as those found in clauses
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
7.11 and 7.12. But, with respect, that misses the point that meaning (d) simply
ascribes to the provision the function of accelerating at least part of the payment in
respect of RP liabilities, which would otherwise have to wait until the end of the
Realisation Period under clause 7.11. There is thus no reason for the inclusion of
such “elaborate and complex” terms: in effect, albeit on a sort of provisional basis,
they are to be taken into account when the Trustee decides how much it is “possible”
to pay under the provision.
123.
A short, and fairly telling, argument against meanings (c) and (d) is that they place a
surprising amount of weight on the phrase “so far as possible”. In the absence of the
phrase, it would be very difficult indeed to contend that the provision bore any
meaning other than (a) or (b), and, as the Judge rightly indicated, the phrase does not
immediately strike one as apt to convert the provision into having meaning (c) or (d).
However, this is no more telling (indeed, in my view, rather less telling) than the point
that meanings (a) and (b) give a surprisingly radical effect to a single sentence at the
end of clause 7.6, when viewed in the context of clause 7 as a whole. Further, in a
sense this argument is the obverse of the point that meaning (a) gives little effect to
the phrase.
124.
Although it is inevitable that, on questions of construction, one concentrates on the
detailed wording of a centrally relevant phrase, it is important not to lose sight of the
point that one is construing the document as a whole. The essential question is
whether, in its documentary and commercial context, the phrase is capable, indeed
should properly be interpreted, as a matter of language, as having the effect ascribed
to it by meanings (c) and (d), taken as part of the provision, which in turn must be
construed as part of the STD.
The provision in its documentary context
125.
There is, in my opinion, force in the point made by Mr Mortimore that meanings (a)
and (b) sit uneasily with the fact that the provision is the third sentence of para 7.6,
whose first two sentences are concerned with the formation of the Pools. This
emphasises the relatively subordinate nature of this third sentence. It would be
somewhat surprising, although obviously not impossible, if it created not merely an
independent obligation, but one which might wholly undercut the obligation
enshrined in the first two sentences, as expanded by clauses 7.7 to 7.12.
126.
Looking at clause 7.6 alone, the “reasonable endeavours”, “advice of investment and
other advisers”, and the “discretion” afforded to the Trustee in the first two sentences
sit somewhat uneasily with the notion of an absolute obligation to sell assets,
whatever the circumstances, and however disadvantageous to other creditors, in order
to meet RP liabilities. More broadly, it would seem surprising if the whole structure
carefully set up by clauses 7.6 to 7.12 (including the relatively detailed Pool
provisions in clauses 7.6 and 7.7 and the specific “waterfall” provisions of clauses
7.11 and 7.12) could be rendered wholly nugatory by the operation of the final
sentence of clause 7.6, whose location and lack of detail suggest that it was intended
to be a piece of practical, possibly ancillary, machinery. As already mentioned, it
cannot be said that the fact that it has an unanticipatedly radical consequence is due to
the current extraordinary economic situation: meanings (a) and (b) each require the
assumption that the drafters of the provision foresaw that there might be insufficient
assets even to pay out all the RP liabilities.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
127.
In addition, the obligation in the first sentence of clause 7.6 to establish a Short Term
Pool takes one, via the definition of that expression, to clause 7.11, which explains
that the Short Term Pool monies are to be used to pay the Short Term Liabilities,
which include the RP liabilities (as the Realisation Period is the first 60 of the “365
days from the Enforcement Date”). If meaning (a) or (b) is correct, however, it seems
clear, indeed Mr Howard accepts, that the Short Term Liabilities would never include
the RP liabilities. That is because they would all have been paid off pursuant to the
provision, or, if they had not been so paid off, it would be because there were no
assets left, in which case the concept of Short Term Liabilities would be irrelevant.
128.
On the other hand, meanings (c) and (d) require the provision to be operated
consistently with the obligations of the Trustee to set up the Pools, to be found in the
first sentence of clause 7.6, and to operate them in accordance with clauses 7.11 and
7.12. Under meaning (c), the RP liabilities are within that expression in clause 7.11,
although their repayment may be effectively accelerated, albeit only in a solvent
situation, pursuant to the provision. Under meaning (d), their repayment would also
be accelerated in an insolvent situation, although the Trustee will often (I suspect
normally) conclude that it is safe (or “possible”) to pay a proportion of a RP liability
under the provision which is ultimately less than the proportion which is finalised
pursuant to clause 7.11 after the end of the Realisation Period. Despite Mr Howard’s
suggestion to the contrary, it seems to me clear that any consequent balancing
payment would be covered by clause 7.11, not least in the light of the words “in
respect of” in clause 7.11.2. If one accepts that the provision merely serves to help
overcome any delay in the repayment of the RP liabilities under clause 7.11, then
there can be no difficulty in concluding that, if it transpires that there has been an
underpayment once the Pool is finalised, clause 7.11 enables that underpayment to be
made good.
129.
Mr Howard also pointed out that clause 7.11.2 required the Short Term Liabilities to
be paid when “due” which, he said, was inconsistent with meanings (c) or (d). But
clause 7.11.2 refers to payment “when due or as soon thereafter as can be practicably
arranged”. As I see it, if, as meaning (c) assumes, the provision cannot apply in an
insolvent situation, then payment of RP liabilities when they fall due is not “possible”
in an insolvent situation, and pro-rated payment of such liabilities must be made out
of the Pool “as soon as practicable”, namely at the end of the Realisation Period (in
the same way as any unpaid pre-Enforcement Date liabilities). The position is even
simpler under meaning (d): an initial payment (as much as is safe or “possible”)
should be made under the provision when an RP liability falls “due”, and any balance
should be paid out of the Pool “as soon as practicable”.
Conclusion
130.
In all these circumstances, I consider that meaning (d) is correct. It does no violence
to the words of the provision, although I acknowledge that it involves a slightly
strained meaning of the word “possible”. I agree with the Judge that meaning (a)
accords with the sense of the words as a matter of first impression. Meaning (c) does
involve giving the expression “as far as possible” a fairly strained meaning. Meaning
(b) is less linguistically satisfactory than meaning (a), as Lloyd LJ and the Judge have
said.
Judgment Approved by the court for handing down.
Re Sigma Finance Corporation (in Administrative Receivership)
131.
Commercially and in the context of clause 7 as a whole, meaning (d) seems to me to
be more satisfactory than meaning (c), and both are very much more satisfactory than
meanings (a) and (b). Taken together, it appears to me that the factors discussed
above establish that proposition. Rimer LJ suggests that meaning (a) would surprise
many lawyers. I agree, but that is not my real concern about meaning (a). My
concern is that it produces an outcome which would surprise (or more than surprise)
reasonable people in the commercial world; accordingly it is not an outcome which I
regard it at all likely as having been intended.
132.
The fact that clauses 7.11.2 and 7.12.2 contain detailed provisions governing pro rata
payment in an insolvent situation, as pointed out by Lloyd LJ at para 69 of his
judgment, does not seem to me to point in favour of meaning (a). With respect, at
best it begs the question whether the provision is merely intended to accelerate the
discharge of RP liabilities from when they would be paid from the Pool, or whether it
was intended to give priority to RP liabilities over the later maturing Short Term
Liabilities. Indeed, I think it goes further than that: the very existence of the detailed
provisions of clauses 7.11.2, 7.12.2, and indeed, 7.9, render it, in my opinion, unlikely
that the drafters of the STD could have envisaged that the whole structure embodied
in clause 7.6 to 7.12 could be effectively swept away by a single sentence at the end
of clause 7.6.
133.
Further, even though the remuneration of the Trustee and the receivers may be
recoverable under clauses outside clause 7, given that meanings (a) and (b)
contemplate that there could insufficient assets to pay all the RP liabilities the absence
of a term such as clause 7.11.1 and 7.12.1 from the provision casts doubt on whether
it really can have been intended that it had meaning (a) or (b).
134.
The fact that three Judges for whom I have the highest respect, Lloyd LJ, Rimer LJ
and (although he did not have meaning (d) before him) Sales J, have concluded that
meaning (a) is correct has caused me to reconsider this conclusion – in particular to
wonder whether I have been persuaded by the commercial merits to adopt an
interpretation which is simply not permissible as a matter of language. My anxiety in
that connection has been reinforced by the fact that the merits of meaning (d) did not
really emerge in these proceedings until after the conclusion of the oral argument.
The fact that a particular interpretation has not previously occurred to any of the
parties or to their advisers, and is put forward by the court deciding the point gives
rise to obvious concerns. However, in the first place, this argument had in fact been
raised, albeit very briefly (a point which I accept cuts both ways). Secondly, one of
the most valuable aspects of the give and take of oral argument is that it sometimes
produces a new or reformulated argument (or gives much greater prominence to an
argument) which had not previously occurred to any of the parties or their advisers (or
had not been advanced by them), and which, on analysis, turns out to be correct.
135.
Having reconsidered the arguments, I remain of the view that meaning (d) is correct,
for the reasons set out above. Accordingly, I would have allowed the appeal of
parties C and D, as the commercial consequences of meaning (d) are very similar
indeed to those of meaning (c), on the basis that they amend their notices of appeal,
and I would dismiss party B’s appeal.
Neutral Citation Number: [2008] EWHC 1594 (Ch)
Claim No: HC08C01225
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
Royal Courts of Justice
Strand, London, WC2A 2LL
Date: 10/07/2008
Before :
THE HON MR JUSTICE FLOYD
--------------------Between :
THE BANK OF NEW YORK
- and (1) MONTANA BOARD OF INVESTMENTS
(2) PARTY A
(3) PARTY B
Claimant
Defendants
----------------------------------------Mr Robin Dicker QC and Mr David Allison (instructed by Allen & Overy LLP) for the
Claimant
Mr William Trower QC and Mr Richard Fisher (instructed by Milbank, Tweed, Hadley &
MvCloy LLP) for the First Defendant
Mr Gabriel Moss QC and Mr Barry Isaacs (instructed by Sidley Austin LLP) for the
Second and Third Defendants
Hearing dates: 3rd and 4th July 2008
--------------------Judgment
Mr Justice Floyd :
1.
This is a case about structured investment vehicles or SIVs. It concerns a Cayman
Island incorporated investment vehicle, a United States security trustee and the law of
the State of New York. It comes before the English Court for an urgently required
decision on the proper construction of one of the underlying agreements. It arises, in
essence, because the parties cannot agree on how the security trustee of a defaulting
SIV should behave when one group of investors wants to direct a quick sale of the
assets, and another group wants to wait for the market to improve.
2.
The Claimant bank (“the Security Trustee”) is the security trustee under an Amended
and Restated Security Agreement dated 27 June 2006 (“the Security Agreement”) of
the assets held by Orion Finance Corporation (“Orion”). Pursuant to and in
accordance with the terms of the Security Agreement, all of Orion’s assets (“the
Collateral”) are charged to the Security Trustee for the benefit of Orion’s Secured
Obligations.
3.
Orion was incorporated on 1 June 1995 under the laws of the Cayman Islands. Orion,
the SIV, invested in a range of asset-backed securities. It funded its investment
activities by issuing various classes of debt securities, including:
i)
Senior Notes;
ii)
Senior Subordinated Notes;
iii)
Capital Subordinated Notes.
4.
The First Defendant is a holder of Senior Notes issued by Orion. On 22 May 2008,
Norris J made an order pursuant to CPR 19.6(1)(b) that the claim be continued against
the Senior Creditor as a representative defendant on behalf of all the holders of the
Senior Notes. I will refer to the First Defendant as the Senior Creditors.
5.
The Second and Third Defendants are the only two holders of the Senior
Subordinated Notes issued by Orion. Also on 22 May 2008, Norris J made an order
pursuant to CPR 39.2(4) that the identities of the Second and Third Defendants are
not to be disclosed in these proceedings. This is an approach which has been adopted
in a number of case concerning SIVs: see Re Cheyne Finance plc [2007] EWHC 2116
(Ch) at [2] (Briggs J); Re Cheyne Finance plc [2007] EWHC 2402, [2008] BCC 182
at [20] (Briggs J); Re Whistlejacket Capital Ltd [2008] EWHC 463 (Ch) at [2]
(Etherton J); Re Whistlejacket Capital Ltd [2008]EWCA Civ 575 (Court of Appeal).
Their identity has not been revealed to me as I did not consider it necessary. I will
refer to the Second and Third Defendants as the Subordinated Creditors, whilst not
forgetting that there are other more junior subordinated creditors, the holders of the
Capital Subordinated Notes (whom they do not represent).
The issues
6.
The Claim Form seeks the determination of the following questions of construction in
relation to the Security Agreement:
(1)
whether the Security Agreement provides the holders of Senior Obligations [i.e.
the Senior Creditors] with the right to direct the Security Trustee with respect to
the time, place and manner of sale of Orion’s assets.
(2)
whether, if such a right exists, such a direction, accompanied by a reasonable
indemnity, is:
(i) a mandatory contractual obligation requiring the Security Trustee to
act consistent with the direction; or
(ii) subject to the discretionary powers granted to the Security Trustee
under the Security Agreement and the general fiduciary duties owed by the
Security Trustee.
(3)
whether the Security Agreement mandates any specific timing for the
liquidation of Collateral following the occurrence of a Mandatory Acceleration
Event when there are insufficient funds available to redeem in full all of the then
outstanding Senior Notes.
7.
The intention of the Claim Form is to decide issues of construction only at this stage.
The Claim Form does not raise any logically subsequent questions as to the precise
content of any fiduciary duties or the way in which any discretion as to timing of the
liquidation of the Collateral should be exercised, which may raise issues of fact.
8.
The Security Trustee, represented by Mr Robin Dicker QC and Mr David Allison, has
remained neutral as to the outcome of the dispute, which has been argued out between
the Senior Creditors (represented by Mr William Trower QC and Mr Richard Fisher )
and the Subordinated Creditors (represented by Mr Gabriel Moss QC and Mr Barry
Isaacs).
The Security Agreement
9.
The relevant provisions of the Security Agreement are either summarised or set out
below. I deal with them in the order in which they appear in the Agreement. Where
they are not merely background I set them out in full to avoid doing so in the text
which follows.
10.
Article II of the Security Agreement deals with the grant of the security interest and
the delivery, maintenance, investment, disposition and preservation of the Collateral.
i)
Section 2.1 contains the grant by Orion of the security interest over the
Collateral in favour of the Security Trustee for the security and benefit of the
Secured Parties (which term includes both the Senior Creditors and the
Subordinated Creditors).
“As collateral for the prompt payment and
performance in full when due (whether at stated
maturity, by acceleration or otherwise) of Secured
Obligations, the Company hereby pledges, assigns,
transfers, conveys and grants a security interest, for the
uses and purpose and subject to the terms and
conditions hereinafter set forth, to the Security Trustee,
for the security and benefit of the Secured Parties (as
their interest may appear) as herein provided, in all the
Company’s right, title and interest in the following
property rights and privileges … (all being collectively
referred to in this Agreement as the “Collateral”)…”
ii)
The Security Trustee is by the same section 2.1 of the Security Agreement to
hold the Collateral
“in trust for the benefit of the Secured Parties (as their
interests may appear) for the uses and purposes and
subject to the terms and conditions set forth in this
Agreement.”
iii)
Section 2.8.4 provides that none of the Secured Parties (other than the Security
Trustee and the Custodian, who in the present case is also the Claimant) shall
have any legal title to any part of the Collateral.
iv)
Section 2.5 provides that, prior to the occurrence of an Enforcement Date,
Orion has the right to arrange or cause to be arranged the purchase or disposal
of any Investment Security and is responsible for making decisions on
investments and dispositions of Collateral which are held by the Custodian.
v)
By contrast, following the occurrence of an Enforcement Date
“only the Security Trustee shall have the right to cause the
disposition of Investment Securities held as part of the
Collateral …and Derivative Contracts held as part of the
Collateral” (emphasis added)
11.
