High Court refuses to strike out negligence claim despite contractual disclaimer

October 19, 2023

A High Court Master has refused to strike out, or give summary judgment on, a claim by the buyers of a company alleging that accountants who prepared the completion accounts for the sale breached a duty of care to them in failing to detect an alleged fraud on the company. On the facts of the case, it was arguable that the presence of a disclaimer in the accountants’ contractual documentation did not preclude the claim: Amathus Drinks PLC & Ors v EAGK LLP & Anor [2023] EWHC 2312 (Ch).

The effectiveness of appropriately worded disclaimers is often a key issue in financial services litigation. This decision will therefore be of interest as an example of a factual scenario where it was found that a contractual disclaimer of responsibility to third parties did not necessarily preclude a claim for negligence misstatement.

As a Master’s decision, this decision will not bind other courts. However, the judgment illustrates that, while a contractual disclaimer will be a powerful factor in determining whether the maker of a statement has assumed responsibility toward a third party, it is not a panacea and will not always be determinative where there are factors which point in the other direction, such as the sophistication of the parties and any direct communication between them. In this case, the court emphasised that there were direct communications between the auditor and the third party. In its view, the nature and extent of those communications, and their relevance to whether on the facts there was an assumption of responsibility, was a matter to be explored at trial.

For a more detailed analysis of the decision, please see our Litigation Notes blog post.

Supreme Court clarifies when a stay of court proceedings will be granted in favour of arbitration under s.9 Arbitration Act 1996

September 25, 2023

A recent Supreme Court decision has clarified the English courts’ approach to determining whether a matter falls within the scope of an arbitration agreement for the purposes of deciding whether to grant a stay of court proceedings under section 9 of the Arbitration Act 1996: Republic of Mozambique v Privinvest Shipbuilding SAL [2023] UKSC 32.

Section 9 enables a party to an arbitration agreement against whom legal proceedings are brought to apply for a stay of the proceedings so far as they concern a “matter” which under the agreement is to be referred to arbitration.

Although not set in a financial services context, the present case will be of interest to financial institutions as it demonstrates that, in considering whether to grant a stay, the court will analyse the substance of a claim rather than how it is presented by the parties. If a “matter” is not an essential element of the claim, or relevant defence to that claim, then it is not a “matter” which requires a stay.

Applying this approach in the present case, the court found that the Republic of Mozambique’s claims against the defendants for, among other things, bribery, conspiracy and dishonest assistance were “matters” which fell outside the scope of the arbitration agreements in a number of related supply contracts, and accordingly a stay was refused.

For more information see this post on our Arbitration Notes blog.

High Court rules against Republic of Argentina in GDP-linked sovereign bond claim finding in favour of the claimants’ construction of provision “rebasing” GDP measurement

August 3, 2023

The High Court has ruled against the Republic of Argentina (Republic) in a claim brought by investors in Euro-denominated sovereign bonds issued in 2005 and 2010 for approximately €1.33 billion: Palladian Partners & Ors v The Republic of Argentina & Anor [2023] EWHC 711 (Comm).

While the present decision turns on the facts and specific terms of the sovereign debt securities, it provides a helpful example of the court’s approach to the contractual interpretation of bond documentation, particularly GDP-linked bonds.

Under the terms of the securities, the Republic’s obligation to pay was linked to the level and growth of the Republic’s GDP, compared to a “Base Case” for each year. In 2014, the Republic had “rebased” its measurement of GDP, so that it used 2004 prices rather than 1993 prices as it had done previously. The Republic subsequently did not pay under the securities for 2013 or any later years because it argued that the Base Case for those years, as adjusted following the rebasing of GDP, had not been met.

The key issue in dispute was the proper construction of the terms of the securities. The court concluded that the claimants were correct that, following a rebasing of GDP, the Base Case was subject to an annual adjustment using the ratio between GDP measured in the new and old prices for each year, rather than a one-off adjustment using a fixed fraction derived from a single year (as the Republic had contended).

The court therefore ordered payment of €1.33 billion for the year 2013, and specific performance for subsequent years of the Republic’s obligations in accordance with the correct approach to adjusting the Base Case.

We consider the decision in more detail below.

Background

The bonds in question were issued as part of a major sovereign debt restructuring launched in 2005, in the wake of a financial crisis which had resulted in the Republic suspending payment of over US$80 billion of debt. At that time, this was the largest sovereign debt default in history.

In the context of the restructuring, the Republic undertook a debt sustainability analysis to assess the necessary level of debt reduction and to model the level of payments which it could afford to make in the future. Certain groups of bondholders, however, believed that the Republic’s economy would grow at a higher rate than projected and that the Republic could, therefore, sustain higher levels of debt payments. For this reason, the Republic introduced the concept of GDP-linked securities, which would provide bondholders with additional payments if it did, indeed, grow at a higher than projected rate.

GDP-linked securities

GDP is a key macroeconomic indicator that measures a country’s economic output. It is an estimate of the total production of goods and services within a country’s borders over a given period. Economists measure “Real GDP” by excluding the effects of inflation/deflation, in order to compare GDP between different time periods and to measure growth. Real GDP is calculated by designating a particular year as a “base” year and using the fixed prices of goods and services in the base year to calculate the value of goods and services in all other years. At the time the bonds were issued, the Republic used 1993 as the base year for measuring GDP. Therefore, Real GDP for 2005 (by way of example) was calculated by using (i) prices of goods and services from 1993 and (ii) quantities from 2005.

It is necessary to “rebase” Real GDP periodically by updating the base year by which GDP is measured, because otherwise there can be distortions over time as the economy evolves and changes structure from the one represented by the base year. After a long process, the Republic rebased GDP in 2014, replacing 1993 prices with 2004 prices. Once the new base year had been adopted, the Republic ceased measuring or publishing GDP data in 1993 prices.

The terms of the bonds

The bonds contained terms which linked payment to real GDP. In each year, payment would only be due if certain “Payment Conditions” were met, which required Real GDP and Real GDP growth each to be higher than a “Base Case” set for that year. The bond documents included a chart which set out the Base Case for each year until maturity, measured in constant 1993 prices. For 2005, Base Case GDP was 287m pesos in 1993 prices; this rose each year until the bonds matured in 2035, by which point Base Case GDP was c.694m pesos in 1993 prices.

The bond documents also provided that if there was a rebasing of GDP during the lifetime of the bonds, then the Base Case GDP as set out in the chart would need to be adjusted for each year (or “Reference Year”). Following a rebasing, Real GDP would be measured by reference to the new “Year of Base Prices” (i.e., the year that had replaced 1993 as the base year), and Base Case GDP would be adjusted by:

“… multiplying the Base Case GDP for such Reference Year (as set forth in the chart above) by a fraction, the numerator of which shall be the Actual Real GDP for such Reference Year measured in constant prices of the Year of Base Prices, and the denominator of which shall be the Actual Real GDP for such Reference Year measured in constant 1993 prices.”

This was referred to as the “Adjustment Provision”. The critical issue in the case was how the Adjustment Provision was to be construed.

The claimants’ case was that, following a rebasing, Base Case GDP for each year was adjusted by the ratio between (i) Real GDP in that year measured in the new Year of Base Prices, and (ii) Real GDP in that year measured in 1993 prices. This would involve adjusting Base Case GDP by a different fraction every year and hence was labelled the “Annual Adjustment Construction”. The claimants argued that the wording of the Adjustment Provision was clear and that this interpretation afforded the words their plain and natural meaning.

The Republic’s case was labelled the “One-Off Overlap Construction”. This required that Base Case GDP for each year was adjusted using a single fixed fraction applied to every year going forward. The fixed fraction was determined by reference to an “Overlap Year”, which in this case was 2012 because that was the last year in which data for Real GDP in 1993 prices was available. The fixed fraction was the ratio between (i) Real GDP for the Overlap Year in the new Year of Base Prices, and (ii) Real GDP for the Overlap Year in 1993 prices. This construction entailed a one-off adjustment to the levels of Base Case GDP in the chart, rescaling the entire series into the prices of the Overlap Year. For any subsequent rebasings during the lifetime of the bonds, a new fixed fraction would need to be calculated, by reference to a new Overlap Year.

The Republic argued that this interpretation ensured that Base Case GDP would be updated in such a way that the bonds were linked to the real economic performance of the Republic as measured by the most reliable estimate of GDP available, rather than being tethered to an outdated and obsolete measure, namely 1993 prices.

Decision

Legal principles

The court reviewed the authorities on contractual interpretation, including the well-known Supreme Court decisions in Rainy Sky SA v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services Ltd [2017] UKSC 24. The court emphasised that contractual construction is a unitary or iterative exercise which involves checking rival meanings against the provisions of the contract and testing the commercial consequences (as stated in In re Sigma Finance Corpn [2009] UKSC 2). This iterative process was appropriate even though the bond documents specified rights and duties that may be passed on to others who were not a party to the original bargain, i.e., subsequent purchasers of the bonds.

