Facility agent chasing (payment) waterfall

Banking & Finance analysis: The High Court decision in Landesbank Hessen-Thüringen Girozentrale v Bayerische Landesbank London Branch—a dispute arising out of the payment waterfall in a facility agreement—is a good reminder of the need to pay attention to the drafting of agreements in which one party plays multiple roles and of the need to think carefully about where each creditor is intended to rank in the payment waterfall.

Original news

Landesbank Hessen-Thüringen Girozentrale and others v Bayerische Landesbank, London Branch and another [2014] EWHC 1404 (Comm)

The High Court was asked to rule on the construction of a facility agreement relating to finance for the purchase of a property in the City of London. The facility agreement required the borrowers to enter into a series of hedging agreements. The court was asked to look at the payment waterfall in the facility agreement to ascertain where payments of hedging gains by the obligors ranked.

What were the facts in the case?

The claim arose out of a facility agreement in respect of a loan facility for the purchase of 30 St Mary Axe in London (better known as 'the Gherkin') by the borrowers from Swiss Re.

The parties to the facility agreement

Both the claimants, Landesbank Hessen-Thüringen Girozentrale (Landesbank) and other banks, and the defendant, Bayerische Landesbank London Branch (BLB) were lenders under the facility agreement.

The borrowers were various entities representing a joint venture between IVG Immobilien, a German real estate group and Evans Randall, a UK investment banking and private equity group.

Prior to syndication of the loan in July 2007, BLB was the only lender. BLB was also party to the facility agreement in various other capacities—namely, as arranger, as facility agent and as security agent. The terms of the facility agreement drew a clear distinction between these various different capacities in which BLB was acting.

Landesbank and the other claimant banks became lenders under the facility agreement on syndication in July 2007.

The facility agreement required the borrowers to enter into a series of interest rate swaps (the Hedging Agreements) to manage interest rate risk during the term of the loan with a 'Hedging Lender' defined as BLB 'or any other Lender which became a Hedging Lender'. Although BLB as Hedging Lender was not a separate party to the facility agreement, various parts of the facility agreement recognised that BLB was also acting in the capacity of Hedging Lender.

The Hedging Agreements

The borrowers and BLB entered into six Hedging Agreements which incorporated the terms of the ISDA Master Agreement.

At the date of the court proceedings, the borrowers were significantly out of the money under the Hedging Agreements to the extent that if early termination occurred, the borrowers would be liable to pay the Hedging Lender in the region of £138m as break gains.

The basis of the dispute

As a result of financial difficulties encountered by the borrowers, the lenders were called upon to consider various restructuring and enforcement options, some of which might have involved early termination of the Hedging Agreements.

The dispute arose from the manner in which BLB in its capacity as Facility Agent would be required to distribute sums which might be paid by the borrowers pursuant to their liability under the Hedging Agreements in circumstances where it was likely that the sums received would be less than the amount the borrowers were liable to pay.

In essence, the case turned on the interpretation of the payment waterfall in the facility agreement.

How was the payment waterfall in the facility agreement drafted?

The payment waterfall in the facility agreement provided that:

'If any amount paid or recovered in relation to the liabilities of an Obligor under any Finance Document is less than the amount then due, the Facility Agent shall apply that amount against amounts outstanding under the Finance Documents in the following order:

(a)     first, to any unpaid fees and reimbursement of unpaid expenses or costs (including break costs and hedging break costs) of the Facility Agent;

(b)     second, to any unpaid fees and reimbursement of unpaid expenses of the Lenders;

(c)     third, to unpaid interest;

(d)     fourth, to unpaid principal; and

(e)     fifth, to other amounts due under the Finance Documents.

In each case (other than (a)), pro rata to the outstanding amounts owing to the relevant Finance Parties under the Finance Documents taking into account any applications under this clause 9.7. Any such application by the Facility Agent will override any appropriation made by an Obligor.'

The dispute concerned the interpretation of limb (a) of the clause and the penultimate sentence in it (words in bold).

What was BLB's case?

The claimants sued BLB in its capacity as Facility Agent and in its capacity as Hedging Lender. Despite being one corporate entity, BLB was represented separately in the two capacities in which it was sued. In its capacity as Facility Agent, its solicitors indicated that it took a neutral stance so it was not represented at trial. BLB's participation in the trial was in its capacity as Hedging Lender.

BLB had entered into various market hedging arrangements to manage its risk exposure under the Hedging Agreements. It argued that 'hedging break costs' in limb (a) of the payment waterfall encompassed the costs and expenses which it would incur if it had to restructure or rebalance those market hedging arrangements as a result of early termination of the Hedging Agreements.

BLB based this argument on the proposition that, as Hedging Lender, it had a risk exposure under the Hedging Agreements (unlike any other lender) which it had to manage with its own market hedging arrangements so it was commercially sensible and reasonable that any sums paid by the borrowers or the guarantors upon which there was a shortfall (particularly any sum paid upon early termination of the Hedging Agreements) should be paid over to BLB as Hedging Lender in priority to the other lenders without BLB as Facility Agent having to pro-rate any such payment with the other lenders.

