Contractual interpretation in the context of secondary loan trading

23 Feb 2016

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Darragh Connell, barrister at Forum Chambers, considers the decision in GSO Credit - A Partners LP and others v Barclays Bank Plc, regarding the 2012 Loan Market Association’s standard terms for secondary loan trading.

Original news

GSO Credit - A Partners LP and others v Barclays Bank Plc and another [2016] EWHC 146 (Comm), [2016] All ER (D) 27 (Feb)

The Commercial Court ruled on the second case on the Financial List and held that, for a trade on the 2012 Loan Market Association terms in respect of a surety bonds facility: (i) the trade would, generally speaking, include the economic burden of the seller’s obligations under issued surety bonds, (ii) the ‘Purchased Assets’ were, generally speaking, ‘funded’ to the extent that money had been paid by the seller under issued surety bonds, rather than to the extent by which the facility had been drawn by the mere issue of the surety bonds.

What was the background to the case?

GSO Credit - A Partners LP and others v Barclays Bank Plc and another is another recent example of the courts grappling with contractual interpretation in the aftermath of Arnold v Britton and others [2015] UKSC 36, [2015] All ER (D) 108 (Jun). It arose in the context of secondary loan trading using standard form documentation published by the Loan Market Association (LMA) in 2012 (the LMA Standard Terms).

The background facts were that monies were lent by certain lenders to various borrowers under a senior facilities agreement (SFA) dated 19 October 2007. One of the lenders was HCC International Insurance Company Plc (HCC). The credit facilities included a surety bonds facility, and HCC was the lender under that facility. In effect, HCC agreed to issue surety bonds in favour of certain public authorities in Spain and Italy. At the material time, HCC’s maximum contingent liability under surety bonds it had issued was €23,790,371.45. No demand had been made under those bonds and no money had been paid out by HCC.

On 7 June 2013, GSO agreed to acquire HCC’s position under the surety bonds facility at a rate of 76 cents/€1 through back-to-back trades carried out via an intermediary, Barclays Bank. The litigation arose because HCC contended that the subject matter of the trades comprised only HCC’s rights as lender against the borrowers under the SFA. On HCC’s argument, it had sold to GSO the right under the SFA to be paid an equal sum by the borrowers if HCC did have to pay the public authorities under the surety bonds. GSO contended that the subject matter of the trades also included HCC’s contingent obligations to public authorities under the surety bonds. The difference between these contentions affected the calculation of the settlement amount and whether the settlement amount was a sum due from GSO or to GSO.

What were the issues relating to the LMA standard form documentation for secondary trading to be decided before the court?

The case principally involved consideration of the following issues:

whether HCC’s contingent obligations under the surety bonds issued at the time of trade formed part of the ‘Purchased Assets’, and

whether the surety bonds constituted a ‘funded’ or ‘unfunded’ portion of the ‘Purchased Assets’ for the purposes of the calculation of the ‘Settlement Amount’

Seller’s argument

HCC argued that the term ‘Purchased Assets’ was to be contrasted with the term ‘Purchased Obligations’ such that ‘Purchased Assets’ excluded ‘Purchased Obligations’. In effect, HCC argued that the definition of ‘Purchased Assets’ in the LMA Standard Terms excluded its obligation to pay the public authority beneficiaries under the issued surety bonds and consisted solely of its rights in relation to the borrowers. Further, HCC argued that the position sold to GSO was therefore ‘funded’ for the purposes of calculating the settlement amount because HCC had issued surety bonds under the surety bonds facility.

As far as HCC was concerned, the effect of the trade was that it as the seller retained exposure (in an amount equal to the difference between the price it received on the trade and the amount of the liability under the surety bonds) while ceding the benefit of cover for that exposure to a buyer who did not have the exposure.

Buyer’s argument

In contrast, GSO argued that the definition of ‘Purchased Assets’ was broad enough to include any obligations under the issued surety bonds, and that the traded position had included these obligations. The traded position was ‘unfunded’ for the purposes of the LMA Standard Terms because no calls had been made on the issued surety bonds.

What did the court decide, and what issues of contractual interpretation did it consider in doing so?

The court did not accept HCC’s argument as to the nature of the trade. Accordingly there was no true ‘contrast’, as HCC argued, between ‘Purchased Assets’ and ‘Purchased Obligations’. This finding was made notwithstanding the fact that the court accepted that a trade of a commitment or portion of a commitment under a surety bonds facility albeit not including the position under surety bonds issued under that facility was a feasible trade. However, in the present case, the court took the view that such a trade had not been provided for by the LMA documentation.