The court also noted that the Republic’s case in effect required the court to construe the Adjustment Provision in such a way as to correct its drafting. The Republic was therefore relying on the principle that a clear mistake in the drafting of a document may be corrected as a matter of construction, if it can be established that something has “gone wrong with the language” (Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101) and provided there is only one possible solution to the drafting error (Trillium (Prime) Property GP Ltd v Elmfield Road Ltd [2018] EWCA Civ 1556).

Application to the present case

The court accepted that the intention behind the bonds was that payments would only be made when the Argentine economy was growing at a sufficiently healthy rate, and that they would not be made if its economy was not growing. However, the court did not accept the Republic’s key contention (discussed further below) that the parties had proceeded on an assumption of long-term 3% growth trend in real GDP without regard to any particular base year, based on the historical performance of the Argentine economy. While 3% had been used for illustrative purposes in some of the investor presentations given by the Republic, they did not stipulate that the Adjustment Provision should be understood as requiring the application of a fixed percentage for Real GDP growth and nor did the bond documents themselves.

The court concluded that the Annual Adjustment Construction was correct. The court said that this was for, “what, ultimately, is a very simple reason…the One-Off Overlap Construction just does not reflect the wording used in the Adjustment Provision. In contrast, the Annual Adjustment Construction is faithful to the wording used”. In particular, the court made the following observations as part of its contractual interpretation exercise:

No drafting error. The court noted that the One-Off Overlap Construction would require the Adjustment Provision to be read as though it contained additional wording to reflect the concept of the Overlap Year and the insertion of a separate step for any subsequent rebasings (because this would require a new fixed fraction to be calculated which would not depend on 1993 prices). Neither of these were defined or identified in any way by the words of the Adjustment Provision.
Intended commercial impact. Moreover, the underlying premise of the Republic’s case was that the One-Off Overlap Construction was the only commercially reasonable interpretation because the parties had intended, following any rebasing, to preserve the same percentage changes in real GDP growth as had been implied by the Base Case GDP figures set out in the chart (which from 2015 onwards was 3% per year). The One-Off Overlap Construction “preserved the percentages” in this way, whereas the Annual Adjustment Provision would result in different percentage growth rates from those in the chart. However, when considering the factual matrix, the court had rejected the suggestion that the Adjustment Provision required the application of a fixed percentage for GDP growth.
Economic considerations. The court also did not consider that economic considerations dictated the premise for which the Republic contended. Under the claimant’s interpretation, rebasing did not make a difference to whether or not the Payment Conditions were satisfied since the Annual Adjustment Construction tied those conditions to 1993 prices. However good or bad the contractual bargain had been at the time the bonds were issued, the Annual Adjustment Construction preserved that bargain, with the result that a creditor or investor who decided at any point to accept or purchase the bonds, based on the known position in terms of 1993 prices, would know that a rebasing would not affect their assessment of whether payments were likely in the future. By contrast, the One-Off Overlap Construction entailed the “goalposts being moved” by a rebasing.
Practical utility of using a measurement known at the time of issuance. The court did not accept the Republic’s contention that there could not be any practical use or value to investors in tying a bond that was supposed to pay out depending on the performance of the real economy to what the Republic characterised as an outdated and superseded measure of the performance of the economy. To the contrary, the court held that there were reasons why investors may have considered the link to 1993 prices to be a good thing. GDP measured in 1993 prices was a known measurement when the bonds were issued in 2005, having been in operation since 1999, and the parties would have certainty in advance as to what level and growth of Real GDP was required to meet the Payment Conditions; conversely, the parties had no idea what any rebased measurement would look like.
Non-linearity of GDP series. The court also noted the non-linear relationship of two GDP “series” in different year of base prices, i.e., the relationship between Real GDP measured in two different Year of Base Prices in any given year will not be the same as in any other given year. The One-Off Overlap Construction did not account for this non-linearity because it involved adjusting the Base Case by a single ratio based on the relationship between Real GDP in 1993 prices and Real GDP in the new Year of Base Prices in a single historic year (the Overlap Year), even though the actual ratio between Real GDP measured in those two ways would be different in each following year.
Moral hazard. Similarly, the One-Off Overlap Construction made the choice of the year used to generate the fixed fraction highly significant. The single Overlap Year would inevitably produce a fraction that was not representative of other years. The court considered it difficult to see why this would be regarded as a commercially sensible arrangement to have entered into or why everything should essentially “pivot” on one year. Indeed, on the One-Off Overlap Construction, the Republic was effectively able to choose the Overlap Year by deciding when to undertake a rebasing and when to cease publishing data in 1993 prices. This gave rise to a “moral hazard” objection, and the court held that there was no reason why investors would have wanted to give the Republic the power to select the Overlap Year, when that could determine whether or not the Republic was liable to make payment under the bonds.

Conclusion and remedies

The court concluded that the language used in the Adjustment Provision pointed towards the correctness of the Annual Adjustment Construction and that there was an economic logic to that construction being more appropriate than the One-Off Overlap Construction. It was in the court’s view impossible to conclude that the latter was the only rational construction such that there was a mistake in the wording of the Adjustment Provision which needed to be corrected.

Applying the Annual Adjustment Construction, the Payment Conditions for 2013 were met, with the amount due being €643 million in respect of the claimants’ holdings and €1.33 billion in respect of all the bonds. The court also made an order for specific performance, requiring the Republic to apply the Annual Adjustment Construction in all subsequent years in determining whether it is obliged to pay under the bonds. Given that the Republic has not measured GDP in 1993 prices since 2013, this will require the Republic to re-start the production of data in 1993 prices and to continue producing it until the maturity of the bonds in 2035.

Chris Bushell

Partner, London

+44 20 7466 2187

Daniel May

Senior Associate

+44 20 7466 7608

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

High Court finds express terms of sub-participation agreement took precedence over framework master agreement

July 6, 2023

The Commercial Court has found that the express terms of a sub-participation agreement negotiated by the parties took precedence over the terms of a framework master agreement, leaving the lender of record liable to repay the participant’s capital investment when the underlying borrower defaulted: Yieldpoint Stable Value Fund, LP v Kimura Commodity Trade Finance Fund Ltd [2023] EWHC 1212 (Comm).

Sub-participation is well-known in syndicated lending. In a typical funded participation arrangement, which is often documented using market standard documents, a lender under a facility agreement subcontracts all or part of its participation in the loan to another party, and so mitigates the risk of default by the underlying borrower while remaining lender of record. Typically, a participant is exposed to the double credit risk of both the borrower and grantor of the sub-participation. However, arrangements can also be very bespoke, and entered into for a variety of reasons.

In the present case, as a matter of contractual construction, Stephen Houseman KC (sitting as a judge of the High Court under the shorter trials scheme) held that the parties used sufficiently clear language to create a hybrid form of sub-participation, which insulated and protected capital while sharing risk and reward on a pari passu basis in respect of income earned on such capital during an agreed fixed term. Accordingly, in circumstances where the borrower had defaulted under the underlying loan, the grantor of the sub-participation was ordered to repay the participant’s capital investment, plus interest. This was despite the fact that a framework master agreement provided template documentation which envisaged that any future individual participation agreement would be a conventional pari passu sub-participation (where the participant would assume a capital default risk in respect of the borrower). The defendant lender has applied to the Court of Appeal for permission to appeal the decision.

This decision will be of interest to financial sector clients as it reinforces the principle that there is no fixed concept of sub-participation as a matter of English law or international financing practice, as articulated by the Board of the Privy Council in Lloyds TSB Bank plc v Clarke & Anor [2002] UKPC 27. Using the label of sub-participation is not sufficient for an arrangement to be construed legally as a “typical” funded sub-participation arrangement. The effect of the agreement will depend on the contractual terms agreed. The decision also introduces the possibility of a novel “hybrid” form of sub-participation, not previously recognised in the case law.

More generally, this judgment demonstrates the general risks of entering into agreements based on templates pursuant to a master agreement, without considering carefully the effect of any bespoke terms which may diverge from the standard terms of the master.

Following this judgment, the court considered the impact of the claimant’s Part 36 offer, ruling that the very high offer deprived the claimant of the usual costs benefits, as it was not a genuine attempt to settle (see our Litigation Notes blog post).

Background

Kimura Commodity Trade Finance Fund Limited (Kimura), together with an entity in the Anglo-American group (AAML) had for some years provided pre-export commodity finance to Minera Tres Valles SPA (MTV), a copper-mining and cathode-producing company incorporated and based in Chile.

