CMBS transactions – whether to treat receipts as principal or interest, and what to do where a ratings agency will not provide a required confirmation
CBRE Loan Servicing Ltd. v. Gemini (Eclipse 2006-3) PLC and others [2015] EWHC 2769 (Ch)
The dispute in this case was, in reality, between the holders of Class A notes issued by the defendant issuer on the one hand and the holders of the subordinated notes in Classes B to E on the other. The proceeds of issue of the notes were used to acquire a loan secured upon a portfolio of commercial properties. The Claimant (CBRE) was the "Special Servicer" in respect of that loan. The income derived by the borrowers from the portfolio was to be used in order to service the loan. This would also allow the issuer to service the notes. The loan was accelerated on 6 August 2012, such that the full amount became payable by the borrowers. There was, however, no default by the issuer in relation to the notes.
At the time of the hearing before Henderson J, some of the property portfolio had been sold in accordance with a disposal programme, and CBRE continued to collect rent in respect of the remainder. Henderson J was asked to decide whether CBRE should treat as income or principal receipts from the following sources: (a) rents received; (b) the proceeds of sale of the properties; and (c) any surrender premiums paid by the tenants of the properties.
This question was important because the way in which receipts were applied in practice, under a Cash Management Agreement (CMA), depended on CBRE's characterisation of them. The CMA provided for two discrete "waterfalls" of payment – if the receipts were treated as interest, there was a specific order in which they should be applied, interest due to the Class A noteholders being paid in priority to interest due to the subordinated noteholders. If, however, the receipts were treated as principal, then the subordinated noteholders would not be entitled to receive anything from them (including by way of interest) until the principal due to the Class A noteholders had been fully paid. The CMA was silent on the question of how CBRE was to distinguish between principal and interest.
The Class A noteholders accepted that rental income from the unsold properties should be treated as interest. It argued, however, that the proceeds of sale of properties, and any surrender premiums, should be treated as principal. This argument was advanced on the basis of various provisions of the CMBS transaction documents, and was consistent with the subordination of other classes to the Class A notes. The holders of the subordinated notes relied on a provision of common law (that was accepted by the Class A noteholders to be correct, albeit inapplicable), that a payment is to be applied to the discharge of interest before principal, unless the debtor or the creditor has appropriated it otherwise.
Henderson J considered this issue as a matter of contractual construction, holding that the receipts should be characterised as principal or interest depending on their source and the role they played in the context of the loan. He held that it would be inappropriate to require the kind of close analysis of the receipts that would be necessary in the context of deciding on their tax treatment. On that basis, he agreed with the Class A noteholder that the proceeds of sale and surrender premiums should be treated as principal, and that rental income should be treated as interest. The key element in Henderson J's reasoning appears to have been that he felt the debtor/creditor analogy to be inapposite to the question of how CBRE ought to characterise the relevant sums.
Henderson J's approach to this issue should be relevant in the context of other CMBS transactions, and his conclusions may also be relevant where the contractual drafting is materially similar.
Deutsche Trustee Co Ltd v. Cheyne Capital (Management) UK (LLP) and another [2015] EWHC 2282 (Ch)
This judgment, of Arnold J, also relates to difficulties in relation to a CMBS transaction (the judgment provides a useful summary of the nature and key features of such transactions generally).
In this case, the subordinated Class G notes were agreed to be the "Controlling Class" for the purposes of the transaction. This entitled Class G (represented by Cheyne as operating adviser to the Controlling Class) to exercise certain rights. Specifically, Cheyne had notified the claimant trustee of the issue (Trustee) that it wished to replace the Special Servicer appointed in relation to defaults that had occurred in the underlying loan. The difficulty with this request was that the Issuer Servicing Agreement (which was the relevant agreement for these purposes) provided that no termination of the appointment of the Special Servicer would take effect unless (in effect) each of Moody's, Fitch and S&P had been informed of the identity of the proposed replacement, and had confirmed that such replacement would not result in a downgrade of the notes. Alternatively, each class of noteholders could approve the replacement by extraordinary resolution. There was no difficulty in practice in obtaining the required confirmations from Moody's or S&P but, consistent with a general policy statement made in 2012, Fitch indicated that it would not respond to any request for confirmation of this kind.
Cheyne submitted (in summary) that the relevant provisions of the Issuer Servicing Agreement did not contemplate a situation in which a ratings agency refused on principle to provide confirmations. On that basis, Cheyne said that the agreement should be construed as requiring confirmation to be provided by such of the ratings agencies as were willing in principle to provide them.
The Trustee argued that this was not what the Issuer Servicing Agreement said. The agreement required that all three agencies provide confirmation, and provided a solution (the recourse to an extraordinary resolution of noteholders) if that was not possible. The drafting of the CMBS documents meant that, in practice, an extraordinary resolution of Class A noteholders would bind the other classes anyway, making the use of that route as an alternative to ratings agency confirmation less onerous than it might appear. In addition, the Trustee said that the agreement specifically contemplated a situation where Moody's was unwilling to provide a confirmation – on that basis, it could not be said that the draftsman had ignored contingencies of that kind.
Arnold J agreed with the Trustee's interpretation. He held that Cheyne's preferred construction of the document effectively ignored the terms in which it was actually drafted, whereas the Trustee's interpretation accorded with the ordinary meaning of the language used. He was also unpersuaded by Cheyne's argument that a decision in the Trustee's favour would produce a commercially absurd result.
The judgment is likely to be significant to other transactions of this kind, as Fitch's policy in relation to confirmations is of general application, and this is unlikely to be the only transaction in which the contractual drafting will not achieve the result that the Controlling Class (usually the most subordinate noteholders) would wish. In addition, the judgment is interesting in the context of U.S. Bank Trustees v. Titan (Europe). In that case, the judge held that it would make no commercial sense for the Special Servicer to have to remain in post because of a general policy of Fitch. The relevant contractual wording was, however, different in a number of respects, including the omission of the option for an extraordinary resolution. The Deutsche Trustee judgment will be appealed.