Article V deals with Enforcement Events, rights of recourse, Acceleration Events, the
liquidation and sale of the Collateral and the subordination and other rights of the
Secured Parties.
i)
Section 5.1.1 provides that the Security Trustee
“shall be entitled to enforce the security constituted by this
Security Agreement upon either (i) receiving notice from the
Investment Manager of the occurrence of an Automatic
Enforcement Event or (ii) otherwise becoming aware of the
occurrence of an Automatic Enforcement Event.”
ii)
For present purposes it is relevant to know that an Automatic Enforcement
Event includes a downgrade by the rating agency, Moody’s, of the Medium
Term Notes issued by Orion: Section 5.1.1(b), as happened here. Other events
include breaches of so called “Capital Adequacy Requirements” and an
“Interest Rate Sensitivity Test” and “Currency Sensitivity Test”.
iii)
Section 5.1.1 also provides that, following the enforcement of the security, the
Security Trustee is to “enforce and/or administer the security… in accordance
with and subject to the provisions” of the Security Agreement.
iv)
Section 5.2.1 provides that an Enforcement Event (as opposed to an Automatic
one) occurs upon the first to occur of a number of events. It will be necessary
to return to this provision in connection with an argument on construction
advanced by the Senior Creditors. The qualifying events include various types
of default by Orion on the Notes. There is a similar provision to Section 5.1.1
(Automatic Enforcement Events) under Section 5.2.4 for Enforcement Events.
v)
Automatic Enforcement Events and Enforcement Events trigger the
Enforcement Date, according to the event which is the earliest to occur: see the
definitions in Section 1.1.
vi)
Section 5.4 provides that the obligations owed under the Senior Notes, the
Senior Subordinated Notes and the Capital Notes are “limited recourse”
obligations of Orion. This means that the holders of the Senior Obligations
and Senior Subordinated Obligations (i.e. the Senior Creditors and the
Subordinated Creditors) have recourse only to the Collateral, and the holder of
each Junior Obligation has recourse only to its Specified Portfolio.
vii)
Section 5.5 deals with Mandatory Acceleration Events. The term Mandatory
Acceleration Event is defined at Section 1.1 of the Security Agreement as “the
occurrence of an Insolvency Event with respect to [Orion]”. So far as relevant
here, Section 1.1 provides that an Insolvency Event will occur in relation to
Orion in a number of circumstances, including if Orion “shall fail generally to
pay its debts as they become due”. A Mandatory Acceleration Event can only
occur where an Enforcement Event has occurred.
viii)
Section 5.5 provides what is to happen on a Mandatory Acceleration Event. It
is one of the clauses which I need to construe so I set it out so far as material:
“Upon the occurrence of a Mandatory Acceleration Event,
all Senior Notes shall become immediately due and payable
and [Orion] will, at the request of the Security Trustee, cause
a redemption in whole (but not in part) of the outstanding
Senior Notes ….; provided, however, that if there are
insufficient funds available to redeem in full all of the then
outstanding Senior Notes at par, the Security Trustee shall
collect and cause the collection of the proceeds of the
Collateral and all amounts received on the Collateral shall be
applied towards payment of the Senior Notes on a pro rata
basis based on the amounts which have become so due and
payable, in accordance with the priority of payments set
forth in Section 6.3.”
ix)
The “acceleration” involved in a Mandatory Acceleration Event is that the
payment date of Senior Notes is brought forward if it is still in the future. If
there are adequate “funds available”, the Senior Notes are paid off at par. But
if not, the Security Trustee must look to the proceeds of the Collateral.
x)
Section 5.6.1 deals with the liquidation and sale of the Collateral following the
occurrence of an Enforcement Date and the provision of the Notice of
Exclusive Control (both of which have occurred in the present case). It
provides, amongst other things, that the Security Trustee
“shall have the exclusive right to exercise any and all rights
with respect to the Collateral and, in connection therewith,
may elect to preserve all or any part of the Collateral and/or
collect and convert into cash all or any part of the
Collateral”.
Section 5.6.1 further provides that, if the Security Trustee collects and
converts into cash all or any part of the Collateral, it
“shall sell, assign and deliver the whole or any part of the
Collateral at such place or places as the Security Trustee
deems best, and for cash, at public or private sale, without
demand of performance or notice of intention to effect any
such disposition or of the time or place thereof (except such
notice as is required by law and cannot be waived) ”
and that
“Any sale shall be conducted in a commercially reasonable
manner”.
xi)
Section 5.9.1 provides for the subordination of the Subordinated Senior Notes
and the Junior Notes.
“Each Subordinated Party agrees by its execution of this
Agreement (or if not a party hereto, shall be deemed to agree
by its acceptance of a Secured Obligation and as a condition
to obtaining the benefits of the Collateral) that its right to
payments shall be fully subordinated to payment in full and
retirement of all Unsubordinated Obligations; such
Subordinated Party shall not be entitled to any payment by
or on behalf of the Company or any Company Subsidiary or
from the Collateral or any proceeds thereof (and shall turn
over to the Security Trustee any amounts received in
violation of this Section 5.9) until such payment in full of all
Unsubordinated Obligations”.
xii)
Section 5.9.2 addresses the rights of each Secured Party. This clause forms an
important part of the argument by the Senior Creditors that they are entitled to
direct the Security Trustee with respect to the time, place and manner of the
sale of the Collateral. The Section provides that each Secured Party agrees by
its execution of the Security Agreement (or if not a party to the Security
Agreement, shall be deemed to agree, by its acceptance of a Secured
Obligation and as a condition to obtaining the benefits of the Collateral),
amongst other things, as follows:
“(a) not to bring any action or proceedings or otherwise
attempt to enforce any remedies or direct the Security
Trustee to take any such actions, under this Agreement or
otherwise, with respect to the Collateral or against [Orion] or
any Company Subsidiary, notwithstanding a failure by
[Orion] or any Company Subsidiary to make payment due to
such Secured Party or the breach of any other obligation by
[Orion] or any Company Subsidiary under this Agreement,
the Transaction Documents or any related document, except
that the Security Trustee, acting in such capacity, and
holders of or creditors with respect to Unsubordinated
Obligations shall have the right to take such action to the
extent and in the manner as contemplated by this
Agreement and the Transaction Documents and holders of
Senior Subordinated Obligations shall have the right to
deliver a notice to the Security Trustee of the occurrence of
an Enforcement Event to the extent and in the manner
contemplated by this Agreement and the Transaction
Documents.
Without limiting the generality of the
foregoing, the holders of Junior Obligations will have no
right to cause an Enforcement Event to occur, to direct the
Security Trustee as to the exercise of remedies or to
otherwise enforce their rights with respect to [Orion] or any
Company Subsidiary unless and until all Senior Obligations
and Senior Subordinated Obligations have been paid in full
(emphasis supplied);
(b) following the occurrence of the Enforcement Date, the
Security Trustee shall have the exclusive right to manage,
sell or otherwise deal with the Collateral, and to waive, settle
or compromise any dispute with respect to the Collateral or
the enforcement thereof subject, in each case, to the
requirement that such actions must be consistent with the
terms of the Agreement, including the Enforcement
Management Guidelines;
(c) in enforcing or otherwise dealing with the Collateral or in
enforcing rights under this Agreement or the other
Transaction Documents the Security Trustee shall be
obligated to so enforce or otherwise deal with the foregoing
in a manner consistent with the full subordination of
Subordinated Obligations contemplated by the provisions of
this Section 5.9.”
12.
No party attached any weight to anything in the Enforcement Management
Guidelines.
13.
Article VI deals with Distribution Priorities. Section 6.2 deals with payment priorities
which govern the making of distributions before a Mandatory Acceleration Event.
Section 6.3 sets out the priorities following the occurrence of a Mandatory
Acceleration Event.
14.
Article VII deals with the appointment of the Security Trustee.
i)
ii)
15.
Section 7.1 addresses the appointment and powers of the Security Trustee. It
provides, amongst other things, as follows:
(a)
the Security Trustee “accepts the duties of Security Trustee hereby created
and applicable to it and agrees to perform the same but only upon the terms
of this Agreement”; and
(b)
the Security Trustee “shall take such action and exercise such rights,
remedies, powers and privileges hereunder as are specifically authorized to
be exercised by the Security Trustee by the terms hereto, together with such
rights, remedies, powers and privileges as are reasonably incidental
thereto, in all furtherance of the uses and purposes hereof”.
Section 7.3 deals with the performance by the Security Trustee of its duties.
The Section provides, amongst other things, as follows:
(a)
“The Security Trustee … shall not be liable for any
action taken or omitted to be taken by it in good faith
and in reasonable reliance upon and in accordance with
the advice of counsel selected by it or for any
misconduct or negligence on the part of any agent or
attorney the Security Trustee appointed with due care”.
(b)
“The Security Trustee undertakes to perform only such
duties as are expressly set forth herein and in
accordance with this Agreement.
No implied
covenants or obligations shall be read into this
Agreement against the Security Trustee”.
(c)
“No provision hereof shall be construed to relieve the
Security Trustee from liability to [Orion] or any
Secured Party for its own gross negligence, bad faith
or wilful misconduct; provided that (i) the Security
Trustee shall not be liable with respect to any action
taken, suffered or omitted by it in good faith and
reasonably believed by it to be authorized or within the
discretion or rights or powers conferred on it by this
Agreement unless the Security Trustee was negligent
in ascertaining the pertinent facts or negligent in
determining the requirements imposed by this
Agreement and (ii) the Security Trustee shall not be
liable for any error of judgment made in good faith by
any of its officers or employees, unless such officers or
employees were negligent in ascertaining the pertinent
facts or in determining the requirements imposed by
this Agreement”.
Article IX deals with miscellaneous matters. The following provisions should be
noted:
i)
Section 9.1 deals with third party rights. It provides that the Security
Agreement “shall be a continuing obligation of [Orion] and shall (i) be binding
upon [Orion] and its successors and assigns and (ii) inure to the benefit of and
be enforceable by the Security Trustee, and, to the extent provided herein, the
other Secured Parties and their respective successors and assigns; provided,
however, except to the extent the holders of Senior Subordinated Obligations
can provide a notice of an Enforcement Event under Section 5.2, the
Subordinated Parties and their respective successors and permitted assigns
shall have no rights to enforce any obligations of [Orion] under this
Agreement so long as any Unsubordinated Obligation remains outstanding.”
ii)
Section 9.6 provides that the Security Agreement “shall be governed by and
construed, and the obligations, rights and remedies of the parties hereunder
shall be determined, in accordance with the internal laws (without application
of its conflicts of laws provisions) of the State of New York”.
iii)
Section 9.7 contains an irrevocable and unconditional submission by the
parties to that agreement to the jurisdiction of the courts of New York and
England. Moreover, the parties agree to waive and not to assert any claim that
the suit, action or proceeding is brought in an inconvenient forum or that the
subject matter of such proceedings may not be litigated in or by such courts.
iv)
Section 9.10 provides that the Security Agreement, the Custody Agreement
and the Securities Account Control Agreement constitute the entire agreement
and understanding of the parties.
The Events giving rise to the present issues
16.
During the course of 2007, serious concerns arose in the financial markets regarding
the level of potential defaults by borrowers in the United States sub-prime mortgage
market. This, in turn, led to a material decline in the market values of most asset
classes held in SIV portfolios. As a result, the rating agencies conducted a review of
the SIV sector which led to the downgrading of the ratings of the assets of a large
number of SIVs.
17.
On 30 November 2007, Moody’s downgraded the ratings of Orion’s US$ and Euro
commercial paper and its US$ and Euro medium-term note programmes. This
downgrade constituted an Automatic Enforcement Event under Section 5.1.1(b) and
(c) of the Security Agreement.
18.
On 4 December 2007, pursuant to Section 5.1 of the Security Agreement, the Security
Trustee sent an Enforcement Notice. This, in turn, caused the occurrence of the
Enforcement Date, following which only the Security Trustee has the right to dispose
of the Collateral.
19.
On 6 December 2007, pursuant to Section 5.1 of the Security Agreement, the Security
Trustee sent a Notice of Exclusive Control to the Custodian. The effect of this notice
is that the Security Trustee has exclusive control of the Collateral.
20.
On 14 January 2008, certain Senior Obligations became due and payable and the
Deposited Funds available at that date were insufficient to discharge those
obligations. In order to raise the funds required to meet these Senior Obligations, it
would have been necessary to liquidate a significant amount of the Collateral.
21.
In these circumstances, the Security Trustee’s financial adviser, Henderson Global
Investors Ltd (“Henderson”), advised that, given the extreme illiquidity in the credit
markets generally at that date, and the structured products markets in particular, the
likely realisation values of the Collateral could be insufficient to meet all Senior
Obligations.
22.
In light of Henderson’s advice, the Security Trustee did not realise the Collateral and,
as a result, Orion could not discharge the Senior Obligations that fell due for payment
on 14 January 2008. This failure constituted an Insolvency Event which, in turn,
constituted a Mandatory Acceleration Event under the terms of the Security
Agreement, the effect of which is that all Senior Notes became immediately due and
payable.
23.
Following the occurrence of the Mandatory Acceleration Event, the Security Trustee
sought restructuring proposals from third parties in an attempt to avoid a piecemeal
sale of the Collateral. The restructuring proposals were rejected by the holders of the
Senior Notes and the Senior Subordinated Notes.
24.
In the absence of any acceptable restructuring proposal, the Security Trustee
consulted the holders of the Senior Notes and the Senior Subordinated Notes
regarding the approach which they considered should be taken in relation to the
realisation of the Collateral. The positions of the holders of the Senior Notes and the
Senior Subordinated Notes were opposed both in relation to the rights and obligations
of the Security Trustee and as to the appropriate course that should be taken.
25.
The holders of the Senior Notes have directed the Security Trustee to commence the
liquidation of the Collateral. The Notices require the Security Trustee
“1.
to commence promptly the liquidation of the Collateral
through a public Foreclosure Sale, on or prior to the date that is
30 calendar days after the date of this Direction, to be
conducted in New York and in a commercially reasonable
manner under Section 9-610 of the New York Uniform
Commercial Code and in accordance with Clause 5.6.1. of the
Security Agreement”
26.
The direction to the Security Trustee also required it to arrange the sale to allow
“credit bidding” by the holders of Senior Notes, so as to allow them to use the value
of their holdings to acquire assets forming part of the Collateral.
27.
The Subordinated Creditors did not agree. They in turn have directed the Security
Trustee to refrain from liquidating any Collateral at the present time.
28.
It is in consequence of this disagreement that the present action arises.
New York Law
29.
The Agreement states that it is to be governed by and construed, and the obligations,
rights and remedies of the parties under it determined, in accordance with the internal
laws (without application of its conflicts of laws provisions) of the State of New
York.
30.
New York Law may be relevant in two main areas, namely:
31.
i)
The general principles of law governing the interpretation of written contracts.
