Disclosure in offering circulars

This analysis discusses the issues raised in Credit Suisse Asset Management LLC v Titan Europe 2006-1 Plc and others with regards to interest payments made in relation to Class X Notes.

Original news

Credit Suisse Asset Management LLC v Titan Europe 2006-1 Plc and others [2016] EWHC 969 (Ch)

What were the facts of the case?

Four sets of proceedings concerned the proper interpretation of Notes in a securitisation structure. Each structure involved the securitisation of loans secured on commercial properties. The issues raised in each of the four proceedings relate to payments due on the Class X Notes of the series. The proceedings are against a background of extensive default on the loans.

The claimant in the four sets of proceedings was Credit Suisse Asset Management LLC (CSAM), the investment manager of a fund which held the Class X notes in the structure and represented the interests of the investors in that fund.

The Class X notes were intended to provide what has been described by some of the parties (other than CSAM) as a 'fee' for the originator and lead manager rather than a return on the capital value of the Notes. The initial principal of the Notes was a nominal amount of €50,000 which was paid into a segregated account (the Class X Account). The Class X principal was secured by a first charge on the Class X Account. The Class X Notes bore interest at the 'Class X Interest Rate' which ranged from 9.024% to 114.508%. The cash management agreement set out the waterfall for payments—first in order of payment was interest due or overdue and payable on the Class A and Class X Notes. The waterfall did not contain any reference to Class X principal because that was to be paid from the Class X Account.

Four issues were raised in relation to interpreting the documents:

  • when calculating the Class X Interest Rate, should additional interest due under the Loans following a default be taken into account? (Issue 1)
  • at what rate is interest to be paid on unpaid interest on the Class X Notes? (Issue 2)
  • if any of the Notes (excluding any Class X Notes) are outstanding following their maturity date or a note enforcement notice having been served, should the Class X Notes be immediately redeemed by the issuer with the funds held in the Class X Accounts or should the Class X Notes remain outstanding until all of the other Notes have been redeemed? (Issue 3)
  • if the Class X Notes are not immediately redeemed following their maturity date or a note enforcement notice having been served and instead remain outstanding, how is the rate of interest that accrues in respect of the Class X Notes to be calculated (Issue 4)

What did the judge rule

The judge was asked to, and did, consider the recent case of Re Sigma Finance Corporation [2009] All ER (D) 297 (Oct) as that case also concerned the interpretation of documents relating to a securitisation structure.

The judge considered each issue in turn.

Issue 1

The judge ruled that no account should be taken of additional interest following a default under the loans. The question turned on the meaning of the words 'the related per annum interest rate due on such Loan' which was in the definition of 'Net Mortgage Rate'. The judge stated that reference to 'interest' could be interpreted as including 'default interest' under the natural and ordinary meaning of the words 'interest rate' but that it was also open to argument that an informed reader would not think default interest would be included when considering the fact that in the loan documents and offering circular relating to the Class X Notes, no reference to default interest was made.

The judge considered what made most sense commercially. Among other points, he discussed the fact that if default interest was included in the definition, the worse the loans performed, the higher proportion of the loan income was payable to the Class X Noteholders. This was counter-intuitive and if the default rate was taken into account, the calculations of the Class X Interest Rate would be very complicated. He also emphasised that the offering circular did not refer in any way to default rates or default provisions of the loans. Nor could investors see the loan documentation.

The conclusion was that the Class X Interest Rate was never intended to include additional interest due under the loans following a default.

Issue 2

In light of the judge's conclusions in relation to issue 1, the judge declined to comment on this issue.

Issue 3

The judge concluded that in light of his decision on issue 1, the Class X Notes should be immediately redeemed.

CSAM argued that the Class X Notes should remain outstanding because if the loans were to be repaid in accordance with their terms, there had to be a Class X Noteholder to receive the difference between the amount due on the loans and the interest payable on the other Notes that were outstanding at the time. If the Class X Notes were redeemed before the other Notes, an excess could be accumulated by the issuer which would remain for the duration of the securitisation when it would be paid to charity, which was not the intention of the structure.

Issue 4

The judge set out that there is no explanation anywhere in the offering circular that the Class X Interest Rate calculation would be made following the maturity dates of the other Notes.

Practical implications of the case

In securitisations, the offering circular includes detailed information on the issuer, the terms and conditions of the notes and the terms of the underwriting. Therefore, it is imperative that the offering circular is drafted very clearly and that it contains all information necessary for the investor to understand what it is buying. The offering circular will refer to the other more detailed documentation, but it is not unreasonable for the investor to rely on the information set out in the offering circular when deciding to purchase notes, and in practice, many (if not most) investors will rely on the information in the offering circular without seeking to confirm their understanding elsewhere. The offering circular will contain a disclaimer limiting liability for the accuracy and completeness of the information within the document but this case emphasises that it is not unreasonable to expect the offering circular to contain all information necessary.

Problems arise when notes are linked to loans. There is a great difference in terms of transparency between certain capital markets instruments and instruments in the loans market. Loans are contractual agreements between two or more parties. They are considered to be confidential, at least until the point in time at which a lender needs to give information about the transaction to a potential transferee or sub-participant. In contrast, offering circulars, especially if the underlying securities are listed, are subject to a range of disclosure requirements. Where these securities are linked to loans, disclosure of data relating to the loans is often very limited. In this case, investors could not see the loans and as the offering circular did not refer to default rates of the loans, it did not make commercial sense to link to the default rate, even if that was the intention.

The European Banking Authority (EBA) Discussion Paper on simple standard and transparent securitisations recognises, among other things, the problems inherent in transparency of securitisations with underlying loans. In that paper, the EBA proposes criteria to identify a simple, standard and transparent securitisation, including the disclosure of data on underlying exposures on a loan-by-loan level as well as disclosure to investors of underlying transaction documentation. The aim of this is to provide investors with more investor confidence in securitisations and provide more information on the underlying loans.

The case, aside from the issues in interest rates generally, emphasises the importance of ensuring offering circulars contain all information necessary for investors but also reiterates the difficulties inherent in structured transactions which are linked to loans.

Emma Millington, solicitor in the Lexis®PSL Banking & Finance team.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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