Kimura and AAML were joint senior lenders to MTV under a US$45m four-year structured finance facility (the MTV Facility). This facility was fully funded at all material times. Kimura’s share of the MTV Facility was US$22.5m.

In 2021, Kimura entered into a sub-participation arrangement with Yieldpoint Stable Value Fund LP (Yieldpoint). The parties signed a framework Master Participation Agreement (MPA), which was based on or comprised the Bankers Association for Finance and Trade standard form at the time. The MPA anticipated that the parties would enter into future individual participation agreements, in line with the MPA’s template documents. The MPA envisaged that any participation agreement would be a conventional pari passu sub-participation (ie Yieldpoint’s capital and income stream would be exposed to primary default risk). The MPA also stated that any inconsistent or conflicting terms of the MPA would be overridden or modified by the express terms of any participation agreements.

As contemplated by the terms of the MPA, the parties subsequently executed a participation agreement to provide funding specifically in respect of the MTV Facility (the MTV Participation). The relevant terms of the MTV Participation were:

a “Participation Amount” of US$5m and a corresponding “Retention Share” of US$17.5m; and
a fixed term of 364 days, ie until the “Maturity Date” of 31 March 2022 (in contrast to the MTV Facility which continued to run until 31 December 2024), with a Special Condition setting out a mechanism to give Yieldpoint an option to extend beyond the Maturity Date by giving 45 days’ notice.

The first capital tranche under the MTV Facility was due on 31 March 2022. However, MTV defaulted and was declared bankrupt by a Chilean court in February 2023.

Yieldpoint gave notice of its intention not to renew the deal with Kimura on 10 February 2022, but Kimura did not repay the principal sum to Yieldpoint on the Maturity Date.

Kimura contended that the transaction was a capital risk investment by way of pari passu participation as economic stakeholder in Kimura’s share of the MTV Facility, ie a conventional proportionate sub-participation, and therefore Yieldpoint’s capital was exposed to the underlying default risk.

Yieldpoint contended that the MTV Participation protected its capital in that it was only subject to default risk of its own contractual counterpart, Kimura (and not MTV), whilst sharing risk and reward on a pari passu basis in respect of income earned on such capital during the agreed fixed term.

Yieldpoint commenced proceedings, seeking repayment of the US$5m principal which it advanced to Kimura.

Decision

The court held that Yieldpoint’s claim for payment of the principal sum succeeded, together with interest since 31 March 2022 (ie the Maturity Date).

General comments on sub-participation and the MPA

The court noted that there was no fixed concept of sub-participation in English law, referring to the case of Lloyd’s TSB Bank v Clarke and the approach of Lord Hoffmann, who held that the label was not conclusive:

“…the fact that the parties labelled their agreement a ‘sub-participation agreement’ did not necessarily mean that it had to have the legal consequences described by Mr Wood and the Bank of England. The legal rights and duties created by the contract were a matter of construction for the court. Whether those legal rights and duties, as ascertained by construction, should be regarded as having a particular legal character was a question of law…The label was not conclusive. Nor was it conclusive as to whether a transaction fell within a particular market category.”

That said, the court observed that the “standard concept” of sub-participation (which was also reflected in the MPA), “involves a proportionate sharing of both risk and reward in the relevant underlying finance. This entails exposure of both capital and income stream (ie interest and/or revenue-sharing) to primary default risk”.

The court said that only clear language could significantly alter the nature of the default structure (both in general and as contemplated by the MPA). The more significant the departure, the clearer and stronger the language needed. In the court’s view, it was inherently unlikely (although not impossible) that the parties intended to make a specific trade pursuant to the terms of the MPA which did not resemble or replicate a conventional sub-participation.

Analysis of the MTV Participation

The court commented that Yieldpoint’s construction of the MTV Participation involved a significant alteration to and departure from the conventional sub-participation model. It involved a hybrid form of sub-participation, insulating and protecting capital (subject only to default risk from its own contractual counterpart, Kimura) whilst sharing risk and reward on a pari passu basis in respect of income earned on the capital during the agreed fixed term. In the court’s view, this required a bright line to be drawn between capital and income. In effect, Yieldpoint’s characterisation was partially a fixed-term loan (as to capital) and partially a participation (as to the interest and “price participation” payments to be received from the underlying borrower).

The court said that the parties had not identified any decided case in which such a hybrid form of sub-participation was involved or even mentioned, nor any case which says it cannot happen. Accordingly, the court applied the test from Lloyds TSB v Clarke (above).

The court commented that each side’s analysis had its own problems, but ultimately accepted Yieldpoint’s hybrid sub-participation characterisation, albeit “not without some discomfort” and involving “a significant degree of linguistic surgery”. There were two principal stages of the court’s analysis.

1. Modification of the terms of the MPA

Assuming that the parties used sufficiently clear language to create a hybrid form of sub-participation, the court considered whether the terms of the MPA could be modified or overridden to make sense of that arrangement. Having considered various definitions in the MPA, the court concluded that it could be modified or changed to capture this form of hybrid sub-participation.

2. Did the parties use sufficiently clear language in the MTV Participation to create a hybrid form of sub-participation?

The court found that the parties did use sufficiently clear language to create a hybrid form of sub-participation, despite using the template documentation provided by the MPA. The key factors considered by the court in reaching this conclusion were as follows:

The inclusion of a maturity date. Crucial to the court’s analysis was the inclusion of the 12-month fixed term “Maturity Date” in the MTV Participation, which (together with the Special Condition relating to renewal below) were sufficiently strong and clear to depart from the pre-ordained sub-participation structure. The court noted that the concept of a maturity date itself is “alien” to sub-participation, whereas it is normal for a fixed-term loan, where the lender takes the default risk of the borrower only. Further, the concept of a maturity date led Kimura to formulate an argument around the “exit regime” at maturity. This was based on alleged implied terms, which the court described as “the most telling point against [Kimura’s] interpretation of the MTV Participation”.
The renewal notice period in the contract. The Special Condition in the MTV Participation created a renewal regime (the mechanism giving Yieldpoint an option to extend beyond the Maturity Date by giving 45 days’ notice). The court said that this was always proposed to be a “fixed term” deal. Kimura’s implied “exit regime” would also have subverted this negotiated renewal in the Special Condition.
A verbal assurance by Kimura to repay the funds. On the evidence, the court found as a matter of fact that Yieldpoint was assured it would get its capital back after one year. Yieldpoint’s own need for the return of this capital to meet upstream redemptions drove the inclusion of the maturity date and renewal notice provisions discussed above.

Accordingly, the court concluded that Kimura had an unconditional obligation to repay the sum of US$5m to Yieldpoint on 31 March 2022 and that it had breached that obligation. Kimura was therefore liable in debt (alternatively damages) together with interest from 31 March 2022.

Damien Byrne Hill

Partner

+44 20 7466 2114

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Emily Barry

Professional Support Consultant

+44 20 7466 2546

Ariel Wiebe

Associate

+44 20 7466 3844

Sarah McCadden

Professional Support Lawyer

+44 20 7466 2193

High Court reaffirms primacy of ISDA Master Agreement jurisdiction clause post-Brexit

June 29, 2023

The High Court’s judgment in Dexia Crediop SpA v Provincia di Brescia [2023] EWHC 959 (Comm) confirms that an English jurisdiction clause within standard form ISDA documentation will not readily be displaced.

The High Court gave effect to an English jurisdiction clause in an ISDA Master Agreement, finding that the claims related to the validity and enforceability of either the ISDA Master Agreement or the underlying swaps. The court rejected the suggestion that the relevant claims for declaratory relief arose out of a connected settlement agreement between the parties (which did not contain a jurisdiction clause and was governed by Italian law).

This decision is consistent with the trend of the English courts to give effect to ISDA standard form jurisdiction clauses, as set out in the previous decisions of BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2019] EWCA Civ 1740 (read our blog post) and Deutsche Bank AG v Comune di Savona [2018] EWCA Civ 1740 (read our blog post). These judgments were made pursuant to Article 25 of the Recast Brussels Regulation, which governs the question of jurisdiction where there has been an agreement between the parties under EU law. The present case (together with the recent decision in Deutsche Bank v Brescia [2022] EWHC 2859 (Comm)) is one of the first to look at the question of competing jurisdiction clauses in an ISDA context since the UK left the EU, deciding the issue under the UK’s domestic rules on jurisdiction agreements.

Helpfully for financial institutions, the English courts are continuing to demonstrate under the post-Brexit regime that they will give effect to the broad and market standard jurisdiction clauses contained in standard form ISDA documentation. This provides some degree of certainty to parties incorporating such clauses into their transactional documentation, should they need to rely on them at a later stage.

Background

The court considered the standard form ISDA Master Agreement jurisdiction clauses relating to two swap transactions entered into by Dexia and Brescia in 2006 (the Swaps).