These principles are relevant to enable me to construe the Security Agreement
in accordance with the choice of law provision found in the agreement.
ii)
The obligations and duties of a security trustee under New York law. New
York law forms part of the factual matrix against the background of which the
terms of the Security Agreement and the intentions of the parties are to be
construed.
The Security Trustee served an expert report from Professor Steve Thel who is the I.
Morris Wormser Professor of Law at Fordham University in New York City. His
evidence was admitted without cross examination and is uncontroversial. The Senior
Creditors called Professor Theodore Eisenberg who is the Henry Allen Mark
Professor of Law at Cornell University Law School in Ithaca, New York. The
Subordinated Creditors called Professor Steven L. Schwarcz who is the Stanley A
Star Professor of Law and Business at Duke University.
Principles of Construction under New York Law.
32.
The main relevant principles of construction may be summarised as follows:
i)
A contract is to be interpreted so as to give effect to the intention of the parties
as expressed in the words of the written agreement.
ii)
The Court may not by construction add or excise terms, nor distort the
meaning of the terms used and thereby make a new contract for the parties
under the guise of interpreting the written agreement.
iii)
When construing an agreement, the Court should first decide whether the
agreement is clear or ambiguous. The Court may determine an agreement to
be ambiguous when the meaning is not clear or it is reasonably susceptible to
different interpretations.
iv)
If the agreement is determined to be clear and complete, the Court will enforce
it as written according to its plain meaning. If the agreement is determined to
be ambiguous, the Court may have regard to extrinsic (or parol) evidence in
order to construe the agreement.
v)
Security agreements are not subject to special rules of contractual
interpretation. However, a New York court would endeavour to interpret an
agreement under which securities are widely held by investors in an objective
and uniform manner because the agreement at issue is not the consequence of
a relationship between particular borrowers and lenders and does not depend
upon particularised intentions of the parties.
33.
None of the parties here seeks to rely on any parol evidence to clarify any ambiguity,
or suggested that the application of these principles would produce a materially
different construction from the one that would be arrived at by applying English rules.
The duties of a Security Trustee under New York Law
34.
New York has a Uniform Commercial Code (UCC). Article 9-610 provides that
“(a)
Disposition after default After default, a secured
party may sell, lease, license or otherwise dispose of all of the
collateral ….”
(b)
Commercially reasonable disposition. Every aspect
of a disposition of collateral, including the method, manner,
time, place and other terms, must be commercially
reasonable….
35.
It is not possible to contract out of 9-610(b): see 9-602(g).
36.
The UCC includes notes added by the draftsmen, which are highly persuasive as to
how the relevant Article is to be interpreted, but not formally binding. Under “Time
of disposition” it is pointed out that
“This Article [i.e. 9-610] does not specify a period within
which a secured party must dispose of collateral… It may, for
example, be prudent not to dispose of goods when the market
has collapsed”.
37.
Article 9-627 is entitled “Determination of Whether Conduct was Commercially
Reasonable” and provides:
“(a)
Greater
amount
obtainable
under
other
circumstances; no preclusion of commercial reasonableness.
The fact that a greater amount could have been obtained by a ..
disposition…. at a different time or in a different method…. is
not of itself sufficient to preclude the secured party from
establishing that the … disposition … was made in a
commercially reasonable manner.”
38.
Sub-article (b) has a list of dispositions that are commercially reasonable, and
includes a disposition “in the usual manner on any recognized market”.
39.
The experts were agreed that under New York law, before default, a security trustee
has very limited duties. That is because, prior to default, the debtor is solvent and in
charge of the collateral which is under his control. After default New York law
imposes on a security trustee an enhanced duty, that is to say to act as prudent men of
intelligence and discretion employ in their own affairs. The prudent security trustee
would preserve trust assets, not waste them.
40.
Where the experts disagreed is as to the existence and application of the enhanced
duty of prudence in the case where there is a conflict of interest between classes of
creditor. I do not think this dispute really matters. It is more concerned with how the
Trustee is to perform his duties in a particular situation than with any of the questions
of construction which I have to answer. What I derive from the general New York law
pertaining to security trustees is that they are required to exercise prudence, or to put
it another way, judgment in the way in which they deal with trust assets.
The First Issue
41.
The first issue is whether the Security Agreement provides the Senior Creditors with
the right to direct the Security Trustee with respect to the time, place and manner of
sale of Orion’s assets.
42.
It is important, in my judgment, to keep separate and distinct two matters. The first is
the existence of an obligation on the Security Trustee to enforce the security for the
benefit of Senior Creditors, so as to secure the payment of Orion’s obligations. The
second is the execution of that obligation. If the obligation exists, there is no doubt
that the Security Trustee must perform the obligation, but it may not follow that
Senior Creditors have the right to dictate the time, place and manner of execution.
43.
There is no provision in the Security Agreement which expressly lays down that the
Senior Creditors have the right to direct the Security Trustee with respect to the time,
place and manner of sale of Orion’s assets.
44.
The Senior Creditors rely on two matters of background. Firstly they rely on the
granting clause, Section 2.1, as showing an underlying purpose which should inform
construction, namely that the grant to the Security Trustee is “for the prompt payment
and performance when due (whether by acceleration or otherwise) of Secured
Obligations… for the security and benefit of the Secured Parties (as their interests
may appear)”. It is correct that this clause forms part of the contractual context, but it
is no more than that. A general clause of this nature does not under either English or
New York Law have as much weight as more specific clauses which follow it.
45.
Secondly the Senior Creditors rely on the extent of subordination of the rights of the
subordinated creditors.
46.
The parties were not agreed as to the precise nature and extent of the subordination of
the Subordinated Creditors’ rights. It is undoubtedly the case that the Subordinated
Creditors rank behind the Senior Creditors in point of payment: see Section 5.9.1.
But it seems to me that the subordination in this agreement goes further than that: the
rights of the Subordinated Creditors under 5.9.2(a) are limited to delivering a notice to
the Security Trustee of the occurrence of an Enforcement Event. Section 5.9.2(c)
refers to the Security Trustee being obligated to enforce the Collateral in a manner
consistent with “full subordination” of the Subordinated Creditors, and Section 9.1
says that, with the single exception of giving Notice of an Enforcement Event, the
Subordinated Creditors have no rights to enforce any obligations of Orion so long as
any of the Senior Creditors remain unpaid.
47.
Keeping those matters of background in mind, the argument of the Senior Creditors
for the existence of a power to direct the Security Trustee as to the time, place and
manner of sale is founded mainly on Section 5.9.2(a). This provision commences
with a prohibition on, amongst others, the Security Trustee and the Senior Creditors
from “bringing any action or proceeding or otherwise attempting to enforce any
remedies”… “with respect to the Collateral”. The prohibition includes, for good
measure, a prohibition on the Senior Creditors directing the Trustee to take prohibited
action.
48.
The wide prohibition in Section 5.9.2(a) is subject to an exception in the case of the
Security Trustee and the Senior Creditors, who shall have the right to “take such
action to the extent and in the manner as contemplated by this Agreement and the
Transaction documents”.
49.
The Senior Creditors argue that the exception gives them the right to give directions
to the Security Trustee to take action with respect to the Collateral. They say that
“such action” refers back to and includes the giving of directions to the Security
Trustee.
50.
I am unable to see Section 5.9.2(a) as doing anything more than preserving such rights
as the Senior Creditors may have to take action, or give directions to the Security
Trustee to take action, as may be given to them elsewhere in the Agreement.
51.
It is clear that the prohibition is intended to be wide, covering for example the mere
giving of notices, as the exception in favour of the Subordinated Creditors, allowing
them to do just that, shows. The exception in favour of the Senior Creditors merely
brings back in all the things which the Senior Creditors would otherwise be able to do
in pursuance of the Agreement. It is clear, therefore, that if the right to give the
direction specified in the first issue is to be found, it must be found elsewhere in the
Agreement or the Transaction Documents.
52.
The Senior Creditors submit that the Agreement and the Transaction Documents do
contemplate the Senior Creditors giving the Security Trustee directions. The Security
Agreement and Transaction Documents contemplate that the Senior Creditors will be able
to give directions to the Security Trustee to enforce the security against the Collateral.
Thus, Section 11.01 of the U.S. Medium-Term Note program Second Amended and
Restated Indenture (the “Indenture Agreement”) envisages that a meeting of the
holders of the Notes of one or more Series may be called at any time for various
purposes, including:
“(a) to give any notice to the Company, the Guarantor, the
Indenture Trustee or the Security Trustee, to give any directions
to the Indenture Trustee or the Security Trustee, to consent to
the waiving of any Event of Default hereunder and its
consequences, to resolve to direct the Security Trustee after an
Enforcement Event has occurred, to enforce the security in
accordance with the Security Agreement, to provide any other
direction to the Security Trustee in accordance with the
provisions of the Security Agreement or to take any other
action authorized to be taken by the Holders of the Notes of
such Series pursuant to any of the provisions of Article Five”.
53.
The Indenture Agreement is, by Section 3.17, subject to the terms of the Security
Agreement.
54.
The Senior Creditors also point to Section 5.2.1 which states that an Enforcement
event will occur on
“(v) any other event which is an Event of Default in respect
of any series of MTNs with respect to which a majority of
the holders… (represented at a meeting of such holders duly
convened) have passed a resolution in accordance with [the
relevant indenture] directing the Security Trustee to enforce
the security constituted by this Security Agreement”
and to the remainder of Section 5.2.9(a) which prohibits the holders of Junior
Obligations from giving directions to the Trustee until the Senior Creditors and the
Subordinated Creditors have paid. All this, the Senior Creditors argue, points to an
ability in the Senior Creditors to give directions to the Trustee to enforce against the
Collateral.
55.
I am unable to see in these provisions and the Security Agreement as a whole
anything other than an obligation on the Security Trustee to enforce the Security in
accordance with the Security Agreement (an obligation which arises in specified
circumstances under the Agreement), and a power in the Senior Creditors to direct
that the Security Trustee should do so once that obligation has arisen. I can see
nothing whatever in the Agreement that gives the Senior Creditors a power, once the
obligation to enforce has arisen, to direct the time, place and manner of a sale of the
Collateral.
56.
Firstly, it seems to me that the Agreement expressly leaves it to the Security Trustee
to decide how it is to go about enforcing the Security, subject only to the terms of the
Agreement. The Security Trustee is given by section 5.6.1 “exclusive control” of the
Collateral and the “exclusive right” to exercise rights in relation to it, which may
include preserving all or part of it or selling it “at such place or places as the Security
Trustee deems best”. It must do it in a “commercially reasonable manner”. These
provisions are inconsistent with a power in the Senior Creditors to mandate the time,
place and manner of the sale.
57.
Mr Trower endeavoured to reconcile his submissions with the provisions of Section
5.6.1 by saying that that Section only regulated the position in the absence of a
direction. Following a direction from the Senior Creditors, it would be the direction of
the Senior Creditors that would prevail. I am unable to read the Agreement in this
way. I have no doubt that if it had been intended to give the Senior Creditors the
power to trump Section 5.6.1, then this would have been spelled out in the
Agreement.
58.
Secondly, it has to be remembered that the Security Trustee may be obliged to enforce
the security in a wide range of circumstances, in some of which it may be more
important to take account of the interests of classes of creditor other than the Senior
Creditors than in others. The Collateral is held for the benefit of all the Secured
Parties. Against that background it is difficult to see, as a matter of construction of
the Agreement, why any one class, even if they are the senior class, should have the
right to dictate the time, place and manner of any sale.
59.
Thirdly, both the position of a security trustee generally under New York Law, and a
number of other provisions of the Agreement make it clear that the Trustee is not the
mere agent of the creditors, but is required to exercise a discretion. It cannot
surrender that discretion or any part of it to any individual class of creditor. The
language of Section 2.5 “shall have the right”, Section 5.1.1 “shall be entitled”, and
Section 7.3 “error of judgment” all contemplate the existence of a discretion.
60.
Fourthly, I think the difficulty with the Senior Creditors’ position is well illustrated by
the terms of the direction which they have purported to give to the Security Trustee.
The direction purports to lay down the time, place and in some respects the manner of
the sale, but also to direct that it take place in a commercially reasonable manner. It is
plain from a reading of Articles 9-610 and 9-627, however, that the time, place and
manner of sale are themselves aspects of the sale which are required to be
commercially reasonable. On receipt of a direction specifying these matters, the
Trustee could be prevented from conducting a sale in a commercially reasonable
manner. I do not think that the Agreement envisages placing the Security Trustee in
this curious position.
61.
So I would answer the first question of construction by saying that the Senior
Creditors do not have the power under the Security Agreement to direct the time,
place and manner of the sale of Orion’s assets.
62.
None of this is to say that the Security Trustee enjoys anything approaching an
unfettered discretion as to how to enforce against the Collateral. Firstly, the Security
Trustee must (not may) enforce in a manner consistent with the full subordination of
the Subordinated Creditors’ rights in the sense discussed above: see Section 5.9.2(c).
Secondly, it must bear in mind the purpose of the security interest which it has been
granted, which is to ensure prompt payment of the Notes when due. Thirdly it is to
bear in mind that all the Senior Creditors have resolved that it should enforce the
security. That is the framework within he must exercise the discretion which he is
given by the Security Agreement to decide on the time, place and manner of sale of
the Collateral.
The Second Issue
63.
The Second Issue does not therefore arise. Moreover, attempting to answer the
question posed by section 2 on the basis that I am wrong, and the Agreement does
give the Senior Creditors rights which I have held them not to have, would be a
particularly artificial task for the court to undertake in this case.
The Third Issue
64.
The Third Issue is directed at Section 5.5. It asks whether the Security Agreement
mandates any specific timing for the liquidation of Collateral following the
occurrence of a Mandatory Acceleration Event when there are insufficient funds
available to redeem in full all of the then outstanding Senior Notes.
65.
Section 5.5 has to be read against the background of Section 2.1: the security is there
for ensuring prompt payment of obligations when due (including when due by
acceleration). It also has to be read against the subordination provisions which I have
dealt with above.
66.
Section 5.5 makes all Senior Notes due and payable. If there are insufficient available
funds, the Security Trustee must “collect… the proceeds of the Collateral”. It seems
to me that these words are apt to include both receiving the income from the
Collateral and selling the assets forming the Collateral and collecting the proceeds.
Thus, where there is a shortfall in the available funds as compared with the amount
required to pay the Senior Creditors in full, the Security Trustee must collect money
from the Collateral (either by receiving income or forcing sales) so as to raise money
to pay the Senior Notes. If the shortfall is small, the Security Trustee would no doubt
be able to comply with his obligations under this Section without selling any
Collateral at all.
67.
A literal response to the question posed would, of course, be that Section 5.5 does not
lay down any specific timing for the liquidation of Collateral. Indeed it does not
necessarily require, depending on the circumstances, the Collateral to be liquidated at
all. In my judgment a more helpful, and correct answer would be that Section 5.5
requires the Security Trustee, in complying with Section 5.5 to conduct any
liquidation or sale of the collateral in accordance with the requirements of Section
5.6.1. I give my reasons below.
68.
Firstly, I can see no reason to read the guidance in 5.6.1 as to the manner in which
sales are to be conducted (for example that they should be in a commercially
reasonable manner) as disapplied in the case of a sale for the purposes of Section 5.5.
That provision applies following the occurrence of an Enforcement Date, which must
be the case where section 5.5 applies. Section 5.6, as I have already held, gives to the
Security Trustee a discretion over the timing of any sale.