Status of money left in the hands of a paying agent once notes are redeemed, and appointment of a receiver by way of equitable execution
Merchant International Company Limited v. Natsionalna Aktsionerna Kompaniia Naftogaz Ukrainy [2015] EWHC 1930 (Comm)
The Claimant (MIC) got judgment against Naftogaz in February 2011. The amount currently outstanding under that judgment is almost US$25 million, which Naftogaz has not paid. MIC's application was for a receiver to be appointed by way of equitable execution in respect of (in summary) any and all of Naftogaz's rights in relation to a sum of US$25 million held by BNY Mellon.
This money was the remainder of a larger sum paid by Naftogaz to BNY Mellon, in order that BNY Mellon (as paying agent) could distribute it to the holders of notes issued by Naftogaz. A previous, unsuccessful attempt by MIC to obtain a third party debt order in relation to these funds led to a judgment of Blair J in 2014 (upheld by the Court of Appeal), that there was no debt due or accruing due to Naftogaz from BNY Mellon in respect of the money. In other words, BNY Mellon was not obliged to repay the money to Naftogaz in the same way that, for example, a banker would normally be obliged to repay money on deposit to a client. The status of funds like this, held by security trustees and paying agents for onward distribution to noteholders, can often be the subject of dispute where the issuer of the notes is also a judgment debtor.
In this case, between the judgment of Blair J and the present application, the relevant notes were redeemed and cancelled, although BNY Mellon still retained the balance of funds transferred to it. The judge accepted that, on the evidence, there were indications that BNY Mellon would repay this sum if asked to do so.
MIC said that in the circumstances, a receiver should be appointed because: (a) BNY Mellon had an express obligation as Naftogaz's agent to act in good faith and that, once the notes had been redeemed, there was no purpose in BNY Mellon holding the money, which it would therefore have to repay; (b) BNY Mellon must account to Naftogaz for the money in order to avoid being unjustly enriched; and (c) BNY Mellon had absolute discretion whether to account to Naftogaz for the money or not, and there was only one way in which it could properly exercise that discretion, given the requirement to act in good faith.
Naftogaz argued that the contractual documentation made it clear that any liability of BNY Mellon to account for the money was expressly excluded, and that, as a matter of law, there could be no restitutionary claim for unjust enrichment by Naftogaz against BNY Mellon in circumstances where there was a contractual arrangement dealing with the issue.
The judge held that, once the notes had been redeemed, the basis for the contractual exclusion of the obligation to account for the money was extinguished. He therefore held that it "follows as an incident of the relationship of principal and agent between Naftogaz and [BNY Mellon]" that BNY Mellon must account to Naftogaz for the money.
Naftogaz also argued that a receiver could only be appointed over property, and that there could be no property where there were no ownership rights. The judge was not required to decide this, in that he had found an obligation on the part of BNY Mellon to account to Naftogaz, but he said that he accepted that making the order sought would be an incremental development of the court's jurisdiction in this area, but that this would be appropriate in the circumstances.
This judgment contains a useful reminder of the principles relating to the appointment of receivers by way of equitable execution, and should also be interesting reading for those holding funds for issuers. Permission to appeal has been granted, and the appeal will be heard in December 2016.
Should a bank be ordered to allow access to accounts in the name of the wife of an individual subject to sanctions?
Hmicho v. Barclays Bank plc [2015] EWHC 1757 (QB)
Mrs Hmicho was the wife of a Syrian businessman who, from March 2015, was added to a list of designated people for the purposes of EU sanctions regulations in relation to those supporting the Government of Syria (as defined in those regulations). The EU regulations, while having direct effect in the UK, were supported by domestic regulations, referred to in the judgment as the "UK Regulations".
In early May 2015, Barclays froze two accounts in Mrs Hmicho's sole name. Mrs Hmicho applied for a mandatory injunction requiring Barclays to restore her access to those accounts. Barclays resisted the application on the basis of the following provisions of the UK Regulations: (a) reg. 3, which states that a person (P) must not deal with funds "belonging to, or owned, held or controlled by a designated person", if P has reasonable cause to suspect that this is what P is doing; (b) reg. 4, which states that P must not make funds available, directly or indirectly, to a designated person, if P knows, or has reasonable cause to suspect, that this is what P is doing; and (c) reg. 5, which states that P must not make funds available to any person for the benefit of a designated person, if P knows, or has reasonable cause to suspect, that this is what P is doing. In addition, Barclays relied on its own terms and conditions, which stated that it was entitled to refuse an instruction where, if it followed such instruction, it might break the law, or be exposed to legal action or censure from any government, regulator or law enforcement agency.
Barclays maintained that it had the "reasonable cause for suspicion" referred to in regs. 3-5, and particularly that the money in the accounts belonged to, was owned, held or controlled by Mr Hmicho. It argued that the application ought to be refused because: (a) almost all the deposits into the account had come from Mr Hmicho; (b) there had been a series of unusual payments into and withdrawals from the accounts that suggested an attempt by Mr Hmicho to circumvent the sanctions regulations, and that suggested that he controlled the accounts; (c) it would be inappropriate for the court to require Barclays to do something that would expose it to the risk of committing a criminal offence; (d) Barclays's terms and conditions meant, in any event, that it was entitled to refuse an instruction where this "might" entail the consequences described; and (e) as Mrs Hmicho accepted, the court should not make an order of this kind unless it had a "high degree of assurance" that Mrs Hmicho would succeed at trial.