The parties were previously involved in litigation in England and Italy concerning the Swaps, which was brought to an end by a settlement agreement. One of the provisions of the settlement agreement purported to confirm the validity of the Swaps. The settlement agreement did not contain a jurisdiction clause, but was governed by Italian law and expressly referred to the fact that the Swaps and the related ISDA Master Agreement were subject to English law and the jurisdiction of the English courts.

Subsequently, the Provincia di Brescia (Brescia) sought to challenge the validity and enforceability of the Swaps and the settlement agreement in a new claim in Italy. In turn, Dexia Crediop SpA (Dexia) brought proceedings in the English court seeking various declarations to the effect that the Swaps were valid and enforceable.

Brescia accepted that the English court had jurisdiction to hear and determine some of the declarations, but applied for an order that it had no jurisdiction in respect of declarations referring to the settlement agreement. Brescia contended that these declarations fell outside the ISDA Master Agreement jurisdiction clause and should be litigated in Italy. Dexia argued that the declarations to which Brescia objected, all related to the Swaps and to the ISDA Master Agreement, and therefore fell within the scope of the jurisdiction clause in the ISDA Master Agreement.

Brescia was not represented at the hearing although the court went on to consider the application anyway, as it had not been withdrawn.

Decision

The court confirmed that no permission to serve out of the jurisdiction was required since the contract contained an English jurisdiction clause (as provided for by CPR 6.33(2B)(b)).

The key question for the court was whether the declarations sought by Dexia related to: (i) the ISDA Master Agreement/Swaps; or (ii) the settlement agreement.

In coming to its decision, the court relied heavily on another recent decision (Deutsche Bank v Brescia [2022] EWHC 2859 (Comm)), where proceedings were brought by Deutsche Bank in relation to two swap transactions entered into by Brescia at the same time as the Swaps. Deutsche Bank sought many of the same declarations as Dexia in the present case, and Brescia took the same position in relation to the ISDA Master Agreement (and related settlement agreement), which were on substantially the same terms. In the Deutsche Bank v Bresica case, the court had held that the ISDA Master Agreement jurisdiction clause:

was drawn in “very wide terms” and applied to future disputes; and
took precedence over the settlement agreement which expressly preserved the rights of the parties under the ISDA Master jurisdiction clause.

In the present case, the court considered the terms of the relevant declarations sought by Dexia, finding that they each related to the validity and enforceability of either the ISDA Master Agreement or the Swaps.

The court also rejected Brescia’s alternative arguments that: (1) England was not the proper forum, given the irrevocable waiver of any objection on the ground of forum non conveniens set out in the ISDA Master Agreement jurisdiction clause; and (2) service of the claim form had not been properly effected, on the basis that service had been effected in accordance with the notice provisions in the ISDA Master Agreement (which was in accordance with CPR rule 6.11, which requires service to be effected by an agreed contractual method where the claim relates to the contract in question).

As a result, the court dismissed Brescia’s application.

Damien Byrne Hill

Partner

+44 20 7466 2114

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Nic Patmore

Senior Associate

+44 20 7466 2298

Supreme Court grants Ukraine permission to defend Russia’s US $3 billion Eurobond claim on grounds of duress

June 5, 2023

The Supreme Court has unanimously held that the Law Debenture Trust Corporation plc (the Trustee), acting on the instruction of and for the benefit of the Russian Federation (Russia), is not entitled to summary judgment in respect of its claim for sums due under Eurobonds issued by Ukraine (the Notes), and that the case should proceed to trial: The Law Debenture Trust Corporation plc v Ukraine (represented by the Minister of Finance of Ukraine acting upon the instructions of the Cabinet of Ministers of Ukraine) [2023] UKSC 11.

The judgment serves as a useful reminder of the principles of capacity and authority, which have a long history in claims against financial institutions. It provides a helpful exploration of whether a sovereign state has capacity to enter into and perform a contract, with the court concluding that Ukraine had no arguable case that it lacked capacity to issue the Notes.

On the issue of authority, the court evaluated Ukraine’s overall conduct and actions leading to the issuance of the Notes. It considered whether Ukraine’s Minister of Finance had ostensible authority to issue the Notes on behalf of Ukraine, and whether the Cabinet of Ministers of Ukraine (CMU) had ostensible authority to pass the relevant resolution authorising the Minister to proceed. The court was firmly of the view that the facts constituted a representation by Ukraine that both the Minister of Finance and the CMU had the requisite authority. Accordingly, Ukraine had no arguable case that the Notes were issued without authority.

However, the court held that Ukraine had an arguable and justiciable defence of duress, so the case should proceed to trial. The court ruled that statements made by an adviser to the President of Russia, suggesting the use of force to destroy Ukraine’s security and territorial integrity, were capable of amounting to a threat to the person (and possibly goods), which are clear examples of “illegitimate” pressure for the purpose of establishing duress, as per the test in Times Travel (UK) Ltd v Pakistan International Airlines Corpn [2021] UKSC 40 (see our blog post). Despite recent guidance from the Supreme Court in the Times Travel case, the present judgment suggests that the law of duress is still in a degree of flux.

This decision also provides an interesting discussion on the intersection between commercial and public international law issues. Given the current state of geopolitical instability, it may suggest that non-justiciability issues will arise more frequently in future cases.

Background

In 2013, Ukraine, represented by its Minister of Finance and acting on instructions of the CMU, issued Eurobonds with a nominal value of US $3 billion and carrying interest of 5% per annum. The Notes were constituted by a trust deed governed by English law, to which the parties were the Trustee and Ukraine. The sole subscriber of the Notes was Russia, which has retained the Notes since their issue.

During 2014 and 2015, Ukraine made three payments under the Notes in the full amount of interest allegedly due on each occasion, totalling around US $230 million. However, Ukraine did not pay the principal amount or the last instalment of interest when the Notes matured in December 2015. On 17 February 2016, the Trustee initiated proceedings against Ukraine in the High Court, claiming approximately US $3 billion plus interests and legal costs.

A key aspect of Ukraine’s defence was that the Notes are voidable (and have been avoided) for duress. Ukraine contended that Russia applied unlawful and illegitimate economic and political pressure (including threats to its territorial integrity and threats of the use of unlawful force) in the lead up to the transaction, in an effort to deter the Ukrainian administration from entering into an Association Agreement with the EU and to accept Russian financial support instead (in the form of the Notes). Following the decision by Ukraine not to sign the Association Agreement, protests in Ukraine grew. Shortly afterwards, Russia invaded Crimea and caused widespread destruction across eastern Ukraine.

Ukraine’s further defences to the Trustee’s claim were that it lacked capacity and authority to enter into the transaction. Ukraine submitted that, in light of Russia’s alleged breach of its obligations to Ukraine not to use force or to intervene internally in the affairs of Ukraine, Ukraine was entitled to rely on the public international law doctrine of countermeasures to decline to make payment under the Notes.

High Court and Court of Appeal decisions

In July 2016, the Trustee applied for summary judgment against Ukraine, which was granted by the High Court on 29 March 2017 (but with general and unconditional permission to appeal).

On 14 September 2018, the Court of Appeal allowed Ukraine’s appeal against summary judgment, on the grounds that it had an arguable and justiciable defence of duress. However, it upheld the High Court’s conclusions in favour of the Trustee on the issues of capacity, authority and countermeasures. The Court of Appeal granted both parties leave to appeal.

Supreme Court decision

The legal issues arising before the Supreme Court were as follows:

Did Ukraine have capacity to issue the Notes or to enter into the relevant contracts?
Were the Notes issued or the relevant contracts entered into without authority?
Can Ukraine maintain that it was entitled to avoid the Notes on account of duress exerted by Russia?
Is it open to Ukraine to maintain that non-payment of the sums due under the Notes is a lawful countermeasure?

Each of these issues is considered further below.

1: Did Ukraine have capacity to issue the Notes or to enter into the relevant contracts?

The Supreme Court held that Ukraine, as a sovereign state which is recognised as such by the UK executive, is considered for the purposes of English law to be a legal person with full capacity. It was not arguable that Ukraine lacked capacity to enter into and perform a contract, irrespective of the provisions of its own domestic constitution and laws. This is because Ukraine’s capacity derives from the UK government’s recognition of the state, not from Ukraine’s internal law. Such recognition is a reflection of the sovereignty and independence of sovereign states and fully accords with and promotes the principle of comity.

2: Were the Notes issued or the related contracts entered into without authority?

Ukraine contended that even if it had capacity to issue the Notes, the Minister of Finance who signed the Trust Deed to “effectuate” the borrowing did not have authority to do so.