69.
Secondly, the purpose of Section 5.5 is to accelerate the maturity of the Senior Notes,
and, after a redemption request, the collection of assets to redeem the Notes in full.
There is no a priori reason why this situation should require any different regime to
apply to asset sales.
70.
Thirdly, disapplying the provisions of Section 5.6 would simply beg the question as to
what timing should apply to Section 5.5. The Senior Creditors suggested that the
Trustee should sell “as soon as reasonably practicable”. I think that it would be
wrong to imply such a term into the Agreement. To do so would be to imply an
obligation into the Agreement against the Security Trustee, contrary to the terms of
Section 7.3.
71.
Fourthly, I think there are difficulties in the way of excluding the requirement for
commercial reasonableness required by Article 9-610 of the UCC. The phrase “as
soon as reasonably practicable” is not the same thing as “commercially reasonable”. I
should be wary of any construction of Section 5.5 which, by implication, amounts to
contracting out of the requirement for commercial reasonableness, contrary to Article
9-602(g).
Conclusion
72.
In summary:
i)
I have answered Question 1 in the sense that the Security Agreement does not
give the Senior Creditors the right to specify the time, place and manner of the
sale of Collateral;
ii)
I have not therefore answered Question 2;
iii)
I have answered Question 3 in the sense that no specific timing of a sale is
mandated following a Mandatory Acceleration Event when insufficient funds
are available. Rather, any sale should take place in accordance with Section
5.6.1.
Concord Trust v Law Debenture Trust Corporation Plc [2005] UKHL 27 (28 April 2005)
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Judgments - Concord Trust v Law
Debenture Trust Corporation plc
HOUSE OF LORDS
SESSION 2004-05
[2005] UKHL 27
on appeal from: [2004] EWCA Civ 1001
OPINIONS
OF THE LORDS OF APPEAL
FOR JUDGMENT IN THE CAUSE
Concord Trust (Original Appellants and Cross-respondents)
v.
Law Debenture Trust Corporation plc (Original Respondents and Cross-appellants)
ON
THURSDAY 28 APRIL 2005
The Appellate Committee comprised:
Lord Steyn
Lord Hoffmann
Lord Hutton
Lord Scott of Foscote
Lord Walker of Gestingthorpe
HOUSE OF LORDS
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSE
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Concord Trust (Original Appellants and Cross-respondents) v. Law
Debenture Trust Corporation plc (Original Respondents and Crossappellants)
[2005] UKHL 27
LORD STEYN
My Lords,
1.
I have had the advantage of reading the opinion of my noble and learned friend Lord
Scott of Foscote. I agree with it. For the reasons given by Lord Scott I would make the
order which he proposes.
LORD HOFFMANN
My Lords,
2.
I have had the advantage of reading in draft the speech of my noble and learned friend
Lord Scott of Foscote. For the reasons he gives, with which I agree, I would make the
order which he proposes.
LORD HUTTON
My Lords,
3.
I have had the advantage of reading in draft the opinion of my noble and learned
friend Lord Scott of Foscote. I agree with it and for the reasons which he gives I would
make the order which he proposes.
LORD SCOTT OF FOSCOTE
My Lords,
The Issues
4.
This appeal requires two issues to be decided. The first is a short point of construction
of Condition 12 of the terms ("the Bond Terms") applicable to a Eurobond issue of
_510 million 2 per cent bonds ('the Bonds') which fall due for payment in December
2005. The Bonds were issued in 1999 by Elektrim Finance BV ("Elektrim Finance")
and guaranteed by Elektrim Finance's parent company, Elektrim SA. When it is not
necessary to distinguish between the two companies I will, for convenience, refer to
them together as "Elektrim". In November 2002 the Bonds were restructured, the
principal sum outstanding being increased to the _510 million. The Bond Terms, as
amended, were set out in the 2nd Schedule to a Trust Deed dated 15 November 2002.
The parties to this Trust Deed were Elektrim and the Law Debenture Trust Corporation
plc ("the Trustee"). The Bonds are marketable securities, traded internationally. There
is no contractual privity between Elektrim on the one hand and the bondholders on the
other hand. The covenants by Elektrim for payment of the principal sum and interest
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due on the Bonds were covenants entered into with the Trustee (see clauses 2, 7 and 8
of the Trust Deed). Concord Trust holds some 10 per cent in value of the Bonds.
5.
Condition 12 of the Bond Terms provides that:
"The Bond Trustee at its discretion may, and if so requested in writing by the
holders of at least thirty per cent in principal amount outstanding of the Bonds or
if so directed by an Extraordinary Resolution of the Bondholders shall (subject in
each case to being indemnified to its satisfaction), give notice to the Issuer and
the Guarantor that the Bonds are, and they shall immediately become, due and
repayable at their relevant redemption value, together with the accrued Interest
Amount as provided in the Bond Trust Deed, upon the occurrence of any of the
following events ("Events of Default") … ".
6.
Fourteen potential "Events of Default" were described. The second of them included a
failure by Elektrim "to perform or observe" any of its obligations under the Bonds or
the Trust Deed (see para.(ii) of Condition 12). However a proviso to Condition 12 has
the result that a paragraph (ii) failure does not qualify as an Event of Default unless the
Trustee has certified that the failure "is materially prejudicial to the interests of the
Bondholders."
7.
The first issue is whether, on the true construction of Condition 12 and in the events
which have happened (which I will later describe), the Trustee is obliged (subject to its
indemnity rights) to give a Condition 12 notice of acceleration to Elektrim. On this
issue Concord is the appellant and the Trustee is the respondent. The Trustee's
contention is that it cannot come under an obligation to give a notice of acceleration if
Elektrim challenge the existence of the Event of Default proposed to be relied on.
8.
The second issue bears upon the first. The Trustee and Concord agree that the Trustee
can insist on being "indemnified to its satisfaction" against the costs of meeting a
challenge by Elektrim to the existence of the Event of Default in reliance on which the
proposed notice of acceleration would be given, or indeed, a challenge by Elektrim to
the validity of the notice of acceleration on any other ground. But the Trustee contends
that it is entitled also to be indemnified to its satisfaction against its possible liability in
damages to Elektrim if it should transpire that the notice of acceleration was invalid
and that the service of the notice on Elektrim has caused Elektrim to suffer commercial
or financial loss. Concord, however, contends that a cause of action in damages for loss
caused to Elektrim by the giving of an invalid notice of acceleration is a mirage. Absent
fraud or bad faith, which no one has suggested, the feared cause of action could not, in
law, arise. So the second issue is whether the Trustee is entitled to insist on an
indemnity to cover its possible exposure to an action by Elektrim for damages.
9.
Both issues have been presented as issues of some public importance. Your Lordships
were told that the Bond Terms and the Trust Deed were in a form fairly standard for
bond issues. The extent of the obligation resting on a bond trustee where an event of
default is thought by the trustee and the bondholders to have occurred but the existence
of which is disputed by the issuer may arise, and perhaps has already arisen, in relation
to other bond issues. Similar issues might arise in relation to syndicate bank loans.
Certainty as to the extent of the rights and obligations of the various participants in
these important commercial transactions is highly desirable. I would respectfully agree.
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The facts
10.
Neither of the two issues, at least in the present case, is a complex one. The relevant
facts have been fully set out both in the judgment at first instance of the ViceChancellor, Sir Andrew Morritt, and in the judgment of Jonathan Parker LJ in the Court
of Appeal and it is unnecessary for me to do more than refer to the essentials.
11.
The importance to the bondholders of the financial substance and stability of Elektrim
SA, the guarantor under the Trust Deed of Elektrim Finance's obligations, is obvious.
So it is not a matter of surprise that Condition 10(d) of the Bond Terms entitled the
Trustee in certain circumstances to require the supervisory board of Elektrim SA to
appoint to its management board a person nominated by the holders of not less than 25
per cent in value of the Bonds. Condition 10(d) has elaborate provision as to the status
of this nominated director and as to what steps Elektrim SA can take if it considers his
performance on the board to be unsatisfactory. It is unnecessary to refer to any details
other than an express provision that:
"Material decisions of [Elektrim SA] and all financial decisions relating to
amounts exceeding _25,000 may only be taken with the consensus of the entire
Management Board."
12.
Pursuant to Condition 10(d) a Mr Piotr Rymaszewski was nominated by the
bondholders and appointed to Elektrim SA's management board. But in June 2003
Elektrim SA suspended Mr Rymaszewski and invited the bondholders to nominate
someone else for appointment. The bondholders took the view that Elektrim SA had
had no right to suspend Mr Rymaszewski, and that his suspension constituted a breach
of the obligations of Elektrim SA under Condition 10(d). The Trustee presumably
agreed with this view for it gave notice to Elektrim SA on 24 July 2003 requiring
Elektrim SA to remedy the breach. Elektrim SA did not do so and Mr Rymaszewski
has remained suspended. Subsequent to Mr Rymaszewski's suspension Elektrim SA
entered into transactions that, under Condition 10(d), required the consensus of the
whole of the management board. But the suspended Mr Rymaszewski was unable to,
and did not, participate in the decisions approving these transactions.
13.
It is evident that the Trustee was not sure whether the continued suspension of Mr
Rymaszewski from Elektrim's board of management constituted an Event of Default
"materially prejudicial" to the interests of the bondholders for Condition 12 purposes.
A committee of bondholders, including Concord and representing some 40 per cent in
value of the bondholders, contended that it was and that the Trustee should certify an
Event of Default. So the Trustee commenced proceedings in the Chancery Division
asking for directions and a declaration as to whether it was entitled to certify that the
suspension of Mr Rymaszewski was an Event of Default that was materially
prejudicial. Three bondholders, one of them Concord, were joined as representative
defendants.
14.
The Trustee's action was heard by Peter Smith J. He gave judgment on 16 February
2004 and held that the suspension of Mr Rymaszewski was a breach of Condition 10(d)
materially prejudicial to the interests of the bondholders and that the Trustee could so
certify without the need for any further factual investigation. Peter Smith J made a
declaration to that effect. It is important to be clear as to the effect of Peter Smith J's
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declaration. The declaration settled, as between the Trustee and the bondholders, the
question whether the suspension of Mr Rymaszewski was a breach of Condition 10(d),
the question whether that breach was an Event of Default within paragraph (ii) of
Condition 12 and the question whether that Event of Default was "materially
prejudicial to the interests of the bondholders." Peter Smith J's declaration gave an
affirmative answer to each of these questions. But on none of these questions did Peter
Smith J's declaration bind Elektrim. Elektrim had not been party to the proceedings.
15.
On 17 February 2004 the Trustee notified Elektrim that Mr Rymaszewski's suspension
constituted a Condition 12(ii) Event of Default and certified that the Event was
materially prejudicial to the bondholders. The Trustee was then requested by the
holders of more than 30 per cent in value of the Bonds (in due course some 71 per cent
in value of bondholders joined in the request) to give Elektrim a Condition 12 notice of
acceleration. The Trustee said that before giving such a notice it required to be
"indemnified to its satisfaction".
16.
Discussions between the Trustee and the bondholders about the quantum of the
indemnity then followed. While these discussions were taking place Elektrim made
clear its contention that there had been no breach of Condition 10(d), and therefore no
Event of Default under Condition 12(ii). If there had been no Event of Default the
Trustee's certificate about material prejudice was, of course, writ in water and a notice
of acceleration would have been invalid. Moreover Elektrim contended, in a letter
dated 2 April 2004 from their solicitors to the Trustee, that a notice of acceleration
would cause them substantial loss by the effect it would have on third parties with
whom they had, or might otherwise have had, financial or commercial dealings. In the
face of these contentions the Trustee was unwilling to give notice of acceleration under
Condition 12 without first receiving an indemnity against its possible exposure to
damages claims by Elektrim for loss caused by the notice. Other points of objection to
the indemnity being offered by the bondholders were also taken by the Trustee but
these objections were relatively trivial. The sticking point was the Trustee's fear of
incurring a damages liability to Elektrim if it gave the notice of acceleration and its
consequent insistence on a very substantial indemnity to protect itself against that
possible liability. The bondholders were not willing to incur the expense of providing
an indemnity against a risk they thought to be grossly exaggerated. In this impasse
Concord issued proceedings against the Trustee seeking a declaration that the Trustee
was obliged by Condition 12 to give a notice of acceleration.
The decisions in the courts below
17.
In a judgment given on 28 May 2004 the Vice-Chancellor dismissed Concord's
application. He held that the Trustee's refusal to accept the limited indemnity the
bondholders had offered was not "Wednesbury unreasonable." The Vice-Chancellor
recorded the Trustee's contention that "Elektrim had an arguable claim against the
Trustee for damages for breach of contract in the event of a wrongful acceleration of
the bonds which could well amount to an award of _1 billion or thereabouts" (para.38
of the judgment). He then examined that proposition, noted that Elektrim was not
bound by Peter Smith J's order and said (at para.41) that it was
" … necessary to consider what level of award might be made against the Trustee
in the event of Elektrim successfully alleging that there was no event of default
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entitling the Trustee to accelerate the bonds."
He concluded that the loss that might be caused to Elektrim by a wrongful acceleration
of the Bonds and be recoverable from the Trustee could be extremely high. He declined
to regard as absurd the contention that the potential liability might be in the region of
_1 billion and said that "on a worst case scenario a wrongful acceleration could give
rise to a claim by Elektrim against the Trustee for damages in the region of _876
million or thereabouts." (para.49). He gave leave to Concord to appeal.
18.
In the Court of Appeal judgment was given on 24 July 2004. Peter Gibson LJ and
Laddie J both agreed with the judgment given by Jonathan Parker LJ. Jonathan Parker
LJ held, first, that in seeking an indemnity in the region of _1 billion the Trustee had
fundamentally misconceived the scale of the risk which it would face if it were to give
an invalid notice of acceleration. He pointed out that an invalid notice of acceleration
would, from a contractual point of view, accelerate nothing. A notice of acceleration
where no Event of Default had occurred would be of no contractual effect. It could not,
therefore, constitute the basis of an action for breach of contract against the Trustee
(paras.75 and 78).
19.
The possibility that the giving of an invalid notice of acceleration might give rise to a
cause of action in tort had not been raised before the Vice-Chancellor. Before the Court
of Appeal Mr Robert Miles QC, counsel for the Trustee, mentioned the possibility of a
defamation action by Elektrim (see para.82 of Jonathan Parker LJ's judgment) but did
not develop the possibility. Jonathan Parker LJ commented that he was "unable to see
what cause of action in tort Elektrim could possibly have against the Trustee in such
circumstances." The possibility of a tort action has, however, been developed by Mr
Howard QC, counsel for the Trustee before your Lordships. I must deal later with his
submissions. They were not put to the Court of Appeal.
20.
Notwithstanding that the Court of Appeal wholly discounted the Trustee's professed
fears of a liability in damages to Elektrim arising out of an invalid notice of
acceleration, the Court of Appeal did not grant Concord the relief it was seeking,
namely, a declaration that the Trustee was obliged forthwith to give notice of
acceleration under Condition 12. The reason for this was that the Court of Appeal took
the view, per Jonathan Parker LJ, that
" … such a declaration would only be appropriate where it is established that all
the conditions prescribed by Condition 12 have been met; in particular, that an
'Event of Default' has occurred" (para.88).