It was argued on behalf of Mrs Hmicho that: (a) Barclays had focused excessively on where the funds in the accounts had come from, as opposed to where they were to go, and the evidence showed clearly that Mrs Hmicho used the accounts to maintain herself and her children, and not for her husband's benefit; (b) only reg. 3 could be relied upon to freeze an account completely, whereas regs. 4 and 5 only allowed Barclays to refuse specific transactions; (c) Barclays had been insufficiently precise as to how the money was said to belong, be owned, held or controlled by Mr Hmicho, and had not addressed the true (and different) meanings of those terms; (d) the court should not assume that, just because Mr and Mrs Hmicho were married, she would make funds available for his use; (e) the balance of convenience lay with Mrs Hmicho, bearing in mind the draconian effect on her and her children of refusing her access to her accounts; (f) damages would be an inadequate remedy for the losses Mrs Hmicho and her children might suffer, such as interruption to the children's education; and (g) there was some doubt as to whether Mrs Hmicho could apply successfully for a licence in respect of all the categories of expenditure she might wish to undertake.
The judgment relates only to Mrs Hmicho's application for an interim injunction, and the issues raised above will therefore only be finally determined at trial. The judge held that: (a) there was not the necessary "high degree of assurance" that Mrs Hmicho would succeed; (b) Barclays had reasonable grounds for suspicion; (c) it would be inappropriate to require Barclays to take steps that might render it criminally liable; (d) while damages would not compensate Mrs Hmicho for all the losses she might suffer, they were an adequate remedy; and (e) the points made in relation to the limited scope of a licence were not compelling.
The judge made no conclusive finding as to whether regs. 4 and 5 allowed Barclays, in principle, to freeze an account. Nor was any reasoning provided in relation to the suggestion that Barclays had failed to specify precisely how it believed reg. 3 applied. The judge rejected the suggestion (described as unrealistic) that Barclays had focused excessively on the source of the funds in the account. The judge was clearly persuaded that Mr Hmicho had tried to circumvent the sanctions regulations, and held that, while the fact of him doing so was significant, his motives (to maintain his family) were not.
The decision overall is not surprising and should be of some interim reassurance to banks that they may be supported by the court in taking a cautious approach to sanctions compliance. The judgment of the court at trial will, however, be interesting in relation to how a bank should approach issues of this kind.
Resolving competing jurisdiction claims
Barclays Bank v. Ente Nazionale di Previdenza ed Assistenza dei Medici e degli Odontoiatri [2015] EWHC 2857 (Comm)
In this application, Blair J heard cross-applications in relation to jurisdiction from the Claimant (ENPAM), an Italian pension fund, and Barclays. Starting from 2007, ENPAM took part in an asset exchange, in which it exchanged assets it held for CDO securities. ENPAM alleged that the CDO securities were wholly inappropriate for its investment objectives, and that Barclays (among others) provided ENPAM with advice in relation to them.
Such advice is alleged to have been provided without Barclays and ENPAM having a prior written framework agreement in place for the provision of investment services, and ENPAM also claimed that the contractual documents in place between the parties did not articulate ENPAM's right to withdraw from the transaction. ENPAM claimed that both these omissions were breaches of Italian statute, properly justiciable in the Italian court, and therefore issued proceedings in Milan for: (a) by way of main claim, damages for pre-contractual and extra-contractual liability (agreed to be, effectively, a claim in tort); and (b) as a secondary claim, but also reliant on the alleged omissions referred to above, a claim for nullity of the asset exchange transaction. ENPAM claimed that the jurisdiction clauses in the transaction documents (in favour of the English court) were ineffective because of the lack of a pre-existing framework agreement. It also said that, as a matter of Italian law, only the proper jurisdiction of its main claim was relevant to the Italian court's decision on whether it had jurisdiction to dispose of the proceedings as a whole.
Barclays then issued proceedings in England, relying on the contractual documents relating to the asset exchange in support of its reliance on the exclusive jurisdiction and indemnity clauses they contained. Barclays claimed breach of those clauses by ENPAM and sought a declaration, damages and the enforcement of its contractual indemnity.
Blair J was required to consider: (a) ENPAM's application for the English court to decline to exercise jurisdiction based on Articles 27 or 28 of Council Regulation (EC) No. 44/2011 (the Judgments Regulation); (b) whether to hear an application by Barclays for summary judgment in respect of its claim for breach of the jurisdiction clauses; and (c) if so, how to determine such application.
The judgment contains a useful reminder as to the differences between Article 27 and Article 28, and the different considerations the court should apply to each. In summary, under Article 27, the court must decline jurisdiction if another court is first seised and the proceedings are between the same parties and involve the same cause of action. By contrast, Article 28 gives the court second seised a discretion to stay its proceedings where related actions are pending in the two courts.
In relation to Article 27, Blair J noted that the issue was whether the Milanese and English proceedings involved the same cause of action, which had an independent and autonomous meaning under European law, and required that the proceedings involve "le même objet et la même cause". The judgment provides useful guidance on resolving this issue, but Blair J concluded by agreeing that "the essential question is whether the claims are mirror images of one another". He also noted that jurisdiction clauses were generally treated as agreements separate from the contracts containing them. There was an established line of English cases that, where a party sued for breach of a jurisdiction clause in one jurisdiction, and sued in another for a breach which would fall within that jurisdiction agreement, the two causes of action were not the same. On that basis, he held that Barclays's claims relating to breach of the jurisdiction clause were not the same as ENPAM's claims in Milan. He did, however, find that the position in relation to Barclays's claim in respect of the indemnity in its transactional documents was different, in that it did amount to a claim under a contract that the Italian proceedings alleged to be void. Barclays indicated that it would not pursue that element of its claim.
The argument in relation to Article 28 was different, in that the parties agreed that the two sets of proceedings were related, and the discussion related to how the English court should exercise its discretion. Blair J decided this point in Barclays's favour, in part on the basis that there was a previously agreed jurisdiction clause in favour of the English court.
In relation to the question of whether the court would determine Barclays's summary judgment application at all, Blair J agreed that it was only in rare cases that the court would consider a summary judgment application at the same hearing as a jurisdiction challenge relating to the proceedings. He held, however, that this was such a case, particularly bearing in mind that ENPAM had indicated that it had no more evidence to serve in relation to the application.