Assuming that the Minister of Finance did not have actual authority to procure the issuance of the Notes, the Supreme Court considered the critical question of whether Ukraine nevertheless represented, by conduct or in some other way, that the Minister of Finance did have such authority. At first instance, the High Court analysed this question as two separate issues: (a) whether the Minister of Finance had ostensible authority to sign the trust deed and to issue the Notes on behalf of Ukraine, on the instructions of the CMU; and (b) whether the CMU had ostensible authority to pass the relevant resolution (resolution 904) authorising the Minister to proceed.

In the Supreme Court’s view, it was not helpful to compartmentalise the relevant events, but to assess the activities of Ukraine as a whole. In particular:

The relevant events took place in the three-month period from October to December 2013 and involved all levels of the Ukrainian state.
At no stage did any level of the Ukrainian state suggest that the Minister had no authority to proceed, nor did any of them attempt to intervene. On the contrary, their “active and evident participation” ensured that the Notes were issued.
The transaction was of a familiar nature to the parties and conformed to Ukraine’s history of borrowing. The Trustee had acted on 31 previous issuances of Eurobonds by Ukraine and those earlier issuances were similar to the present issuance. In all of them, the Minister of Finance, representing the CMU had acted on behalf of Ukraine. In the view of the court, it was significant that Ukraine considered itself bound by the terms of the 31 earlier issuances and did not suggest that the Minister did not have the necessary authority in respect of those issuances. The court held that such background “would inevitably and properly inform the attitude of the Trustee“ to the proposed transaction.
The Trustee would naturally expect the Minister of Finance to have authority to effect such borrowing acting pursuant to an instruction from the CMU, unless that person was on notice of any matters which would have led a reasonable person to make inquiries as to whether the Minister and the CMU had authority.

The Supreme Court was firmly of the view that these facts constituted a representation by Ukraine that the CMU had authority to issue resolution 904 and that the Minister of Finance had authority to issue the Notes, acting on the instructions of the CMU, in just the same way that the Minister had in relation to the 31 previous issuances of Eurobonds.

The Supreme Court rejected all other arguments made by Ukraine on the authority question and concluded that Ukraine had no arguable case that the Notes were issued, or the relevant contracts entered into, without authority.

3: Can Ukraine maintain that it was entitled to avoid the Notes for duress exerted by Russia?

The next question for the Supreme Court was whether Ukraine had an arguable defence of duress so that the case should proceed to trial.

In reaching its judgment on this issue, the Supreme Court considered the development of the law of duress, citing the seminal cases of Barton v Armstrong [1976] AC 104 and Times Travel (UK) Ltd v Pakistan International Airlines Corpn [2021] UKSC 40 (which was handed down after the decisions of the courts below in this case, and also after the initial hearing of this appeal).

The Supreme Court noted there are two questions which arise when a party’s consent to a contract has been influenced by pressure exerted by the other party:

Whether the pressure is of a kind which English law regards as “illegitimate”. The court noted that the meaning of this term is not always clear, although commented that “illegitimate” is not synonymous with “unlawful”. The court noted that duress of the person and duress of goods are clear examples of illegitimate pressure, whereas economic pressure is not necessarily illegitimate, particularly where the threatened conduct is lawful.
If the pressure is “illegitimate”, then the question is whether that pressure affected the party’s consent to the contract so as to render the contract voidable; ie a “test of causation in duress”. The court commented that this case was not the occasion on which to address this issue, as it had not been the subject of detailed argument.

Ukraine alleged two categories of conduct: economic pressure and threats of the use of force. Accordingly, the Supreme Court proceeded to consider the different types of pressure separately in order to address the question of whether they were “illegitimate” under the English law of duress:

Economic pressure. For example, the imposition of restrictions on trade, and the threat of further restrictions; threats to procure Russian banks to commence insolvency proceedings against Ukrainian businesses; and threats to cancel joint projects, or otherwise withdraw from cooperation in a number of industries.
Threats of the use of force. Express or implicit threats of the use of force to destroy Ukraine’s security and its territorial integrity.

Economic pressure

In respect of economic pressure, the Supreme Court considered that embargoes, trade sanctions, and protectionism are common measures of state governance. It said there was no trace of the pressure imposed by such measures ever having been treated in English law as constituting duress, and measures of this kind could not be viewed as inherently illegitimate or contrary to public policy.

The remaining question was whether trade restrictions which would not otherwise constitute duress under English law, may nevertheless do so because they breach unincorporated international law (ie international law which has not been incorporated into English domestic law). The Supreme Court held that there appeared to be no principled basis for treating international law as a guide to the illegitimacy of conduct under the English law of duress.

Consequently, the Supreme Court held that the threats alleged by Ukraine to constitute economic pressure were not illegitimate, and therefore not in themselves sufficient to amount to duress under English law to establish a defence to the Trustee’s claim.

Threats of the use of force

In respect of the threats of force, Ukraine alleged that certain statements were made by an adviser to the President of Russia, such as supporting a partitioning of Ukraine if it signed the Association Agreement with the EU (among others). The question for the court at this stage was whether the alleged statements were capable of amounting to such a threat. The Supreme Court considered that they were, because such a use of force would “almost inevitably” result in violence being used against Ukrainian military personnel and civilians, and it has long been established that a threat to the person may amount to duress. Indeed, the court noted that a threat to the person need not be unlawful under English law in order to constitute duress. Use of force would also almost inevitably result in destruction or damage to property in Ukraine, and so may also constitute duress of goods.

Given the Supreme Court’s acceptance that Ukraine’s allegations concerning the threatened use of force were relevant to support its defence of duress, the question arose as to whether the doctrine of foreign act of state applies, so as to render the issue non-justiciable. In the Supreme Court’s view, the doctrine did not apply, because the court could rule on the issue without determining the validity or lawfulness of Russia’s acts under international law.

The Supreme Court concluded that Ukraine’s defence of duress, so far as based on threats of physical violence, could not be determined without a trial and so the Trustee was not entitled to summary judgment.

The majority held that Ukraine will have to amend its pleadings to focus its case on duress of the person and of goods, based on Russia’s threats of the use of force. Ukraine’s arguments in respect of trade restrictions were also relevant. Lord Carnwath, who dissented on this point, was prepared to let Ukraine’s defence of duress go forward to trial as pleaded.

4: Can Ukraine maintain that non-payment of the sums due under the Notes is a lawful countermeasure?

The majority of the Supreme Court rejected Ukraine’s submission that the common law should give effect to the rules of public international law governing countermeasures between states, and accordingly held that Ukraine had no arguable defence based on any right it may have in international law to take countermeasures on the international plane.

The Supreme Court held that principles of international law governing the rights of states to take countermeasures are rules addressed to the conduct of states amongst themselves on the international plane, and are generally not justiciable before courts in this jurisdiction for two reasons:

English law does not recognise a defence reflecting the availability of countermeasures on the international plane, so Ukraine’s case is, “quite simply, irrelevant to the determination of the rights and duties arising in English law in relation to the Notes”.
The subject matter of such inter-state disputes is inherently unsuitable for adjudication by UK courts.

The majority’s view was therefore that Ukraine’s case on countermeasures falls prima facie within the principle of non-justiciability of inter-state disputes.

Dissenting on this matter, Lord Carnwath would have permitted the defence of countermeasures to proceed to trial. Ukraine submitted that the extraordinary circumstances of this case justified an exception to the doctrine of foreign act of state, and Lord Carnwath did not see any reason why it should be prevented at this stage from seeking to make good that case at trial.

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A spectrum of possibilities: characterising a charge as fixed or floating after Re Spectrum Plus

May 25, 2023

The High Court has held that certain assets sold by a company around the time of its administration were subject to a fixed charge rather than a floating charge and as such, the sale proceeds were not to be distributed to preferential creditors or unsecured creditors: Avanti Communications Ltd, Re [2023] EWHC 940 (Ch).

In reaching its conclusion, the court conducted a detailed analysis of the case law and academic commentary on fixed and floating charges, and rejected the idea that only assets subject to a prohibition on dealings could be subject to a fixed charge. The court said that the case law supported a more nuanced approach to the question of whether a charge is fixed or floating, and to look at the range of possibilities on a spectrum. In considering whether a charge is fixed or floating, various factors must be taken into account, including: (i) the nature of the restrictions on dealing with the assets; (ii) the chargee’s control over the assets; and (iii) the nature of the assets themselves (ie whether they resemble circulating capital or fluctuating assets of the company).

The decision will be of interest to financial institutions keen to ensure that the nature of any security interest purported to have been granted in their favour is indeed what is obtained. Whilst it is a first instance decision, it appears to clarify some of the concerns and commentary which followed the House of Lords decision in Spectrum Plus Limited, Re [2005] UKHL 41.

Background

This was an application made by the Joint Administrators and Avanti Communications Limited (the Company) for directions pursuant to paragraph 63 of Schedule B1 to the Insolvency Act 1986.