Jonathan Parker LJ held that Elektrim should be given the opportunity to present its
arguments to the court in support of its contention that no Event of Default had
occurred (para.90). So an order was made that the Trustee, on receiving an appropriate
indemnity from the bondholders to cover the costs of the litigation, should commence
proceedings, joining Elektrim SA, Elektrim Finance and Concord as defendants, to
determine, in effect, whether an acceleration notice given on the footing that the
suspension of Mr Rymaszewski was a Condition 12 para.(ii) Event of Default would be
a valid notice of acceleration. The order said, also, that until that issue had been
determined, the Trustee was not obliged to serve an acceleration notice.
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21.
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In the end, therefore, save as to the costs of the proceedings, the Court of Appeal, by a
quite different route, produced exactly the same result as had been produced by the
Vice-Chancellor. A notice of acceleration did not have to be served by the Trustee until
the issue as to whether Mr Rymaszewski's suspension constituted a Condition 12 para.
(ii) Event of Default had been settled as between the Trustee and Elektrim. In these
circumstances it is not surprising that both Concord and the Trustee have appealed.
Concord challenges the correctness of what appears to have been very much of a
postscript, dealt with in paragraphs 88 and 90 of Jonathan Parker LJ's judgment. The
Trustee renews its contention, successful before the Vice-Chancellor but unsuccessful
before the Court of Appeal, that Elektrim may suffer serious financial loss as a
consequence of the service of an invalid notice of acceleration and that Elektrim might
have an arguable cause of action in damages to recover that loss from the Trustee.
The first issue: is the Trustee under an obligation to the bondholders to
give the notice of acceleration?
22.
This is, as Ms Susan Prevezer QC, counsel for Concord, acknowledged at the outset
of her submissions to your Lordships, a very short point of construction of Condition
12 of the Bond Terms. Condition 12 must, of course, be construed in context. It is an
integral part of the Trust Deed and there are other provisions of the Trust Deed to
which I should refer in order to enable Condition 12 to be considered in its proper
setting.
23.
Clause 9.3 of the Trust Deed, part of a section headed "Enforcement", and clauses
10.1 and 10.3 under the heading "Proceedings, Action and Indemnification", place
enforcement obligations on the Trustee in much the same terms as are to be found in
Condition 12. The issue of construction which has arisen in respect of Condition 12
could arise also in respect of these comparable provisions.
24.
The structure of the Trust Deed, including the 2nd Schedule, in relation to action
taken by the Trustee to protect or to enforce the bondholders' rights is, first, that the
Trustee has broad discretionary powers to take such action, including but not limited to
the commencement of legal proceedings, as it thinks fit (see clause 9.1). Secondly,
however, the Trustee is placed under an obligation to take action either if so requested
in writing by at least 30 per cent in value of the bondholders or if so directed by an
Extraordinary Resolution of the bondholders (see para.20 of the 4th Schedule). If the
Trustee were to exercise its discretionary power to take action, whether by
commencing legal proceedings against Elektrim under clause 9.1 or by giving the
direction to the Security Agent referred to in clause 9.3 or by giving Elektrim a notice
of acceleration under Condition 12, Elektrim could challenge the action on the ground
that an Event of Default, the necessary trigger, had not in fact occurred. It could
challenge the validity of the action that had been taken but could not, otherwise than by
successfully applying for an interim injunction, prevent the action from being taken in
the first place. A request in writing to the Trustee by the requisite number of
bondholders or a direction given to the Trustee by an Extraordinary Resolution
overrides the Trustee's discretion and obliges the Trustee (subject always to satisfactory
indemnities being given) to do that which it would anyway have had the discretionary
power to do. The proposition that the mandatory obligation on the Trustee to take the
action in question does not arise unless the issuer and/or the guarantor have accepted,
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or are unable to challenge, the existence of the triggering Event of Default cannot, in
my opinion, be right.
25.
The wellspring of the Court of Appeal's conclusion that the issue as to the existence of
the Event of Default trigger had to be settled as between the Trustee and Elektrim
before the Trustee's mandatory obligation to give the acceleration notice could arise
was, I think, a feeling of sympathy for Elektrim. Having held that Elektrim would have
no cause of action against the Trustee to recover loss caused to it by the giving of an
invalid notice, Jonathan Parker LJ then moved to the conclusion that the issue as the
validity of the notice should be settled before it was given. But this, in my respectful
opinion, involved a confusion between two issues. The issue as to whether the Trustee
had come under a mandatory obligation to give Elektrim the notice of acceleration was
an issue as between the Trustee and the bondholders. The obligation, if it had arisen,
would have been owed to the bondholders, not to Elektrim. It would make no
difference to Elektrim whether the notice were given by the Trustee because in its
discretion it had decided to do so or because it had come under a mandatory obligation
to the bondholders to do so.
26.
Elektrim's concern is that an invalid notice of acceleration, whether given in the
exercise of a discretion or in discharge of a mandatory obligation, should not be given.
If the Trustee is proposing to serve a notice of acceleration, an issue may arise between
Elektrim and the Trustee as to whether the Trustee should be allowed to do so. That, I
repeat, would be an issue between Elektrim and the Trustee. If Elektrim had a
reasonably arguable case that the notice would be invalid and that, if given, it might
cause Elektrim damage, Elektrim could seek an interim injunction to restrain the giving
of the notice until the issue had been settled. If Elektrim could satisfy the court, on the
usual balance of convenience grounds, that an interim injunction should be granted,
Elektrim could postpone the giving of the notice of acceleration until the issue as to its
validity, if given, had been settled. But, in the present case, Elektrim have not sought
any such injunction. They have not submitted to judicial scrutiny their contention that
the notice, if given, would be invalid and would be likely to cause them serious
damage. Instead they have terrified the Trustee into declining to accept the apparently
mandatory obligation to the bondholders imposed by Condition 12 and into acting as,
in effect, their surrogate in the current proceedings. It is the Trustee that, in these
proceedings, has argued the case that, on an application for an interim injunction,
Elektrim would have had to have argued.
27.
In my opinion, Jonathan Parker LJ fell into error when, at the end of his judgment, he
treated the mandatory obligation imposed by Condition 12 as being dependant on the
ability of the Trustee to uphold against Elektrim the validity of the proposed notice of
acceleration. But the proceedings before Peter Smith J had settled, once and for all as
between the bondholders and the Trustee, that a materially prejudicial Event of Default
had occurred. It follows that as between the Trustee and the bondholders it was not
open to the Trustee to argue that an Event of Default had not happened, or might not
have happened, or that anything more needed to happen before the mandatory
obligation on the Trustee, imposed by Condition 12, to give Elektrim the notice of
acceleration arose.
28.
Any other construction of Condition 12, or, for that matter of clauses 9.3 and 10.3 of
the Trust Deed, would make little sense of the indemnity provision. Why would the
Trustee need an indemnity before responding to the written request, or to the
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Extraordinary Resolution, if the Trustee's obligation to take the action in question did
not arise until the validity of the proposed action had been accepted by or established
against the issuer and/or the guarantor? The reason for the indemnity provision was,
surely, in case the issuer or guarantor were to mount a challenge to the proposed action.
29.
In my opinion, on the true construction of Condition 12 and once the question whether
a materially prejudicial Event of Default had occurred had been settled as between the
Trustee and the bondholders and the bondholders had made the requisite written
request, the Trustee, subject to the indemnity point, came under a mandatory obligation,
owed to the bondholders, to give Elektrim the Condition 12 notice of acceleration. I
would accordingly allow Concord's appeal on the first issue and set aside the directions
given by the Court of Appeal in paragraphs 2 and 3 of its order of 28 July 2004.
The second issue: what liability can the Trustee reasonably require to be indemnified
against?
30.
The second issue is based on four premises: first, that the Trustee will give Elektrim a
Condition 12 notice of acceleration in reliance on the suspension of Mr Rymaszewski as
an Event of Default and on its own "materially prejudicial" certificate; second, that the
notice of acceleration would become public knowledge and that the reaction to it by
third parties might lead to Elektrim suffering serious financial or commercial loss; third,
that Elektrim challenges the validity of the notice and institutes legal proceedings
against the Trustee claiming damages; and, fourth, that Elektrim succeeds in the legal
proceedings in establishing against the Trustee the invalidity of the notice.
31.
The first premise must be accepted. It is a consequence of the conclusion that the
Trustee is under a mandatory obligation owed to the bondholders to give the notice. The
second premise was accepted by the Vice-Chancellor. He thought the loss suffered by
Elektrim as a result of a notice of acceleration might, on a worst case scenario, be as
high as _846 million. Jonathan Parker LJ thought that the potential loss was greatly
exaggerated (see para.86 of his judgment). In my opinion, your Lordships are not in a
position to speculate about this. There are many too many imponderables. I would, for
my part, without in any way endorsing the figures that have been suggested, be prepared
to accept the second premise as formulated above.
32.
The third premise must be accepted. Indeed, on 7 January 2005 Elektrim served on the
Trustee a Notice of Arbitration that (a) challenged the Trustee's declaration that the
suspension of Mr Rymaszewski, as well as certain other subsequent events, constituted
Events of Default; (b) claimed a declaration that the Trustee was not entitled to
accelerate the Bonds on the basis of any of these alleged Events of Default; and (c)
claimed damages in respect of, among other things, the Trustee's declarations of Events
of Default.
33.
As to the fourth premise, your Lordships have no means of judging, any more than had
the Vice-Chancellor or the Court of Appeal, the extent of the risk that a tribunal of fact,
whether a court or an arbitrator, might disagree with the conclusions of Peter Smith J
and hold that the suspension of Mr Rymaszewski did not constitute an Event of Default
and that a valid notice of acceleration in reliance on the suspension as an Event of
Default could not be given. The Trustee is entitled under Condition 12 to be
"indemnified to its satisfaction" before it gives the notice of acceleration and, unless it is
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certain that a challenge by Elektrim to the validity of the notice would fail, the Trustee
is entitled to be indemnified on the footing that the challenge might succeed. I would,
therefore, be prepared to accept the fourth premise.
34.
The issue, however, is what, on a worst case scenario, the consequence of a successful
challenge by Elektrim to the notice of acceleration might be. It is common ground that
the Trustee is entitled to an indemnity at least sufficient to cover the legal costs
incurred by the Trustee in an unsuccessful defence of the notice. Your Lordships have
not been addressed as to the sufficiency for that purpose of the indemnity that has
already been offered by Concord. The critical issue is whether the Trustee is at risk not
simply of incurring a liability in costs but also of a liability to Elektrim in damages for
loss caused by the giving of an invalid notice. It is, or should be, common ground that
the Trustee cannot reasonably insist on an indemnity to cover the latter risk unless the
risk is more than a merely fanciful one.
35.
The Trustee's printed case, expanded upon by Mr Howard in his submissions to your
Lordships, identified four possible causes of action in damages that might face the
Trustee. These were:
(i) breach of an express or implied term of the contract;
(ii) breach of a tortious duty of care;
(iii) conspiring with the bondholders to cause Elektrim injury by unlawful
means; and
(iv) interfering by unlawful means with Elektrim's business.
I must deal with each of these suggested causes of action in turn but in relation to each
it is necessary to keep in mind that the Trustee does not have to, and does not, contend
that the cause of action would lie. The Trustee simply contends that it is reasonably
arguable that the cause of action might lie. I agree that that is the correct approach.
36.
Breach of contract: The act that would have to constitute the breach of contract is the
giving of an invalid notice of acceleration, or, perhaps, having regard to the claims
apparently made in the arbitration, the unjustified assertion of the occurrence of an
Event of Default. There is nowhere in the Trust Deed any express undertaking by the
Trustee not to do either of those things. So a suitable implied term would have to be
read into the Trust Deed.
37.
Various tests for the implication of terms into a contract have been formulated in
various well-known cases. In particular, a term will be implied if it is necessary to give
business efficacy to the contract (The Moorcock [1889] 14 PD 64 at 68). The proposed
implied term cannot satisfy this test. The Trust Deed works perfectly well without the
implied term. It is open to Elektrim to challenge the existence of an alleged Event of
Default or the validity of a notice of acceleration. If the challenge succeeds neither the
alleged Event nor the invalid notice will be of any contractual significance. I am in
respectful and complete agreement with Jonathan Parker LJ on this point (see para.71
of his judgment). The implied term is not necessary to give business efficacy to the
Trust Deed. Nor are any of the other tests that have from time to time been formulated
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for the implication of terms into a contract any more apt. In my opinion, it is not
reasonably arguable that the unjustified assertion by the Trustee of an Event of Default
or the giving by the Trustee of an invalid notice of acceleration exposes the Trustee to
the risk of being found liable in damages for breach of contract.
38.
Negligence: The relationship between Elektrim and the Trustee is a contractual one. If
there is no contractual duty of care owed by the Trustee to Elektrim in relation to the
assertion of an Event of Default or the giving of a notice of acceleration, and in my
opinion there is not, I find it very difficult to understand how it could be arguable that
the Trustee owed a tortious duty of care. But, in any event, an action against the
Trustee for damages based on a breach by the Trustee of a tortious duty of care would,
in my opinion, be hopeless. Peter Smith J held that the suspension of Mr Rymaszewski
was a breach of Condition 10(d) that was "materially prejudicial" and that the Trustee
was entitled to certify to that effect "without any further enquiry or investigation". The
Trustee did so. The Trustee's obligation to give the notice of acceleration thereupon
(subject to the indemnity point) arose. In these circumstances it is not remotely
arguable that the Trustee's actions in declaring there had been an Event of Default and
giving the notice of acceleration could be categorised as negligent.
39.
Conspiracy to cause Elektrim injury by unlawful means. This tort was not raised in
either of the courts below as a possible vehicle for a damages claim by Elektrim against
the Trustee. Your Lordships do not, therefore, have the advantage of knowing what the
Court of Appeal would have thought about the proposition. In my opinion, however,
the possibility of the Trustee being found liable in damages in a conspiracy action can
properly be described as fanciful. First, the tort of conspiracy requires proof of an
intention to cause injury to the victim. No such intention could be suggested here. It is
evident that the Trustee's concern has been to discharge its obligations to the
bondholders. It went to Peter Smith J to elucidate what the extent of its obligations
were. To categorise its conduct in following through the conclusions of Peter Smith J
as conduct done with the intention of causing injury to Elektrim seems to me grotesque.
Moreover, there is the problem of "unlawful means". What are the "unlawful means"
that the Trustee will have employed? Mr Howard's answer is that the giving of an
invalid notice of acceleration might be held to constitute "unlawful means"
notwithstanding a bona fide belief by the Trustee in the validity of the notice. This
proposition, too, I would reject as unarguable. A landlord, in the bona fide belief that
his tenant has committed a breach of covenant, may give notice to the tenant to remedy
the believed breach and, if the notice is not complied with, may serve a forfeiture
notice and institute proceedings for possession. The tenant can challenge the forfeiture
and deny that any breach of covenant has occurred. This challenge may succeed. But I
have never heard it suggested that the bona fide giving of the invalid notice could,
without more, found a cause of action against the landlord for one of the economic
torts. I would reject as unarguable the contention that Elektrim could get off the ground
a claim for damages against the Trustee based on the conspiracy tort.
40.
Interference by unlawful means with Elektrim's business: The objections to this tort
are much the same as those I have referred to when considering the conspiracy tort. The
giving by the Trustee of a notice of acceleration believed by the Trustee to be valid
could not, in my opinion, constitute unlawful means. An invalid notice to quit served
by a landlord in the bona fide belief that it is valid does not, in my opinion, expose the
landlord to a cause of action in tort for interference by unlawful means with the tenant's
business. Nor here.