Blair J also determined the summary judgment application itself in Barclays's favour, save in relation to one element of it. Various of the reasons for his decision are very much specific to the case, but there are some useful general considerations. First, Blair J did not accept ENPAM's argument that, by awarding damages for breach of the jurisdiction clause, he would be tying the hands of the Italian court in any way in determining the Milan proceedings. Second, he rejected ENPAM's argument that the relevant jurisdiction clause was not exclusive in favour of the English court. This argument was premised on the fact that the clause purported to be exclusive as regards claims by ENPAM only, but permitted Barclays to bring proceedings in jurisdictions other than England. This drafting is relatively common, and it is interesting to note that Blair J found it to be enforceable according to its terms.
This case is worth consideration, because situations involving claims like these, designed to play the game of competing jurisdictions, are relatively common, albeit that the introduction of the Recast Brussels Regulation in relation to claims started after 10 January 2015 will give the court chosen by the parties the primary opportunity to take jurisdiction, even where it is not first seised. While Barclays was successful in its application, the judgment is also a reminder that different elements of a claim of this kind will be treated differently, and each will require careful consideration.
Swaps dispute with Italian local authority
Dexia Crediop SpA v. Comune di Prato [2015] EWHC 1746 (Comm)
This judgment considered the liability of an Italian local authority (Prato) to make payments due under an interest rate swap it entered into with Dexia. Dexia was appointed as Prato's adviser in relation to debt restructuring and interest rate swaps in November 2002, following a tender process. At around the same time, Dexia and Prato entered into an ISDA Master Agreement (1992 version), pursuant to which they entered into six interest rate swap transactions between December 2002 and June 2006. From late 2010, Prato stopped making payments due under the sixth (and only outstanding) swap. Dexia started proceedings claiming the sums due to it. Prato defended those proceedings on bases including: (a) that the swaps were void as a matter of English law because of Prato's lack of capacity; and (b) Prato was entitled to treat the swaps as null and void, because of breaches by Dexia of mandatory rules of Italian law.
The issue of capacity has been considered in a number of other cases involving derivative transactions entered into with public bodies, or quasi-public bodies. It will usually depend, in terms of outcome, on the relevant provisions of local law, and the precise nature of the transaction entered into. In this case, Prato relied on various provisions of Italian local government law, and was unsuccessful in relation to each. Its capacity defence therefore failed.
A more unusual outcome, perhaps, was that relating to Prato's arguments based on mandatory rules of Italian law. It said that: (a) Dexia had been obliged, in circumstances where the swap transactions were not concluded "on-site" (apparently referring to whether the contracts were concluded at Dexia's offices or not), to include a specific contractual provision allowing Prato a seven-day cooling off period, following which it could cancel the contracts with no penalty; and (b) Dexia had been obliged to include provision for certain specific matters in the contract between the parties.
The swaps agreed between Dexia and Prato were expressed (in the Schedule to the Master Agreement) to be governed by English law. However, because the relevant contracts were all made between 1 April 1991 and 16 December 2009, the Rome Convention (as implemented in the UK by the Contracts (Applicable Law) Act 1990 applied to them. Under article 3(3) of the Rome Convention, if all the elements relevant to the situation at the time when a choice of law is made relate only to one country (and it is not the governing law of that country that has been chosen), the parties must still comply with any mandatory rules of the laws of the relevant country. In this case, Walker J did not accept that either the use of a globally-accepted, standard form ISDA Master Agreement, or Dexia's use of banks outside Italy in order to hedge its own exposure, amounted to a connection with a country other than Italy. Dexia had therefore been obliged to comply with any mandatory rules of Italian law (rules which could not be contracted out of). On that basis, he held that Dexia had breached the first of the rules identified by Prato, and that Prato was accordingly entitled to treat the relevant agreements as null and void (only at the option of Prato).
This judgment provides an interesting contrast to the outcome of the ENPAM case referred to above, where ENPAM ran a similar point in relation to Italian law. It leaves open the question of what consequences follow, as Walker J held that he had not heard sufficient argument on these points. The remaining issues to be determined, however, were complex. While the Rome Convention has been replaced, in relation to contracts since December 2009, the type of provision which caught Dexia out is replicated in its replacement. Banks (and others) should be careful to ensure that they still pause to consider any mandatory local rules when concluding contracts with clients overseas, even where those contracts are agreed to be subject to standard terms and a choice of law clause.
The Consumer Credit Act 1974, including provisions relating to unfair relationships
Barclays Bank plc v. L. Londell McMillan [2015] EWHC 1596 (Comm)
Since the judgment of the Supreme Court in Plevin v. Paragon Personal Finance Ltd, there has been a considerable amount of interest in the provisions of sections 140A and 140B of the Consumer Credit Act 1974 (the Act), which deal with unfair relationships between debtors and creditors. In this judgment, and the one summarised below, the court considered the Act in light of Plevin, but in relation to loan agreements rather than PPI.
With effect from 2007, the Act was amended so as to give the court (at section 140B(1)) a range of powers in relation to a credit agreement, including the power to alter its terms and to reduce or discharge any amount payable by a debtor or a surety. Such powers can only be exercised where the relationship between debtor and creditor has been found to be unfair under section 140A of the Act, because of (in summary): (a) any of the terms of the credit agreement or related agreement; (ii) the way in which the creditor has exercised or enforced any of its rights; or (iii) any other thing done or not done, by or on behalf of the creditor, before or after the making of the credit agreement.
In this case, Mr McMillan was a former partner in the firm Dewey & LeBoeuf LLP (the Firm) in its New York office. The Firm negotiated with Barclays to provide partner capital subscription loans (PCSLs) to its partners. Broadly, the terms of the PCSL were that Barclays would pay the required amount of the relevant partner's capital subscription to the Firm, which would service the interest payments, deducting them from the partner's drawings. In normal circumstances, the loan would be repaid to Barclays by the Firm out of the partner's capital account if the partner left the firm. The PCSL was governed by English law.