Knowles J held (at para [55]) that the definition of ‘Purchased Obligations’ expressly contemplated the buyer assuming obligations. Thus, the definition referred to:

‘…the obligations under the Credit Documentation expressly assumed or to be assumed by the Buyer…including without limitation the obligations of the Seller with respect to the Traded Portion…’

The court noted that it was particularly significant that each standard form went on to include as a ‘Novated Obligation’ or an ‘Assumed Obligation’ an obligation under a bond entered into or issued by the seller in connection with the relevant credit agreement, ‘corresponding to the Traded Portion’.

In relation to the second issue, the court considered Condition 13 of the 2012 LMA Standard Terms which made clear that ‘Purchased Assets’ may have a ‘portion’ that is ‘unfunded’ and a portion that is ‘funded’. Notably, there is no definition of ‘funded’ in the 2012 LMA Standard Terms and the word does not appear in the definition of ‘Purchased Assets’. According to HCC’s argument, the ‘Purchased Assets’ were ‘funded’ because €23,790,371.45 of the commitment under the surety bonds facility had been utilised, by the issue of surety bonds in that total.

The court rejected HCC’s argument that a portion of the ‘Purchased Assets’ had been ‘funded’ by the issue of the surety bonds. Knowles J took the view that ‘funded’ is not just another word for ‘drawn’ as where a surety bonds facility is drawn in order to issue surety bonds. Nor is it just another word for utilisation of the facility at the point of issue of surety bonds. ‘Funded’ is a word directed to the question whether and what money has been paid by the lender pursuant to the facility. Accordingly, under a surety bonds facility it is when the lender pays money under the bond, not when the bond is issued, that the borrower under the facility owes a debt to the lender.

Does the judgment have any wider significance for the secondary trading market as a whole?

Although to an extent the decision is specific to its facts, the analysis has broader significance to trading on LMA standard terms and conditions. Thus the decision is authority for the proposition that in relation to a trade on the 2012 LMA Standard Terms in respect of a surety bonds facility:

the trade will, generally speaking, include the economic burden of the seller’s obligations under issued surety bonds, and

the ‘Purchased Assets’ are, generally speaking, ‘funded’ to the extent that money has been paid by the seller under issued surety bonds, rather than to the extent by which the facility has been drawn by the mere issue of the surety bonds

In terms of the approach taken by the court to interpreting LMA documentation, Knowles J noted that the trade confirmations provided for the potential use of the standard form LMA Transfer Agreement (Bank Debt) or standard form LMA Assignment (Bank Debt) where there was no form of transfer provided under the credit agreement. Notwithstanding that a transfer under the credit agreement occurred, the court considered the effect of including reference to the alternative standard form options which were not ‘irrelevant to an understanding of the meaning of the 2012 LMA Standard Terms’.

Further, the court referred extensively to a variety of related LMA documentation other than the 2012 Standard Terms to support the view that the relevant trade confirmation had included the contingent obligations to public authorities under the surety bonds. Thus, the judge referred to, among other things:

the LMA’s Secondary Debt Trading Documentation (Par and Distressed) Users Guide, dated 5 November 2012

the definitions of the terms ‘Credit’ and in turn ‘Credit Support’ in the LMA Transfer Agreement 2010 terms, and

the LMA Assignment Agreement 2011 terms

In doing so, Knowles J expressly rejected the reliance placed by HCC on the terms of SFA.

This is the second case to reach trial in the new Financial List. Why was the case moved to the Financial List?

The Financial List is a new list managed by designated judges and can be used for any claim that principally relates to banking transactions and financial products, such as derivatives, bank guarantees, bonds, hedge funds, debt securities and private equity deals, provided that the claim is worth more than £50m. The list can also be used for any claim which requires particular expertise in the financial markets, or any claim that raises issues of general importance to the financial markets.

In this case, all parties consented to the matter being transferred to the Financial List. This was in part owing to the significance of the case to the financial markets where LMA documentation is used for secondary trading across the global financial markets.

Does the hearing of the case tell us anything interesting about the Financial List and how it might be expected to operate in the future?

A principal concern in this case for Barclays was that the various trades needed to be construed consistently. Only if parties to commercial contracts can rely upon a uniform commercial construction being given to standard terms, can they prudently incorporate them in their contracts. The Financial List will play a crucial role in ensuring that standard agreements relevant to the functioning of the financial markets are construed consistently by judges such as Knowles J who have the necessary expertise to determine disputes of this nature.

Darragh Connell is a barrister at Forum Chambers, a new boutique banking and finance set of chambers based in Quality Court, Chancery Lane, London.

Interviewed by Emily Jones.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.