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41.
Mr Howard's written Case (para.80) placed reliance on statements to the contrary
which he said were to be found in leading textbooks on banking law.
(1) Paragraph 3404 of Butterworths Encyclopedia of Banking Law is headed
"Wrongful acceleration and cancellation". The text reads
"Where the bank wrongfully cancels a facility, the bank may be liable in
damages … The borrower may ignore the acceleration. However, if the
acceleration is public, the bank may be liable for substantial damages …"
This passage does not assist. It is dealing with a case where the bank had entered into a
contractual commitment to allow a certain level of borrowing. If, in breach of that
commitment, the bank withdraws the facility the bank is, of course, at risk of liability in
damages for breach of contract.
(2) Chapter 11 of Commercial Law and Commercial Practice (2003) discusses
Material Adverse Change Clauses (MAC clauses). The author, Professor Richard
Hooley, refers at page 307 to the situation in which an MAC clause is invalidly
invoked:
"What if the bank relied on the MAC clause, refused to lend or declared an event of
default, and was later held to have got it wrong?"
At page 327, Professor Hooley makes this comment:
"… the Bank may rely on the MAC clause to declare an event of default,
terminate its commitment to make further advances and accelerate repayment of
the loan. In each case, should the bank get it wrong, and find itself in breach of
the loan agreement, it will be liable to the borrower for such damages as are
necessary to put the borrower in the position that it would have been in if the
advance had been made or continued within the terms of the agreement. There is
a risk that substantial damages may be awarded against the bank."
Just so. The author is speaking of a contractual liability where the acceleration, the
withdrawal of the facility, deprives the bank's customer of a borrowing facility to
which the customer has a contractual entitlement. This goes nowhere towards
establishing a tortious liability.
(3) Finally, reference is made to the International Law Financial Review (1998) where
the following passages are to be found:
"The MAC event of default can have more serious consequences for a borrower,
because it permits lenders to terminate lending commitments permanently and to
accelerate the maturity of loans" (p 17)
and
"For the lenders, an incorrect determination under some circumstances could
result in a large damage award" (p 19)
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Here, too, it is clear that the author is referring to a damages award for breach of a
contractual lending commitment.
42.
None of these academic authorities advances the Trustee's case that it is at risk of a
successful tort claim by Elektrim. Indeed the reverse is the case. If any of the learned
authors had thought that the invalid invocation of an MAC clause might give rise to a
tortious claim in damages by the borrower against the bank, or other lender, it is to be
expected that there would have been some mention of such a claim. But there is none.
43.
In my opinion, it is not reasonably arguable that the giving by the Trustee of a
Condition 12 notice of acceleration based upon the Event of Default held by Peter
Smith J to have been constituted by the suspension of Mr Rymaszewski could give rise
to a tortious cause of action in damages by Elektrim against the Trustee. I would,
therefore, dismiss the Trustee's cross-appeal.
44.
In considering the possibilities of a tortious claim in damages by Elektrim against the
Trustee I have been assuming that the proper law of the tort would be English law. This
seems to me a realistic assumption for clause 29.1 of the Trust Deed and Condition 19
of Bond Terms say that the Trust Deed and the Bonds are governed by English law. It
was suggested by Mr Howard, rather faintly I think, that a tort claim might be governed
by the law of a foreign country in which Elektrim had suffered the damage. He had
Poland particularly in mind as Elektrim SA and Elektrim Finance are Polish companies
and carry on business in Poland. Mr Howard said that the civil liability of the Trustee
to Elektrim under the Polish law of tort might be quite different from its liability, or
non-liability, under English law and suggested that it was reasonable for the Trustee to
seek an indemnity against the uncertainties of an action brought against it in Poland.
The Trustee's fear of liability under the law of Poland, or some other foreign law, was
not mentioned at all in the courts below. No evidence at all was adduced as to the
causes of action in damages that might under Polish law or any other foreign law be
available to Elektrim. I quite accept that the Trustee could not be expected to show that
a cause of action in damages under some identified foreign law would clearly lie but it
could at least be expected to show sufficient differences between the foreign law and
English law to give some substance to the expressed fear that such a cause of action
might lie. In the circumstances, and in the absence of any evidence to the contrary, your
Lordships are, in my opinion, bound to presume that there is no significant difference
for present purposes between the law of Poland, or the law of any other country in
which Elektrim might suffer damage, and the law of England.
45.
In the result I would allow Concord's appeal, set aside paragraphs 2 to 4 of the order
of the Court of Appeal and declare that the Trustee (subject to receiving a satisfactory
costs indemnity) is forthwith obliged to give a Condition 12 notice to Elektrim that the
Bonds are accelerated. If there is any outstanding issue as to the costs indemnity to
which the Trustee is entitled, the parties must apply at first instance. The parties may
make written submissions as to the costs in the courts below and before your
Lordships.
LORD WALKER OF GESTINGTHORPE
My Lords,
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46.
I have had the advantage of reading in draft the opinion of my noble and learned
friend Lord Scott of Foscote. I am in full agreement with it. I too would allow the
appeal, dismiss the cross-appeal and make the order which Lord Scott proposes.
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Neutral Citation Number: [2007] EWHC 2255 (Ch)
Case No: HC07C00763 and HC07C01505
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
Royal Courts of Justice
Strand, London, WC2A 2LL
Date: 12 October 2007
Before :
MR JUSTICE LEWISON
--------------------Between :
THE LAW DEBENTURE TRUST
CORPORATION PLC
- and (1) CONCORD TRUST
(2) ACCIONA SA
(3) ELEKTRIM SA (IN BANKRUPTCY)
(4) VIVENDI HOLDING 1 CORP
Claimant
Defendants
And Between:
ELEKTRIM SA (IN BANKRUPTCY)
Claimant
-andVIVENDI HOLDINGS 1 CORP
Defendant
--------------------Mr Robert Miles QC and Mr Andrew Clutterbuck (instructed by Simmons & Simmons) for
the Claimant.
Mr Richard Millett QC and Mr Julian Kenny (instructed by Barlow Lyde & Gilbert) for
the third defendant (claimant in the anti-suit injunction).
Mr Ali Malek QC and Mr David Quest (instructed by Orrick Herrington & Sutcliffe) for
the fourth defendant (defendant in the anti-suit injunction).
Hearing dates: 28th September 2007
---------------------
Judgment
Mr Justice Lewison:
Introduction................................................................................................................................2
The relevant terms of the Trust Deed and the bond conditions .................................................2
The background to the claim......................................................................................................4
The contingent payment claim...................................................................................................7
The Part 8 proceedings...............................................................................................................7
Anti-suit injunctions: the principles...........................................................................................8
The amended complaint in Miami .............................................................................................9
The amended complaint.........................................................................................................9
The claim against the Trustee ..............................................................................................10
The claim against Elektrim ..................................................................................................14
Result .......................................................................................................................................16
Introduction
1.
The Law Debenture Trust Corporation plc is the Trustee of €510,000,000 2% Bonds
(“the bonds”) issued by Elektrim Finance BV and guaranteed by Elektrim S.A.
(“Elektrim”) pursuant to a supplemental Trust Deed dated 15 November 2002 (“the
Trust Deed”). The bonds were due for redemption on 15 December 2005.
2.
As is usual with bonds of this kind, the powers and duties of the Trustee are regulated
by the Trust Deed. The bonds are subject to bond conditions, which incorporate all the
terms of the Trust Deed. The bonds are in registered form and are held through the
two principal clearing systems of eurobonds, Euroclear and Clearstream. At Euroclear
and Clearstream banks and brokers maintain securities accounts through which they
hold bonds either on their own behalf or as nominees on behalf of others. The bonds
are freely tradable, and are likely to be bought by or on behalf of sophisticated
investors. The tradable nature of the bonds, and the method of registration of account
holders in the clearing system, has the effect that the Trustee will often be unaware of
the identity of the person entitled to the bonds. Since early 2001 the bondholders have
been represented by a bondholders’ committee. The committee has in turn been
represented by Bingham McCutchen LLP, an international law firm.
3.
One of the bondholders was Everest Capital Ltd (“Everest”). Apparently, it held the
bonds for the benefit of General Motors. At the times relevant to the events I will
describe, Everest (or one of its associated companies) was a member of the
bondholders’ committee. It was represented by Mr Richard Torres. On 29 May 2007
Everest entered into an Assignment Agreement (in which it was described as a
“sophisticated investor”) which assigned its bonds to Vivendi Holdings 1 Corp
(“VH1”), together with certain claims arising out of its position as bondholder.
4.
On 1 June 2007 VH1 filed a complaint in Miami. The complaint was amended on 7
June. By the amended complaint VH1 claims relief against the Trustee and against
Elektrim. The applications before me are applications to continue the anti-suit
injunctions that I granted against VH1 on 8 June. No applications for final orders have
been made under Part 24; and VH1 is unwilling to agree that the applications be
treated as the trial of the actions.
The relevant terms of the Trust Deed and the bond conditions
5.
The terms of the Trust Deed were incorporated into bond conditions, with the effect
that any bondholder became bound by the terms of the Trust Deed as well as by the
bond conditions. Among the terms of the Trust Deed are the following:
“9. Enforcement
9.1
The Trustee may at any time, at its discretion and
without notice, take such proceedings and/or other action as it
may think fit against or in relation to [Elektrim Finance] or
[Elektrim] to enforce their respective obligations under these
presents...
10. Proceedings, Action and Indemnification
10.1
The Trustee shall not be bound to take any proceedings
mentioned in clause 9 or any other action in relation to these
presents unless respectively directed or requested to do so (i) by
an Extraordinary Resolution of the holders of the Bonds or (ii)
in writing by the holders of at least 30 percent in principal
amount outstanding of the Bonds and in either (i) or (ii) then
only if it shall be indemnified to its satisfaction against all
Liabilities to which it may thereby render itself liable or which
it may incur by so doing.
10.2
Only the Trustee may enforce (i) [against the security
provided by Elektrim] or (ii) the provisions of these presents.
No Bondholder shall be entitled to proceed directly against
[Elektrim Finance] or [Elektrim] to enforce the performance of
any of the provisions of these presents unless the Trustee
having become bound as aforesaid to take proceedings fails to
do so within a reasonable time and such failure is continuing.”
6.
Clause 1.2 (H) of the Trust Deed said that any references to taking proceedings
included proving in a winding up. By clause 1.2 (A) this extended definition also
applied to the bond conditions.
7.
The bond conditions contained a term to similar effect:
“13. Enforcement of Rights
At any time after the Bonds become due and repayable, the
Bond Trustee may, at its discretion and without further notice,
institute such proceedings against [Elektrim Finance] or
[Elektrim] as it may think fit to enforce the Bonds and the
provisions of the [Trust Deed], but it need not take any such
proceedings unless (i) it shall have been so directed by an
Extraordinary Resolution of the Bondholders or so requested by
in writing by holders of at least thirty percent in principal
amount outstanding of the Bonds and (ii) it shall have been
indemnified to its satisfaction. No Bondholder may proceed
directly against [Elektrim Finance] or [Elektrim] unless the
Bond Trustee, having become bound to proceed, fails to do so
within a reasonable time and such failure is continuing.”
8.
Condition 6 (k) of the bond conditions required Elektrim (as principal) to pay a
contingent payment on the Contingent Payment Date. A covenant to the same effect is
contained in the Trust Deed. The contingent payment has also been referred to as the
“equity kicker”. In very broad (and so to some extent inaccurate) terms the amount of
the Contingent Payment is the difference between:
9.
i)
The fair market value of Elektrim’s net assets (i.e. its assets after deduction of
debt apart from contingent liabilities) as determined on the Contingent
Payment Date and
ii)
€160 million.
Under clause 15.1(A) of the Trust Deed, Elektrim and Elektrim Finance both
covenanted with the Trustee that each of them would “at all times carry on and
conduct its affairs and procure that its Subsidiaries carry on and conduct their
respective affairs in a proper and efficient manner”.
The background to the claim
10.
Elektrim’s principal asset is or was its shareholding in a Polish telecommunications
company known as PTC. A major French media company called Vivendi Universal
SA (“Vivendi”) has been in dispute with Elektrim and with Deutsche Telekom AG
(“DT”), a major German media company, for several years about the PTC stake.
Vivendi alleges that it has invested over €2bn under various agreements and is
entitled, through a Polish company which it controls, known as ET or Telco, to the
PTC stake. Elektrim and DT, on the other hand, allege that Elektrim was entitled to
the PTC stake and that, by virtue of various awards of a Vienna arbitral tribunal,
Elektrim is obliged to transfer the stake to DT. The battle for control of the PTC stake
has been fought in numerous proceedings, including arbitrations in Vienna,
Switzerland and London, and Court proceedings in Poland.
11.
While these various proceedings were pending, the bonds fell due for redemption.
Elektrim did not pay. On the instructions of the bondholders, the Trustee began
insolvency proceedings against Elektrim in Poland on 3 March 2005 petitioning for
Elektrim’s bankruptcy. The petition was founded on the sum of €434,541,700.20 plus
interest and other amounts being due and payable. The petition was issued pursuant to
instructions given to the Trustee under clause 10.1 of the Trust Deed. The petition was
presented by the Trustee on behalf of (and as trustee for) the entire class of
bondholders. Elektrim fought the petition hard. It initially succeeded in having it
dismissed. That was overturned on appeal. It then persuaded the Polish Bankruptcy
Court to require a report into its solvency. This all took many months. ET had also
issued a bankruptcy petition of its own against Elektrim.
12.
On 2 August 2006 the London Court of International Arbitration (“LCIA”) made its
Order on Interim Measures No 6 in the arbitration between Vivendi and Elektrim.
Paragraph 2 of the order enjoined Elektrim from voluntarily selling or agreeing to sell
the PTC Shares. On 21 September 2006 the district court of Warsaw enjoined
Elektrim from disposing of its assets. This order appears to have been granted on the
trustee’s application.
13.
On 5 September 2006 DT issued a press release stating that a DT group employee had
been appointed chief executive of PTC and that:
“The new management appointment at PTC is a direct
consequence of Deutsche Telekom’s acquisition of the 48 per
cent stake of PTC formerly held by the Polish company
Elektrim. The acquisition is based on a call option awarded to
Deutsche Telekom by a Court of Arbitration.”
14.
The Court of Arbitration referred to was in fact the Vienna Court of Arbitration, and
the award referred to was an award of 6 June 2006. On 2 October 2006 the Vienna
Arbitration Court issued a Second Partial Award in the arbitration between Elektrim
and DT. That award recited the operative parts of the earlier award of 6 June 2006 in
which the Court had held that DT had validly exercised an option over Elektrim’s
shareholding in PTC. It further declared that on payment of the price to be
determined, DT would acquire that shareholding. In the body of its Second Partial
Award of 2 October the Arbitration Court said:
“32. In the present case, [DT] itself admits that a great
uncertainty shrouds both the thing to be sold and the price for
which it should be deemed to have been sold on 15 February
2005.