The Firm became insolvent, and the issue in these proceedings was whether Mr McMillan was required to repay to Barclays the US$540,000 plus interest which it claimed was due. Mr McMillan advanced a number of defences to Barclays' claim. One such defence was that the relationship between him and Barclays was unfair under the terms of the Act.
The judge considered some of the key points arising out of the judgment in Plevin, and went on to apply them to the facts of the case. In this context, the burden of proof is on the creditor to show that the relationship alleged to be unfair is not. The judge held that Barclays had done so by reason of the following:
- the terms of the PCSL were negotiated between the bank and the Firm, and the bank was entitled to assume, and did assume, that the Firm was acting in the best interests of its partners;
- Mr McMillan was not a naïve or vulnerable consumer; he was a partner in a major international law firm and could reasonably be expected to understand the clear terms of the agreement he signed, and its financial implications;
- the structure of the PCSL was standard, and there was nothing in its terms that was unusual or unfair;
- Mr McMillan could have chosen to fund his capital contribution by means of a loan from another bank, or through any other source available to him.
The judge's reasoning shows that the borrower's ability to understand the terms of what is being offered have a direct bearing on whether his or her relationship with the creditor is unfair. The judgment also shows the application of Lord Sumption's consideration as to whether the borrower had genuine freedom of choice or not − in this case, Mr McMillan did. A further issue raised by the judgment concerns the relevance of whether provisions in a credit agreement are standard, or whether they are unusual in nature. This is an area which will doubtless be developed in other cases.
McMullon v. Secure the Bridge Ltd [2015] EWCA Civ 884
The judgment in McMillan provides a useful contrast to this case in that, while the provisions of the Act relied on were the same, the facts (and the nature of the borrower) were very different. The bare facts of this case might seem unfavourable to the creditor. Mrs McMullon was the carer for her disabled granddaughter, and her husband's business had gone into administration. Her income was solely derived from benefits because, while she owned a buy-to-let property in Huddersfield, it had been unoccupied for some time and provided no income. Mrs McMullon also had substantial credit card debts, some of which related to the costs of courses she undertook with a business called The Wealth Intelligence Academy, her apparent objective being to set up a property business with which she could solve her financial problems.
Her coach on these courses was a Mr Hopkins, who was also the principal of a financial planning business called Trafalgar Square, and a director of, and a shareholder in the creditor in this case, Secure the Bridge Ltd. Secure the Bridge specialised in providing fixed-term bridging loans. Mrs McMullon discussed her financial difficulties with Mr Hopkins, who introduced her to Trafalgar Square, where one of his colleagues sought to assist Mrs McMullon in obtaining a remortgage of her buy-to-let property, so that she had funds to buy more rental properties from which she could derive an income. Preliminary indications were that she would not be able to obtain a mortgage, and a possible reason for this was Mrs McMullon's large credit card debts. Mr Hopkins therefore suggested that she take out a bridging loan of £25,000 in order to reduce her credit card bill, in the hope of encouraging a mortgage lender to take her on.
Mrs McMullon signed a credit agreement with Secure the Bridge (the Agreement). Over the following months, it became clear that Mrs McMullon would not obtain a mortgage. From 15 November 2010, she defaulted on payments due under the Agreement.
Mrs McMullon's claim was unsuccessful at first instance, and she appealed. There was no claim that the relationship between Mrs McMullon and Secure the Bridge was unfair because of the terms of the Agreement. The claims were directed at the conduct of Mr Hopkins. The Court of Appeal was invited to consider three issues, two of which may have some general relevance. First, it was argued on behalf of Mrs McMullon that, having found the relationship between the parties to be "inappropriate", the recorder at first instance should not have gone on to find that it was fair. The Court of Appeal noted the recorder's judgment that Mrs McMullon was neither misled nor unduly influenced by Mr Hopkins, and that she knew of his role at Secure the Bridge. It held that the inappropriate nature of the relationship was not such as to render it unfair in all the circumstances.
Second, it was alleged that considerations relating to affordability made the relationship unfair. Those considerations were that the Agreement was profitable to Secure the Bridge (in terms of interest and fees) and Trafalgar Square (as broker), while Mrs McMullon had no way of repaying it unless she obtained a mortgage which had already been refused. The Court of Appeal struggled with this point to some extent, in that it appeared that after the Agreement had been signed, Mr Hopkins falsified information on a mortgage application for Mrs McMullon (which she did not see). This not only reflected badly on Mr Hopkins, but Hildyard J was concerned that it showed him to be aware that Mrs McMullon would not receive a mortgage on the basis of her true financial position. The Court of Appeal ultimately determined, however, that this provided insufficient basis to disturb the recorder's findings.
NRAM plc v. McAdam and another [2015] EWCA Civ 751
The last of the cases under the Act in the second half of 2015 did not relate to the unfair relationship provisions. The issue was whether, where Northern Rock had not distinguished in its documentation between agreements that were regulated and unregulated by the Act, its successor, NRAM, was effectively required to treat all the agreements as regulated when calculating redress.
The Act only regulates credit agreements for amounts lower than a ceiling level. Northern Rock's contractual documents for fixed sum loans sold together with mortgages stated that they were agreements regulated by the Act, even where the sum advanced was in excess of that ceiling level.
The Act provides that from 2008, unless periodic statements are provided to borrowers, they are not required to pay any interest or default sum due during the period of the default. NRAM did not provide the prescribed information to borrowers, and the information it did provide was provided in the same form to borrowers under both regulated and unregulated credit agreements. In 2012, it discovered this mistake, and provided borrowers with regulated agreements with corrected information, and credited them with any interest or other payments wrongly debited from them during the period of its default. It did not provide the same (or any) redress to borrowers whom it had treated in an identical way, but whose credit agreements were unregulated because they were in excess of the ceiling amount. The defendants in this case were borrowers in such a position and, at first instance, they succeeded in persuading the court that they were entitled to the same redress as borrowers with regulated agreements.
