This case is a reminder of how extensive a secured creditor’s rights can be in respect of the charged property, even before the right to enforce arises.

It is also the first time that the English Court of Appeal has analysed the rights of parties to a securitisation. The decision, based on documents that are typical in the market, shows that certain parties to a securitisation (namely the Trustee and Insurer) can have a wide discretion to make what is in effect a commercial decision. In this instance, they were able to change the nature of the underlying security from convertible debt to cash.

This case is one of the many to have been brought following the approval by the Paris Commercial Court (on 15 January 2007) of Eurotunnel’s restructuring plan. It concerned Eurotunnel’s so‑called "Tier 3" debt which, under the plan, was to be exchanged for new convertible loan notes or, alternatively, a cash payment. The dispute was triggered by a complaint by one of the noteholders, QVT Financial LP, which argued that the cash option was contrary to QVT’s understanding of the commercial context.

The Court of Appeal found that QVT’s arguments were not supported by the underlying documents.

Case: Citibank NA v MBIA Assurance SA and another, CA (22.01.07)

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A recent case has provided the first opportunity for the English Court of Appeal to consider the rights of parties to a securitisation. The case is a reminder of how extensive a secured creditor’s rights can be in respect of the charged property, even before enforcement arises. It also shows that, when exercised, those rights may lead to a commercial result that was not necessarily contemplated by certain of the parties which hold the underlying economic interest.

Background

The dispute is one of the many to have been brought following the approval by the Paris Commercial Court (on January 15 2007) of Eurotunnel’s restructuring plan. The salient facts can be summarised as follows:

  • the debt in question, known as "Eurotunnel tier 3 junior debt", was held by an SPV;
  • under the securitisation, the SPV had used that debt to issue seven different tranches of loan notes;
  • certain of those loan notes were secured by a guarantee issued by MBIA;
  • the documents that provided for the securitisation included, in the usual way, a trust deed and a deed of charge between Citibank (as trustee), the SPV (as owner of the debt) and MBIA (as "loan note controller" and, for certain notes, guarantor);
  • Eurotunnel’s restructuring plan provided that the SPV would assign its debt to another Eurotunnel company in return for certain convertible notes with an option to receive cash instead of the notes (the "cash option");
  • MBIA (in its capacity as loan note controller) directed Citibank (as trustee) to exercise the cash option.

One of the loan noteholders, QVT, queried Citibank’s power and rights to require the SPV to exercise that cash option. The notes held by QVT were not guaranteed.

High Court Decision

Citibank sought directions from the court. At first instance it was held that MBIA had the power to direct Citibank to exercise the cash option and that the exercise of that option did not require Citibank’s consent under the negative pledge contained in the deed of charge and conditions attached to the loan note. QVT appealed.

Court of Appeal’s Decision

The Court of Appeal dismissed QVT’s appeal.

We summarise below the Court’s analysis of the two main issues:

1. Citibank’s power to cause the SPV to exercise the cash option

The Court saw this as a question of the true interpretation of the trust deed and deed of charge. While in the normal way the holder of security would not be expected to take steps in relation to the charged property before the security becomes enforceable, unless it could be shown that the sufficiency of the security was threatened, there is nothing to prevent the parties from agreeing that the holder of the security should have rights to intervene before the security becomes enforceable. The Court found authority for that in Nelson v Hannan [1943].

The deed of charge was worded in such a way as to entitle Citibank to require the SPV to enforce any rights that it may have under the documents that provided for the tier 3 debt and any document replacing or supplementing those documents. The wording was found to be broad enough to include Eurotunnel’s restructuring plan which, in turn, included the cash option.

The Court found that it made no difference that the effect of the exercise of the cash option was to turn property into cash. The Court noted QVT’s argument that such a result was contrary to what QVT had expected when they invested in the loan notes. However, the Court said that if those were commercial expectations of certain loan note holders, then the language used in the relevant documents was not reflective of those commercial expectations. The Court added that, in any event, the circumstances have changed from those envisaged at the time of the original subscription of the notes.

2. Was Citibank bound to comply with MBIA’s direction or must it exercise its own independent judgment?

As above, the Court saw this as a question of the true interpretation of the documents and found against QVT. Citibank was contractually obliged to give a direction to the SPV if so required by MBIA.

In addressing this issue, the Court also dismissed QVT’s arguments that the negative pledge in the charge applied to the exercise of the cash option.

Comment

The decision highlights the wide discretion of certain parties (in this case the guarantor and the trustee) to a securitisation to make what is, in effect, a commercial decision to change the nature of the security before it becomes enforceable. The purchasers of notes issued by securitisation vehicles should be aware of this as a potential risk and look carefully at the relevant clauses in the deed of charge and trust deed.

Case: Citibank NA v MBIA Assurance SA and another, CA, 22 January 2007.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 30/01/2007.