33. First, as regards the Option Shares, [DT] has appropriately
declared that the present title to the Shares is uncertain, and was
uncertain at the time of the exercise of the call option. It points
out that “it remains unclear whether DT has acquired 226,080
PTC shares (i.e., over 48% of the PTC shares), on the one hand,
or only a single PTC share, on the other” [referring to DT’s
submissions]. It is known that at least one parallel arbitration
between different parties bears on the title on those shares. The
Arbitral Tribunal is not informed about those proceedings nor
concerning any finding of the other Arbitral Tribunal, so that
the above mentioned uncertainty perdures to the fullest extent
conceivable. Therefore the validity of the so-called “share
purchase agreement” that would have been concluded on 15
February 2005 is put to doubt by reason of the indetermination
of its very subject matter, an indetermination which the present
proceeding at the present stage cannot lift in any meaningful
way…
34. Second, as concerns the price of the shares whichever they
are, this price is neither determined nor determinable at the
present time.”
15.
It concluded that the exercise by DT of its option fulfilled the requirement to bring
about the transfer of the shares once the determination of the precise number and price
had been determined. The order made by the Court was that DT would acquire full
legal title to the shares on payment of an amount in cash not less than the current book
value of the shares and the provision of an undertaking to pay any subsequent
adjustment of the price. It also ordered Elektrim to transfer “full factual control over
the Option Shares” to DT. This Partial Award was sent to the bondholders’
committee; and was seen by Everest acting by Mr Torres.
16.
The hearing of the bankruptcy petition against Elektrim was due for hearing on 4
October 2006. On that day Bingham McCutchen sent an e-mail to the Trustee’s
lawyers saying that the bondholders committee (which expressly included Everest)
confirmed that they approved of the Trustee applying for an adjournment of the
petition to enable them to consider “the implications of the Vienna award” and/or the
acceptance of €525 million out of the funds paid by DT on terms that the bankruptcy
petition was withdrawn. The hearing was duly adjourned to a further hearing on 27
October in the face of opposition from ET. Also on 4 October 2006, DT issued
another press release stating:
“In yet another award of October 2, 2006, the Arbitral Tribunal
in Vienna conferred the ownership title to the disputable 48%
of the shares in PTC to [DT] (with effect as of February 15,
2005), which remains in concord with the joint stand of
[Elektrim] and [DT] presented to date. For this reason [DT] has
paid an amount of more than Euro600m, which surely covers
the current book value of the shares in PTC.”
17.
On 12 October 2006 an application by ET for an attachment over Elektrim’s
receivable from DT was rejected by the Polish bankruptcy court. In the Justification
for the court’s decision the judge explained that Polish law did not prevent a debtor
from paying his debts. He also said that the Trustee represented essentially all
Elektrim’s creditors whose rights had been determined by a final court ruling; and that
to prevent Elektrim from paying what it owed the Trustee would in effect decide the
bankruptcy proceedings against Elektrim.
18.
At a meeting on 20 October 2006 the Trustee’s Polish lawyers learnt of a proposal for
DT to make payments into an escrow account.
19.
On 23 October 2006 the LCIA made Order on Interim Measures No 7 in the
arbitration between Vivendi and Elektrim. By that order the LCIA declared that their
Order on Interim Measures No 6 did not prevent Elektrim from applying the sum of
€600 million paid or payable by DT in discharge of Elektrim’s liability to the
bondholders who had presented the bankruptcy petition. The sum of €600 million was
the book value of the PTC shares, payment of which had been contemplated by Order
on Interim Measures No 6.
20.
On 24 October 2006 Bingham McCutchen were asked for bank account details, so
that Elektrim might pay off the petition debt. Elektrim paid €525 million to the
Trustee on 26 October 2006 without prior agreement or notice. On the morning of 27
October 2006 Bingham McCutchen sent an e-mail to the Trustee’s lawyers. It
confirmed instructions from Acciona and Trafalgar (bondholders who, between them,
held about 38 per cent in value of the bonds and who together with Everest were
members of the bondholders’ committee). The e-mail said that the bondholders
approved of the Trustee applying to the bankruptcy court for a direction that the
payment by Elektrim was lawful; and if that direction was obtained, to permit the
petition to be dismissed or to withdraw it. The Trustee was also to attempt to have
ET’s bankruptcy petition dismissed. At the hearing on that day the Polish bankruptcy
court ruled that the payment was lawful. Among the points made by the court in its
written ruling were the following:
i)
It had become superfluous to hear the Trustee’s petition;
ii)
There was nothing to prevent a debtor from paying off a creditor’s claim;
iii)
Although ET opposed withdrawal of the petition it advanced no substantial
grounds for its opposition;
iv)
Transfer of the shares was not a voluntary act of Elektrim because DT was
exercising a pre-existing right, and hence was not in breach of any court order;
v)
The Trustee represented all the creditors of Elektrim. ET was not a creditor
because it had not filed for Elektrim’s bankruptcy;
vi)
If the petitioner decides he no longer has an interest in pursuing the
bankruptcy, he is entitled to withdraw the petition;
vii)
A genuinely disputed claim cannot lead to a bankruptcy;
viii)
Bankruptcy cannot be declared on the ground that the petitioner is concerned
that, in the future, a claim, if established will not be able to be met.
21.
In the light of the court’s ruling, the petition was withdrawn and the Trustee retained
the money. However, it did not immediately distribute the money to the bondholders
because of its concern that ET might appeal against the dismissal of bankruptcy
proceedings, resulting in Elektrim’s liquidation and a possible claim by a liquidator
for the return of the €525 million under “claw-back” provisions in Polish bankruptcy
legislation. ET did attempt to appeal, but its attempts failed.
22.
Vivendi, meanwhile, had alleged that it had claims over the money, but the precise
nature of those claims was not articulated.
The contingent payment claim
23.
On 15 December 2005, the Trustee commenced a claim in this court against Elektrim
seeking damages for the loss of the Contingent Payment. The basis of the action is
alleged asset-stripping by Elektrim in breach of clause 15.1(A) of the Trust Deed
resulting in the loss of the full value of the Contingent Payment obligation under
clause 6(k) of the Bond Conditions. The claim is for the loss of a real or substantial
chance that the Contingent Payment would have become payable.
The Part 8 proceedings
24.
On 2 March 2007 the Trustee began Part 8 proceedings seeking directions. On 2 April
2007, I made a representation order appointing two of the Bondholders, Concord and
Acciona, to represent all the Bondholders pursuant to CPR 19.7(2). On 1 May 2007 I
gave judgment holding that the claims intimated by Vivendi to the effect that the
monies received by the Trustee were tainted lacked any merit; and I made an order
that those claims had no reasonable foundation. I also ordered that notice of my
judgment and order of 1 May 2007 be served on Vivendi and ET pursuant to CPR
19.8A. This gave Vivendi the right to apply within 28 days of service to set aside the
order of 1 May 2007, failing which the order would be binding on it: CPR 19.8A(8).
The notice was served on Vivendi (as acknowledged by their UK solicitors on 23 May
2007) and it was informed that a further hearing of the Part 8 claim was fixed for the
week of 5 June 2007. Vivendi has not applied to set aside my order.
25.
On 29 May 2007 VH1 purchased a tranche of bonds from Everest under an
Assignment Agreement. These included bonds to which General Motors had
apparently been beneficially entitled.
Anti-suit injunctions: the principles
26.
The broad principle underlying the jurisdiction to grant an anti-suit injunction
restraining foreign proceedings is that it is to be exercised when the ends of justice
require it. This may occur when the foreign proceedings are vexatious or oppressive;
or where the institution of the foreign proceedings is a breach of a binding contract.
However, the jurisdiction is one to be exercised with caution. I take the summary of
principle from the judgment of Evans-Lombe J sitting in the Court of Appeal in Royal
Bank of Canada v Rabobank [2004] 1 Lloyd’s Rep 471, with the modification of the
fifth principle suggested by Mance L.J. in the same case:
(i) Under English law a person has no right to be sued in a
particular forum, domestic or foreign, unless there is some
specific factor that gives him that right, but a person may show
such a right if he can invoke a contractual provision conferring
it on him or if he can point to clearly unconscionable conduct
(or the threat of unconscionable conduct) on the part of the
party sought to be restrained: Turner v Grovit [2002] 1 WLR
107, 118C at para 25 per Lord Hobhouse.
(ii) There will be such unconscionable conduct if the pursuit of
foreign proceedings is vexatious or oppressive or interferes
with the due process of this Court: South Carolina Insurance
Co v Assurantie Maatschappij de Zeven Provincien NV [1987]
AC 24 at page 41D; Glencore International AG v Exter
Shipping Ltd [2002] 2 All ER (Comm) 1, 14a at para 42.
(iii) The fact that there are such concurrent proceedings does
not in itself mean that the conduct of either action is vexatious
or oppressive or an abuse of court, nor does that in itself justify
the grant of an injunction: Société Nationale Industrielle
Aerospatiale v Lee Kui Jak [1987] AC 817 at page 894C;
Credit Suisse First Boston (Europe) Ltd v MLC (Bermuda) Ltd
[1999] 1 Lloyd's Rep 767 at 781; Airbus Industrie GIE v Patel
[1999] 1 AC 119 at 133G/H.
(iv) However, the court recognises the undesirable
consequences that may result if concurrent actions in respect of
the same subject matter proceed in two different countries: that
'there may be conflicting judgments of the two courts
concerned' or that there 'may be an ugly rush to get one action
decided ahead of the other in order to create a situation of res
judicata or issue estoppel in the latter': see The Abidin Daver
[1984] AC 398 at pages 423H–424A per Lord Brandon.
(v) The English court will, generally speaking, only restrain the
plaintiff from pursuing proceedings in the foreign court if such
pursuit would be vexatious or oppressive. This presupposes
that, as a general rule, the English court must conclude that it
provides the natural forum for the trial of the action; and
further, since the court is concerned with the ends of justice,
that account must be taken not only of injustice to the
defendant if the plaintiff is allowed to pursue the foreign
proceedings, but also of injustice to the plaintiff if he is not
allowed to do so. So the court will not grant an injunction if, by
doing so, it will deprive the plaintiff of advantages in the
foreign forum of which it would be unjust to deprive him:
Société Aerospatiale, ibid at 896F–H.
(vi) In exercising its jurisdiction to grant an injunction, 'regard
must be had to comity and so the jurisdiction is one which must
be exercised with caution': Airbus Industrie, ibid at 133F.
Generally speaking in deciding whether or not to order that a
party be restrained in the pursuit of foreign proceedings the
court will be reluctant to take upon itself the decision whether a
foreign forum is an inappropriate one: Turner v Grovit, ibid at
para 25.
27.
I add two glosses to this summary:
i)
The first principle recognises that a person may have a right not to be sued in a
foreign court if he can show a contractual provision conferring that right on
him. If he can, then ordinarily the court will enforce the contract: Donohoe v
Armco Inc [2002] 1 Lloyd’s Rep. 425. By the same token a person may be able
to rely on a contractual provision which entitles him not to be sued at all (The
Angelic Grace [1995] 1 Lloyd’s Rep 87), or not to be sued by the particular
claimant. If he can, then it seems to me that the court will ordinarily enforce
that contract too.
ii)
The courts have refrained from defining what is meant by “vexatious or
oppressive”, leaving it to be worked out on a case by case basis. Among the
examples in the decided cases in which it was held that foreign proceedings
fell within that description are cases which are bound to fail (Shell
International Petroleum Co Ltd v Coral Oil Co Ltd [1999] 2 Lloyd’s Rep
606); cases which could and should have formed part of an earlier English
action (Dicey & Morris 14th ed para 12-073; Glencore International AG v
Exter Shipping Ltd [2002] All ER (Comm) 1 (CA), paras 67 and 68) and cases
which interfere with the processes of the English court.
The amended complaint in Miami
The amended complaint
28.
As I have said the complaint was filed on 1 June 2007 and amended on 7 June. It
makes claims against both the Trustee and Elektrim. The recitation of the facts is
peppered with allegations of fraud against the Trustee. But all those allegations are to
be withdrawn. Why they were made in the first place, and upon what material, has not
been explained. Following the conclusion of the hearing, I was provided (at my
request) with a further version of the amended complaint with the allegations of fraud
against the Trustee deleted. I have worked from that document.
The claim against the Trustee
29.
I begin with the surviving claim against the Trustee. The claims are against an English
trustee, concerning the Trustee’s duties under an English law trust deed, expressly
governed by English law and containing a non-exclusive English jurisdiction clause,
with the Trustee (whose acts are attacked) being in England and the relevant acts
having occurred in England. Mr Malek QC, appearing for VH1, accepts that England
is the natural forum for this claim. Nor does he suggest that there is any advantage in
proceeding in Miami of which VH1 will be deprived if an injunction is granted. The
sole substantive question, then, is whether the claim against the Trustee is vexatious
or oppressive.
30.
The surviving claim against the Trustee is contained in counts 1 and 2 of the amended
complaint. It is first alleged that the Trustee was in breach of fiduciary duty in failing
to disclose to Everest the full contents of the Second Partial Award of 2 October 2006
before withdrawal of the bankruptcy petition. It is now conceded by VH1 that this
factual allegation is simply wrong. Not only did the Trustee disclose the award to the
bondholders’ committee, but Mr Torres himself saw it (although he says that he did
not understand its significance). Moreover, the lawyers acting for the bondholders’
committee themselves instructed the Trustee to obtain an adjournment of the
bankruptcy petition for the very purpose of considering the implications of the award.
This allegation is hopeless.
31.
The second allegation is that the Trustee failed to obtain from Elektrim the full
content of the First Partial Award of 6 June 2006 and disclose it to “Plaintiff” before
agreeing to withdraw the petition. (The reference to “Plaintiff” is plainly mistaken
because “Plaintiff”, i.e. VH1, was not a bondholder at the relevant time, but I ignore
that error). However, the Second Partial Award, which the bondholders’ committee
(including Mr Torres) did have, recited the operative part of the First Partial Award in
full. The bondholders did not ask the Trustee to obtain a full copy of the award. Nor
did Bingham McCutchen. As an allegation of breach of fiduciary duty, this is also
hopeless.
32.
The third allegation is that the Trustee failed to disclose to Everest its knowledge that
DT and Elektrim had engaged in a transaction that was contrary to the direction of the
Vienna Arbitration Court. But the Trustee expressly applied to the Polish bankruptcy
court for a determination whether it was entitled to accept the money offered by
Elektrim. The Polish bankruptcy court ruled that it was. This allegation is likewise
hopeless.
33.
The fourth allegation is that the Trustee accepted “tainted money” from Elektrim
without consulting Everest or obtaining the prior approval of the bondholders. I
should first examine what the pleader means by the nebulous expression “tainted
money”. In the context of the amended complaint it is clear that it means money
which was vulnerable in the hands of the Trustee at the suit of a third party (i.e.
Vivendi). This is clear from paragraph 54 of the amended complaint which asserts
that the risk was that the money received by the Trustee “would have to be disgorged
while at the same time not being able to regain the claw-back provisions for
fraudulent conveyances that would have existed if the bankruptcy petition had not
been withdrawn.” It is plain from this that the pleaded risk of disgorgement is one that
is alleged to exist on the basis that Elektrim was not made bankrupt. The only such
liability could have been a liability to Vivendi. Mr Malek’s skeleton argument
suggested precisely the opposite of the pleaded case. I reject that suggestion. The
pleaded case is clear.
34.
The fourth allegation is therefore a collateral attack on my decision of 1 May in which
I held that Vivendi had no arguable proprietary claim to the money which would
prevent the Trustee from distributing it to bondholders. VH1 accepts that it is bound
by that decision, and that it cannot therefore argue points that contradict or undermine
it. The fourth allegation is therefore hopeless; or alternatively it amounts to a
collateral attack on a decision of the English court.