The Court of Appeal disagreed. It was required to consider whether:
- it was possible to contract in to the Act – the court considered that it was conceptually possible, but that very clear wording would be required, which was absent in this case;
- the relevant provisions of the Act were incorporated into the contractual documents – the court held that the relevant contractual provisions indicated that the Act applied on its terms, not because of a contractual intention that it should, and the provisions of the Act were therefore not part of the contract;
- NRAM had expressly or impliedly agreed that all borrowers were to have the protection of the Act – the court held that without doing violence to the credit agreements, it was not possible to read the statements that the Act applied as giving rise to an independent contractual agreement to grant the borrowers some or all of the protections that would apply if the agreement was regulated;
- an estoppel was created by the wording included in the unregulated contracts that precluded NRAM from treating them as such – the Court of Appeal held that the judge at first instance had relied on the same matters as those that he said gave rise to a contractual agreement that the Act would apply, and that he was wrong for the same reasons. It also found that there was no shared understanding between the parties in this regard; and
- there was a representation or warranty that the loan agreement was a regulated agreement when it was not – the court held that there was such a warranty, but the consequences of this were not addressed. It appears likely from the recitation of the facts in other parts of the judgment that NRAM would argue that any claims for breach of warranty were time-barred.
This judgment is interesting in its consideration of earlier cases dealing with mistakes of this kind. The outcome may seem harsh to the borrower but, viewed in another way, any other interpretation would have resulted in a windfall not provided for under the Act.
CoCos – litigation between Lloyds and its noteholders
(1) LBG Capital No. 1 PLC; (2) LBG Capital No. 2 PLC v. BNY Mellon Corporate [2015] EWCA Civ 1257
This period saw the handing down of both first instance and appeal judgments in this case. It also saw the publication by the FCA of the FCA's Policy Statement 15/14 as to which see here.
In 2009, Lloyds Banking Group (LBG), via two special purpose companies, issued the so-called Enhanced Capital Notes (ECNs), which were contingent convertible securities. The ECNs had different maturities, but could be redeemed early if a Capital Disqualification Event (CDE) took place. The dispute between LBG and the holders of the ECNs (represented by the note trustee, BNY Mellon), was as to whether a CDE had taken place.
The judgment of the Court of Appeal considered in some detail the evolution of capital requirements and stress testing during the period from 2008 until the introduction of the EU Fourth Capital Requirements Directive (CRDIV), the PRA's published statements in relation to CRDIV in late December 2013, and the stress test carried out in relation to LBG in December 2014. The court accepted that evolution of such requirements was anticipated in December 2009, when the ECNs were issued. It also accepted that regulatory developments after the ECNs were issued were not relevant to their construction, but were relevant to the issue of whether a CDE had occurred.
At points during this period, LBG sought to increase its capital in order to satisfy the requirements in force at the time. The ECNs were issued in order to do this without diluting existing shareholdings. In general terms, the ECNs would convert into ordinary shares (which would count as part of the highest tier of capital, then termed CT1 capital), if LBG's CT1 capital ratio fell to less than 5%. This trigger point for conversion was selected based on the prevailing capital requirements.
The introduction of CRDIV changed those requirements substantially. The concept of "Core Tier 1" or CT1 capital was replaced by Common Equity Tier 1 (CET1) capital. In addition, contingent convertible securities had to have a trigger point for conversion of at least 5.125%. The PRA also indicated that it believed triggers at this minimum level might not be enough to prevent a firm from failing, and LBG therefore sought to exchange the ECNs for contingent convertible securities with a trigger point for conversion at 7%.
A CDE was defined as including an event whereby, as a result of changes to regulatory capital requirements, the ECNs would cease to be taken into account in whole or in part for the purposes of any stress test applied by the regulator "in respect of the Consolidated Core Tier 1 Ratio". The drafting of the definition did not take account of the subsequent disappearance of CT1 capital as a concept, and its replacement with CET1 capital. The stress test conducted by the PRA in December 2014 did not include the ECNs. LBG therefore declared a CDE and sought to redeem the ECNs (which carried a high coupon) early. At first instance, the judge held that it was not entitled to do so because, while the December 2014 stress test was relevant for these purposes, the ECNs had not been excluded from it for a reason of principle, but (effectively) because LBG's capital position was sufficiently strong that it did not need to rely on them.
Both LBG and BNY Mellon appealed. LBG said that while the stress test was indeed relevant, the effect of the changes introduced by CRDIV was that the conversion trigger for the ECNs was now far below the relevant minimum ratio. It was therefore the case that the ratio would be breached before the ECNs ever converted, and that they would therefore not be taken into account for the purposes of any stress test conducted by the PRA. BNY Mellon argued that the judge was wrong to take the stress test of December 2014 into account for these purposes, as it was not one conducted in relation to "Consolidated Core Tier 1" capital. BNY Mellon also argued that the judge was correct that the ECNs had not ceased to be taken into account for the purposes of stress testing; they had simply not been taken into account on this occasion.
The Court of Appeal upheld the judge's decision that the December 2014 stress test was relevant to the determination of whether a CDE had occurred. However, it unanimously allowed LBG's appeal, primarily on the basis that the draftsman of the terms of the ECNs had made an obvious error in not providing for a scenario whereby stress testing was carried out not in relation to CT1 capital ratios, but in relation to their then equivalent. The aim and purpose of the CDE definition would be undermined if such an event happened only following a stress test that was carried out by reference to an historic or superseded capital ratio. Accordingly a CDE was deemed to have occurred. Interestingly, the Court of Appeal held that this would also have been obvious to a reasonable addressee of the terms of the ECNs. BNY Mellon noted that many holders of the ECNs were retail investors, who would have assumed the language used to be meticulous. The Court of Appeal held that the fact that investors included retail investors was irrelevant to assessing what the "reasonable addressee" of the terms would have thought, in that the relevant document made it clear that a decision to invest ought only to be taken after informed and detailed consideration of the risks. This aspect of the judgment provides an interesting contrast to the FCA's approach to CoCos (considered below).