The principal activity of the Company was the operation of satellites and the sale of wholesale satellite broadband and connectivity services. In March and April 2022, around the time the Company was put into administration, various transactions involving certain assets (the Relevant Assets) occurred, including an intragroup transfer and a disposal. In summary, the Relevant Assets were:

a satellite;
equipment used in the operation of network and ground station facilities;
certain satellite network filings (the sale of which would require Ofcom’s consent); and
certain ground station licences issued by Ofcom to entitle the Company to operate the ground stations (the sale of which also required Ofcom’s consent).

The Relevant Assets were subject to debentures (notably a 2017 debenture) and expressed to be subject to a fixed charge. Any assets not subject to a fixed charge were expressed to be subject to a floating charge. The provisions of the relevant security documents were complex, but in short, disposals of the Relevant Assets were subject to restrictions and waterfall provisions. There were some exceptions to these restrictions, eg assets having a fair market value of less than $2m, disposals of satellite capacity in the ordinary course of business, disposals of obsolete assets, disposals of assets which were no longer useful and disposals of licenses in the ordinary course of business.

The development of the law in this area will be well known to practitioners. By way of reminder, the House of Lords in Re Spectrum Plus essentially said that, for a charge to be fixed, the chargee must have the contractual right to exercise control over the relevant asset and must in practice actually do so. However, two important points were not made clear in Re Spectrum Plus: (1) the degree of control required for a charge to be fixed; and (2) whether the decision was limited to its facts, ie whether it applied to charges over book debts only. Following Re Spectrum Plus, some commentators took a literal approach to the characterisation issue and said that the control test must apply to all assets and scenarios, and that a total prohibition on disposals would be required for a charge to be characterised as fixed. In practice, whilst views differed, many thought Re Spectrum Plus was probably confined to its facts, ie that it applies to book debts and not to other asset classes.

Decision

The question for the court, termed the “Characterisation Issue”, was whether the Relevant Assets were secured by fixed or floating charges at the time of the transactions. As there was no evidence of crystallisation or release of the security between the date of creation and the relevant transactions, the court simply had to determine whether the Relevant Assets were secured by fixed or floating charges at the time of the transactions.

The court conducted a detailed analysis of the case law and academic commentary on fixed and floating charges, and began by noting that, in order to determine whether a charge is fixed or floating, it is necessary to conduct a two-stage enquiry (as set out in Agnew v Commissioners of Inland Revenue [2001] UKPC 28):

First Stage: the court must first construe the relevant charge instrument in order to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets.
Second Stage: the court must then embark on a process of categorisation (or characterisation) of the charge, which is a matter of law.

First Stage: construction of charge instrument

In respect of the First Stage, the court noted that the labels used by the parties are relevant as a guide to what security they objectively intended to create. However, the court is fundamentally concerned with the nature of the rights and obligations the parties intended to create. The nature of the assets in question may also be taken into account in considering this, and the court noted that a distinction often drawn in the authorities was between a chargor’s circulating capital and its non-circulating capital, on the basis that complying with the terms of a fixed charge over a company’s circulating capital would paralyse its business (as per Agnew). Regard may also be had to the nature of the business of the chargor when construing the rights and obligations created under the contractual documentation.

In this case, the First Stage could be broken down into two questions:

Were the Relevant Assets within the scope of the charging clause in the relevant security documents (notably here the 2017 debenture)?
What was the nature of the contractual restrictions and permissions on the disposal of the Relevant Assets, under the terms of the security documents?

In respect of the first question, the court considered that the Relevant Assets in this case did indeed fall within the scope of the charge created by clause 3.1(b) of the 2017 debenture. The court noted that the classes of assets listed in sub-paragraphs (i)–(xi) of this section of the charging clause encompassed a very broad range of asset type, and the charge was expressed to be a fixed charge, although the court noted that this label was not decisive.

In terms of the second question, having analysed the position in detail, the court held that the Relevant Assets were all subject to considerable restrictions upon their disposal. Although there were various exceptions permitting asset sales, the court considered that these exceptions were unlikely to apply to the Relevant Assets, or had limited application. The court held that, most importantly, the exceptions provided no opportunity for the Company to dispose of the Relevant Assets in the ordinary course of the Company’s trading.

Second Stage: categorisation of the charge

In respect of the Second Stage, the court noted that the question is whether the rights and obligations in respect of the Relevant Assets are consistent, as a matter of law, with fixed charge security or floating charge security. In considering this question, the labels used by the parties are not relevant. The correct characterisation of the instrument of charge is a question of law, having regard to the rights and obligations ascertained at the First Stage.

With particular regard to the decisions in Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284, Agnew, and Re Cimex Tissues Ltd [1994] BCC 626, the court noted that one of the most critical questions is who has control of the relevant class of assets, as between chargor and chargee.

In considering the question of the level of control, the court made particular reference to an extract from the textbooks Legal Problems of Credit and Security (Seventh Edition), at pages 4-23, and The Law of Security and Title Based Financing (Third Edition), at paragraph 6.110. The court noted that both textbooks suggested that the law may have reached the point where a charge can only be characterised as fixed, where there is a total prohibition of all dealings and withdrawals or a total restriction on any disposal of the charged assets by the chargor without the consent of the chargee. The court noted that if this was the correct position, then the charge created by the 2017 debenture in this case could not have been a fixed charge over the Relevant Assets, as certain dealings were permitted by the security documents.

The court also referred to an article which appeared in the Journal of International Banking and Financial Law, on 1 October 2008, (2008) 9 JIBFL 467, titled Floating charges: the current state of play. The court was in respectful disagreement with certain statements, including that “a charge is fixed if and only if the chargor is required to preserve the charged assets, or their permitted substitutes, for the benefit of the charge. Without this requirement, the charge is floating”. Nevertheless, the court did say that the article provided some useful commentary on the correct approach to distinguishing between fixed and floating charges, notably that Re Spectrum Plus was a case concerning debts and that, whilst it may have general application, it could easily be misapplied in considering how to characterise charges over other revenue generating assets.

The court analysed key passages from Lord Scott and Lord Walker in Re Spectrum Plus and held that the speeches of their Lordships did not support an absolute approach suggested in the textbooks referred to above, to the effect that a total prohibition on disposals is required before a charge can be a fixed charge. Notably, the court recited part of Lord Scott’s speech in Re Spectrum Plus, rejecting the idea that it was a statement to the effect that a charge is a fixed charge, if and only if the chargor is required to preserve the charged assets, or their permitted substitutes for the benefit of the chargee.

Whilst the court could see it might be helpful to look at “the range of possibilities as a spectrum”, with total freedom of management at one end, and a total prohibition on dealings of any kind at the other end, the court did not consider that it was the case that a charge will only be fixed if it is located at the total prohibition end of the spectrum.

As such, the court considered that the charge over the Relevant Assets was not necessarily a floating charge simply because the Company had some ability to deal with the Relevant Assets under the terms of the security documents.

The court also held that it would not be sensible or appropriate to attempt its own description of the characteristics of a fixed charge and a floating charge, as the existing case law already provided ample guidance. Nor would it be sensible or feasible to try to identify “the location of the point on the spectrum of possibilities where a floating charge gives way to a fixed charge, or vice versa”. The case law supports a nuanced approach to the question of whether a charge is fixed or floating, which requires a number of factors to be taken into account.

The court went on to consider the factors, as identified in case law, which are relevant in determining whether a charge is fixed or floating:

The nature of the restrictions on dealing with the Relevant Assets stated in the security.
The chargee’s control over the Relevant Assets and whether the Company was free to deal with them in the ordinary course of its business.
The nature of the Relevant Assets themselves, ie whether they resemble circulating capital or fluctuating assets of the company, whether they need to be sold to generate income, or if they are income generating.

The court concluded in this case that the chargor’s ability to deal with the Relevant Assets was materially and significantly limited, the scheme of restrictions contained in the security documents gave the chargee very significant control over the Relevant Assets, and the Company had no ability to deal with the Relevant Assets in the ordinary course of business. The Relevant Assets were income generating (ie they could be characterised as the tangible and non-tangible infrastructure owned by the Company, but did not need to be sold to generate income) and were not circulating capital, fluctuating assets or stock in trade. Taking all the circumstances of the case into account, the Relevant Assets were therefore held to be subject to a fixed charge, both when created and at the time of the transactions.

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High Court grants order for payment into court enabling company to redeem loan notes held by sanctioned entity

May 23, 2023

The High Court has granted an order for moneys to be paid into court in circumstances where a company wished to redeem loan notes before their maturity date due to a proposed refinancing, but had been prevented from paying the sums to the holder of those notes in light of UK, EU and US sanctions: Fortenova Grupa D.D. v LLC Shushary Holding & Ors [2023] EWHC 1165 (Ch).