35.
The fifth allegation is that the Trustee failed to disclose to Everest all the risks of
accepting tainted money. This allegation is also hopeless, not least because (as I have
decided in a judgment by which VH1 is bound) the money was not tainted. Mr Malek
sought to argue that Everest was entitled to rely on the Trustee to draw to its attention
how its interests under the bonds might be affected by receipt of the money. This
amounts to an allegation that the Trustee had a duty to give advice (either legal or
commercial) to the bondholders. The first objection to this argument is that no such
duty is pleaded in the amended complaint. It does not, therefore, form any part of the
claim that I am asked to restrain. The second objection is that in circumstances in
which the bondholders were being advised by an international law firm of the stature
of Bingham McCutchen it is inconceivable that the Trustee owed the bondholders any
duty to tender legal advice (particularly when there is no allegation that the Trustee
was asked for any advice). The third objection is that (as Everest’s own Assignment
Agreement explicitly records) Everest was a sophisticated investor well able to weigh
up the commercial pros and cons of a commercial course of action. The fourth
objection is that Everest did not ask the Trustee for any advice. Indeed the hearing on
4 October 2006 was adjourned at the request of (among others) Everest in order for it,
together with its own lawyers, to consider the implications of the award of 2 October.
The fifth objection is that if the Trustee owed any duty to tender commercial advice it
must have owed that duty to all bondholders whether or not they were members of the
bondholders’ committee. But since the Trustee would have had no means of knowing
the identity of all bondholders, no duty can have arisen. This allegation is likewise
hopeless.
36.
The sixth allegation is that the Trustee failed to exercise adequate due diligence prior
to withdrawing the bankruptcy petition by failing to conduct a full investigation of the
legality of the transaction. There are two fatal objections to this allegation. First, the
Trustee sought and obtained an order of the Polish bankruptcy court which declared
that it was entitled to accept the payment. Second, bondholders holding more than 30
per cent of the value of the bonds instructed it to accept the payment and withdraw the
petition. The Trustee is both entitled and obliged to act on the instructions of
bondholders holding more than 30 per cent in value of the bonds. This allegation is
therefore hopeless.
37.
The seventh allegation is that the Trustee acquiesced in delays of the bankruptcy
petition. No loss is alleged to flow from this alleged breach. Moreover, the only
particularised allegation of delay relates to the adjournment of the hearing on 4
October 2006, which Everest supported. This allegation is hopeless.
38.
The final allegation is that by withdrawing the petition the Trustee gave up the right to
recapture fraudulently transferred assets. This allegation adds nothing to the preceding
allegations; and is open to the same objection as the preceding allegations, namely
that the Trustee was instructed or authorised to withdraw the petition by bondholders
holding more than 30 per cent in value of the bonds. In addition, any action to
recapture fraudulently transferred assets would have to have been taken by the
liquidator of Elektrim (or its Polish equivalent). The Trustee had no “right” to give up.
39.
Suppose that there is some merit in one or more of the claims against the Trustee,
what then? VH1 says that while Everest wanted to be paid it “did not want to receive
tainted money and the possible liability that could come with tainted money”. But
VH1 is bound by my judgment which holds that the money was not tainted. So
persistence in this allegation is a collateral attack on my judgment.
40.
In my judgment count 1 of the amended complaint discloses no arguable cause of
action against the Trustee for breach of fiduciary duty. Count 2 repeats the same
allegations but under the heading of breach of duty of care and diligence. For the
same reasons, these allegations disclose no arguable cause of action against the
Trustee.
41.
In addition, I consider that the allegations of causation of loss flowing from the
alleged breaches are themselves fanciful. The amended complaint goes on to say that
had Everest “opposed withdrawal and explained its reasons for doing so, the
withdrawal would not have occurred” or that the bankruptcy court “would not have
permitted the withdrawal”. The Trustee says that its instructions to withdraw the
petition came from holders of more than 30 per cent in value of the bonds and that
there is no realistic prospect of showing that bondholders other than Everest would
have acted differently had they known about the 6 June 2006 Award. It has adduced
evidence from the bondholders supporting that position. In riposte Mr Malek says:
42.
i)
Mr Torres’ evidence is that in practice the Trustee and the bondholders acted
unanimously. Given the Trustee’s cautious approach in the past, and the
history of litigation between the Trustee and the bondholders, it seems likely
that if vociferous objections had been raised by one of the bondholders then
the Trustee would have been very reluctant to take any step which might
prejudice the bondholders’ position.
ii)
Mr Torres might well have been able to muster 30% of the bondholders to
support an instruction to pursue the bankruptcy petition. At best the Trustee
would have found itself in a position of deadlock.
iii)
Finally, there is the possibility that Everest could have approached the Polish
court directly.
The first point to make is that the way Mr Malek puts it is not that “the withdrawal
would not have occurred”; but that Everest lost the chance of dissuading the Trustee
from withdrawing the petition or of persuading the court that the petition should not
be withdrawn. That is not the way in which the claim is pleaded in the amended
complaint. I will assume, however, that the greater plea includes the lesser.
43.
The first possibility (namely that a single bondholder’s protests could have dissuaded
the Trustee from accepting the money and withdrawing the petition) is fanciful. It
ignores the Trustee’s obligation to act on the instructions of bondholders holding
more than 30 per cent in value of the bonds. I regard the suggestion that Everest could
have whipped up support from 30 per cent of the bondholders as equally fanciful. In
the first place, Everest had no means of knowing who the bondholders were, and the
Trustee is not alleged to have had any obligation to inform them of the identity of
other bondholders (even if the Trustee had the means of knowledge, which it did not).
In the second place, the fact was that the bondholders were being offered repayment
of the bonds after many years of waiting. If Elektrim were declared bankrupt, it would
have been because its liabilities exceeded its assets, which would in itself have
prejudiced its ability to repay the bonds.
44.
The final possibility can also be summarily dismissed. In the first place Everest had
no locus standi before the Polish bankruptcy court, because it was not a creditor of
Elektrim and had not filed a petition for Elektrim’s bankruptcy. Moreover the Polish
court had made it clear in its ruling of 27 October that a petitioner was entitled to
withdraw his petition if he wanted to. It also ruled that a bankruptcy petition could not
be founded on an allegation that a contingent claim, if established, would not be met.
So the possibility of the equity kicker becoming payable would not have figured in
any decision of the Polish court. The idea that the Polish court would have compelled
the Trustee to proceed with its petition when it did not want to is fanciful.
45.
Any chance of stopping the withdrawal of the petition that Everest had was not in my
judgment a real or substantial chance. It is not, therefore, an actionable head of loss.
46.
In summary, I consider that the amended complaint discloses no arguable cause of
action against the Trustee; and moreover discloses no arguable claim for recoverable
loss arising out of the alleged breaches. It is a claim that is bound to fail and, in my
judgment, is vexatious.
47.
There is a further reason why, in my judgment, the claim in Miami against the Trustee
should not be allowed to proceed. One of the principal purposes of the Part 8
proceedings was to determine whether there were any meritorious claims against the
Trustee concerning the receipt from Elektrim of the €525m and the events of October
2006. In the course of the proceedings I made a representation order under which the
bondholders (including Everest) were represented by two bondholders. In the course
of the proceedings the representative bondholders, through leading counsel instructed
on their behalf, argued that the receipt of the monies by the Trustee was lawful and
that there was no impediment to distribution. I accepted that argument and gave
judgment to that effect. VH1 as assignee of the bonds from Everest is bound by that
judgment. Its claim against the Trustee in Miami argues precisely the opposite. Its
claim in Miami is therefore a collateral attack on that judgment. In addition the claim
that VH1 seeks to advance in Miami is a claim that could and should have been raised
in the course of the Part 8 proceedings in this court. If necessary, Everest could have
applied to have been separately represented in those proceedings on the ground that
there was a conflict of interest between it and the remaining bondholders. It did not;
and should not be allowed to do so now.
48.
In my judgment the claim against the Trustee is vexatious and should not be allowed
to proceed further. I will continue the anti-suit injunction.
The claim against Elektrim
49.
Mr Malek does not suggest that there is any juridical advantage in suing Elektrim in
Miami of which VH1 would be unjustly deprived if the anti-suit injunction is
continued.
50.
In the amended complaint VH1 alleges that Elektrim made fraudulent
misrepresentations and non-disclosures, in particular about the circumstances and
legality of the transfer of the PTC shares to DT. These fraudulent misrepresentations
are said to have been contained in two press releases issued in the name of DT which
VH1 alleges “upon information and belief” (unspecified) were part of a conspiracy
between DT and Elektrim to defraud Elektrim’s creditors. The DT press releases were
intended to, and did, induce Everest and the other bondholders to believe that DT had
acquired title to 48 per cent of the PTC shares. According to the press releases DT’s
title had apparently been obtained lawfully pursuant to the determination of an
arbitration tribunal. It appeared that the PTC shares had been irrevocably transferred
out of Elektrim in return for the payment of their book value of about €600 million. In
reliance on these press releases Everest supported the decision to withdraw the
bankruptcy petition. But for the misrepresentations by Elektrim, Everest would have
taken steps to prevent a withdrawal of the petition. The steps open to it would have
been the same steps alleged in its claim against the Trustee.
51.
The primary ground on which Elektrim bases its claim to an anti-suit injunction is that
it says that the claim is made in breach of the terms of the Trust Deed and the bond
conditions. The relevant part of the Trust Deed and the bond conditions confer on the
Trustee the sole and exclusive right “to enforce the performance of any of the
provisions of these presents”. Mr Millett QC, appearing for Elektrim, says that the
amended complaint in Miami, when taken as a whole, is an attempt to “enforce the
performance of … the provisions” of the Trust Deed and/or the bond conditions. Mr
Malek, on the other hand, says that the Miami proceedings are not in breach of clause
10.2 because they are not proceedings “to enforce the performance of any of the
provisions” of the Trust Deed. The nature of VH1’s claim against Elektrim is a claim
in fraud, a Florida law tort. No claim in contract is made against Elektrim, either to
enforce the Trust Deed or to claim damages for its breach. Consequently there is no
contractual impediment to the Miami proceedings.
52.
The scope of the prohibition is a question of interpretation of the Trust Deed and the
bond conditions. In determining what the relevant provisions would mean to a
reasonable reader, I must take into account the commercial context within which the
words were used, and the purpose which it can be inferred that the provisions were
designed to achieve. In an extreme case a court may conclude that something has
gone wrong with the language.
53.
The effect of each of clause 10.2 and condition 13 is to prohibit individual
bondholders from “enforcing the performance of” the terms of the Trust Deed and of
the Bonds against Elektrim, unless the Trustee has become bound to do so and has
failed to do so. The question is: what do the quoted words preclude?
54.
55.
Mr Millett submits, and I agree, that the overall structure of the Trust Deed and the
bond conditions considered in the light of the evidence leads to the conclusions that:
i)
The use of a trustee is a common and effective way of aggregating (or pooling)
the administration and enforcement of bonds. The benefits of aggregating
these tasks are (i) cost savings for everyone and (ii) fairness of outcome
between the bondholders inter se.
ii)
However the benefits of the scheme come at a price: i.e. the bondholders have
to give up their individual rights of suit against the issuer (and, in this case,
against the guarantor of the debts).
iii)
The bondholders cannot be free to pursue their own claims “to enforce
performance of” the bonds individually against Elektrim because otherwise the
Trustee scheme does not work. Instead they must trust the Trustee to do it. Of
course, if he fails, then and only then may bondholders pursue their own
course.
iv)
The purpose of the clause 10 (and condition 13) regime is to ensure that the
class of bondholders all act through the Trustee. That ensures that they all
share equally in the fortunes of the investment and that there is no competition
between the bondholders.
v)
Another evident purpose of the regime is to prohibit individual bondholders
from pursuing class claims for their own account. If an individual bondholder
is free to pursue a claim based on a loss caused to the bondholders as a class,
then either there is the potential for multiplicity of actions or for duplication of
actions brought by the Trustee on the one hand and individual bondholders on
the other.
It is common ground that the phrase “enforce performance of” the bond conditions is
not confined to claims for specific performance. It must extend at least to a claim for
damages for compensation for non-performance of the bond conditions. However, Mr
Millett goes further. He submits that the phrase is apt to include any claim designed to
vindicate the rights of a bondholder in his capacity as such. The test of what claims
are caught by the phrase should be purposive and substantive, and not procedural or
dependent on the ingenuity of the draftsman. A claim designed to compensate a
bondholder for the loss of something that would have belonged to him in his capacity
as a bondholder is caught by the prohibition, whether the cause of action is pleaded in
contract or tort. Thus a claim such as that advanced in the Miami proceedings, which
is designed to secure to the plaintiff the lost value of the equity kicker which would
have become payable under the bond conditions is within the prohibition because:
i)
The claimed loss is one which was suffered by Everest in its capacity as
bondholder, and the claim is therefore one which is designed to vindicate its
rights as bondholder;
ii)
The allegedly fraudulent statements were not made to Everest individually but,
to the extent that they were directed at the bondholders (rather than to the
world generally) they were directed to the bondholders as a class. The claimed
loss is one which (if established) was suffered by all the bondholders as a
class, rather than by Everest individually;
iii)
The claimed loss is predicated on Elektrim having been declared bankrupt. If
that had happened, the only way of recovering the value attributable to the
equity kicker would have been by proving in Elektrim’s bankruptcy. Proving
in bankruptcy is one of the species of proceedings whose conduct in
accordance with the Trust Deed and the bond conditions is exclusively within
the control of the Trustee.
56.
I accept Mr Millett’s submissions for the reasons that he gave. I therefore conclude
that the Miami proceedings are proceedings which, in substance, are proceedings to
enforce the provisions of the Trust Deed and the bond conditions; and are therefore
within the contractual prohibition. The anti-suit injunction should be continued on that
ground.
57.
In addition Mr Millett argued that the claim as framed was hopeless, both in terms of
liability and in terms of causation of loss. The allegedly fraudulent statements were
press releases put out by DT; not by Elektrim. DT is said to have colluded with
Elektrim in putting out the press releases. The pleaded complaint is that the press
release was put out on October 4 2006 “without disclosing the full content of the
Second Partial Award”. Reading between the lines, it seems to be implicit in that plea
that if the full content of the Second Partial Award had been disclosed, the allegation
of fraud could not have been made. The complaint goes on to allege that:
“Everest relied on this release, which deceived Everest, …
about the content and effect of the Second Partial Award.”
58.
However, it is now conceded (contrary to Mr Torres’ declaration) that Everest in fact
saw the full contents of the Second Partial Award at exactly the same time. With the
document in its hands, how can it plausibly be argued that it relied on and was
deceived by a press release? Moreover, not only did Everest itself have the Second
Partial Award in its hands, it was also in the hands of Bingham McCutchen. With
highly experienced and competent lawyers retained to advise on and consider the
implications of the Second Partial Award, how can it be plausibly argued that Everest
relied on a press release rather than on its lawyers’ advice? In my judgment there is no
real answer to these questions.
59.
In addition, for the reasons I have given in relation to the claim against the Trustee,
the causal link between the allegedly fraudulent statements and the claimed loss is
fanciful. I consider therefore that the claim as framed against Elektrim is also bound
to fail, and on that ground too the anti-suit injunction should be continued.
Result
60.
I will continue both injunctions until trial or further order.