Companies litigating with their shareholders – issues relating to privilege
John Michael Sharp (and others) v. Sir Victor Maurice Blank (and others) [2015] EWHC 2681 (Ch)
This judgment also relates to litigation involving LBG and (on this occasion), its shareholders, in relation to its acquisition of HBOS. It considered the extent to which companies are able to withhold their legal advice from shareholders on the basis of privilege.
The claimant shareholders disputed LBG's blanket claim to privilege over correspondence with, and documents containing legal advice from, Linklaters. Such documents were stated to include advice in relation to Lloyds's acquisition of HBOS, its participation in the UK Government's Recapitalisation Scheme, and the form and content of a circular and a prospectus. The argument advanced by the shareholders against the availability of privilege in the circumstances is based upon an old rule applicable to litigation between trustees and beneficiaries, as well as companies and shareholders. The rule is expressed differently by different commentators but, in basic terms, companies cannot usually withhold disclosure of legal advice from their shareholders, even where such advice would be privileged as against a third party.
LBG suggested that the origin of this rule lay in common interest. Companies and shareholders could generally be expected to have a common interest in the subject matter of the legal advice. By logical consequence, once the interests of the shareholders and the company were adverse, the rule should cease to apply, and the company should be able to assert privilege in its advice. The alternative view put forward was that the rule is founded not on common interest but on funding. Where a company pays for legal advice as to its management out of its funds, then effectively its shareholders are paying for that advice and have a right to see it. This was the view preferred by the judge, on the basis that he saw little in the rule to suggest that it was an example of common interest privilege.
This distinction matters, because it has a direct bearing on the availability of what was agreed to be an exception to the rule. The relevant authorities all state that the rule can cease to apply where the company's and the relevant shareholder's interests are adverse.
One possible conclusion of LBG's argument that the rule arises out of common interest might be that a shareholder would be entitled to see legal advice obtained by a company so long as its interests in relation to the subject matter of such advice were not hostile to those of the company. Once they became hostile, as in the context of litigation, the right to see the advice would cease. It is not clear whether LBG put its case in that way, and it appears from at least one case in relation to common interest that it would have had difficulty in doing so1. Another possible formulation might be that the rule would not apply unless the interests of the shareholder and the company were held in common when the advice was taken.
By contrast, if the rule is based on who paid for the advice, then the exception to it would not operate in this way. This is, in essence, what the judge found in this case. The outcome of his judgment is that, unless the advice was itself obtained in contemplation of litigation between the company and the shareholder, it will not be privileged, even if the shareholder then sues the company in relation to its subject matter.
The important question therefore becomes whether the company obtained the advice in contemplation of proceedings by shareholders. Companies previously seem to have been given some latitude in this regard, but the judge specifically rejected LBG's assertion that there was a general principle which said that, once a company is committed to a course of action, litigation in relation to it is in contemplation. He stated that: "[i]t is one thing to say the board could reasonably have expected some dissentient shareholders to be unhappy with a decision; it is quite another thing to say that litigation was in the circumstances reasonably contemplated".
While cases involving the application of the rule have arisen periodically, it is interesting to see it applied in a case like the present one. It seems clear that it has various untested boundaries, and it may be time for companies (including banks) to consider it more closely.
Interpretation of the standard form freezing order
JSC BTA Bank v. Ablyazov [2015] UKSC 64
The Supreme Court has recently clarified that the definition of "assets" in the Commercial Court's standard form freezing order can include the proceeds of loan agreements. The freezing order was made in 2009 against Mukhtar Ablyazov, against whom JSC BTA Bank (the Bank) had obtained judgments in excess of US$4 billion, which it had been unable to enforce.
After the freezing order was made, Mr Ablyazov entered into four loan agreements with two BVI companies, pursuant to which he became entitled to borrow some £40 million in total (the Loan Agreements). The Loan Agreements stated that: "[t]he proceeds of the Loan Facility shall be used at [Mr Ablyazov's] sole discretion. [Mr Ablyazov] may direct the Lender to transfer the proceeds of the Loan Facility to any third party". The proceeds of the Loan Agreements were, in fact, used by Mr Ablyazov to fund his own legal expenses, those of co-defendants, and to meet various other expenses.
The issues that the Supreme Court was required to consider were whether: (a) Mr Ablyazov's right to draw down under the Loan Agreements was an asset for the purposes of the Freezing Order; (b) if so, his actions amounted to disposing of, dealing with or diminishing the value of the assets; and (c) the proceeds of the Loan Agreements were assets, on the basis that Mr Ablyazov had power to dispose of or deal with them as if they were his own (relying on a so-called extension to the definition of "assets" in the Commercial Court's standard form freezing order).
That extension includes the following: "[the freezing order] applies to all the respondents' assets whether or not they are in their own name ... the respondents' assets include any asset which they have power, directly or indirectly, to dispose of, or deal with as it if were their own. The respondents are to be regarded as having such power if a third party holds or controls the assets in accordance with their direct or indirect instructions".
It was clear to both the Court of Appeal and the Supreme Court considering this case that freezing orders are to be strictly construed in favour of the respondent, and that injunctions must be clear and unequivocal. The Supreme Court also held that a flexible approach, in order to thwart attempts to evade freezing orders, did not justify the expansive interpretation of an order already made. It also held that the respondent's own conduct was (unsurprisingly) irrelevant to the actual meaning of the injunction made against him.
The Supreme Court also said: "the context of a freezing order has been of particular importance in determining its true construction in a particular case". "Context" here seems to mean the context of the freezing order jurisdiction itself, its purpose and evolution.
The right to draw down money under a loan agreement is a chose in action. It was the Bank's primary submission that all choses in action are included within the definition of "assets" for the purposes of a freezing order. That submission was rejected at first instance, and on both the Bank's appeals. The reason for which the Bank failed is interesting, particularly in light of Lord Clarke's statement (in relation to the choses in action) that: "[i]n ordinary legal parlance they would I think be regarded as assets".