The claim concerned loan notes issued by an EU company and held by the subsidiary of a well-known Russian bank, which is subject to sanctions as a result of the war in Ukraine, including in the UK, EU and US.

Due to a proposed refinancing, the company wished to redeem the notes held by the Russian subsidiary before their maturity date in September 2023. However, the company could not pay the sums to the Russian subsidiary to redeem the notes because of the sanctions in place. The company obtained relevant licences from the relevant authorities to make a payment into court, and then applied to court to make such a payment. The court granted the company’s application for: (i) an order that moneys be paid into court enabling the company to redeem the loan notes and for the company to take the necessary steps to release the security in the Russian subsidiary’s favour, with the intention that the Russian subsidiary could apply for the moneys if and when sanctions are lifted; and (ii) a declaration that the company is not liable for default interest on the notes.

The judgment will be of interest to financial institutions following case law developments involving sanctioned entities. The court appears to have taken a sensible and pragmatic approach to dealing with the difficulties caused by sanctions and has provided guidance on the approach to take where an obligor wishes to exercise its right to redeem.

We discuss the decision in further detail below.

Background

This was an expedited Part 8 trial of a claim concerning loan notes with a face value of approximately €400m issued by Fortenova Grupa d.d. (the Company), which is part of the Fortenova Group, a major food producer in Central and Southeastern Europe. The notes are held by the first defendant, LLC Shushary Holding (Shushary), a subsidiary of the Russian bank VTB Bank PJSC (VTB).

Pursuant to a 2019 Subscription Agreement, governed by English law and subject to the exclusive jurisdiction of the English court, the Company had issued a total of €1.157 billion worth of senior secured floating rate notes. Shushary held approximately 37.9% of the notes. The fifth and sixth defendants, as holders of the remainder of the notes, were joined to the proceedings so that they could be bound by the court’s decision. In accordance with the terms of the Subscription Agreement, the loan notes were secured against various assets of the Company and other companies in the Fortenova Group.

During 2021, the Company began exploring options for refinancing the notes. Due to the proposed refinancing, the Company wished to redeem the notes held by Shushary before their maturity date in September 2023 (as permitted under the Subscription Agreement). In line with a Payment Direction Letter, which post-dated the Subscription Agreement, the Company was to pay any sums due in respect of the Shushary notes to certain bank accounts with VTB and VTB Bank Europe SE, in the names of Shushary and VTB (the VTB accounts).

However, in February 2022, as a result of Russia’s invasion of Ukraine, the UK, the US and the EU imposed sanctions in respect of Russian individuals and entities, including VTB. As a result, it became unlawful for the Company to make payments to Shushary or VTB and so the Company could not redeem the Shushary notes, despite being contractually entitled to do so. This made it impossible for the Company to proceed with the proposed refinancing and was causing it serious prejudice.

Accordingly, the Company applied for an order that moneys be paid into court to enable the Shushary notes to be redeemed, and for the security in Shushary’s favour to be released so that the refinancing could proceed. It would then be for Shushary to apply for the moneys to be released from there, when and if sanctions are lifted. The Company also sought a declaration that it was not liable for default interest on the notes, because it has been unable to pay interest to Shushary in accordance with the Subscription Agreement while the sanctions are in place.

Decision

Payment into court

In granting an order for the payment of moneys into the Court Funds Office bank account, the court recognised that the Company must comply with the sanctions legislation in the UK, the US and the EU, and therefore the Company needed the relevant licences from the relevant authorities in order to pay the Shushary moneys into court. Importantly, the court remarked that “the court order itself is not sufficient protection” for the Company and its advisers. The court noted that the Company had sought and obtained various licences and mentioned, in respect of UK sanctions, that the Office of Financial Sanctions Implementation (OFSI) had recently, on 28 March 2023, issued a new general licence which “UK persons involved in the transactions should be able to rely upon to pay the Shushary moneys into court and which may render a specific licence issued further to the OFSI pre-licence unnecessary”.

In considering the nature of the equity of redemption, the court referred to the authorities which emphasised that the policy of the courts of equity was always to ensure that there is nothing to prevent redemption, or rather that there are “no clogs” on the equity of redemption. The court noted that there was no dispute as to the clearly established principles in this area and held that:

“The court will fashion a remedy to ensure that a debtor is able to rid their property of encumbrances and that will include directing that security be released upon payment into court of the sums required to redeem.”

As it was not lawful for the Company to make payment to the VTB accounts in accordance with the Subscription Agreement and the Payment Direction Letter in light of the various sanctions, resulting in the Company being prevented from exercising its right to redeem the Shushary notes and obtain a release of the security, the court held that an order permitting the Company to pay moneys into court, in the event of the Company exercising its right of redemption, was a “perfectly proper and sensible route” in the circumstances. Moreover, without the relief, the court noted the Company and the Fortenova Group more widely faced a real risk to their financial stability.

The court held that the possibility of Shushary being unable to receive funds for a potentially lengthy period of time was no reason to refuse redemption. Indeed, the court held that this was precisely why the court should make the order, as otherwise the Company would be left in a state of paralysis.

It was submitted that Shushary would have preferred payment to be made to a blocked account in its name within the EU, or in rubles to a Russian account. Payment to Russia would clearly be unlawful and unacceptable. Therefore, the court held that, as no suitable account in the EU was identified, there appeared to be “no alternative” but for the moneys to be paid into court.

Accordingly, the court ordered that moneys be paid into court to enable the Shushary notes to be redeemed and for the security in Shushary’s favour to be released so that the refinancing could proceed. It would then be for Shushary to apply to court for the moneys to be released to it, or to such other person as it nominated, with the application showing that such payment would be lawful and not in contravention of any applicable sanctions regime.

The court commented that the application for the payment of moneys into court was a “relatively straightforward way” of dealing with the “unfortunate situation”, and notably the application was “not strenuously opposed” by Shushary. The court also considered that the Company bringing the claim on its own behalf and pursuant to CPR 19.8(1) on behalf of the companies within the Fortenova Group that had granted security for the notes was a “sensible way to have proceeded”.

Default interest

The court also held that, in the circumstances, the Company was not liable to pay default interest under the Subscription Agreement. The relevant default interest clause stated:

“If an obligor fails to pay any amount payable by it under a finance document on its due date, interest shall accrue on the overdue amount from the due date up to the date of actual payment.”

It was argued that the clause presupposes that it is lawful for the obligor to pay the debt. However, the Company cannot be said to have failed to pay sums due to Shushary, in circumstances where the Company was willing to pay those sums, but was not permitted to do so as a result of international sanctions which prohibited the Company from paying Shushary. Having been referred to a series of cases decided during wartime (notably NV Ledeboter and Van der Held’s Textielhandel v Hibbert [1947] KB 964), where it was held that the debtor cannot be in default if performance of the obligation would be unlawful, the court held that the situation with the present case was analogous and so the correct construction in the circumstances was that the Company was not liable to pay default interest.

In reaching its conclusion, the court agreed with a previous judgment in this case handed down on 5 April 2023 (Fortenova v Shushary [2023] EWHC 970 (Ch)), where the court had expressed a preliminary view that it would be a “harsh construction” if the Company was fixed with default interest, when it was at all times willing and able to pay but was prevented from doing so by sanctions.

Although the court held that it was not necessary to consider the Company’s argument on the default interest being an unenforceable penalty in the circumstances, the court considered that the argument was “quite compelling” and added to the construction argument.

Rupert Lewis

Partner

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Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Sarah McCadden

Professional Support Lawyer

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Force majeure: general assertions as to impact of Covid-19 and Brexit not sufficient to defeat summary judgment application

May 15, 2023

The High Court has entered summary judgment in favour of a port operator against a sea ferry operator for the payment of a shortfall due for a failure to meet minimum volumes. The court rejected an argument that the operator could rely on a force majeure defence in light of Brexit and the Covid-19 pandemic: PD Teesport Ltd v P&O North Sea Ferries Ltd [2023] EWHC 857 (Comm).

While not set in a financial services context, the decision is a useful reminder that whether a force majeure clause is triggered will depend on a close analysis of the wording of the clause. Where the clause requires specific conditions to be met, it will be insufficient to rely on broad assertions as to the impact of the Covid-19 pandemic and/or Brexit.

In the present case, the force majeure clause required the claimant to have been affected by a force majeure event, and for that same event to have prevented the defendant meeting the minimum volumes guaranteed under the agreement. On the facts, the defendant had not established that it had a real prospect of showing that Brexit or the Covid-19 pandemic had affected the claimant, and thus the defendant could not rely on the force majeure clause.

The case also touches on obligations of good faith, emphasising the need to plead the content of an alleged good faith obligation and particularise any alleged breach.