BLB also argued that the reference to 'the Facility Agent' in limb (a) of the payment waterfall was shorthand for BLB generally (including in its capacity as Hedging Lender) and was not limited to BLB in its capacity as facility agent. This was for two reasons:

firstly, by definition, BLB as Facility Agent was only an agent and so did not enter into any hedging arrangements or other arrangements in that capacity so would not incur any 'break costs and hedging break costs'—on that basis the words in brackets in that provision were meaningless and the court should resist a construction which rendered any part of the contract meaningless, and

secondly, if limb (a) of the payment waterfall was limited to the unpaid fees, expenses and costs of BLB as Facility Agent, then if the obligors made a payment upon early termination of the Hedging Agreements which was less than was due, that payment would not be for the benefit of BLB but would have to be pro-rated with the other lenders, notwithstanding that:

The practical effect of this construction (given how much principal and interest was outstanding under the loan) would be that BLB recovered nothing in respect of the hedging break costs it would incur.

it was BLB which bore the commercial risk of the Hedging Agreements and the market hedging arrangements it had put in place, and

the payment made by the obligors was made under the Hedging Agreements

What was Landesbank's case?

Landesbank argued that the words 'the Facility Agent' in limb (a) of the payment waterfall denoted BLB acting in its capacity as Facility Agent and not in any other capacity, whether as Hedging Lender or otherwise.

It argued that this was clear from the parties clause in the facility agreement in which BLB was described in its separate capacities including, in one, 'in its capacity as facility agent for the Lenders'. It also argued that there were a number of other places in the facility agreement where the drafting distinguished between the different capacities and roles of 'Facility Agent', 'Security Agent', 'Hedging Lender' and 'Lender' even though at the time the agreement was made, BLB fulfilled all of those roles.

One particular example of this was in a clause dealing with withdrawals from certain accounts which referred to payments being made by the Facility Agent from those accounts, including of 'break gains payable to the Hedging Lender'. Landesbank argued that in this clause 'Facility Agent' could not also encompass 'Hedging Lender' given that the two capacities were expressly distinguished.

Landesbank also argued that if 'the Facility Agent' in limb (a) of the payment waterfall was shorthand for BLB generally then it must also encompass BLB in all of its other capacities, including as Lender. This would mean that BLB had priority over all of the other Lenders as regards any of its fees and expenses as Lender. Landesbank argued that this construction was inconsistent with the other limbs of the payment waterfall—particularly limb (b) and the penultimate sentence of the clause which deals with 'other outstanding amounts' pro rata among the Lenders.

What was the decision in the case?

The High Court found in favour of Landesbank and the other claimants.

In relation to the drafting of the facility agreement, the court noted that:

it was clear from the parties clause and from the way in which the facility agreement distinguished between the different capacities in which BLB was acting that when the phrase 'Facility Agent' was used, it meant BLB in its capacity as Facility Agent and was not shorthand for BLB acting in any other capacity

it was contemplated in the definition of 'Hedging Lender' that a Lender other than BLB might become Hedging Lender, in which case a construction of limb (a) of the payment waterfall which interpreted 'the Facility Agent' as encompassing Hedging Lender as well would be unworkable and nonsensical

the terms of the facility agreement allowed the other Lenders to terminate the agency of BLB and appoint another bank as Facility Agent, in which case a construction of limb (a) of the payment waterfall which interpreted 'the Facility Agent' as encompassing BLB as Hedging Lender (in circumstances where it was no longer Facility Agent) would be unsustainable

limb (b) of the payment waterfall and the penultimate sentence in the clause provided that fees and expenses of all the Lenders, including BLB, were pro rated—if the reference to 'the Facility Agent' in limb (a) of the payment waterfall included BLB as Hedging Lender then it must also include BLB in all its capacities, including Lender, which was inconsistent with the other parts of the payment waterfall which provided that no Lender received priority

The court also noted that limb (a) of the payment waterfall was concerned with giving priority to the reimbursement of the fees, costs and expenses incurred by the Facility Agent in carrying out its role as agent of the Lenders. It made 'perfect commercial sense' that the Facility Agent should recover such amounts in priority to the other Lenders, without having to pro-rate them (as under the other limbs of the payment waterfall) because it had acted as the Lenders' agent and the Lenders had undertaken to indemnify the Facility Agent for those amounts.

Unfortunately for BLB, the court found that limb (a) of the payment waterfall had a 'clear meaning and effect'—if there was a shortfall in the amount paid by or recovered from the borrowers, the Facility Agent would be obliged to apply that amount to unpaid interest and principal due to the Lenders under the facility agreement in priority to sums due to the Hedging Lender under the Hedging Agreements or costs and expenses incurred by the Hedging Lender in relation to its market hedging arrangements.

What are the lessons from this case?

This case does not tell us anything new about the role of facility agents or the operation of payment waterfalls but it is a good reminder of the need to pay attention to the drafting of agreements in which one party plays multiple roles.

It also serves as a reminder that where a transaction involves hedging arrangements, it is good practice to clarify early on where payments relating to the hedging will rank in the payment waterfall, before or on early termination. The Loan Market Association (LMA) intercreditor agreement for leveraged finance transactions contains provisions which deal with hedging counterparties. The intercreditor agreement is available to LMA members on the documentation section of the LMA website (subscription required for full access).

Kate Gaskell, solicitor in the Lexis®PSL Banking & Finance team.

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