The reason why they are not to be regarded in this way in the specific parlance of freezing orders seems to be context. The authorities decided on the basis of the original drafting of freezing orders did not support the premise that all choses in action were assets, and the Supreme Court saw no reason to interfere with them.
Based on the new standard wording (in bold above), however, the Supreme Court allowed the Bank's appeal. It held that, on a proper construction of the Loan Agreements, Mr Ablyazov had the power to direct his lenders as to what to do with the money they were contractually obliged to pay under the Loan Agreements. The Supreme Court determined that the underlined words were not directed at assets the respondent owned, but at assets that he, she or it controlled.
This judgment will, of course, have implications for respondents to freezing orders and, now that the meaning of the extended definition of asset has been clarified, there may be cases in which applicants will also have to address the court specifically on whether its inclusion is justified. The implications for third parties are also interesting. Banks are among those most often notified of, and affected by, freezing orders. While they do not acquire any civil liability to the party which obtained the freezing order, they may be subject to contempt proceedings if they do not comply with its terms. This judgment has a number of possible implications in this context. Credit cards, for example, arguably give a borrower the power to spend the lender's money as though it were his or her own. It is therefore likely that banks and other credit card providers will have to prevent respondents using their credit cards, unless they do so in compliance with the freezing order. This is also likely to be the case in relation to further spending on an overdrawn current account, and banks may generally wish to be cautious about this issue.
Claims for unjust enrichment and unpaid vendor's liens
Bank of Cyprus UK Limited v. Menelaou [2015] UKSC 66
The Supreme Court considered a claim for unjust enrichment made by Bank of Cyprus (the Bank) against Melissa Menelaou (referred to in the judgment as Melissa). Melissa's parents were indebted to the Bank in the amount of £2.2 million, such debt being secured on their family home. In 2008, Mr and Mrs Menelaou decided to sell that property in order to buy a smaller family home and in order to make some capital available. The house they decided to purchase was bought in Melissa's name. The Bank agreed to the transaction, on the condition that the new property purchased was to be charged in its favour, in the amount of £750,000. Melissa was not aware of the existence of the charge, and once she learned of it, when her parents needed to sell the house in 2010, she issued proceedings against the Bank claiming that the charge was void. The Bank counterclaimed for a declaration that it was entitled to be subrogated to an unpaid vendor's lien over the property.
At trial, all parties involved (including the solicitors who had acted for both the Bank and the Menelaous in relation to the transaction) agreed that the charge was void, and the Bank was able to rely on an indemnity from the solicitors. The judge dismissed the Bank's counterclaim, but granted it permission to appeal. The Bank's appeal was successful before the Court of Appeal, and Melissa applied to the Supreme Court.
The Supreme Court dismissed Melissa's appeal, holding that the Bank was entitled to be subrogated to an unpaid vendor's lien, but the reasoning of the various judges hearing the appeal differed. The key area of disagreement between them was as to the use of subrogation to an unpaid vendor's lien as a remedy in this case. Specifically, there was some disagreement as to whether, as a proprietary remedy, such subrogation was appropriate where there was no proprietary claim. A lien arises over a property where a vendor has not been paid for it, and the vendor can then refuse to convey the property until the money is paid. A third party who has contributed to the purchase price can be subrogated into that position.
Lord Carnwath was alone in suggesting that the Bank needed to be able to trace its money into the purchase of the property in order to be able to be subrogated to the unpaid vendor's lien. There was some debate as to whether this was possible in the present case, because the purchase price for the property had been deducted by the solicitors from the proceeds of sale of Mr and Mrs Menelaou's previous house, rather than being advanced from the Bank directly. Lord Carnwath held that the circumstances were such that the solicitors held the money on trust for the Bank throughout, and it was therefore able to trace its money into the property. The remedy was therefore appropriate.
Lord Clarke approached the issue somewhat differently. He noted that there were four relevant questions in considering the Bank's unjust enrichment claim: (a) had Melissa been enriched?; (b) was such enrichment at the Bank's expense?; (c) was the enrichment unjust?; and (d) did Melissa have any available defences? He took the view that in taking the property unencumbered by the charge, Melissa had been enriched, and that if such enrichment was at the Bank's expense, it was unjust. Lord Clarke also found that the enrichment was at the Bank's expense, in that had it not agreed to release part of the proceeds of sale of the Menelaous' old property to be used in the purchase of the new property, Melissa could never have acquired the house. There was no need for a direct payment to have been made from the Bank to Melissa in order for its claim to succeed – there had been a transfer of value, which was sufficient. In relation to the available remedy, Lord Clarke said that there was no need to show the existence of a proprietary claim in order for the remedy to be available. He held that a flexible approach could be adopted to the remedy appropriate to each case, and that the result of agreeing to the remedy proposed by the Bank here was simply to reverse an unjust enrichment that would otherwise have taken place.
Lord Neuberger (with whom Lords Kerr and Wilson agreed) largely agreed with Lord Clarke. He also tentatively agreed with Lord Carnwath's conclusion that the Bank had a good proprietary claim that would make the remedy it sought less controversial (Lord Clarke also agreed with Lord Neuberger's tentative views on this point). Lord Neuberger agreed that Melissa had been unjustly enriched at the Bank's expense. Unlike Lord Clarke, he appears to have had some sympathy (although less than Lord Carnwath) with Melissa's argument that she was in no way responsible for what happened, although he came to the conclusion that, as the property was essentially gifted to her, Melissa could be in no better position than her parents. He also agreed that there was no requirement for tracing to be possible in order for the remedy sought by the Bank to be available.
The judgment provides a useful reminder in relation to the way in which the court considers unjust enrichment claims. The majority of the discussion, however, relates to the availability of subrogation to a vendor's lien as a remedy in the circumstances. Such discussion is complex, and there may still be scope for further debate, although the Supreme Court appears to have followed a flexible approach.
To read the complete Financial Markets Disputes and Regulatory Update - Winter 2015/Spring 2016, click here.
Footnote
1 Commercial Union Assurance Co v. Mander [1997] CLC 32
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