The importance of careful drafting and spens clauses in finance documentation

The importance of careful drafting and spens clauses in finance documentation

What did the Commercial Court decide in Canary Wharf Finance plc v Deutsche Trustee Company Ltd? Emma Millington, solicitor in the Lexis®PSL Banking & Finance team, considers the recent decision by the Commercial Court as to whether a prepayment was a mandatory prepayment or voluntary prepayment under the terms and conditions of mortgage-backed debentures and whether a premium was payable to the Noteholders as a result.

Original news

Canary Wharf Finance plc v Deutsche Trustee Company Ltd [2016] EWHC 100 (Comm)

The Commercial Court were asked to construe a clause in the terms and conditions of mortgage-backed debentures (the Notes), which the claimant (the Issuer), a special purpose company in the Canary Wharf Group (the CW Group), had issued, pursuant to the securitisation of the CW Group's real estate portfolio. The Noteholders argued that the redemption of the Notes was an optional redemption under the relevant terms and conditions, with the result that the Issuer had to pay a premium to the Noteholders whereas the Issuer argued that the redemption was mandatory, meaning that a premium was not payable. The court held in favour of the Noteholders.

What is the background to the case?

The Issuer issued the Notes pursuant to a securitisation of the CW Group's real estate portfolio. The Notes were issued under a trust deed between the Issuer and the first defendant (the Trustee). The original trust deed was dated 6 June 2000 but the latest version was 23 April 2007, having been amended and restated as further Notes had been issued. The Issuer had lent the sums raised by issuing the Notes to another special purpose company in the CW Group (the Borrower) pursuant to an Intercompany Loan Agreement (the ICLA). The date of the original ICLA was also 6 June 2000, but the latest version was dated 17 June 2014. The ICLA was secured by charges over the CW Group's properties.

In the period leading up to June 2014, the Borrower sold one of the properties in the securitised portfolio. Clause 17.20(a) of the ICLA required the Issuer and Trustee to release the mortgaged property in certain circumstances, including where the Borrower prepaid a specified amount of the loans in circumstances where the net indebtedness of the Borrower did not increase as a result of the repayment and consequent release of the security (Clause 17.20(a)(ii)). On 20 June 2014, the property was sold for £795,000,000 with the Borrower paying £577,900,000 of that sum by way of prepayment under the ICLA. On 22 July 2014, after giving the requisite notice, the Issuer used that sum to redeem the Class A1 Notes early. The Class A1 Notes were due in October 2033 and carried a fixed interest rate of 6.455% per annum.

Condition 5(b)(iv) of the Notes provided for the Notes to be redeemed by payment of the Principal Amount Outstanding in respect of the Notes plus accrued interest in the event of a mandatory prepayment. Condition 5(c) of the Notes provided for the Issuer, in the event of an optional redemption of the Notes, to pay the higher of the principal amount outstanding plus accrued interest and a sum equivalent to the price of treasury stock which would produce the same yield as the Notes would have produced for their duration plus accrued interest. The amount payable under Condition 5(c) would be significantly higher.

The Issuer sought a declaration that the redemption took place under Condition 5(b)(iv) and sought a further declaration that any further releases under Clause 17.20(a)(ii) of the ICLA would lead to amounts payable to Noteholders to be calculated in accordance with Condition 5(b)(iv). The defendants opposed the relief sought by the Issuer and sought declarations to the opposite effect, as supported by the Trustee.

The spens clause

Clauses such as Condition 5(c) are sometimes known as a 'spens' clause or a 'make whole' clause. A 'spens' clause provides a formula for compensating the investor for the loss of opportunity to earn interest at the original rate if the bond had continued to maturity. This clause has the effect of making an early redemption unattractive to an issuer since it might prove too expensive to redeem the securities if the investor also has to be paid under the spens clause or make whole formula.

The importance of imperative language

The Issuer's main argument was that a prepayment pursuant to Clause 17.20 was a 'mandatory prepayment of the Intercompany Loan' for the purposes of Condition 5(b)(iv), meaning that it did not have to pay a premium when it redeemed the Notes. However, it was held that Clause 17.20 did not impose an obligation on the Borrower to make a prepayment. Other provisions in the ICLA used the word 'shall' to describe mandatory events, whereas Clause 17.20 did not use any imperative wording, but instead used the word 'if', indicating that the repayment was optional rather than mandatory. The Issuer argued that even if the Borrower's use of Clause 17.20(a)(ii) was optional, repayment would still be mandatory because the prepayment necessarily had to be made out of the proceeds of the sale of the property. The judge found, however, that even though in practice it is highly likely that repayment would be made from the proceeds of sale (especially given that the Borrower is a special purpose company), the clause did not limit the repayment to the proceeds of sale and so the repayment could not be described as 'mandatory'.

The Issuer also argued that Clause 17.20(a)(ii) and Condition 5(b)(iv) were clearly interrelated as the language in each of these provisions tracked each other. The judge stated that this argument was based on impression rather than substantive meaning.

The judge concluded that the language in the ICLA was sufficiently 'clear and unambiguous' so that the premium was due to be paid to the Noteholders.

Commercial considerations

The judge considered the commercial implications of the provisions for completeness and by way of cross-checking the decision he had reached in considering the language of the contract.

When considering the commercial considerations, the judge said that it would undermine the value and benefit of long-dated Notes if they could be redeemed by the Issuer at par without fully compensating the Noteholders. The Noteholders pointed out that premium was payable where prepayment of the indebtedness by the Borrower resulted from matters within the Borrower's control or otherwise because of a fault of the Borrower. However, where the prepayment was not as a result of the Borrower's fault or out of its control, no premium was payable. The Issuer pointed out examples where it rejected the distinction set out by the Noteholders. The Issuer also argued that from a commercial perspective, it made sense for the Borrower to be able to sell assets without having to pay substantial premiums.

What does this mean for practitioners?

The principles of construction of contracts in English law are well established and the courts will determine the intention of parties to a contract objectively, using the written terms of the contract as the primary source for reaching their decision. This approach reflects the standard approach to how a court will interpret contracts (in contrast to Napier Park v Harbourmaster Pro-Rata CLO 2 BV [2014] EWCA Civ 984 where the courts took commercial considerations into account when interpreting documentation for a collateralised loan obligation).

Practitioners must continue to be diligent in ensuring that the language found in clauses reflects the intention of the parties (for example by using imperative language appropriately) as this case is another example showing how judges will primarily look at the language in the contract and not necessarily commercial considerations (although in this case, in any event, the judge found that the commercial implications argument were without merit).

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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About the author:

Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.

Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.