For more information on this decision, please see our Litigation Notes blog.

High Court dismisses claim to recover US investment bank’s success fee in connection with the public offer of shares in Indian bank

May 4, 2023

The Commercial Court has dismissed a claim by a US investment bank to recover a success fee in relation to the public offering of shares in one of India’s largest banks in July 2020, where the engagement letter was interpreted to have referenced only private capital raisings. The claim was brought on the basis of an engagement letter between the parties, pursuant to which the investment bank was engaged to assist with attracting additional capital investment (as were various other advisors/institutions): Cantor Fitzgerald & Co. v YES Bank Ltd [2023] EWHC 745 (Comm).

The decision turned on the contractual construction of the engagement letter, which was a negotiated document, but included a significant amount of generic and boilerplate drafting. On this basis, the court avoided a formulaic, black-letter approach to textual analysis and focused on the ordinary meaning of the words used, as per Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services Ltd [2017] UKSC 24.

The court was persuaded by the use of grammar in the relevant clause, that a success fee was payable to the investment bank only where capital was raised in the private market. This interpretation was supported by the surrounding circumstances, from which it was obvious that a public offering was not viable as matters stood at the time of the engagement and was not contemplated by the engagement letter.

The decision will be of interest to financial institutions in demonstrating the court’s approach to contractual interpretation in the context of investment banking advisory engagements on equity raising transactions. Contracts documenting such arrangements will by their nature be largely boilerplate, and therefore special care should be taken to ensure that standard wording is specifically tailored to ensure that it is wide enough to cover all potential eventualities. Whilst each case will turn on the particular language used and the circumstances of the transaction, the decision is an example of how a clause for a success fee drafted narrowly can lead to a negative result for the investment advisor.

We consider the decision in more detail below.

Background

In 2019, the defendant bank (Bank), based in Mumbai, was experiencing severe financial difficulties. The court observed that the Bank’s lack of capital funding was “an existential crisis”.

In December 2019, the Bank signed an engagement letter with the claimant (Cantor), a US broker-dealer, investment bank and financial advisor, based in New York; under which Cantor agreed to assist the Bank to raise finance. Various other advisors/institutions were also instructed by the Bank with the same brief. The engagement letter contained the following wording:

“We have been advised by the Company that it contemplates one or more financing(s) through the private placement, offering or other sale of equity instruments in any form, including, without limitation, preferred or common equity, or instruments convertible into preferred or common equity or other related forms of interests or capital of the Company in one or a series of transactions (a “Financing”).”

Schedule I of the engagement letter contained a list of the potential investors who were ring-fenced for Cantor, and Cantor was entitled to 2% of the proceeds received/receivable in connection with any “Financing” under the engagement letter (in addition to a non-refundable retainer of USD 500,000). Cantor devoted time and effort to attract investors, leading to some non-binding submissions made by investors to the Bank, but the amounts involved were not sufficient and the offers were subject to significant conditions.

The financial position of the Bank deteriorated, and in March 2020 the Reserve Bank of India published a Reconstruction Scheme. Under this scheme, the State Bank of India (SBI) was to acquire a 49% shareholding in the Bank, and the Bank’s financial issues were eased with an infusion of capital of approximately USD 1.3 billion from a consortium of investors led by SBI. The entire board of directors of the Bank was also replaced. This intervention had the effect of raising investors’ confidence in the Bank.

The new board resolved to raise further capital investment and the Bank initiated a Further Public Offering (FPO), successfully raising around USD 2 billion. Three investors who had been identified at Schedule I of the engagement letter subscribed to shares worth approximately USD 373 million. Although Cantor had no direct involvement in the FPO, it claimed that it was entitled to a 2% fee in respect of the capital contribution made by these investors.

Decision

The court summarised the main issue between the parties as relating to the construction of “a few words in one sentence of one clause of the Engagement Letter”. The question was whether, in the definition of “Financing”, the adjective “private” modified all the transaction categories of “placement, offering or other sale of equity instruments in any form”.

The court considered general principles of contractual construction as to the ordinary meaning of the words used, in the context of the contract as a whole and any relevant factual background, as per Arnold v Britton and Wood v Capita Insurance Services Ltd. The court observed that although the engagement letter was governed by English law, given that its subject matter was the raising of capital finance in respect of an Indian public company, it was common ground that the parties must be taken to have had some familiarity with the relevant Indian statutory and regulatory provisions.

While the text of the engagement letter was considered, negotiated and agreed, the court noted that much of the language used looked like generic, boilerplate drafting. Accordingly, the court avoided a formulaic, black-letter approach to textual analysis and focused on the ordinary meaning of the words used. In this respect, the court referred to the conventional understanding that where an adjective (here, the word “private”) is followed by a series of nouns in a list (here, the types of transaction), the adjective modifies all of the nouns in that list.

In the court’s judgment, the ordinary and natural meaning of the definition of “Financing” in the clause, was that it comprised any private placement, any private offering and any other private sale. This provisional view was not substantially affected by considering the relevant words in the wider contractual context. By contrast, it was supported by the surrounding circumstances, from which it was obvious that a public offering (including an FPO) was not viable, as matters stood in December 2019. In reaching this conclusion, the court made the following observations/conclusions:

The court noted that the term “private placement” is a term of art in Indian legislation such as the Indian Companies Act 2013 and regulations issued by the Securities and Exchange Board of India. However, the court held, in the context of a submission by Cantor that if “private placement” was a term of art covering preferential issues and QIPs, the subsequent phrases “offering” and “other sale” would become redundant, and it was “unrealistic” in the context of the engagement letter that “private placement” was used as a term of art, rather than as a phrase in general worldwide use among professional people with a financial background.
The court considered the broader context of the public and private financing options available to the Bank to raise finance as a matter of Indian law. These included: a public offering, such as an initial public offering (IPO), or FPO; a form of private placement called a Qualified Institutional Placement (QIP); a preferential issue to a limited number of investors; or a rights issue to existing shareholders. A public offering would have required the Bank to issue a prospectus and make public disclosures about its financial position. At the time Cantor was engaged, the Bank was concerned that this may cause a run on the bank. Furthermore, Cantor, as a US institution, did not possess the requisite licences as an Indian merchant bank to advise as the lead manager of an IPO/FPO, QIP or rights issue (although it was acknowledged that Cantor could have acted as an offshore financial advisor in the background to such a transaction).

The court therefore ruled that the FPO was not within the scope of the engagement letter and Cantor’s claim, based on the express terms of the engagement letter, failed.

The court did award Cantor interest for the late payment of the non-refundable retainer payable by the Bank, in the sum of USD 21,195.08. However, the court observed that this “minor success” was not enough to make Cantor the overall winner.

Notwithstanding the result, the court noted:

“…the nature of a contract such as the Engagement Letter is that Cantor’s right to be paid is contingent on a single result and that if this had happened, Cantor would have been entitled to the fee stipulated in clause 3(b), no matter how great or how small its efforts had been, and no matter if it had introduced many potential investors or hardly any.”

The court went even further adding that it would not have mattered if Cantor’s efforts had had no causative effect at all. This suggests that parties will be held to the specified terms of their agreement. In circumstances where there is an “all or nothing” engagement letter, courts will be reluctant to engage in what would be a fact specific enquiry to determine whether a fee is “fair”, but will simply determine whether the event occurred or not and therefore whether or not the fee is due. It will not be open for either party to re-open the bargain they have struck if it subsequently transpires that the agreed fee is not commensurate with the services provided.

Cantor’s alternative case of implied term

Cantor pleaded an alternative case that the engagement letter was subject to an implied term that it would be entitled to a 2% fee for any investment it secured, even if the structure of the investments were different to those contemplated by the engagement letter. The court rejected this argument on the basis that the implied term was “not necessary as a matter of business efficacy, nor [was] it obvious” (referring to the recent Court of Appeal decision in Yoo Design Services Ltd v Iliv Realty PTE Ltd [2021] EWCA Civ 560).

Cantor’s alternative case in unjust enrichment

Cantor’s further alternative case was that the Bank had been enriched by Cantor’s services, and that was at Cantor’s expense, and unjust. However, the court denied this claim on the basis that in circumstances where the parties had agreed to the particular terms of the engagement letter, such a claim would interfere with the contractual allocation of risk, and thus override the parties’ agreement (Dargamo Holdings Ltd & Anor v Avonwick Holdings Ltd & Ors [2021] EWCA Civ 1149 and Barton v Morris [2023] UKSC 3).

Natasha Johnson

Partner

+44 20 7466 2981

Ajay Malhotra

Partner

+44 20 7466 7605

Anuradha Agnihotri

Of Counsel (India)

+44 20 7466 3915

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Gayatri Gogoi

Associate

+44 20 7466 2663

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Tag: Contractual construction

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